Hercules Capital Inc (HTGC) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hercules Technology Growth Capital third-quarter 2014 earnings conference call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's presentation, Ms. Jessica Baron. Ma'am, please begin.

Thank you, operator, and good afternoon, everyone. On the call today are Manuel Henriquez, Hercules's co-founder, Chairman, and CEO, and myself, Vice President of Finance and Chief Financial Officer.

Hercules's third-quarter 2014 financial results were released just after today's market close. They can be accessed from the Company's website at www.htgc.com. We have arranged for a replay of the call at Hercules's 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 disclosures in our earnings release regarding forward-looking information. Actual financial results filed with the Securities and Exchange Commission may differ from these 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 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 the 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'd now like to turn the call over to Manuel Henriquez, Hercules's co-founder, Chairman, and CEO. Manuel?

Thank you, Jessica, and good afternoon, and thank you, everyone, for joining us today. I am once again extremely pleased to report another outstanding quarter of quarterly performance for Hercules on all fronts. This achievement could not be realized if not for the dedication and the cohesive team of united workers and employees we have here who make this possible every quarter and every year.

In addition to our employees' meaningful contribution, our growing brand awareness as the largest BDC providing capital to the venture capital-backed companies and our reputation as a strong financial partner and growing relationship with the top-tier venture capitalists and entrepreneurs who continue to drive deal flow to us is something we are most grateful for. We would like to thank you and thank these parties for their continued trust and confidence in Hercules as a source of capital provider for themselves -- for them.

Q3 was an extremely busy quarter. On many fronts, we continued to expand our franchise and market penetration. I am still interested in striking a balance of shortening these calls and making it better for investors and analysts to ask calls during the Q&A session. Many of the items we'll cover today on this call are detailed in our earnings release and our 10-K, so we're going to once again attempt to shorten this call and try to not focus on everything we have stated in our earnings releases and dedicate more time for the question-and-answer session to make it more informative.

I once again ask for our shareholders to provide feedback on these calls, as I want to continuously change and improve these calls on the benefit for our shareholders and our investors and the analysts who follow us. Now back to the call.

The agenda today will cover the following matters: a brief summary of our operating performance and results for Q3; an operating -- an overview of our current market conditions, including the venture capital market activities, M&A and IPO activities, in the market; our perspective and outlook for the remainder of 2014, specifically in Q4; and then I will turn the call over to Jessica, who will cover more significant details on our operating performance and accomplishments.

Some key highlights on Hercules's outstanding accomplishments and operating performance during Q3. I am once again very pleased to report that Hercules delivered another very strong third-quarter financial performance. New commitments were extremely strong.

I'd like to remind everyone that Q3 is typically our slowest period of time. That said, we had approximately $194 million of closed commitments during the quarter, putting Hercules on pace for another record year of originations that could potentially top the $800 million, $900 million level in new commitments. Unprecedented and just a fabulous achievement on our continued developing of our brand and our market presence in the marketplace.

We continued to pursue transactions throughout the year, and I'd like to remind everyone that commitments do not necessarily translate into closed transactions. We will work as hard as we can to make sure that we try to hit that $800 million, $900 million number, and we still have good visibility to that pipeline today, but some of these transactions can and will slip before year-end. I can't express the importance to our partners in the venture community and our visionary and relentless entrepreneurs for trusting Hercules as their continued primary capital provider of choice.

Now to fundings; equally as strong during the quarter. We had an unprecedented $129 million of fundings during the third quarter, which drove growth quarter over quarter and materially offset our continued expectations of a portfolio decline in the third quarter with a continuing strong effort on fundings of new transactions as continued loan origination activities by our individuals.

This $129 million helped us to offset our continuously rotating out of marginal, lower-performing loans as we continue and strive to improve our credit outlook and stabilize our portfolio for future growth, as we've done time over time in past years. We are committed, and remain committed, to a high-quality credit underwriting shop. And if that means sacrificing earnings for quality asset growth, we will once again will be willing to do that.

We finished the quarter with a very strong unfunded commitment or backlog of approximately $243 million. I'd like to remind everybody, this represents potential future interest-earning assets if and when these unfunded commitments get drawn. This is a very important number and a growing figure, as we have purposely structured many of our unfunded commitments to only fund upon a borrower's achieving specific value-unlocking events or milestones that only serve to enhance our overall collateral position with these companies.

We continue to see funding-to-commitment ratios trending lower and currently are trending of approximately at a 55%, 65% level, which is historically lower than our norm of 75%, 85%. This will help explain our growing unfunded commitment, driven in part by our own self-doing by driving more milestones related to funding of our transactions.

During the quarter, a number of our existing convertible bondholders also have elected to exercise their right to convert their bonds. As part of this conversion and retirement of these bonds, we have realized an expense related to these bonds' retirement and redemptions of approximately $1 million as a non-recurring expense attributed to the retirement and extinguishment of these bonds that will have an impact of approximately $0.02 in net investment income.

Our true GAAP NII on a GAAP basis was approximately $0.30, which takes into account the $1 million in expenses that we incurred during the quarter, meaning that our net investment income on a GAAP basis was actually $19 million, or $0.30, when you actually deduct the $1 million expense attributed to the early redemption of these convertible bonds. I also want to highlight, already in Q4 we continue to see many of our existing bondholders electing to convert the additional bonds, and we expect potentially to see an additional $0.01 to $0.02, or approximately $1 million or so, in expenses in Q4 that may be potentially related to additional early exercise of these convertible bonds.

Hercules's stock continues to perform well in the market, and consistent with that trading and meaningful premium over net asset value, many of these bondholders have realized that the conversion option of the bonds is significantly in the money when these convertible bonds can be converted to equity of Hercules at $11.42 a share while our stock is trading well north of that today. These bondholders have the sole and only ability to exercise that conversion. Hercules does not have the ability to exercise that conversion until we surpass a certain ratio of the conversion of the bonds trading at a premium.

On a DNOI basis, we also achieved an impressive $0.35 in Q3 DNOI, representing approximately a $0.01 pickup from the previous quarter in 2014; that is, June. Now, despite intense competition, Hercules continues to be a lender of choice for venture capital-backed companies, as demonstrated by our closed new commitments of nearly $200 million and maintaining an overall effective yield in its portfolio of 16.7% as of the third quarter. This is solidly well ahead of many of our competitors in the sector and is only a testament to Hercules's continued focus on pruning its portfolio to ensure high-quality yield generation and maintaining a very high-quality level of credit on its investment loan book.

We had been expecting to see a continued yield compression in the third quarter of at least 30 to 50 basis points. We only saw a 20 basis points compression in that yield compression, and we expect still to see that yield compression continue through Q4 and potentially continue at a 30 to 50 basis points level. But as we saw in Q3, we may be surprised plus or minus 20 basis points in either direction that could occur during the fourth quarter.

Now, at the beginning of Q3, we successfully also accessed the debt capital markets. We went to the market in July and effectively raised our first ever 10-year bond offering. That was a 10-year, $103 million bond offering at a fixed rate of 6.25%. This bond offering helped us continue to enhance liquidity in our balance sheet as well as have capital available in the event of the convertible bonds redemptions that started taking place, allowing us to be well positioned in order to absorb the convertibility of the bond, which in fact we were well positioned to take advantage of by having this added liquidity to our balance sheet.

Notwithstanding an extremely busy and a very active third quarter, in keeping with Hercules's ability to execute on many levels, we also achieved an extremely important corporate milestone, one that I am particularly personally proud of, having founded Hercules over 10 years ago. Having received an investment-grade rating from S&P of BBB- served to only solidify and validate our cumulative team's efforts and experience in building Hercules over the past 10 years.

This is a huge testament to our firm's and our own ability to successfully underwrite high-quality transactions and remain extremely selective in the underwriting process, even if that means potentially missing or purposely missing earnings because we do not agree or see the high quality of assets that we demand to underwrite. That is a tenet of ours that we will always continue to ensure that we maintain our historical credit performance as best as we possibly can by maintaining that disciplined approach.

Hercules is the first BDC that I am aware of that is focused primarily in the venture lending platform to receive an investment-grade rating from S&P in this asset class. We are extremely grateful and pleased to have earned this unique achievement, as it allows us to access the debt capital markets and therefore allow us to lower our overall cost of financing, further giving Hercules a significant competitive advantage over many of our competitors.

We remain very committed to addressing the growing needs of the innovative, disruptive technology and life science companies that we serve. Hercules will continue to defend its franchise, its brand, and its market presence by servicing the needs of our innovative, venture growth-stage companies as their capital provider of choice. We have the balance sheet, we have the wherewithal, and we have the ability to use our yield coverage, if and when needed, to continue to expand our franchise and slow any encroachment that we see penetrating from any competitors, and we intend to defend that position with our balance sheet.

To that end, we will continue to expand our financing solutions to innovative, venture capital-backed companies at all stages of development. This means from early stage to expansion stage or venture growth stage companies by offering a broad financing solution from asset-based revolving lines of credit based on accounts receivable or inventory, basically called ABLS-based lending, equipment-based-only financing solutions, acquisition financing, senior stretch, and growth loans.

We will not be undercut, and we will intend and continue to grow our presence in the market. With this larger suite of financing solutions, an enhanced balance sheet of very liquid and access to the debt capital markets, we are extremely well positioned to effectively compete with venture banks and other BDCs attempting to enter the venture lending marketplace.

We have the balance sheet, as I said, and the liquidity and the intent, and what I consider the most important element of that equation, the historical experience of working in this asset class to understand when and how best to underwrite these high-quality assets. We are well positioned to enter 2015. We are continuing to position our balance sheet for this continued growth in 2015, and you can expect to see continued growth in that investment portfolio as we enter the early part of 2015.

In addition to all of that, we have recently launched many new initiatives at the beginning of the year that will continue to enhance our balance sheet. We most recently completed another securitization during the fourth quarter. This new securitization was achieved with an anticipated rating from Kroll upon pricing on the new securitization of $129 million that occurred at a 3.524%, which is expected to close and settle on November 13.

As indicated during our Q2 earnings call, we remain extremely committed to a quality loan portfolio. We are very committed to preserving our historical credit track record and performance. I am very proud to say that nearly after 11 years of founding Hercules, as of Q3 2014, our cumulative net GAAP loss is approximately $19 million cumulatively over 11 years on over a base of $4.6 billion of commitments over 300 companies. That is a testament to our commitment to quality underwriting and not short-term earnings.

During the third quarter, Hercules continued to proactively rotate our portfolio of marginal performing loans, as I indicated earlier. Even though this may impact our short-term earnings, I believe very strongly that this is the right thing to continue to do. As others are eager to encroach into this asset class, we are able to rotate out of marginal quality loans and enhance our own credit outlook at the behest of others who may not be as familiar in this asset class as we are.

Early payoffs during the third quarter were slightly higher than anticipated but within a manageable level. If you may recall, we indicated that we expected to see approximately $80 million of early payoffs in Q3, and the fact of reality is it came in at $84 million. This gives you some confidence in our ability to be able to forecast and manage our expectations of our own portfolio and balance sheet.

Now let me turn my attention to exits and liquidity in our portfolio. At the end of the quarter, Hercules held equity warrant positions in six portfolio companies that had file registrations in anticipation of an IPO offering. Those companies include Box, Zosano, Good Technology, Dance -- Dance subsequently withdrew its IPO filing in Q4 -- and two additional companies who have filed under the JOBS Act. In addition and subsequent to quarter end, we had an additional issuer file for an IPO registration.

Although we have witnessed an increase in market volatility, much of which had been expected by us, many potential life sciences and technology IPO candidates have chosen to delay their IPOs for the early part of 2015. As a result, we have indicated that in Q2 2014 earnings call, our adjusted expectation for potential realized gains is now $15 million to $20 million, with the Box IPO slipping now to sometime in 2015.

The Box IPO alone could potentially have represented, as you see in our unrealized gains and our schedule of investments, potentially $20 million to $40 million in gains had that IPO been completed in fiscal 2014. With that IPO being pushed out, we remain confident in seeing liquidity of realized gains in the neighborhood of $15 million to $20 million between now and the remainder of the year.

Now turning my attention to the venture capital community, I have been absolutely surprised on the vibrancy and resiliency of the venture capital community. On a fund-raising level, the venture capitalists have raised nearly $25 billion of capital through the first three quarters of 2014, topping all of the capital raised in 2013 of a total of $20 billion. This is a very, very solid and important sign of health in the venture industry.

Not to be left behind, the venture capitalists were eagerly busy in making new venture capital investments during the third quarter. These teams continue their aggressive and impressive pace of new investments, totaling nearly $11 billion invested in Q3. But what's more impressive is the year-to-date activity through the third quarter of 2014, with over $37 billion invested. That $37 billion exceeds the annual total levels of investments for each of the past 8 years, an unprecedented pace and one that we obviously welcome to see in the marketplace.

Sectors that the venture capitalists focus their time and attention on: business and financial services companies received 29% of the capital, followed strongly by healthcare and life sciences receiving approximately 26% of the capital. Those two sectors tend to emulate our portfolio quite strongly.

By stage, the venture capitalists at Hercules are quite aligned again. Of the $37 billion that's invested, 60% of that capital was invested in later-stage companies, right in Hercules's wheelhouse and our area of focus and our area of desire where we want to defend and grow our franchise quite strongly.

On a year-to-date basis, pre-IPO later-stage venture capital companies have received 64% of all the capital. That represents over $24 billion of capital invested in fiscal 2014 to later-stage companies, right in our sweet spot where we focused on.

By regions, not to be left behind, and as a reminder, Hercules's offices in northern California, Boston, Mid-Atlantic region, New York and Virginia -- which I will classify altogether as Mid-Atlantic region -- and northern California received 43% of the venture capital dollars, followed by the Mid-Atlantic region at 15% and New England at 8%, all where we have regional offices and physical local presence to be part of the venture community and the entrepreneur community.

Lastly, turning my attention to what we all care about, venture capital exits and liquidity events. Equally as strong, IPO activities continues to pick up steam with 22 companies going public during the third quarter, raising $1.3 billion. This, of course, excludes the monstrous capital raise that Alibaba did of raising over $23 billion alone.

Year to date through Q3, 85 companies have completed their IPO offerings, surpassing eight of the last year's annual IPO activity, with 2007 representing the nearest threshold for a total calendar year at 81 and we've completed 85 so far through the third quarter. I am strongly encouraged by these numbers.

On the M&A side, equally impressive activities by the venture capitalists. M&A saw 139 companies complete their acquisitions, for a total of $21 billion in exit valuations for their companies. Year to date, 407 companies have been acquired from venture capitalists, for a total of $53 billion. These are very, very good numbers and one that gives me very good confidence in our continued pace of investment activity and growth in our portfolio as we turn into 2015.

Now turning my attention quickly back to our outlook for Q4 and the remainder of 2014, we began by making various critical long-term strategic changes to our organization, effectively beginning in Q2. We've set the foundation for the next 10 years of growth. These changes will continue throughout 2014 and most of 2015 as we continue to adopt and execute upon many of these strategic changes and directions that we're doing.

We expect to continue to grow our Company. In fact, we are actively seeking to hire 8 to 10 additional investment professionals. That process, as lofty as it may sound, may take us 9 to 15 months to do. We invest and hire under the same discipline -- we're slow, we're methodical, and we're meticulous in who we want to hire and who we believe is worthy to continue to carry our origination activities and credit qualifications that we deem necessary to be successful at Hercules.

We continue to expect to leverage our balance sheet. Although our balance sheet is modestly levered today, you can expect to see us leverage the balance sheet further in fiscal 2015 to further drive both earnings growth, dividend growth, and ROA and ROE on behalf of our shareholders if and when the quality of assets are there that we've deemed appropriate to leverage the portfolio in that direction.

We anticipate net portfolio growth for Q4 of approximately net up of $40 million to $60 million. This is, by the way, on top of expected early payoffs in our portfolio by our continuation of rotating out and pruning of an additional $100 million to $140 million of loans that we expect to see as early payoffs during the fourth quarter.

Notwithstanding that comment, it's quite important. We expect to see $100 million to $140 million of early payoffs, but yet we are forecasting our portfolio to rise net up, quarter over quarter, between $40 million to $60 million. That gives you a perspective of the confidence that we have in our pipeline. However, that pipeline will continue to monetize itself later in the quarter, so we expect to see most of that earnings impact to occur in Q1 of 2015 and not necessarily much in Q4 2014.

We are expecting normal amortization to also change. As our portfolio has gotten bigger, we expect normal amortization to rise from our historical levels of $25 million to $35 million a quarter to now a $37 million to $45 million level, consistently on a per-quarterly basis.

During the third quarter, as I indicated earlier, we also commenced and recently completed the $103 million, 10-year bond offering. These are important indications, and I also shared with you earlier that we recently announced the near-completion of a $129 million new securitization, giving Hercules a second-time access to the securitization market. But this time with a very unique securitization instrument that now includes a front-end, 18-month revolver that allows us to keep the duration of that securitization longer, for potentially as long as 30 to 36 months, which will allow us to more cost effectively use and utilize that securitization and further lowering our overall cost of capital for the benefit of our shareholders.

Lastly and repeating myself earlier, in early November we have received additional requests from our existing bondholders to elect to convert and retire so far approximately $23 million of the remaining balance of our convertible debt instrument. Combined with the $34 million of convertible instruments that have been retired in Q3, this brings our total convertible debt retirement to approximately $57 million in conversions.

We currently have approximately $18 million or so left of our existing convert. Although we do not control when and if those bondholders will convert, we certainly expect to continue to see pace of conversion and, hopefully, full retirement of that convertible bond instrument some time in Q4, or it could be as late as Q1. Again, it is entirely out of our control. Because of that continued pace of convertible bond conversions and retirement, which only enhances our liquidity, we expect to see an impact to earnings in Q4 of anywhere between $0.01 to $0.02 attributed to the retirement of these bond instruments themselves.

Lastly, and I apologize -- it's been a very, very busy quarter. At the end of the quarter, we finished with another robust pipeline of over $1.3 billion and approximately $210 million of which is in signed term sheets. This is why we are looking to hire additional investment professionals. We are as busy as we've ever been, and we continue to grow our business and our franchise to that end.

With that, I would like then to turn the call over to Jessica Baron, our CFO, to continue to provide you additional details regarding our financial performance.

Thanks, Manuel, and thanks, everyone, for listening. I'd like to remind everyone that we filed our 10-Q as well as our earnings press release after the market closed today. And I'll briefly discuss our financial results for the third quarter of 2014.

Turning to the operating results, we delivered total investment income or revenue of $37 million, a decrease of 9.8% when compared to the third quarter of 2013. The year-over-year decline was driven by the decrease in the weighted average loan portfolio outstanding and the mix of early payoffs relative to the third quarter of 2013.

The all-in effective yield on our debt investments during the third quarter was 16.7%, as Manuel mentioned, down approximately 20 basis points relative to the previous quarter. The slight decrease, again, was due to the mix of portfolio companies that paid us off early in Q3 versus Q2. This was a function of the vintage of the early repayment, the contractual prepayment penalty on the loans, and the balance of unamortized fees for each investment at payoff.

Interest expense and loan fees were approximately $7.9 million during the third quarter of 2014 as compared to $8.7 million during the third quarter of 2013. The year-over-year decrease is primarily attributed to the $34.8 million paydown of SBIC debentures that happened in the first quarter of 2014, the amortization of $34.5 million of asset-backed notes since the third quarter of 2013, and due to the $34.1 million of convertible note redemptions that Manuel mentioned.

Interest expense decreased by approximately $950,000, related to the settlement of the convertible note. These decreases were offset by the addition of approximately $1.1 million of interest and fees attributed to the 2024 notes issued in the third quarter of 2014. The weighted average cost of debt increased to 6.6% in the third quarter of 2014 versus 6% during the third quarter of 2013. This increase is due to the acceleration of fee amortization triggered by the amortization of the asset-backed notes.

Operating expenses for the quarter was $9.1 million, as compared to $10.8 million in the third quarter of 2013. This decrease was primarily due to a decrease in variable compensation expense period over period.

Q3 of 2014 net investment income was $19 million compared to $21.6 million in the third quarter of 2013, representing a decrease of approximately 12%. Net investment income per share was $0.30 for the third quarter of 2014 as compared to $0.35 for the same quarter ended 2013.

We recorded approximately $9.1 million of net unrealized depreciation on our investments during this quarter. Of the $9.1 million of depreciation, $2.6 million of this depreciation was primarily attributable to net collateral-based impairments on debt equity and warrant investments in three companies. $2.8 million of depreciation was due to market or yield adjustments and fair value determinations, and approximately $3.7 million of this depreciation was related to the reversal of prior-period appreciation due to loan path, sale, and sales of warrants and equity investments.

We recorded $5.9 million of gross realized gains from the sale of warrant and equity investments in three portfolio companies, and these gains were slightly offset by the write-off of a couple of warrant investments in other portfolio companies.

We ended the third quarter of 2014 with total investment assets, including warrants and equity, at a cost basis of approximately $1 billion. This was net up by about $16.7 million from our investment portfolio balance of $995.6 million as of June 30. This increase was primarily driven by our strong originations and funding activities of new investments, totaling approximately $129.7 million in debt, equity, and warrant investments. And this was offset, again, by approximately $117 million of principal repayments and proceeds from the sales of investments.

The debt portfolio company net count increased by three companies, from 90 to 93, since June 30. This change is due to six companies paying us off, offset by the addition of debt investments in nine new companies during the quarter. As previously noted, we also anticipate our debt investment portfolio to potentially increase in the fourth quarter by $40 million to $60 million.

A reminder that debt investment amortization typically commences 9 to 12 months after an interest-only period we have on our term loans, and then amortization is scheduled to occur over a 36- to 42-month timeframe. Apart from early repayments, we currently have scheduled amortization of $30 million to $40 million on our portfolio on a quarterly basis.

With respect to the credit quality of our portfolio, the credit quality remains very solid. The weighted average loan rating on our portfolio was 2.07 as of September 30, reflecting a slight improvement from 2.10 reported at the end of the second quarter. We had three investments on non-accrual at the end of the quarter, consistent with last quarter. The cost basis of these three investments is 2% as a percentage of our total investment portfolio, and at fair value, 0.7% of the total investment portfolio.

On to liquidity, again a summary. At the end of the third quarter, we had approximately $309 million in total available liquidity, which includes $159 million of cash on hand and $150 million of credit facility availability. As of September 30, our debt-to-equity leverage ratio, including our SBA debentures, was 81%, slightly higher than the 72.9% as of June 30. And this was due to the $103 million bond offering we did in July.

As a reminder, our $190.2 million of SBA debentures outstanding are excluded for regulatory leverage calculation purposes. This exemption effectively allows us to leverage beyond a 1-to-1 debt-to-equity ratio to 1.29-to-1, which means that at the end of the third quarter, we had additional capacity to add $342.9 million of leverage to our balance sheet. Our net leverage, which is calculated based on total debt minus cash, is approximately 56.8% at the end of September.

Subsequent to quarter end, approximately $23.1 million of convertible senior notes converted and will be settled with a combination of cash and stock payments. And as Manuel mentioned, we anticipate a $0.01 to $0.02 non-cash impact on our Q4 earnings as the result of the acceleration of origination fees, amortization of the conversion features and issuance of shares attributed to this conversion.

Also, and as Manuel highlighted, we are further bolstering our balance sheet for sustainable long-term growth. We priced a term debt securitization of $129.3 million. This is expected to close next week on November 13. The interest rate, as he noted, on this securitization was 3.524%. The present quarter impact of this net additional liquidity for our new asset-backed notes will be an additional $0.01 to $0.02 for the fourth quarter.

Our net asset value at September 30 was $656.2 million, or $10.22 per share, as compared to approximately $658.9 million, or $10.42 per share as of June 30. The decrease is primarily due to the issuance of approximately 900,000 shares related to the settlement of the convertible notes in Q3, and secondarily due to slight fair value adjustments to the portfolio.

Finally, and as previously noted, we'll be distributing a dividend of $0.31 to our shareholders, and this payment is scheduled for November 24.

So in closing, as Manuel mentioned, we're optimistic due to what we're seeing in the venture debt marketplace. We'll continue to take a very cautious and steady approach to onboarding new assets in the fourth quarter and into 2015. We remain committed to our strategy of controlled growth, and we intend to continue to apply our stringent underwriting standards, which have resulted in our stellar first 10-year performance and historically low historical loss rates.

So with that, operator, we're now ready to open the call for questions.

(Operator Instructions) Troy Ward, KBW.

-- overall platform over the next several quarters, it sounded like. Can you speak to, on the front-facing side, whether you're going to be expanding any verticals, if there's any additional targeted assets or any changes in what type of assets you're going to be approaching?

Hey, Troy, I'm sorry. Your first part of your question broke up, so I don't know the context. If you don't mind asking again, we didn't hear it.

I'm sorry. You were talking about making changes to the overall platform over the next several quarters, some long-term changes to Hercules and whether that includes any changes in the focus on the assets.

No, no. In fact, there is absolutely zero interest in not focusing on the asset. It is much more important to focus on the growing capital needs of a lot of our companies. More and more of our companies are continuously pulling us into offering revolvers, inventory lines, traditional ABL-type financings in lieu of the banking community challenges that are going on out there.

We are being asked and pulled in that direction, so those are some of the things we're talking about doing that we've been teasing the market with as we've been exploring those opportunities that are historically lower in margin, if you will, but also lower in risk. So by having the ability to tap the securitization market, for example, I'm able to now originate a lower-yielding asset, but maintain a nice spread in doing so. So that's one of the things that we're effectively doing is using that balance sheet much more intelligently to preserve spreads, but then offer additional new products or capital financing vehicles for our underlying portfolio companies.

Okay, and then similar to that, as we work a lot in the middle market, the regulatory pressures on banks is very evident. Could you speak to the regulatory pressures, potentially, on competitors in your market -- the tech banks? Do you see the tech banks being more aggressive? Do you see any regulatory changes coming that affect their ability to effectively participate in your markets?

Yes to all the above. We are seeing a bloodbath of banks going after each other on credits that are typically sub-$5 million range. They are -- it's getting to the point of being very, very scary on how low these banks are willing to go to each other on that pace.

The wonderful thing about that is, because of the regulatory environment, those same banks can't do a large term loan to a cash flow-negative company as well as an ABL line or a line of credit to that same company. And so we're definitely testing that threshold where I think banks having a $20 million to $25 million exposure to a cash flow-negative company that requires subject around the venture capital dollars, I think that we are seeing an inability of banks to really fill that need and address that area of the market.

But anything below $5 million is just horrific. If you're an asset class originator looking to do $2 million to $4 million loans, I feel terrible for you.

Are you seeing any new competition start to gravitate towards that upper level, that $20 million term note? Are there new buckets of capital starting to focus on that market yet?

No, because that level of market is even more sophisticated because, to quote my mother-in-law, "Big deals, big problems; little deals, small problems." And so there's a big risk factor when you don't know what you're doing and you start weighing in to venture lending at a $20 million to $30 million level and you get it wrong, in a matter of 12 to 15 months you will realize you got it wrong.

And so the venture lending platform in the market is an asset class that typically affords itself to an apprenticeship process where you want to start small to big. And if you want to dare to be big early on, my answer is I have some companies I want to show you.

Okay. And then, I know -- one more for me. Historically, or more recently, I guess, you've talked about sectors that you stay away from. And if I recall, clean tech is one of those. What are you seeing in that particular slice of the market, especially considering the energy volatility that we've seen in, call it the last 6 months?

I wouldn't say that Hercules is out or does not care about the energy sector. That's not necessarily at all remotely accurate. I think that what we said openly is that I think that the energy space, to your point, is going through a bit of an adjustment right now. And I think, with the volatility of oil now trading as low as $70 to $85 a barrel, whatever you want to call it, and OPEC now finally making a realization, they may start cutting back production a little bit, I think that people start getting quite panicky when you're looking at the alternative energy space and looking at oil.

Anywhere floating below $70 a barrel, people get nervous. And there are some pundits out there that are talking about oil could go to $45 a barrel. I don't share that view.

But the clean energy industry is more than just renewables and more than just simply looking at biofuels or new plastics. It has to do with enabling semiconductor technology, enabling screen, flexible backs -- flexible screens, organic screens for iPods, iPhones, those kind of things.

So it's a much broader industry, and that's one that we are actually, because of our balance sheet and lack of competition in an energy area, we are seeing a fairly growing pipeline of opportunities there. And we are absolutely going to capitalize on the energy, the clean energy and industry renewables. So that's an area that we are actively involved with.

An area that is still challenged that we'd like to see more capital being invested in is communications, networking infrastructure. Those are areas that I think are still underserved that we'd like to see more capital flow. That's an area of interest.

The medical device category has gone through some challenging times of late from a regulatory point of view, and so I think that the medical device industry is probably near-term challenged. But I think there still has some interesting opportunities there, but you've got to be very, very judicious on some of the devices that you're looking at.

That's great color. Thanks, Manuel.

Ron Jewsikow, Wells Fargo Securities.

Just a quick question on your 2019 bonds. Could you remind us what call protection is there on those as they sit today? Because we noticed that you were able to price 10-year bonds tighter than the current rate on those.

Yes, the 2019, those are the 10-year bonds.

He's asking about the 7-year bonds.

Oh, the 7-year bonds, sorry.

2019, sorry, yes.

Sorry. We have so many bonds now even I'm getting confused sometimes.

But don't worry, I'm not.

So the tranching of the 7-year bonds, the ones that were done in 2012, those are a 3-year non-call, and they start coming off, the call protection, in April. And I think there's three tiers: April, May -- or April, June, September, I believe, is when the call feature starts running down -- running off on those.

Right. About $85 million, the call protection comes off in April.

Okay. And then shifting focus a little bit towards the ABL investments, given that they carry lower yields and probably lower risk, should we expect more funding on the Union Bank facility you just, I believe, lowered your pricing on?

Yes, we definitely view the ability -- the ABL assets are one that lend themselves much more to a bank financing structure. And ABL assets, in all earnest, we just started the process late in Q2. It's going to take -- to get a meaningful portfolio there it's probably going to take us a year to achieve like $100 million, $150 million of ABL portfolio.

And yes, they're a lower yield, but as I said, because of the lower yield, we can then match-fund those against our bank lines and harvest that spread of 300 to 500 basis points.

Yes, it makes total sense. And then just one housekeeping item. On the Dance Pharma withdrawal, was that fundamental or was that market driven?

You know, I refuse, nor will I ever speculate as to underlying portfolio companies will and what they went through to do the withdrawal. So that's something entirely in the control of their board of directors and we have no say or perspective on that.

All right. Thanks for taking my questions and congrats on the quarter.

Chris York, JMP Securities.

Just wanted to touch on expenses a little bit. As you guys talked about in your prepared remarks, planning to continue some strategic changes, add maybe five to eight professionals. How should we think about your SG&A and operating expenses, I guess, going forward in 2015?

Well, as we've always done, and I'm sure you're aware of, operating expenses will always lead revenue generation, because it takes anywhere between 6 to 9 months for a new originator or a new hire to actually become productive, because the first 6 months we are obsessively retraining or reconditioning to Hercules underwriting. And so expenses will always lag revenues.

That said, as I indicated in the opening remarks, we expect the hiring process to take probably 9 to 15 months, so I think that you may see expenses modulate upward, kind of ballpark here, a quarter of a million dollars to a third of a million dollars per quarter as we dial in those new hires. But it's going to be only done as we may dial in two guys or two folks initially. And as they become productive, we'll dial two or three more in, and we are just going to step them in gradually, not all at once.

Okay, that's helpful. That's it for me. Thanks, Manuel.

Fin O'Shea, Raymond James.

Aside from the ABL on just more generally with leverage, should the market continue to get more aggressive versus your expectations or even call it the minus 20% -- 20 basis points a quarter. Would you guys be willing to increase leverage to up your earnings profile?

Well, clearly, the answer is yes, if the debt capital markets are open and predictable. I mean one of the things that people forget, as our own underwriting becomes more competitive, our own personal capital raises become also equally competitive on the downside. So I would like investors to begin to focus on what is that NIM, or the net interest margin of spread.

And that's what I spend a lot of time looking at and preserving that, because if our yields on the front end are coming down or being compressed, our yields on the back end from a leverage point of view are equally going down as well. So it's kind of a win-win. And so we intend to continue to capitalize the leverage in the balance sheet and pursue any additional debt financing transactions if and when those debt capital markets are attractive and open.

Okay, great. And just one more follow-up related to your general thoughts. We're seeing color here on a very robust VC market, but also very robust competition on the investing side. If you could just give us your thoughts on that, the balance.

Sure. There is absolutely no question that venture capitalists to venture capitalists are themselves seeing pretty significant competition with each other. Everyone is jockeying to make that last round of equity capital investment in that next soon-to-be IPO pop or big IPO win out there.

So with that, we're dealing in an environment right now which is very pro-entrepreneurs, both from the debt capital provider point of view for themselves as well as from the equity capital provider themselves, which leads to a higher valuation for their own company. So if you're an entrepreneur, this is a fantastic market to start a company in right now and build one.

Awesome. And would you say it's a big positive, also, for the debt providers?

It is, because one of the most important things that we look for is a fast liquidity turnaround. So as we put capital in these companies and achieve an IPO or M&A event, that IPO capital comes back to us with the nice capital gains, and we recycle that to invest in another crop of new companies. So it's a good environment across the board.

Okay, thanks a lot, guys. Appreciate it.

Aaron Deer, Sandler O'Neill.

Manuel, talking -- I'd like to hear about the competitive nature of the market. Can you maybe talk specifically about how that's affecting rates on new originations? And I guess let's exclude the ABL stuff since we know that that's lower rate. But if you look, apples to apples, at credits that you're originating today versus a year ago, how much lower are the rates on those credits?

So you'd be fascinated by this analysis I just did earlier this week. I went back and looked at the interest rate on our transactions for -- I think it was eight or ten quarters. And the most interesting revelation was, from an interest rate point of view, it's absolutely flat for almost a 10-year period of time.

With the toggle or the differences that you're seeing manifesting themselves are more surrounding around terms and conditions, so that may lead to longer-only, interest-only periods, different amortization schedules, different warrant coverages. But the rates themselves, the coupons themselves, are pretty much static. We have not seen over the last, I think it was 10 quarters that I did the analysis, much change in the coupon rates of our loans.

We have certainly seen anywhere between -- on a fully burdened yield basis, you've probably seen a change between 60 to 120 basis points when you look at it on apples to apples, driven primarily from an OID compression as less warrants have been issued.

Are you characterizing what is then a higher level of risk that you're taking on the balance sheet, given the different terms and structure?

Well, Aaron, I know you always like to look at risk that way. I think our risk profile is self-evident by continuing historical performance. So the answer is I don't think we're taking any more risk than we took 10 years ago or 7 years ago. So I think the risk profile of these companies being one and the same, and I don't think it's changed at all.

Right. Aaron, I think that the calibrating point there, as Manuel mentioned on the call in his prepared remarks, is that we have more milestones embedded into these commitments which we're making to these portfolio companies. So I would say, from a risk perspective, through the lens that we look at these companies, the risk is the same or even improved as we have fine-tuned our structuring of tranching out these investments.

And we are walking away from a lot more transactions than we probably had in a long time. I think, when you look at our approval rating from initial interested company to us approving it, a year or two years ago we may have been in a 15%, 20% overall approval rating. I think today we're barely at 8% or 10% of those, meaning for every 100 companies we look at, we're only approving 8 to 10 of those, while two years ago, we were probably approving more like 12 to 15 of those companies, as an example.

So our risk rating, or our risk approval process, has gotten significantly tighter and more difficult.

So there's other aspects to the credit that are actually getting better that offset maybe a longer IO period or something like that?

Oh, absolutely. One of the gaining items to your question that's very important is, as the previous caller asked, and you see a higher level of predictability from an exit, meaning that 2 or 3 years ago, you may be forecasting an exit for that company, either IPO or M&A that was 3 years out. Today you may be looking at a window that could be as short as 15 and 24 months, for example, and giving it greater access to the capital market.

The other element of that has to do with the other two prior callers was the robustness of the venture capital market. Having $37 billion of investment means that the venture community is pretty much flush with capital, and therefore that capital helps us get our debt repaid and mitigate any downside risk in our companies, especially when you underwrite the right ones.

Okay. And then the -- you guys had some nice net realized gains the past couple of quarters. The unrealized losses, though, have been there as well. I just want to get a little color on that. Is that mostly tied to the non-accruals that you have currently? Or are there any specific warrant positions or maybe public companies where there is some marks that are being taken there?

Yes, I mean, in the warrant side, you can look at our schedule of investments relative to the previous quarter. We all know that there was a lot of volatility around the measurement date of 9/30. You'll see that some of our holdings in some of the portfolio companies that we have in the life science spaces have depreciated, period over period.

There were a few loans that we did take some impairments on. They're current on cash pay, et cetera. They're just coming up on some pretty critical fundraising milestones for those particular companies, and that attributed as well to the depreciation we booked for the quarter. But also, as a reminder, when we do have a realized gain, there was $4 million of flipping out of unrealized appreciation that we had to book due to booking the realized gain. So part of that was really just in effect bookkeeping, yes.

Yes, and Aaron, as you know, we go to great lengths in our earnings to have this table that Jessica has really honed in on over the last couple years, which is quite helpful. And you'll see that collateral-based impairment, meaning troubled credit impairment, is only -- actually, the loan itself is only $2.1 million. The total collateral impairment is $2.6 million of that.

So we go to great lengths to make sure that investors are able to have a very high level of transparency, you'll see in this table, that shows you the Level 1 and 2 assets versus Level 3 assets that are impaired on a fair value basis as opposed to credit-related.

Yes, I know, and appreciate that disclosure. So okay, that's it for me. Thank you.

Christopher Nolan, MLV Company.

I'll be really quick here. Does the strong IPO and M&A market impact your portfolio growth outlook for 2015 as people start thinking about using equity as an alternative to venture debt?

Well, Chris, you'll be surprised at my comment. It's actually the opposite of that. Because if you're an entrepreneur and you believe that you can sell your company 6 months from now or a year from now at a higher valuation, the last thing you're going to do is take an equity round today.

So what is going on is, when you have a very robust M&A and IPO market, demand for debt actually increases quite dramatically, which is why you're seeing our portfolio or demand for capital from us has gone up so dramatically, because entrepreneurs all want to preserve ownership in their companies in anticipation of an exit, or an exit occurring in 6, 12, 9, 18 months from now. That's important.

So what we go out of our way to do is we are not there to compete with venture capital dollars or venture capital partners. So we want to just complement or supplement those equity dollars. So we work diligently with both the entrepreneurs and the venture capitalists to find the right balance.

But, yes, in a very robust exit market debt demand goes through the roof.

Great. And my follow-up is, given the robust or developing venture market, any update to the realized gains that you guys gave guidance on earlier in the year? I believe that you gave guidance of $20 million to $30 million for 2014. And just given the strong market trends in the venture market, wonder whether you can give any updated color on that.

Sure. One of the things people need to realize is that oftentimes when a company goes public, we may be subject to what's called -- well, you're an investment banker -- the investment banker lockup, meaning you have a 180-day lockup. And so we may be frozen from selling. So ostensibly, any IPO that takes place in Q4 we will not be able to monetize that because we're going to be locked up most likely through Q1 of 2015. So you have that phenomenon to deal with.

So a lot of the harvesting that you may see occur in Q4 just so happens to be our public holdings that we have today. Those are really freely available to trade, assuming that we hit the threshold of exit valuations that we think is appropriate. So most of that gain is going to come in the form of those preexisting public companies we have already today.

Great. Thanks, Manuel.

Thank you. (Operator Instructions)

All right. Howard, I think we're ready to do the closing comments. I think we're done or do you have anybody else in the queue?

I'm showing no additional audio comments at this time, sir.

Right, so let me do the closing comments then.

Thank you, everybody, and thank you, operator, for joining us today. We look forward to meeting with investors over the next couple of weeks. We're going to be in various conferences on the East Coast throughout the month of November.

Feel free -- you can look at those conferences on our website. If you'd like to meet with us, if we have availability, we'd be more than happy to meet with our investors at any point in time. Feel free to contact our investor relations department.

And, again, thank you for being a shareholder of Hercules, and we look forward to our conference call on the fourth quarter. Thank you, everybody.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.