Hercules Capital Inc (HTGC) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q1, 2011 Hercules Technology Growth Capital Earnings Conference Call. At this time all participants are in a 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 call is being recorded.

I would now like to introduce your host for today's conference, Ms. Linda with investor relations. You may begin.

Thank you, operator, and good afternoon, everyone. On the call today we have Manuel Henriquez, Hercules Co-Founder, Chairman and CEO and David Lund, CFO.

Hercules first quarter 2011 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 replay for this call at Hercules 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. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation of final audit results.

In addition, the statements contained in the release that are not purely historical are forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including without limitations the risks and uncertainties including the uncertainties surrounding the current market turbulence and other factors we identify from time to time in our filings with the Securities and Exchange Commission.

Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions could prove to be inaccurate and, as a result, the forward-looking statements based on the assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof and Hercules assumes no obligation to update the forward-looking statements or subsequent events.

To obtain copies of related SEC filings, please visit sec.gov or visit our website at www.htgc.com. Now I'll turn the call over to Manuel Henriquez, Hercules Co-founder, Chairman and CEO. Manuel?

Thank you, Linda, and thank you for reading that mouthful on the forward-looking statements, always appreciated. Good afternoon, everybody, and thank you everybody for joining us on the call today.

The outline of the call is going to be on a cover at a high level the first quarter results and achievements focusing on our balance sheet and bolstering our liquidity position. David will expand upon the results later on in the call. I then want to share my thoughts and commentary on the environment, domestic capital activity and the current market trends and conditions that we see out there, including the competitive landscape, and of course speak to the 2011 market opportunities that we see for Hercules and continue our earnings growth as we indicated in previous calls we expect to do throughout 2011, assuming market conditions do not change.

With that, let me turn to the first quarter results and highlights of our performance. By now most of you have seen our earnings release. I'm proud to say that we saw net investment income of $9.8 million, up 75% from the same period last year on an aggregate dollar basis and up 44% to $0.23 per share on the same period of 2010.

DNOI, another level of reporting that we started a few quarters ago, at $10.5 million, up 73% over the same period last year, and on an EPS basis you saw that number up 47% to $0.25 per share. In addition to that, we declared our 23rd consecutive dividend you'll see from our GAAP earnings of $0.25 of DNOI and $0.23 on a GAAP NII basis declaring a dividend $0.22 per share. You see more than ample coverage on our performance on a GAAP basis to a dividend coverage and you'll see us continue to deliver those types of performance in 2011, as we continue to deploy our liquidity off our balance sheet.

Now, turning to portfolio growth during the quarter, we saw a lot of interesting things go on in first quarter. We saw an ample amount of liquidity in the marketplace. However, we do what we know how to do best, which is we maintain our discipline, we remain focused in our underwriting standards and we turned down an inordinate amount transactions we felt that the credit quality wasn't there or the pricing wasn't warranted for the risk profile of the underlying company.

With that, I would like to say that we've seen frothiness in the market. We're seeing excess liquidity in the market and we're seeing commercial banks attempting to deploy assets as fast as possible -- excuse me, to build assets as fast as possible at almost whatever cost they possibly can. We are somewhat concerned about this development in the marketplace because we're seeing a tight compression of yields and we're seeing an abundance of liquidity looking to find a home and looking to find new investment opportunities.

However, because of our focus and our commitment to our various sectors we are able to differentiate ourselves from many of our competitors from the skill of our origination team by having our groups in the life sciences, technology and, of course, clean tech and to a lower middle market initiative. All those allow us to continue to see above market spreads without any increase in leverage or risk profile of underlying companies.

Back to the liquidity, the abundance of liquidity in the marketplace you would expect to see our yield tighten in the quarter. However, our yields compression did not come true in Q1 because of our discipline and I'll speak to more of that as the call goes through.

I'm happy to say that in Q1 our team originated $98 million of new commitments during the quarter. We funded $84 million of that in the quarter as well. However, the portfolio was adversely impacted by early repay offs and redemptions of $86 million. $22 million of that was normal scheduled amortization of existing loans and $61 million of that was unanticipated early payoffs, some however which we encouraged or chose not to defend our incumbency position and allow the credits to pay us out and seek capital elsewhere. This is something we have done quite much in our past and you see us do the same tactics back in 2007 where we're facing concerns in the market where we allow marginal credits or credits we choose not to defend our incumbency positions to go elsewhere.

Q2, as I turn my attention to Q2 I'm expecting to see some growth in our portfolio and I'm expecting to see some significant changes in the environment. I will still expect to see frothiness in some sectors, in particular technology sector that we're seeing today, and certainly any transaction early, early stage nature that we're seeing in the marketplace. Our early stage exposure, however, still remains sub 2% of our total aggregate portfolio.

Unfunded commitments are taking longer to draw. We're seeing the transactions are taking disproportionate longer periods of time to close and conversely we're seeing taking a bit longer than normal to actually fully draw down their commitments. What that means is that we're seeing assets being placed on the books longer than we expected thereby having a somewhat of an impact in earnings that earnings are becoming back-end weighted during the quarter.

We're all seeing some effects of our capital raise. Given our most recent capital raise, which David will expand upon, we're expecting to see slightly higher interest expense in the coming quarters as we deploy the new capital from our recently closed convertible debt and our soon to be closed refinancing and extension of our RBC and Wells Fargo credit facilities. Those will have somewhat of an adverse effect on our earnings in the quarters to come because of the interest and unused fees associated with those transactions, which David will speak to.

As I turn to 2011, I expect to see a growth in asset originations to levels of 2010 or greater. As a reminder, in 2010 we did over $520 million of new commitments and I'm expecting to see same level or greater in 2011 with what I'm seeing today in the market. However, I would caution that the predominance of that growth will be realized in the second half of the year.

Now turning my attention to credit quality, because of our continued focus on credit and our continued discipline in underwriting, I'm happy to say that the credit performance remains pretty solid and pretty strong, as it has been in the last few quarters. However, we do have as customary a handful of companies that experienced some challenges in the quarter, which we are diligently working with and working with the financial sponsors and the underlying companies.

I have one company in particular I'd like to highlight. I'd like to highlight this one company in particular because they suffered a disproportionate amount of damage with the recent storms. We do have a transaction and an investment in Alabama. I never thought I would have an earnings call describing weather risk as part of the equation, but however this company in Alabama has experienced a disproportionate amount of storm damage and it's unfortunate and our prayers are with some of the employees. Many of the employees of this company have also lost their homes in the recent tornadoes.

Because of this, we have opted to work with the company and the financial sponsors to restructure this credit facility to allow the company some time to regroup and rebuild itself and, as such, you see it take from a fair value accounting point of view an additional impairment attributed to that transaction until such time that company gets itself back on its feet. I hope to report to you by the end of Q2 that the company and its employees and its families have made progress in getting themselves back on their feet and once again focusing on better things than having to rebuild all their homes in their lives. Our prayers are with these folks and we hope that they continue to weather this difficult time that they're seeing.

On loan yields, and as I said at the beginning of the call and as I said in Q4, we still remain and we still expect to see some yield compression in 2011 of 150 basis points, 250 basis points. However, that yield compression has not yet manifested itself in Q1, primarily because our selective underwriting standards and our ability to continue to skim the cream or the best of the companies that we see and continue to maintain a discipline. If we had to and if we wanted to we could clearly lower our yield standards and originate a larger proportion of transactions, however, we believe strongly that having a controlled and having a stead hand in the tiller is the best thing to do for continued controlled growth of our assets in our loan portfolio.

With that, in 2001 the first quarter I spent an inordinate amount of time ensuring and bolstering our right hand side of the balance sheet. I dedicated an incredible amount of time and attention to ensuring that we have access to long-term liquidity and, more importantly, long-term fixed cost of capital from our convertible debt facility, which is five-year convertible, and our continued dependency and reliance on the SBA, which is 10-year cost of capital.

Notwithstanding that, we also worked diligently in renewing our credit facility with Wells Fargo, which I am happy to say that we increased the commitment from Wells Fargo to $50 million, $75 million and also added RBC for an additional $25 million into that new loan syndicate representing $100 million of commitments on a $300 million accordion credit facility. That facility has not closed yet and we expect the facility to close here in May and David will report a little further on that.

Also during the quarter we were very busy. We also completed a private placement of the $75 million convertible debt instrument, which was unrated and had a coupon rate of 6% fixed cost and had a conversion feature of 15% of value to prevailing stock price. David will also explain further that during his part of the conversation as well.

We also extended our maturity in our $20 million credit facility at Union Bank of California, as we also anticipated redoing and increasing in the later part of 2011. We're all about ensuring long-term access to liquidity and ensuring that we have the capital to grow beyond simply relying on equity capital to continue to leverage our balance sheet and drive higher returns and higher ROEs for our investors.

The last call I also mentioned the repayment of our $25 million SBA 10-year debenture, which has a coupon of approximately -- or I should say a cost of capital -- of approximately 6.6% on that 10-year debenture. We also disclosed during the quarter of Q4 that that repayment would trigger a $500,000 cost attributed to unamortized fees and expenses on the origination of that SBA facility that will be recognized -- that was recognized in Q1. I'm happy to say that the SBA has successfully granted us the ability to re-borrow or commit an additional $25 million to allow us to fully borrow under the SBA program the $225 million of capital under that program. We recently drew down during the quarter approximately $19 million of that capital at a favorable pricing that we locked in of just north of 4%, which David will expand upon as well.

Diversity and ensuring a broad access to liquidity is a key component of mine for 2011 as I do not want to become any significantly dependent upon any one source of financing for our growth. In addition to that, we spent an inordinate amount of time in our portfolio ensuring that, as we look to a rising rate environment, we're well positioned to take advantage of the rising rate environment. I'm happy to report that over 88% of our existing loans today have floating-rate loans or floating-rate loans with a LIBOR floor, meaning that as rates are expected to rise our portfolio interest income should rise after a small period of time of absorbing the LIBOR floor that exists out there.

We also co-matched as much as we possibly can the liability side of the balance sheet by having fixed rate cost of capital from our SBA debentures and our five-year convertible debt instrument, which we talked about recently as a fixed rate of cost to capital. David again will also expand upon that.

We concluded Q1 with over $221 million of liquidity and if you add upon that the recent convertible debt we have over $300 million of liquidity going into Q2 available for future and new investments.

Now, as I turn to liquidity, it's critically important to always be aware that Hercules has a warrant portfolio of over 91 positions. I will speak to that further because I believe that it's time to start bringing much more attention to our warrant portfolio and highlighting the importance of that portfolio.

I still expect to see 10 to 12 liquidity events in 2011 and that is a significant improvement over that of 2010. I'm happy to say year-to-date we've had now various liquidity events, [InfoLogix], most of you are aware of, we discussed in Q4, realized an $8.3 million net gain on our sale of InfoLogix investments.

We recently have been selling our position in Kamada also realizing a $1.3 million gain in our position in Kamada and we had during Q1 Pacira completed the IPO in Q1. We also currently have five additional companies that are in IPO registration, which I'll expand shortly on their names, and I expect to see at least two or three more IPO registrations between now and the end of the year given what we have now aware of some of our portfolio companies.

Back to our warrant portfolios, our warrant portfolio today comprises of 91 existing warrant positions into various life sciences clean tech and life patent and technology companies. We also have 42 equity positions in various technology life sciences companies. Our fair value GAAP accounting holdings of the warrant portfolio is approximately $22 million in value and the fair market value of the equity positions are approximately $27 million.

Historically our realized warrant gains for our warrant multiples on our portfolio range from 1.04 times realized gain to as high as 8.74 realized gain. Clearly historical performance is not indicative of future expected returns and not to mention we also expect at least 50% of our warrant portfolio today never to monetize in value, meaning most likely expire and zero in value. Of the remaining 50% we expect those to monetize at values in multiples ranging from one to three to four or five times. It's really difficult for us to gage those returns but it is clearly, as the IPO market continues to improve, there is hidden value in our portfolio that you'll see us begin to monetize in the coming quarters.

As I said earlier, we have currently five companies in IPO registration and the venture industry finished Q1 with a total of 45 companies in IPO registration basically saying that Hercules has 10% representation of the companies in IPO registration are Hercules portfolio companies. Those companies, for example, are Horizon Pharmaceuticals, NextSystems, Reply and most recently BrightSource and WageWorks are the five companies representing Hercules companies in IPO registration.

Now, no call is complete without me speaking to the venture industry and I once again would like to remind everybody that Hercules is critically tied to the performance of the venture capital industry as it forwards to always keep a perspective of what's going on in the venture industry. I can only take time in the call to give a broader overview of the venture activity for our investors so they can have a better perspective than what we have here in the valley because we live and breathe the venture capital marketplace.

I'm happy to say that Q1 2011 the venture capitalists invested $6.4 billion into 661 deals, which is up 35% from the same period last year. This is a very good sign in the continued resilience in the industry and robustness in the industry that we expected to see.

From a sector perspective we saw the largest sector we've seen in capital continue to be both information technologies receiving $6.1 billion of capital representing a 60% increase over the same period last year while life sciences also known as healthcare also received $1.6 billion, up 21% from the same period the following year. Renewable energies, also referred to as clean tech, an area which we continue to increase our activities in also saw a doubling in the capital investment in the same period of 2010 to $742 million.

From a stage of development point of view, we continue to see the same trend we've been seeing for a while and also emulating that of the Hercules portfolio, which is a disproportionate amount of capital being concentrated and focused on later stage deals, which accounted for 64% of the venture capital activity went to a later stage transaction and 16% merely went to seed in early stage deals. I'd like to remind everybody, Hercules portfolio is highly weighted towards later stage transactions purposely so that we made a conscience decision back in the spring of 2008.

On the liquidity front, the venture capitalists, or the venture capital portfolio companies, realized 104 exit events that netted over $9.8 billion of activities. That's a strong increase over the same period last year and that 104 liquidity event was in the following categories. 91 companies were acquired by strategic investors representing $8.9 billion. Two companies were acquired by private equity shops, a new trend representing $120 million, and 11 companies achieved IPO raising a total of $768 million and that's up from eight companies raising $711 million in 2010.

Lastly, to fully understand the venture capital ecosystem one must also understand the capital raising and fund raising activities by the venture capitalists themselves, also a strong performance delivered by the venture industry. The venture capitalist funds raised $7.7 billion of new capital in Q1, 2011, almost double that amount capital raised in 2010 representing $3.9 billion, the highest first quarter capital raise since 2001 bolstering and signaling the continued strong trend in the venture industry.

All of that allocation, $3.9 billion went to early-stage companies, $2.3 billion went to multi-stage companies and of course $1.5 billion went to later stage deals. The U.S. private equity capital industry as a whole raised $23.4 billion of capital in that same period of time.

With that, I'd like to turn the call over to David Lund. David?

Thank you, Manuel. I would like to take this time to review our first quarter operating results and then we will open the call to address questions. We delivered solid results for the first quarter of 2011. We achieved approximately $19.2 million in investment income for the quarter compared to $16.8 million in the fourth quarter of 2010 and $12.5 million in the first quarter of 2010 due to higher average balance of interest earning investments and one-time fees related to early payoffs.

We continue to generate a strong effective yield on our portfolio investments during the quarter. The first quarter yield of 18.1% as compared to 14.5% in the first quarter of 2010 was positively impacted by the acceleration of investment income related to the early payoff of six portfolio companies in the first quarter. Excluding the income acceleration of our effective yield would have been 15.9% for the quarter as compared to 15.8% in this preceding quarter.

Fee income increased by approximately $1.4 million to $2.7 million as compared to $1.3 million in the first quarter of 2010. This increase is primarily the result of one-time fees related to early repayments. Prepayment fees and fee acceleration totaled approximately $2 million. As we stated in the past, the level of our one-time fees is hard to predict quarter-to-quarter but we believe a normalized run rate would be $1 million to $1.2 million.

Our loan interest expense and fees increased from the prior quarter, primarily due to the acceleration on our SBA debenture repayments. As you may recall from our prior quarter earnings call, we repaid $25 million of debentures in January, which resulted in a fee acceleration of approximately $550,000. I will discuss the status of the debenture borrowings further when I discuss our liquidity.

Our weighted average debt balance outstanding during the quarter was approximately $164.4 million, all of which were SBA debentures.

Operating expenses for the quarter excluding interest expense and loan fees were $6.2 million as compared to $5.4 million in the prior quarter and $4.6 million in the first quarter of 2010. This increase is primarily related to higher compensation expense as we build out our origination team and higher accounting and legal expenses.

Net realized gains for the quarter of $4.4 million recognized during Q1, 2011 were attributable to net gains of approximately $8.3 million on the closing of the sale of InfoLogix and $1.3 million from the sale of equity in Kamada. These gains were offset by the realized loss on trading machines.

Our unrealized depreciation during the quarter was primarily attributable to the change from unrealized depreciation to net realized gains and losses on InfoLogix, Kamada trading machines, valuation adjustments on two portfolio companies and fair value adjustments in accordance with ASCA 20.

Since inception net realized losses on a GAAP basis totaled approximately $48.5 million. This represents less than 2.2% of total commitments since inception of greater that $2.2 billion or approximately 33 basis points on an annualized basis.

I would like to now briefly discuss credit quality. The weighted average loan rating of our portfolio was 2.44 compared to 2.21 from the prior quarter due to the early payoff of rated one and two loan companies. I would like to note that we had one loan on non-accrual at the end of the quarter that we are carrying at a zero value at quarter end consistent with prior periods.

Q1 net investment income was $9.8 million or $0.23 per share on higher weighted average share count of 42.7 million shares compared to $0.16 per share in Q1, 2010 on 35.2 million shares and $0.22 per share on 38.9 million shares in Q4.

We distribution a dividend of $0.22 during the first quarter of 2011 and, as Manuel indicated, announced that we had declared a $0.22 dividend payable on June 23rd to shareholders of record on May 13th. As Manuel also mentioned, we closed approximately $98 million in commitments to new and existing companies in the first quarter and funded approximately $84.4 million.

We experienced an abnormally large number of payments during the quarter $86 million in total principal repayments, including $61.4 million of early principal repayments, $2.9 million in working capital pay downs and $21.7 million in scheduled principal repayments. We currently do not expect to see such significant repayments during the second quarter or in the remainder of 2011.

Year-over-year the investment portfolio has grown by 16%. At quarter end we had over $131 million in unfunded commitments and have over $73 million in signed term sheets, giving us good visibility into fundings over the next two to four months.

Our warrant portfolio in approximately 91 portfolio companies will allow us to potentially invest approximately $68.1 million that we believe will provide capital returns to the Company in the future as we continue to see improvement in the IPO and M&A markets. I would like to point out that we currently have five portfolio companies in IPO registration.

Turning to liquidity, as Manuel mentioned, we have significantly enhanced our balance sheet liquidity position through several financing activities. First, we received an initial $100 million commitment under a new three-year senior secured facility through Wells Fargo and RBC Capital Markets.

The facility contains an accordion feature in which we can increase the credit line up to an aggregate of $300 million funded by additional lenders who may join the facility. However, there can be no assurance that we will be able to add additional lenders to this facility. This amends the previous $300 million accordion credit facility under which Wells Fargo had initially committed $50 million in capital.

Second, in April we closed a private offering of $75 million of five-year convertible debt with a 6cp coupon rate paid semiannually and due in 2016. While this debt will have an impact to operating results in the near term as we invest the capital it will, we believe, yield a solid long-term return on equity for our shareholders. With the closing of the convertible debt offering we anticipate an increase in interest expense of approximately $1.1 million per quarter, or $0.03 per share. Until that capital is fully deployed it will have an adverse effect on earnings per quarter.

Additionally, once the Wells RBC Capital our facility is renewed we'll see -- also incur an unused fee expense of approximately $0.005 per share per quarter. In total we expect the convertible debt expense and facility fees to negatively impact earnings in the near term by approximately $0.04 per quarter until the capital is deployed.

Third, Union Bank extended its $20 million commitment through July 31st of 2011 and finally, as I mentioned earlier, we repaid $25 million of our 6.6% 10-year SBA debentures in January of this year. On April 27th we received approval from the SBA to borrow those funds under our second license allowing us full access to the $225 million available under the SBA program. We believe the ability to borrow at the current low rates will allow lower cost of capital on the $25 million of approximately 2% per year.

All of these activities place us in a strong liquidity position. As of March 31st we had $220 million of liquidity comprised of $114 million in cash, access to $70 million of borrowing under our facilities subject to advance rate and approximately $36 million of the capacity under our SBA license subject to regulatory limitations. This is of course (inaudible) and bolstered by the $75 million of convertible debt, the additional $25 million from the SBA and the additional $50 million that will be available under the Wells Fargo RBC facility on which we are concluding the documentation.

In summary, we had a solid quarter. We continue our disciplined approach to investing in quality portfolio companies. We believe our liquidity position places us in a very advantageous position to invest and grow our portfolio in 2011.

Now, I will turn the call back to Manuel.

Thank you, David. In summary, we remain very optimistic about the growth prospect in 2011. We now are in solid liquidity position to take advantage of the continued market where our competitors remain weak and unable to task capital. Although the market may be flush with liquidity, the patient and disciplined investment that we've exhibited in the past will lead us to a stronger portfolio in selectively picking the right transactions. Investments maybe lumpy quarter-to-quarter but in aggregate I believe that we will hit if not exceed all origination activities we did in 2010 to over $500 million in new transactions we expect to place on the books in 2011.

However, it is important and highly critical that we remain very selective and disciplined in our underlying standards as we've exhibited in the past. I will not compromise credit quality simply for short-term earnings growth. We are well positioned as a portfolio for a rising rate environment, both in our liability side of the balance sheet and our asset side of the balance sheet by having floating rate loans and fixed rate cost of capital with 10 years and five years maturities.

We have over $300 million of liquidity on our balance sheet. We see a continued robust venture capital marketplace. We're seeing continued and maturely improving IPO market and just this week alone I have seen over seven M&A transactions to venture companies that sell. I have seen dramatic pick ups and key leading indicators that I look to for investment activity in the marketplace. With that, and assuming the economy continues to grow, I anticipate to see solid earnings growth for our shareholders in the second half of 2011 and beyond.

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

(Operator Instructions). Our first question comes from Jason Hecht of JMP Securities.

Yes that's John Hecht. First of all, with respect it sounded like you guys kind of had some reversals of prior appreciation, unrealized appreciation. You had a couple of new write downs in the quarter. I am wondering if you could just tell us what happened in those companies. Are those specifically related to some storm activities Manuel talked about or is there a couple other specific situations there?

No, as we do and we continued to do in the past, when a company is approaching around the financing, as you may recall, because we invest in venture stage companies we -- there's a high dependency on these underlying portfolio companies to seek out and raise capital every nine to 14 months and, as their financing event approaches we often times would write down the facility to match fair value accounting to commensurate with the short-term risk and upon the completion of a round of financing that depreciation may be reversed contingent upon the amount of capital raised. So we do have some transactions that we're watching closely but there's nothing out of the ordinary in terms of any critical near term concerns.

As you'll see in our Q that we expect to be filed on Monday, there is no one sale company that is making up any different proportion amount of that and there's nothing in the near term that I am concerned about that's not already reflected on the balance sheet. There's no question that the folks in Alabama our hearts go out to them. We are working diligently with that company to try to restructure that credit and give them time to make that up and we have a few companies that are also going through an elongated capital raise that we expect to have them close sometime in Q2 and that should also see a reversal. But I am not in the near term materially concerned about any change in the credit portfolio.

Okay and you had a very active quarter of deployment, very active quarter in repayments and it sounds like you're suggesting that some of the repayments potential by some just aggressive actions or behavior by some commercial banks. Is there -- do you think this is a persistent pattern or do you think this is a temporary pattern and is it a type of asset that you have or is it across the board in your assets?

You know, I've been doing this for 25 years. This pattern of commercial banks gorging and stuffing themselves I've seen more than once and eventually a couple credit hiccups and they pull back. I'm not at all concerned. I mean, the wonderful thing about investing in venture capital companies are the companies seek capital in these sequences when they run out of money every nine and 14 months; they raise money so there's no really opportunity lost in that context.

I also want to make sure that people heard me correctly. We chose on some deals not to defend our incumbency position and allow the credits to go because we're either equity holders through a warrant and, as these companies continue to mature we encourage them to go get lower cost of capital as they continue to mature and reach cash flow breakeven. We expect them to eventually leave the nest, if you will, and unfurl their wings and go out and get lower cost of capital out there. So we've chosen not to defend some incumbency positions.

Also, as I said in the call earlier, not just when we did in 2007 and early 2008 we encourage come companies to seek capital elsewhere that we were uncomfortable with the risk profile or the manifestations of their revenues or their lack of revenues that we felt the risk profile changed and we wanted them to go seek capital somewhere else. We do that every once in a while and I think when the margin gets frosted like this we like to kind of go through the portfolio and purge some of those positions.

Okay and then final question is within the new deployments has there been any change in industry composition? It still sounds like you're a little bit more focused on the late stage, given the emerging pricing pressure in the early stage, but can you give us any characterization of the new capital deployment?

Well, I think that you'll start seeing a shift towards continue later stage. Clean tech is representing a very interesting opportunity for us. As you may or may not recall from years of covering us, we've been looking at the clean tech industry now for almost three years. We completely passed purposely on the first generation of clean tech investments. A lot of them were a little too pie in the sky for us. I think the second generation and third generation of clean tech companies are beginning to show some traction, some validity, some valued business models and I think you're seeing those in our portfolio continuing to grow. I think that the software industry represents a very interesting growth area that we're focusing more time and attention towards that.

Healthcare and life sciences continue to show some nice signs of improvement. You'll see the majority of the IPOs in Q1 were healthcare related or life sciences related. We think that trend will continue to go there and we're seeing disproportionate amount of competition on the technology portfolio where a lot of folks seem to be wanting to put assets on the books on the technology perspective and so we're taking our time about making technology investments. It's probably a little weaker than I would like it to be but nothing that right now I am materially concerned about and if others want to gorge on tech deals we're fine letting it happen for the time being and if we decide to lower our yields and be competitive we can always do that but right now we're choosing to skim the cream and be very selective in our investment focus.

Okay thanks very much.

Vernon Plack, BB&T Capital Markets.

Manuel, was interested in just you talked about turning down deals from a quality perspective. I just wanted to really understand what that means at this point in the cycle and maybe some more color in terms of what you're seeing that concerns you other than the pricing issue.

Sure. Well, I think that we've got to be very careful not to take my comments out of context and apply them to both the industry sectors and the stage of focus of the Company. So let me take and opportunity now to kind of expand on that. Look at on the lower middle market it continues to be a blood bath. I mean, the increased competition, the increased liquidity I am seeing deteriorated credit standards. We're seeing some banks have been super aggressive on a lower middle market, over heated market, supply and demand imbalances, pricing deterioration, leverage going up. I mean, in all honesty, the lower middle market right now to me is just a -- you know, who has the lowest cost of capital and who is willing to take looser terms and higher leverage and lower spreads?

I remain just perplexed by the lower middle market area and we're highly selective of lower middle market. We're -- only will consider transactions in the business services, technology related or healthcare industries so we're not even looking at the broader lower middle market category, which is even more over heated out there and I think that a lot of the other VCs so far this quarter have kind of expressed the same views where commercial banks in particular are just throwing money at L300, L250 with the first turns of EBITDA on any lower middle market company they can get their hands on. So I think that trend will continue for some time now and I see the broader VC marketplace seeing yield compressions and spread compressions taking place.

On the technology side on the venture side we're definitely seeing a lot more heated competition on the technology side, primarily driven by liquidity on the IPO and M&A market. I think a lot of folks are seeing that as the IPO [take] continues to improve that people want to get their hands on assets that have the ability to be flipped quickly, meaning flipped into an IPO so you're seeing some fairly heatedness going on there. We continue to be selective and just look at obtaining yields but if I wanted lower yields like 200 basis points, 250 basis points, as I talked about, we could definitely accelerate growth. We don't feel yet that it's a time to have to do that. We haven't had to do it now but we certainly have that in reserve if we want to do that.

And then lastly, healthcare, healthcare life sciences continue to be very robust. I think that by having sector expertise it's a critical differentiating factor. Hercules is a specialized VC. We're specialized of course in the venture industry but we also have very high degree of talent in our organization that have individuals who are specific to the sub verticals and have very strong expertise that allow us to differentiate ourselves merely beyond being a low cost of capital provider in the marketplace and we're grateful to that recognition from the venture industry. The venture capitalists themselves and the entrepreneurs who recognized it's more than just financing than low cost of capital and making sure your partner understands your business and is able to structure your transaction accordingly and we see that as a competitive advantage that continues to benefit us in the marketplace today.

Thank you and, David, can you give me some non-accrual numbers, the number of investments that were all non-accrual at the end of the quarter?

Yes we only -- we had one investment on non-accrual at the end of the quarter. We have a -- it's a zero carrying value on a cost basis it's less than 0.7% of our total asset so it's a nominal investment that we've got a non accrual.

Okay thanks very much.

Greg Mason, Stifel Nicolaus.

Great. I wanted to kind of follow up on Vernon's question there. As I remember right, I was thinking the number of competitors in the venture capital lending space was really limited to a handful of players so are you saying that the VC banks, Comerica and Silicon Valley, are being extremely aggressive or are we actually seeing new entrants into the VC lending market?

No I mean look at, there's no new entrants in the market of any meaningful size and any meaningful threat. Actually the largest competitor is not so much the banks. They are pretty good competition but the real competitor is actually equity itself. As I said, when -- and we saw -- I've seen this cycle in the 2003 and I saw it in 2000 -- sorry 1997 and 1998. And when the IPO market becomes hotter and it is becoming hotter and it's not of course on fire and it's not running out of control but when you go from zero to 11 and 11 to 20 that perks people's attention on a quarterly basis and so we're seeing that a lot of venture capitalists in particular are coming in and bidding up valuations for underlying companies and in order to have an incumbency position or, better yet, in order to be in a pole position for the company goes public that they can realize some multiple returns as they go out and do their own fund raising for their own funds.

So ironically enough our biggest competition is actually equity capital themselves. And that's to be expected and it's fine. It happens and I've been doing this a long time. Eventually that will taper out and you'll see the venture capitalists realize that they'll run out of money and they need to supplement some of the portfolio companies with debt. On the earlier stage side there's no question that the competition from the banks is becoming stronger. They're doing deals at 3% and 4% yields and sometimes they're doing deals at just simply prime and we encourage to some of our portfolio companies to go do that. Some companies are appropriate; some companies are not appropriate for that so I think that there is -- the competition right now is very interesting to watch develop. As I said earlier, it gets really heated for one or two quarters and then it tapers off again.

Okay great and then you said you had 88% of your loans are floating rate with floors. Can you tell us kind of what your average LIBOR floor is? When do you start benefiting from increases in rates?

I don't have that here but we can certainly get that to you on what the average LIBOR floor is. If I remember correctly, I think on a weighted basis the average yield -- sorry, the average coupon rate is probably somewhere 9.5 to 10 is probably the average coupon rate so you could kind of look at it that way from a LIBOR floor being four or five points.

Okay and then your exits of $86 million, most of that sounds like debt exits. Does that include the InfoLogix sale in that $86 million number?

No thanks for pointing that out. That's exactly right. I mean a big chunk of that $86 million was the $30 million plus position debt and equity that we had in InfoLogix so just disproportionately one single investment made up a big chunk of that, which we were expecting anyways.

Okay great; thanks, Manuel.

Steven Kwok, KBW.

I wanted to touch base on the rise in the cost of debt. I was wondering if you could help us think through how long it could take for you to deploy the assets to offset that impact?

Well, let's be careful on the rise of the cost of debt. I am not sure that's necessarily the case. The spike in interest expense in Q1 is attributable to the $500,000 of the SBA payout so that kind of skews that number a bit. What we're saying, however, is that if you take a $75 million convertible debt and at 6% cost of capital you've approximately a $4 million interest expense and until I deploy that capital I have an interest on the capital. It's all in the balance sheet that I have to then convert into funded assets. I expect that funded assets to happen in Q3 and early part of Q4.

As we indicated in our call, we have approximately $130 million of unfunded commitments. We have another $58 million or so -- excuse me -- $57 million, excuse me, of signed term sheets so together you have already close to $200 million of visibility of that deployable capital and I am only in May turning into Q2 and the rest of the year. So a lot of that capital we expect to be fully absorbed by Q3, early Q4 so I don't expect to have the full year of simply having interest expense on the $4 million convertible debt to be unused. So we start deploying that and matching that with 12% or so spread, gross spread, of capital.

Sure and then in terms of thinking about your dividend, should we focus on NOI or DNOI?

You know, there's a third element if you want to get technical, taxable income. I mean, at the end of the day, not to get into GAAP versus tax accounting, at the end of the day the only thing that matters on your RIC is your dividend is covered by taxable income. DNOI, as some BDCs have indicated, is a close proximity to taxable income but taxable income is not easily derived inter year because a lot of timing differences. That's why it's easier to calculate taxable income at the end of the year but we continue to believe strongly that a VC should cover its dividend, both on a DNOI and an NOI basis at a minimum, which we're doing. We have been doing but we certainly expect to see a dividend grow and we certainly expect to cover the dividend in 2011.

One final question is the cost of yields during the first quarter if you could talk about that, what you've seen and what you're seeing in the current market. Thank you.

Steven, I think the yields were--

Well, it was 18.1% on a fully loaded basis and on a -- without the one-time fees it would have been 15.9%. We're, as Manuel indicated earlier, we're really expecting to see those decrease over the course of the year 100, 200, 250 basis points.

So let me answer this way. That's the income statement effective yield calculation. On a new asset origination we're seeing yields kind of holding in the 11.5%, 12.5% range so that hasn't changed and that's the yield that I was referring to earlier that I expect to see 150 or 250 basis points compression and where we just did not see it in Q1, primarily because we chose not to match the market from the frothiness out there. We chose to be very selective and so far we have not seen any need to kind of lower our new origination yields. We still have that in our back pocket if we wanted to but we have not used that yet.

Got it. Thanks for taking my questions.

Jasper Burch, Macquarie.

I think you pretty much just answered one of my questions but just to get a little more color on it, you obviously gave a lot of good color on sort of the competitive landscape and how market yields are moving the market so you're saying that you aren't, given your stance, you're saying that we shouldn't expect any actual change in the yields of investments that you're putting on your portfolio, at least for the next couple quarters?

No I didn't say that at all; what I am saying is that thus far we have chosen not to match the market currently today because we still are able to originate the transactions that we care about at the yields that we want. However, if the frothiness in the market continues we may choose to lower our yields by the hundreds of 250 basis points that we talked about. I don't know yet because so far even going to Q2 I've seen very small deterioration of that, maybe 50 basis points, but it's too early to call Q2 yet. I do anticipate, as I said in Q4 and I will reinforce it again now, I do anticipate that we will see yield depression on new assets by 150 to 250 basis points some time in 2011. So far we've been fortunate enough in our deal flow and our relationship with the venture capitalists and our market differentiation that we're able to continue to be a senior secured lender and not having to reach down the cap structure to buy yields.

Okay that's really helpful and then also I guess on sort of the structure of investment in the covenants are you seeing material changes in order to keep those yields or do you see material changes in the market or just yield compression?

No I think the biggest change in the market is probably more the duration or interest only periods. It's is probably one of the tweaks that are going on. On lower middle market I mean that doesn't apply. Lower middle market is exactly what you said. It is loosening terms. Credit standards are I think deteriorating. Increased leverage is happening and spread compression. I will say it again, what I am seeing manifesting itself in the lower middle market is simply a low cost to capital rates and I don't get it. In most VCs have similar cost of capital that we do, which is in the 6% or 7% range, and it's just a dog-eat-dog business out there in the lower middle market.

Excellent and I guess just two more quick questions; one, did you say that the entire floating rate portion of your portfolio has floors?

No I did not say that.

Okay can you give us the percentage?

I don't have the percent of which has floors but it doesn't quite matter when you have a raising rate environment on the that and your average coupon rate is in the north of 9.5%, 10.5% range. I don't know, David, do you have the floor?

83% of our investments have floors in them. 88% have -- are floating so then the balance obviously is fixed.

Excellent thank you and then I guess just lastly, I mean, given how flush with capital you guys are, obviously we were happy to see the convert deal go off and you got pretty good terms on that. I was just wondering though what sort of drove the timing of that? Why did you decide to do it in April instead of waiting a little bit longer?

I've got to be honest, Jasper, the whole issue for me is not taking market risk. I think that when [Apollos] and [Aries] in prospects completed their convertible offerings it's something that we've been looking at for a while, as well as a CLO we've been looking at for a while and I felt that the market, as most recently evident, but what happened with the Apollo follow-on offering I think the market right now is taking a pause on convertible debt. I wanted to make it in before that pause took place. We did.

I think that we got I think fantastic terms. I think the investors in the convertible debt rightfully recognized our underwriting capabilities at standard. We were one of only two I believe that pulled off a non-rated deal, which is creditable and we pulled it off at a [15%] premium, actually to the stock price, which is critical so I think that the investors who invested in the convert got a great transaction and I think we also got a great transaction and I didn't want to take any market risk because when the Q2 comes off from the government support I don't know what's going happen to the economy and I don't want to be left to the whims of a rising rate environment or the government not supporting the economy as it has been doing with the Q2 initiative, so I think it was a strategic initiative for us to do it and I know it has an adverse impact on earnings in the short term but long-term it's a very strategic valuable tool to have cost of capital 6% locked in for five years.

No we completely agree and nice job on the quarter and thank you for taking my questions.

Jonathan Bock, Wells Fargo.

Manuel, you mentioned that the lower middle market is quite frothy and I'd expect that to be the case in tech and life sciences deals as well but you are also building out a lower middle market practice and I want to know what's you're expected contribution from that team at this point in time?

As I said in Q4 and I'll say it again, the best way of describing the lower middle market and I think we have four strong individuals in lower middle market. I think that the lower middle market initiative is something that I strongly believe in. I think that we need to have a toe hold or foothold in that area over time but I think that lower middle market to be done effectively well has to be done with a different cost of capital structure than we have today and I think that, as we continue to build out our lower middle market portfolio, we need to be able to go out and secure different types of credit facilities simply tied to the collateral of those lower middle market assets, which are EBITDA or level two assets which combine with -- excuse me -- commercial banks are more comfortable with.

Because we're still primarily viewed as a venture provider, and I still want to be viewed as a venture provider and continue to be focused as a venture provider, our initiative in lower middle market is highly selective. It will only be focused on business services, on healthcare or technology related. We will not and are not interested in doing broadly based lower middle market companies and if we don't see the quality of deals there and we don't see the spreads that we want, eventually we will have to close down that group again and simply say we'll wait for a better environment or get our cost of capital in line in order to be able to originate deals that are tighter spreads.

But I need to caution everybody, what we're seeing lower middle market, which I don't think is much different than anybody else is, is a significant increase in competition, an increase in leverage and a tightening of spreads. I am hoping that the market is over heated right now but it will taper off in Q3 and Q4 but it is over heated.

That's great color thank you. And, David, just an expense question, can you give us a sense of G&A and compensation benefits maybe going forward? I noticed there was an increase obviously quarter-over-quarter you mentioned related to the build out and the hiring of new individuals. How should we look at those two items going forward?

Yes and certainly some of these are one-time expenses. We're expecting something in the range of $21 million to $22 million on an annual basis with regards to G&A expenses.

And, Jonathan, that may go up because I am looking at some very strong talented individuals to join our venture group. As some of our competitors continue to waffle out there or have issues, we're still continuing to pick up talent. We continue to evaluate competitors' portfolios with our liquidity position. It affords us a lot of flexibility so looking at talent, looking at portfolios are all things that we're doing.

All right, guys, thank you.

Our final question comes from Douglas Harter of Credit Suisse.

Thanks. You were talking about that up to this point you haven't decided to lower your yields targets to get some additional growth. What could cause you to do that?

If we see a dramatic curtailment of new investment activities of deal spreads that we want, at which point we decide to lower our yields we can probably fill that bucket pretty quickly. Today we've been fortunate thanks to our venture capital relationships that are -- and frankly our investor professionals and their relationships -- that we're still able to structure deals and get rewarded and recognized for our industry expertise and our sector expertise which allows us to be a differentiated model than simply commoditized bank just giving capital to the companies.

However, I think that yield compression, as I said, will probably start occurring in Q3 and Q4. That may change. I at this point don't believe that we will not see a compression on that yield of 150 to 250 basis points. So far Q2 is pretty good. I'd like it to be a little stronger than it is but so far it's pretty good. We've disclosed what our pipeline looks like. We have over $900 million of deals in the pipeline. I have $58 million of signed term sheets. I have already converted $50 million of transactions in Q2. It's a closed deal so things are looking good and we may decide to tweak a little bit of yield and later on in May. So far we don't see that we have to do that but we're looking at it.

I guess just on the competitive front, if it remains as frothy as it is, would you expect early payments, prepayments to continue at an elevated rate?

No believe it or not, a lot of the prepayments that occurred, as we said earlier on the other caller who asked the question, of that $86 million of prepayments I don't say half but a significant portion of that was made up of one single company, InfoLogix that made up over $30 million plus of that repayment loan. And then two other of those companies -- I won't say the names -- two other of those companies we kind of encouraged them to pay us off early or pay us down and one or two of the other ones we decided not to defend it as an incumbent and let them go.

The beautiful thing about being incumbent you always have the option as a last look to re-price the debt at the prevailing market rate if you wanted to and we chose not to do that in those deals. So we have a lot more control on some of these prepayments than most. We can decide to not allow them to happen by matching the terms or letting them go. And that's what we continue do that and we've done that in the past.

Great thank you.

Thank you. I am showing no further questions in the queue. I'll hand the call back over to management.

Thank you, operator, and thank you, everyone, for continuing your interest and support of Hercules Technology Growth Capital. We remain optimistic and we are encouraged by our abundance of liquidity and we look to deploy and remain in 2011. We will be attending two conferences in the next couple days. We'll be attending the RBC Conferences tomorrow in Boston so I am jumping on a red eye to head out to that conference and then we're presenting at a JMP Conference early next week as well on the 11th of May. If you require, if you would like to arrange an asset meeting, feel free to call David Lund, our CFO, or myself at 650 289-3060 and, again, thank you very much for being our shareholder and for being part of the Hercules Technology Growth Capital story. Operator?

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect and have a wonderful day.