Hercules Capital Inc (HTGC) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. And welcome to the Hercules Technology Growth Capital Q1 Fiscal Year 2012 Earnings Conference Call. (Operator Instructions)

Now, it's my pleasure to turn the call over to Linda Wells. Please go ahead.

Thank you, operator. And good afternoon, everyone.

On the call today are Manuel Henriquez, Hercules' Co-Founder, Chairman, CEO; and Jessica Baron, Vice President of Finance and Chief Financial Officer.

Hercules' first quarter 2012 financial results were released just after today's market closed. They can be accessed from the Company's website at www.htgc.com. We have arranged for a replay of the call at Hercules' web page or by using the telephone number 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 and final audit results.

In addition, the statements contained in this 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 limitation the risks and uncertainties, including the uncertainty 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 can prove to be inaccurate. And as a result, the forward-looking statements based on those 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 the website, www.htgc.com.

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

Thank you, Linda. And good afternoon, everybody, and thank you for joining us today.

I'd like to start the call by pointing out a couple of major milestones that we've had, on top of all the major bullet points that you see in our press release. One big accomplishment that I'm very proud of is that our team today issued and filed the 10-Q prior to the earnings call. And I expect throughout 2012 and beyond that that's going to be our practice. And now we're going to try to drive [that in] a little earlier in the call as well. I know a lot of folks have been asking for that, and we've been listening. And I'm proud to say that our team executed and delivered on that promise. So thank you, for the accounting team and financing, for that hard effort and work they did.

Now, back to the earnings call and some overview. As typical, I'll start the agenda by giving a quick overview of the operations and summary of the operations in Q1. I'll give some observations and discussion points on the environment, both on the competitive landscape on the venture capital marketplace and where I think we're going. I'll give some perspective on the outlook of 2012 and the overall marketplace, keeping in mind to everybody -- an obvious statement here, but it's an election year. And we have lovely issues to deal with in the global markets with sovereign debt concerns between France, Greece, and more countries in Europe that we have to deal with and be accounted for when we look at our cost-to-capital equations -- and then, of course, turn over the call to Jessica Baron, our newly minted CFO. And then I'll start covering the overview of the Company.

So in the first quarter -- I'm happy to say, as most of you've seen, we've been a very, very busy first quarter. We've done an incredible amount of activities, both on the capital deployment side, liquidity side from IPO exits, from capital raising; and continue to see harvesting the portfolio and growing the portfolio, including our dividend growth that you saw occur in the first quarter, thanks to our Board of Directors.

So we delivered once again total record investment income for the year and for the quarter very strong. We raised our quarterly dividend by a penny, to $0.24. And we achieved a number of regular liquidity events in the history of this company. And frankly, in my career, I've never had three IPO events take place in the same week. That's over a 25-year history it's ever happened. So another testimony to our team in selecting the right companies. And we ended the quarter with a strong total asset position and liquidity position for the Company. So extremely well positioned for additional growth in 2012 -- I will cover and elaborate further on the call.

As to the specifics on Q1 -- we reported quarterly investment income of $22.4 million, up 17% year-over-year; or on a quarterly basis of net investment income, or NII, of $11.4 million or $0.24 a share to a 16.3% increase year-over-year on the period. DNOI, not to be left behind, was also very strong, at $0.26, and DNOI -- $12.2 million in DNOI income reported for the quarter. As I said, the Board of Directors did declare an increase on the dividend of 4%, or $0.01, which is payable, as we'll disclose in the following portion of the call itself.

Turning my attention to the portfolio growth -- although I believe, and will continue to approach the market in a very conservative and controlled manner, as we've done in the past, I will consistently run the business on a controlled growth, looking to originate in the $500 million to $700 million of new commitment in fiscal 2012. I will expand on that as we go through the call as well.

In keeping with our consistent, conservative investment strategy, we've maintained a slow and steady growth approach to building assets in the quarter. That said, we had over $101 million of new commitments executed during the quarter, which also included the conversion of the Facebook investment. In that quarter, we also had very strong funding. We had $65 million of funding during the quarter, and we also experienced early payoffs and anticipated repayments of approximately $16.5 million [in] $19 million of normal amortization.

Our net portfolio growth for the quarter was net approximately $40 million, in line with our expectations, and which will expand on our perspective for Q2 net portfolio growth as well. Investment portfolio finished the quarter at approximately $695 million, an impressive 56% growth year-over-year and consistent with our strategy of continually converting our liquidity on our balance sheet to earning assets in a controlled fashion.

Of that $695 million, $615 million of that was in interest-earning loans. Overall, the portfolio growth was met with consistent and strong quarterly credit performance, currently standing at 2.8%, which is consistent where we expect the portfolio to be managed on a risk profile point of view in maintaining a very disciplined credit performance overall.

As we mentioned last quarter, we expect to see and continue to see yield compression. Despite some of the other commentary some of the other BDCs have said in the marketplace, I want to point out the strong differential between our belief in yield compression and that of not confusing yield compression with reaching down the balance sheet of the cap structure. Hercules maintains and will continue to maintain a level of asset origination that are senior secured first lien assets -- not second lien, not last out senior.

We're seeing a tendency in the marketplace of many BDCs claiming to not see yield compression by reaching down the cap structure. We believe in retaining a very forthright transparent perspective on the marketplace, and we will continue to see and expect to see 50 to 100 basis points yield compression by maintaining a senior secured first lien position on the assets that we invest in.

For modeling purposes, we expect to see yields on new asset originations to be at a 12.5% to 13.5% level. I fully recognize that the range that I'm providing is lower than what we're currently realizing when you see the yield in the first quarter adjusted for one-time events was at 13.7%, and non-adjusted for one-time events at 14.6%. We believe in providing visibility to what we believe is a consistent dividend yield; hence the transparency and belief that we're continuing to [see] and speak about in the call.

We are seeing, however, a compression or slowing down of the yield compression that we expect. Although we experienced approximately 30 basis points yield compression in the first quarter, we're seeing evidence in the second quarter so far of that yield compression slowing down. At this point, I cannot give any assurances whether or not we will see a full yield compression of 100 basis points throughout the year. But for modeling purposes, we expect to see that, and we want to give visibility to that outcome, so far.

Turning attention to the balance sheet -- as you've seen, and as we've indicated, our preference continues to be, and will always be, to leverage the balance sheet first, but also keep leverage balanced with what our yield or what our expectations on a leveraged basis to be.

As you saw evidenced in the first quarter, [and] second part of the second quarter, we've tapped both the equity capital markets for a $48 million equity raise in Q1. We also in February repaid $24 million of SBA debenture, which we disclosed in the fourth quarter earnings call, further lowering cost of capital. And most recently, we executed a $43 million senior unsecured [Bay Bond] offering -- seven-year duration, three-year non-call 7% -- which is listed on the New York Stock Exchange as well.

During the quarter, we also changed listings for the NASDAQ to New York Stock Exchange, while maintaining our same stock symbol, HTGC; and while also having our now bond offering listed in New York Stock Exchange under the symbol HTGZ, as in zero.

Given our focus on disciplinary growth and liquidity, I'm happy to report that at the end of the quarter, we had $170 million of liquidity, $40 million of that in cash balances and $130 million of credit facilities. I'd like to note -- the $170 million does not -- repeat, does not -- include the Bay Bond offering completed here in April. If you would include the Bay Bond offering, which is completed, our liquidity position would've been approximately $225 million on a pro forma basis.

Turning my attention to liquidity -- we had a very robust Q1. I'm very proud of the team in identifying a company that we continue to identify in our portfolio of warrants and investment activities. Never in history have I seen Hercules achieve six liquidity events in Q1. It is a record for Hercules and could be a record for my own history of investing in a venture [and as] 25 years having six liquidity events in one quarter. Truly speaks to the testimony and the conviction and hard work of our team in identifying the right companies and working with the right venture capital sponsors. I'm very grateful that the venture capital industry continues to recognize Hercules as the leader and continues to provide us unprecedented deal flow.

On the M&A front -- BARRX Medical closed its transaction to be acquired, representing a $2.2 million gain for Hercules, or a 33% IRR from that investment. NEXX Systems had previously filed S-1 to go public, which is not untypical for technology companies that file S-1s and be acquired during the IPO phase. I am proud to say that also achieved a strong liquidity event, with a $5.2 million gain on our investment in NEXX Systems.

We also had four IPOs, completed IPOs, in the first quarter; three of which in the same week. Cempra Systems went effective in February. Annie's went effective in March, Merrimack in March, and Enphase in March. Annie's, Merrinmack and Enphase all completed IPOs during the same week.

I'm happy to report that beyond the Annie's IPO, we were successfully able to sell, shortly after the IPO, our entire position in Annie's for a net realized gain of approximately $2.3 million to $2.4 million, representing an IRR of approximately 28% and a warrant gain of 4.2 times multiple on the warrant itself.

Notwithstanding a strong showing of liquidity in the first quarter, I'm also happy to report we still have two companies at IPO registration, both of which are on road shows this week -- one of them being, of course, Facebook; and of course WageWorks.

In fairness to our transparency, we also have three companies who had IPO registrations withdraw their IPOs, citing adverse market conditions, looking for valuations or different outcomes in the IPO. And they chose to pull it and complete a [prior] round of financing. This is also not untypical in the process.

To our liquidity, in terms of our warrant portfolio and equity investments we have in Hercules -- we continue to have a very strong position with over 110 warrant positions and 38 equity positions in technology and life sciences companies, representing on the value base of $32 million in value to the warrant positions and $48 million in value for the equity positions.

As I said a moment ago, the Annie's warrant multiple is 4.2 times. Historically, our warrant portfolio has monetized from a 1x multiple to 8.7x multiples. We do not expect, and nor should you, that those warrant multiples historically will repeat themselves.

We continue to believe -- and what we've said since we started the Company -- that at least 50% of our warrants will never monetize in value. I may recognize that to be a very conservative number, but I believe it's the right statement to make and the right outcome to have when you're looking at the warrant position we have today.

Now, let me turn my attention to the venture industry. As most of you know, no call is complete without giving you some color on the venture industry. Overall, the venture capital industry invested $6.3 billion in over $717 transactions during the first quarter. Although this decline of 18% -- we are very comfortable with decline in the sectors that we share the outlook on being fairly valued or over-valued. The software industry experienced the strongest sector growth quarter-over-quarter, year-over-year. And we expect the software industry in itself to continue to have very robust 2012 investment activities.

We think that the consumer Internet sector is extremely valued, and we were not surprised by the 76% drop in venture capital activity dollars into social networking, merely reflective of our own visibility and our own viewpoints on that segment of the market. Notwithstanding that segment -- on the IT side, overall, IT investment activity saw an increase year-over-year of 14%. We remain very bullish on the outlook of technology investing, while we've taken a slightly more conservative view -- almost bearish view -- on our life science investments as we cycle through certain life science investments.

The technology sector saw $2 billion of investment activities to [200 of these other] companies. Of the IT investment of $2 billion, $1.3 billion of that was invested in the software industry, which saw the most dramatic growth of 60% year-over-year.

In terms of our life sciences investment -- life sciences investment saw an 18% decline year-over-year on the venture industry to $1.5 billion. Interesting enough, our portfolio almost declined commensurate with that of the venture industry, once again pinpointing to our alignment with the venture industry and venture activities. Biopharma experienced the most significant decline, a 46% decline in capital to $523 million. Med devices, on the other hand, was basically flat, with $748 million of capital being invested in the medical device company.

The energy sector, which is a little confusing sector to understand, saw some significant growth. The growth shifted away from renewables into more enabling solutions. $943 million was invested in the cleantech sector. The renewable side of that equation saw the lion's share of that capital of $513 million.

As we indicated in Q4 earnings call, we're cycling our investment activities to a more expansive stage and early-stage investment, primarily driven by what we believe is our excessive valuations that we're seeing on later-stage deals. That happens to coincide with the venture industry activities as well.

We saw a 21% increase in first [seed and] first-stage round of investments, and [second-round] companies received a 17% increase. Notwithstanding, late-stage investments still remain robust. At 61% of the capital, the venture capitals invested [were] in slight decline of just under 20%.

IPO exits -- very happy to see what we saw in the first quarter. Twenty-two venture-stage companies achieved liquidity events, raising $1.4 billion. This compares to only 11 companies in the same period last year, 2011, raising $768 million -- a tremendous showing. And I hope to see greater increased activities, especially driven by the Jobs Act passage that recently passed Congress. Again, this is the strongest IPO activity that we have seen since 2000, and a record level of exit events for Hercules during the same period of time.

We currently have two companies in IPO registration, as I said already -- Facebook and WageWorks. We expect those to come out, assuming market issues remain strong, in the next week or so.

As I turn my attention to other outcomes in the quarter -- it's interesting to [point] that the venture industry finished the quarter with over 50 companies in IPO registrations that are venture-backed -- a very, very strong showing. Two of those are publicly Hercules companies. We are aware additional companies expect to be filing in the second quarter that have yet to file, and we expect to see that occurring here shortly.

Some industry statistics during the quarter -- we saw [variable-bus] M&A activities. [I'm] somewhat disappointed about some of the reporters writing about the venture capital M&A activity not being robust. I beg to differ with the statistics. Ninety-four companies achieved M&A exits, raising over $18 billion, a 42% increase. And yes, the number of companies that achieve M&A events is down. The number that did achieve liquidity -- the dollars are significantly higher.

What the reporters failed to recognize was the robust IPO market would shift some companies' exists from M&A to IPO, and those still staying M&A will get a higher valuation. This is actually a very good sign and something that I think is outstanding to see in the marketplace, which we will benefit from given our warrant and equity positions.

Interesting [enough] that occurred in the quarter -- was also not written about -- was the concentration of M&A activity that took place. For example, Google alone acquired 12 companies during the quarter. In addition to that, not being left behind, Groupon, ironically enough, also acquired six companies during the quarter. Those two players alone, Google and Groupon, made up of 18 companies that experienced M&A events of the 94.

Speaking to the drive for consolidation of technology by established companies looking into the venture industry to bolster up the technology offerings, we expect to see much more robust M&A activities in Q2 and beyond. Lastly, venture capital fundraising also experienced a very robust period of growth. $7 billion was raised by 47 funds during the quarter, representing a 34% increase year-over-year.

So, when I look at the venture industry, I am very surprised by activities and a level of investment and exits that we're seeing in the marketplace -- highly encouraging and well positioning Hercules for that market to continue to manifest itself with exits, whether IPO or M&A events.

Now, bringing my attention back to Hercules -- as we look to 2012 and the second quarter, I have to say, despite my optimism, I remain very cautiously optimistic and [guard and control] our investment activities. This is not a sprint, it's not about simply originating to make earnings. It is about credit quality and maintaining the right balance of credit quality and liquidity, as we've shown our abilities for the last seven and a half years.

I expect to see 2012 to remain at $500 million, $700 million activities of new commitments. I am happy to report, as evidenced in the press release we share with you today, that assuming the existing signed terms convert, we're already at a $270 million run rate of signed term sheets already, and it's only the first week in May -- more than halfway through the $500 million that we're seeing in the low end of the range of $700 million.

We expect to see portfolio growth. We expect to see portfolio growth in the second quarter between $40 million to $60 million net portfolio growth. As Jessica will expand upon, we've all seen some early stage or early payoffs take place during the quarter, which we're fine with as an incumbent, that we purposely have chosen not to defend the incumbency position for either credit quality or other concerns that we want to manage out some of that exposure. We will consciously and continuously do that as we look to balance the portfolio by stage, geography, venture capital sponsor, as well as sector concentrations that we do.

In summary -- Q1 was a very, very strong quarter for us, and I'm very proud of the team's accomplishment. We maintain a very disciplined approach. As we indicated, we purposely came out of Q1 on a slow start after a very strong 2011, with over $700 million of commitments. We saw good liquidity in our portfolio on both exits from M&A and IPO, and also recycling of investments that we chose not to defend the incumbency. With the closing of the Bay Bond, we have over $225 of liquidity available to make the investments. We will continue to diversify the portfolio and will continue to balance the portfolio throughout 2012 and beyond.

I will expand on the competitive environment during Q&A session, and now turn the call over to Jessica.

Thank you, Manuel. Thank you, everyone, for listening today.

We filed our 10-Q, as Manuel indicated, after the market close today, as well as our earnings press release. And here's a brief recap of our financial results for the first quarter of '12.

We delivered $22.4 million in total investment income or revenues, a quarterly record; and an increase of 16.7% when compared to $19.2 million for the first quarter of 2011. This year-over-year growth was driven by higher average outstanding balance of yielding assets during the quarter. The fair value of our yielding debt investment portfolio at quarter end was $614.6 million, an increase of 38.1% from the same period a year ago.

The effective yields on our portfolio investments during the first quarter was 14.6%, down from 15.6% in the fourth quarter of 2011. Excluding the income acceleration impact from early payoffs and one-time events, the effective yield for the quarter was 13.7%, or down 30 basis points, compared to 14% in the last quarter.

We'd like to reiterate that we expect the 50- to 100-basis point decline in our debt portfolio's effective yield during 2012. Excluding early payoffs, we expect, as Manuel indicated, a normal run rate for our portfolio of 12.5% to 15.5%. I'd also like to note that our PIK income -- which is noncash revenue, which must in turn be paid out to our shareholders in dividends -- continues to represent a small component, or less than 1.3%, of our total investment income for the first quarter.

Our cost of debt increased to $5 million in Q1 of '12 compared to $3.2 million incurred in Q1 of 2011. The increase is primarily due to the $1.6 million of interest and fee expense incurred on the $75 million of senior unsecured convertible notes issued in April of 2011. This also includes an approximately $271,000 noncash charge attributed to the fair value of the conversion feature accretion.

Also to note -- during the quarter, we recognized a one-time fee expense of about $457,000 due to the acceleration of fees on our SBA debentures. As you may recall from our prior quarterly earnings call, we repaid $24.3 million of debentures in February.

Our weighted average cost of debt was 6.8% in Q1 of '12, which compares to 7% in Q1 of 2011. This year-over-year decline is attributed to a decline in the weighted average cost of debt on our SBA debentures year-over-year. It's now 5.8% in Q1 of '12, versus 7.3% in the first quarter of 2011.

Operating expenses for the quarter totaled $6 million, as compared to $6.2 million in the first quarter of 2011. The decrease is primarily due to year-over-year decreases of approximately $198,000 and $134,000 in accounting and tax work fees and related workout expenses. Q1 of '12 net investment income was $11.4 million, or $0.24 per share based on 47 million shares outstanding; compared to $9.8 million, or $0.23 per share based on 42.7 million shares outstanding in Q1 of '11.

As Manuel indicated, we have record activity in terms of liquidity events in our portfolio during the first quarter, with four companies completing their IPOs -- one being acquired and one accretive acquisition being announced. Our net unrealized appreciation during the first quarter was $2.8 million, of which $2.7 million was related to net increases in equity investment valuations and $1.6 million was attributable to net increase in warrant investment valuations. This was partially offset by approximately $1.5 million due to unrealized depreciation on our debt investments related to general changes in current market interest rates.

Our net realized gains for the first quarter was approximately $2.8 million. We recognized a growth gain of $2.2 million from the sale of equity in BARRX and $1.3 million from the sale of equity in Aegerion Pharmaceuticals. These gains were partially offset by realized losses of approximately $460,000 from the sale of common stock in two of our public portfolio companies and due to a write-off of a warrant in one private portfolio company that has a cost basis of around $355,000.

Now, moving on to the balance sheet -- I'd like to first provide a summary of the investment portfolio. We've seen significant growth in our portfolio over the last year as a result of our debt investment origination activities. As of March 31st, 2012, total investment assets were $694.5 million, an increase of $249.5 million, or 56.1%, since March 31st, 2011.

During the quarter, we closed debt and equity commitments of approximately $101.3 million and funded approximately $65 million to new and existing portfolio companies. Since the end of the first quarter, we've closed an additional $46.5 million of commitments. And today, we have $129.7 million of pending commitments with new potential portfolio companies. We maintain a cautious approach to onboarding new assets given the uncertain economic environment.

We experienced $35.5 million in principal repayments for the quarter, including $60.5 million of early principal repayments and $19 million in scheduled principal repayments. As noted already in April, we have received almost $40 million in early repayments.

Regarding the composition of our portfolio at quarter end -- over 91% of our loans have floating rates or floating [rates of floors], and over 99%, as Manuel indicated, of our loan investments are senior debt investments, first liens. We remain pleased with the loan portfolio credit quality. The weighted average loan rating on our portfolio was 2.08% at March 31st, 2012 compared to 2.44% at March 31st, 2011. We have only one debt investment on nonaccrual at the end of the quarter that has a cost basis of $7.3 million and a carrying value of approximately $675,000.

At March 31st, 2012, our warrant and equity investments combined at fair value represent approximately 11.5% of our total portfolio versus about 10.3% at the end of 2011. The primary change was the addition of our Facebook equity investment.

Our equity investments at fair value as of March 31st total approximately $48 million. Our warrant positions in over $110 portfolio companies could provide us with the option to potentially invest $72.4 million of additional capital in our portfolio company. We believe these assets can provide capital returns for the Company in the future.

Already in the second quarter, we expect to realize net gains of approximately $2.3 million to $2.4 million from the sale of our warrants in Annie's and net gains of approximately $5.2 million from the sale of our warrant and equity investments in NEXX Systems.

Now, describing our liquidity at March 31st, 2012 -- we had approximately $178.4 million of availability, comprised of $48.4 million of cash and $130 million in borrowing capacity under our credit facilities. We ended the quarter with $200.7 million of SBA debentures outstanding.

We have been very active from a capital management perspective so far this year. In January, we completed a follow-on public offering of five million shares of common stock for gross proceeds of approximately $48 million. Also subsequent to quarter end, on April 12th, we raised $43 million in aggregate principal amount of 7% unsecured notes due 2019. As a result of adding this additional leverage, we anticipate an increase in interest and fee expense of approximately $800,000 per quarter, or $0.015 per share. Until that capital is fully deployed, which we anticipate to take one to two quarters, this will create a drag on our quarterly earnings.

Also, we should note that in February 2012, we repaid $24.3 million of our SBA debentures at a cost of debt of approximately 6.6%. We have submitted a commitment request to re-borrow these $24.3 million of debentures. And based on the pricing of the debentures at the March 2012 cooling, which was less than 3%, we should expect to reduce our cost to debt on these borrowings by approximately 2.5% to 3% over the long term. We expect the commitment review process to take approximately two to three months.

Our net asset value at March 31st was $485.4 million, or $9.76 per share based on 49.7 million shares outstanding; as compared to $431 million, or $9.83 based on 43.4 million shares outstanding at the end of the fourth quarter. The slight decline in NAV during the quarter is attributable to the seasonal restricted stock vestings and due to employee option exercises in the money grants.

Finally, moving on to our dividends -- as you may have seen from our press release issued a little bit earlier today, we raised our dividend by a penny to $0.24 per share payable on May 25th to shareholders of record on May 18th.

In closing -- we had a solid first quarter, reporting record revenue and total record assets. Our recent financing activities position us well to service the high demand out there for venture capital debt and build our portfolio in 2012. However, we remain disciplined in our investment approach [to given] market uncertainty.

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

(Operator Instructions) Jason Arnold, RBC Capital Markets.

Great job this quarter.

Just wanted to ask you if you could update us on your favorite industry niches within venture tech that you're kind of seeing more opportunity in at present -- and then perhaps vice-versa -- what you're straying away from at present?

As we indicated earlier, 2012 is a funny year. It's an election year. With a looming change in administration, your investment focuses are skewed with that always in the backdrop. So healthcare investing, for example, becomes a little more risky, [for] the fear of reimbursement risk may change on some of these underlying healthcare companies. So we're taking a kind of wait-and-see or very conservative underwriting for healthcare investing until a change in administration is evident or not evident, at which point we'll accelerate (inaudible) those investment activities any further. So that's an area that we remain shy on.

On the cleantech side -- we're not interested in looking at large capital-intensive models. And certainly any models that require government subsidies or government grants, or some form of government assistance, is something that we're shying away from for the time being. And clearly, a change in administration would also change the outlook for renewable energy investing. And not to say that the Republicans will not support levels of renewable investing, but it won't be to the level that the current administration is doing. And you'll see probably a shift in much more natural resources drilling and looking at enabling solutions in that area.

Areas that are grossly underinvested that we're looking at that we find extremely attractive -- with the advent of a Facebook IPO looming and the amount of engine ad-serving they need, I would not be surprised to see additional acquisitions take place in the ad-serving marketplace, and kind of, in essence, copying or emulating what Google did early on in its process of acquiring multiple ad-serving engines. So I think you'll see some additional investments in consolidation ad-serving models that are out there.

I think that semiconductor is an area that I think America has lost its competitive advantage on. It's too expensive to build foundries and too expensive to design semis out there. So it's an area that we're probably taking a much more conservative look-and-see. We're not necessarily very bullish on semiconductors.

Software is a very strong growth area for us. We expect to see a very robust activity in software investments in 2012. And we'll continue to invest in medical devices in 2012 as well and select life sciences. I want to make sure people understand -- we're not walking away from life sciences at all. We're looking to balance our portfolio in life sciences with an increased activity in tech. So it's a balancing act that's going on by seeing higher activities in tech originations and also allowing some more mature life sciences companies to migrate off the portfolio as they should and seek out other forms of financing as they mature in their life cycles.

Great color there, thank you.

And then, just one quick follow-up -- while I think you mentioned pricing of 12.5% to 13.5% on new investments, maybe you could talk about any changes in terms that you're seeing, if any; and then what you're seeing kind of the competitive front as well?

Sure. We're not seeing any real dramatic changes in terms. I think that things that you're seeing are companies that would like to have a little more interest-only than normal. That, of course, adds risk to the equation. And we'll evaluate that risk on a risk-reward basis. Whether or not we want to underwrite the same risk without getting more reward from it, it's all credit-dependent, or independent company evaluation process.

So I think we're seeing elongated requests for interest-only periods. There's a point in time where we will not do, as we've turned down multiple deals in Q1. We've seen some of our competitors do what I consider to be utterly silly or borderline ridiculous, doing 24 months, 30-month interest-only deals. That's called equity in my world. So I have no idea why you're doing a loan to a venture-stage company that has 18- or 30-month interest-only. That's approaching silliness.

So I think we're seeing a little bit of our competitors kind of stretching for deal originations and doing second-lien deals, senior stretch, very, very long interest-only periods. And we were happy to pass on all those deals.

Great color. Thank you very much.

Greg Mason, Stifel Nicolaus.

First, Manuel, I appreciate you putting out the Q; it's very helpful. In that Q, you have about $60 million of SBIC debt left that's got an over 6% yield. Do you expect to continue to recycle some of that expensive SBIC debt out for cheaper?

My God, Greg, aren't you doing your homework quickly? Congratulations. Yes, to answer your question. We do expect to do that. And in fairness to the team and the staff of the SBA, we work very diligently with them. And we will do that later this year. But we will work with that staff before we do that. We are not interested at all in stepping in front of the staff until they're ready to do that. So the intent is, yes, to cycle through the next tranche of $25 million, and lowering that cost of capital further.

Great.

And then, can you talk a little bit -- in your press release, you said book value declined due to the restricted stock grants. Can you give us maybe a little more color? Should we expect more of these? And how is that going to impact the stock-based comp expense in our models going forward?

Sure. Well, a couple things -- one, the decline is de minimis, so I'm not making excuses for it. The issue that triggered the most of it was -- back in 2007, 2008, I believe -- I think it was 2008 grants, if I remember correctly -- while the overall BDC market was down, we actually issued stock at the $4.71, I believe -- sorry, $4.21. So a lot of our employees -- rightfully so, including myself -- ended up exercising those options that we had. And I think we have little to none left of those. So that was one of the biggest impacts on driving that decline.

On the restricted stock grants -- one of the things that we've done is -- our Board of Directors has rightfully, to their credit, embraced a lot of the compensation alignments. So we shifted our compensation policies to be almost skewed half and half cash, and half stock, to make sure that we have an alignment with shareholders. So you'll see us have a more controlled-cash comp expense and also have that issue with stock to create a greater alignment investing and also long-term retention with our employees.

Great. And Jessica, does the restricted stock grants -- does that ultimately flow into the income statement through higher expenses?

Actually, it's called out separately on the income statement for our noncash compensation. And as Manuel indicated -- typical, it's a seasonal step-up with the new vestings and the new grants occurring in the first quarter of the year.

So Greg, let me expand on that. What happens is, the way we structured it -- we have a one-year cliff. So it's not untypical for most companies like ourselves, with a one-year cliff. So every March-April timeframe, you'll see that cliff issue vest.

Yes.

And then, it's ratably vested over the commensurate period of time on a monthly basis.

Great. And then --

But [two months skewed].

Great.

And then, one last question, and I'll hop back in the queue -- I know that Aires is starting to hop into the VC space with their team lift-out. How does that impact you guys with a new player with a lot of capital potentially coming into the space? Does that impact you?

Well, let me be clear -- I'm a big fan of Mike at Aires. I think he's done a great job of running that shop. And I think that Mike will maintain the discipline on asset origination. So I applaud him for seeing the value in the venture debt category, and also maintaining underwriting discipline. So I actually applaud having sophisticated players such as Aires coming in the asset class, and really maintaining underwriting discipline. So I think it's fantastic.

Great. Thanks, Manuel.

Jonathan Bock, Wells Fargo.

Good afternoon, and congrats on another strong quarter, guys.

Thank you.

First question on yield compression -- can you speak to the competitive elements that are driving yields down? Is this banks, venture debt investors in general, or additional competition from venture equity? What are the key elements here?

It's like I said in the fourth quarter news call -- a lot of it is really driven by the venture industry wanting to pedal away high-value warrants in exchange for reduced interest coverage. And we will do that in certain cases. But when you're looking at a private company that's valued at $10 billion, and they're asking to take additional warrants on that -- for me to look at an exit event that's worthwhile for investors, I'm looking at $30 billion exit. And short of being another [Insta-gram], good luck with that.

There's a point of the social networking asset class and certain element of the tech that I frankly think that are overvalued. And with that, we're happy to say no. And so some players are willing to take lower yields; we're going to simply wait it out, and we're not going to do it.

But the banks themselves will always continue to remain a strong threat there. But we're not -- they exist in their own niche, and we have our own little niche that we play in. So it's not driven so much by competition; it's more deal structuring than anything else.

Great. That's great color.

Next question, on leverage -- post the April debt raise, can you talk about where you plan to take regulatory leverage over the next two to three quarters?

I'll sound like a broken record. This hasn't changed as [long as] I've founded this company. The comfort level that I think that we should have is between 0.7% and 0.75% on regulatory leverage side, which equates to about 1.1% to 1.2% with SBIC.

Okay. So understanding, then, the 7% retail notes that you just issued -- is it your intension that you're going to have a very strong 2Q, and that's why you raised that debt capital ahead of what could be considered the really strong quarter, if we're starting to look at your term sheets?

Well, you know me better than that. I'm not going to give you guidance on the quarter, other than saying that I believe that net originations for us, or net asset growth for us, is probably in the $40 million to $60 million range. That's inclusive of the $40 million of early payoffs. So on a pro forma, you're looking at $80 million to $100 million off, adjusting downward for the early payoff of the $40 million. That's what I think we're going to be achieving to do.

As to the capital raise -- I will always raise capital in anticipation of need, especially in an election year. I'd rather have [dry powder] that I carry a negative spread on the income statement for a quarter or two, and be in a position to deploy that capital when others don't have the capital. So we will always have excess liquidity in the balance sheet by one or two quarters as a matter of strategy.

Thank you.

And that also brings up one question you mentioned about spread. When you look at the 7% cost of the notes, and then perhaps apply that to your OpEx, which is about 4% of assets -- can you talk us through how you look at the cost of capital on these notes -- particularly how that relates to the fact that new investment yields you're looking at right now are starting to decline?

Well, let's be clear -- the new investment yields of 12.5% to 13.5% are unlevered. So we've got to start with that equation first. So notwithstanding that comment -- I look at cost of capital from a multitude of perspectives. I have my SBIC cost of capital, which is running at, as Jessica indicated on the earnings call, 5.8% currently today. That will go down even further. I have the convertible bond offerings are at 6% cost of capital. I have the Bay Bond that you just referred to at 7%. And I have our equity that's around an 8%, 8.25% yield rate. You blend it all together, you're looking at somewhere in the neighborhood of around 7%, 7.25% weighted cost of capital.

So cost of capital is something that every BDC should be looking at, and I think every BDC is looking at it. And we're not probably much different than other BDCs out there when you're looking at it. The only thing we don't use right now is the short-term bank lines that are probably 200 basis points cheaper, but when you actually factor in their restrictions of single obligor, geographic regions, other restrictions they may have -- an [imputed] cost of capital of those bank lines are actually higher.

Great, thanks.

And then, one last question related to the portfolio division between late- and mid-stage investments -- I'm sorry if I missed it -- what is that division today? And where are you currently looking to take that over the next few quarters?

I don't know if we disclosed that publicly in the Q and on the earnings report. So I don't have that on the tip of my hands. I don't think we publicly disclosed it as of this juncture. We can look to do that in the future. So because I don't have that, I don't want to run afoul of Reg FD. I don't have it in front of me. So if I do something, I'll try to do it in a press release, so I don't have Reg FD issues on one of the conferences that I'm speaking to shortly. But I don't have that in front of me.

No problem, guys. Again, great quarter.

Thank you very much.

Henry Coffey, Sterne, Agee.

Manuel, historically you've always been able to kind of shuffle through the deck and find the right spot to be in company stage and life, and frequently industry, to in essence dodge the banks. I'm assuming, with all this talk about yield senior, that that process is happening. And where is this putting you in terms of life cycle [of] company?

That's what happens when you've been covering as long as you have -- you actually have the benefit of history. That is correct. I am using part of the playbook of 2007 as I go into the outlook on 2008. I am not advocating a credit collapse. However, I am doing very similar load balancing in asset allocations that I applied in 2007 going into 2008. So you're astutely correct on picking up on that.

We are purposely not defending certain credits. When I see banks eager to take us out of credits, what most people don't realize -- as the incumbent, you always have the right of last offer on these deals. And we're choosing not to exercise our right of last offer. And that is because either we feel that we have overly concentrated credit risk in that asset, we feel that that sector may be cycling down or out of favor, or a multitude of different reasons that we choose [asset-dependent] incumbency.

So you astutely picked up on a very important point about portfolio management that we do here. That's correct.

Now, also -- by the way, when you get my age, you get great rates at the movies. Also, how viable -- is there an evolution going on with your bank lines where we're getting closer and closer to the point where that could be a healthy, viable source of leverage? Or is it still just kind of a secondary vehicle for you? Is there someone out there that's going to give you an active, secured, amortizing term bank line that would allow you to, as you did so well, go through the '07-'08 cycle without a lot of distress? Or is it still kind of a questionable source of leverage?

I got to be honest with our bank partners. I think our bank partners are quite good and quite healthy and quite strong. I'm not worried about Wells Fargo, RBC, or Union Bank. All three of them did fine and survived just fine through the credit crisis. I think the issue for us is that we are seeing some thawing of some terms here.

The biggest concern for us in these credit lines is the advance rates, coupled with the single-obligor caps. I think there's some evidence of softening on that issue. It is our intent to use those bank lines. But I think that intent is more in traditional format of BDCs, which has used those bank lines as warehouse facilities, into an eventual conduit of some sort.

As we all know, the conduit market today, the CLO market, is not necessarily readily available yet. And that's one of my hesitations to use short-term bank lines beyond that [use], short-term nature. So I think that they serve a viable purpose. But I cannot use them to be long-term sources of funding.

So we still need to keep our eye on the CLO market for some relief? I know you talked about yields and shifting demands. But the real issue seems to be finding healthy sources of attractively priced capital, and then finding the -- we trust that you know how to find the loans, so to speak.

Yes, exactly right. Look, a BDC, unlike a bank, always has the challenge of cost of capital. Banks today range from 1.8% to 3.4% cost of capital. So we got to deal with that issue. But they also have the ability to have eight times, seven times leverage on the balance sheet. BDCs, as a whole, have a dividend yield they have to pay off. So that's a significant part of the source of funding. And those dividend yields today range from 8% to 12%.

So that makes it very expensive when (inaudible) your capital base has a cost of capital in that range. So what we're doing -- thanks to our partnership with the SBA, we're able to kind of manage that cost of capital on a blended basis. But it'll be a disservice, until I see dividend yields back in the 6.5% range, that I'm going to get our cost of capital much lower than another 100 basis points, if I'm lucky.

Thank you very much.

You're welcome.

Douglas Harter, Credit Suisse.

I was wondering if you could talk about if you're seeing any change in the conversion of commitments to fundings.

I wish I was. I'm still seeing -- we're still operating at historical norms of 75%, 80% conversion of a commitment to fundings, and still think we're managing down more in the 65% to 70% range today. So we're still seeing two patterns that are continuing. We're still seeing the rates should be lower than historical norms. And we're still seeing the phenomenon of things closing later in the quarter and drawing less money at close, especially driven by a robust IPO and M&A market.

So what's going on is now everyone wants a secured line to have as an insurance policy. And if they go public they don't need it, or if they get acquired they don't need it. But everybody wants to have this insurance policy on having these bank lines available from us in order to fund their business. So it's a good problem to have.

Great.

And then, if you could also talk about -- I think you said you were looking to move down towards earlier-stage companies. Can you talk about what that means from a cost perspective and a staffing perspective?

I think I indicated this in the fourth quarter earnings call. We are in the midst of looking to hire three to five individuals over the next 12 months or so. We're not in a sprint to get it done, and we're focusing on the right caliber individual. We're really acutely focused on individuals who have sector expertise or stage expertise that we're looking for.

So it's a methodical process of -- just like investing. It's controlled hiring. I mean, we're constantly interviewing people. We're very selective on how we interview. Our expectations for those candidates is quite high. And we have a very, very solid team in place here that those new individuals have to have the caliber and the expertise and experience our existing legacy team does. We have a highly experienced team of originators, and they're not going to tolerate marginal guys who are not going to be contributing pretty quickly on day one. So it's a high threshold.

Great, thank you.

Aaron Deer, Sandler O'Neill.

Actually, just following up on your previous response about the timing of the fundings. You mentioned that a lot of it comes in the back half of the quarter. Is that part of what's giving you the confidence that even though you're kind of starting on a net down basis here, given the pay-downs that you had early this quarter, that you think you're going to be able to make up so much ground here by the end of the quarter?

Well, let's be clear. I think if you look at page 10 of the earnings release, I believe it is -- on page 10, we give you an outline that -- unlike other BDCs, we'll give you visibility already -- that we have close commitments so far in Q2, representing $47 million of close commitments already. And we have signed [term sheets] in the quarter of approximately $130 million already in-house. So I also have $125 million of unfunded commitments. So the $40 million -- we will absorb that quite easily and redeploy that capital within the quarter or so afterwards.

The $40 million is what is in essence causing the penny and a half to two pennies decline in our Q2 outlook because of the interest expense and the early payoffs of these assets. It'll take us a quarter to two quarters to completely deploy that capital out there. But I'm not worried about it, given our pipeline that -- I don't think I've disclosed it, but I'll say now -- we have about a $1.35 billion pipeline right now of transactions.

So my concern is I don't have enough staff onboard to go through all these opportunities that we have that we're looking at and we need to attack. I have the opposite problem. I'm not worried about deal flow; I'm worried about ensuring that we continue to scale our team with the right level of investment professionals that we're looking for.

That's great.

And then, circling back to the yield discussion -- the guidance you gave seemed a little low. I just wanted to put a little bit more color on that, if you can give kind of what the year-to-date or the first quarter pay-downs -- what the yield was on those pay-downs relative to what the new debt that's being onboarded is coming on at.

I don't know if Jessica has that.

Yes. I don't have that information. I can get it shortly.

Okay. Thanks.

I don't think that -- remember, when I refer to our yield going down, it's because we're maintaining discipline on senior secured first lien, not senior secured second lien or last out. So I just feel --

-- appreciate that, I'm just --

-- not all senior is senior.

Right. No, I understand, I'm just trying to understand what the delta is between what's coming off versus what's coming on. So --

We'll get you the answer. But I suspect it's probably going to be 100 basis points delta. But we'll get you that answer.

Very good. Thank you.

Greg Mason.

Greg?

Apologize, I was on mute.

I just wanted to follow up on -- as you're talking about the early versus mid to late stages, I think you talked about the people you're looking at. But in terms of the opportunities in early to mid, where do you think the opportunities for new investments are? I know last quarter, you said you thought early was actually getting more attractive relative to your historical view.

Well, let me be clear. That's true. But this may be painfully obvious, but I feel I need to make the statement. An early-stage deal is only a $2 million to $3 million transaction in size. Well, a mid-stage deal expansion is probably $7 million to $12 million. And a later-stage deal, or a [salvage-stage] company, is going to be in the $12 million to $20 million in size.

So you got to factor by stage of growing at 2x or 3x in terms of capital. So one late-stage deal is probably two to three mid-stage deals and five early-stage deals. So it requires a lot more throughput. And you got to comb through a lot more companies. There's a lot of early-stage companies out there -- doesn't make them all good. Unlike a bank, we're not interested in market share. I have no idea -- market share [means we're] going to invest.

So we're focused on quality companies and companies that have good management teams and have good [venture] support, with that as a more methodical process -- to build a portfolio out to move the needle significantly is a year process to rebalance it by stages. It's a slow, methodical process because of the smaller transaction size. Takes a lot more smaller deals to move the needle.

Great. Thanks, Manuel.

Thank you.

At this time, there are no additional questioners in the queue. I'd like to turn the program back over to management for any additional or closing remarks.

Thank you, operator.

Thank you, everyone, for your continued support and interest and belief in Hercules. If you'd like to arrange a meeting or have additional questions, feel free to contact our Investor Relations department.

I'd also like to remind you that we are participating in the JMP conference next Tuesday in San Francisco and the Wells Fargo conference May 23rd in New York City, which -- we'll be happy to meet with investors. If you have an interest in meeting with us at either of those two conferences, please let us know, and we'll try to arrange for scheduling.

Again, thank you very much for being our shareholders and for your continued support of Hercules. And thank you to our team for their hard work and dedication.

Thank you, operator.

Thank you, sir.

Ladies and gentlemen, this does conclude today's program. Thank you for your participation. Attendees, you may disconnect at this time.