Hercules Technology Growth's CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Hercules Capital, (HTGC)

Hercules Technology Growth Capital (NASDAQ:HTGC)

Q1 2013 Earnings Call

May 2, 2013 5:00 PM ET


Linda Wells - Investor Relations, Market Street Partners

Manuel Henriquez - Co-Founder, Chairman and Chief Executive Officer

Jessica Baron - Vice President of Finance and Chief Financial Officer


Greg Mason - KBW

Kyle Joseph - Stephens

Robert Dodd - Raymond James

Aaron Deer - Sandler O' Neill

Chris York - JMP Securities


Welcome to the Hercules Technology Growth Capital first quarter 2013 earnings conference call. (Operator Instructions) I would now like to introduce your host for today's presentation, Ms. Linda Wells. Ma'am, you may begin.

Linda Wells

Thank you, operator, and good afternoon, everyone. On the call today are Manuel Henriquez, Hercules Co-Founder, Chairman and CEO; and Jessica Baron, Vice President of Finance and Chief Financial Officer.

Hercules first quarter 2013 financial results were released just after today's market close. They can be accessed from the company's website at www.htgc.com. We've arranged a replay of the call at Hercules' web page or by using the telephone number and passcode 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 uncertainties surrounding the current market turbulence, and other factors we identified 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?

Manuel Henriquez

Thank you, Linda, and good afternoon everybody and thank you for joining us on the call today. I'm here today to discuss our first quarter results, discussing many corporate activities that have taken place, and to also share with you some perspective of the 2013 outlook that we have. In first quarter we delivered very strong quarterly performance and outstanding execution, as we continued our controlled growth strategy and purposely not assuming a market shift strategy. I'll elaborate on that statement further in our call.

Our preference is to remain steadfast and disciplined and in order to taking a credit, underwriting environment, and maintaining a strong credit outlook and strategy, as we look to convert our additional liquidity of over $200 million to earning assets over the course of 2013 in a very controlled fashion to lead to higher earnings and eventual dividend growth for the benefit of our shareholders. Our performance in Q1 2013 compared to Q1 2012 was very strong and marked with many of our key metrics and variables up 20% to 30% at year-over-year basis.

Our activity in general today, I will cover a brief summary of our operating performance and results for Q1. I'll discuss the current market conditions, including venture capital activities, our outlook for Q2 and outlook for the remainder of 2013, and then turn the call over to Jessica Baron, our CFO.

Let me first start by discussing our Q1 performance at a summary level. For Q1 we delivered record high total investment income of $31 million, representing a 38% increase year-over-year. We also achieved year-over-year growth of 30% net investment income of $15 million or $0.27 per share in Q1.

We also increased DNOI by 33% to $60.2 million or $0.30 a share. Because of this strong performance, our board of directors increased the dividend by $0.02 to $0.27 per share, representing 8% increase over our Q4 dividend, and our second consecutive dividend increase for benefited shareholders. This has continued to show as we convert our excess liquidity to earning assets, we will pass those benefits on to our shareholders.

On the IPO and M&A side, despite everyone dismal in IPO and M&A market, Hercules continues to pick the right winners. Having two realized exits so far in 2013, one completed IPO, Omthera, and one announced M&A event for our portfolio company Althea. Not to be left behind, we finished the quarter with five portfolio companies in IPO registration at the end of the quarter.

Now, turning my attention to portfolio growth. Also equally strong on a year-over-year basis we strength a 121% increase in new commitments over the same period in 2012, representing $224 million of new commitments. Fundings also were strong at $138 million of fundings during the quarter, which included $35 million of credit renewals from existing portfolio company. On a net basis, our portfolio grew for approximately $63 million in the quarter, basically in line with the guidance that we had shared with our shareholders during our Q4 earnings call.

We're also seeing a very interesting change in our commitments to funding ratios, and we felt that it's importation to share this with our investors and the investment community out there. Because we're taking a much more controlled approach for our portfolio growth in 2013, we expect to see a modulation downward of the ratio of fundings to commitments.

Historically, we were experiencing a 70% to 80% commitment to funding ratio, and now we're expecting that funding ratio to modulate much more in the 60% to 70% funding to commitment ratio itself. That is partly driven by our own abilities, where we're actually now enclosing or requiring much more operating milestones or testimony of achievement attraction on the early portfolio companies before making significant capital available to those companies. We're doing this as an effort to set a high bar to continue to maintain a very strong credit disciplined portfolio.

As I turn my attention to Q2 and the remainder 2013, we are guiding for portfolio growth on a conservative size for Q2 in the $30 million to $50 million level. As you'll see we have a very strong pipeline. We're doing this however, because we want to see continued performance with the early companies, as we approach the next level of financing and also to have additional one or two months of additional portfolio under our belt as we make capital available to those companies.

We also are aware and we also expect to see potential two or three payoffs to take place during the quarter of Q2 that could or may represent $20 million to $45 million in payoff, thereby if there comes a situation, would equate to a net portfolio growth, and we're doing that purposely for the time being and we're happy to asses that that in the Q&A session. Again, repeating the numbers, we're expecting $30 million to $50 million net portfolio growth with possibility of $20 million to $45 million of early payoff to take place as well.

On the credit side, our credit performance remains stellar. We continue to track and monitor credit performance very, very tightly, and we continue to focus our credit as one of the tenants of our underwriting processes. Because of that, you will see the controlled growth and under our new sphere that I'm speaking of. We have seen evidence in the vital markets and some evidence in our own portfolio of early signs of credit flare-ups. As Hercules has done in the past, when we see such signs of early credit flare-ups in the capital markets and invested capital markets, we immediately adopt a more conservative stance in order to preserve and protect our balance sheet.

Although, we have seen significant credit improvement in our Los Angeles portfolio, we continue to take a control growth in our life sciences portfolio as well.

This has helped us navigate the line of credit related issues throughout our history and remains an important part of our underwriting standards. Because we've remained on the sidelines on early-stage technology investing, we will continue to remain on the sidelines especially in lieu of the venture capital community pullback and capital allocation from the fourth quarter to the first quarter.

Although that capital allocation is something we've been expecting to remind our shareholders we have purposely deemphasized or as to say throttle back our investment activity and technology, especially to early-staged companies, because we felt that (inaudible) in particular was quite sloppy and many companies' evaluations were well ahead of their own business models.

As such we have purposely taken the approach to allow others to fill that void and vacuum or we will wait for that correction to occur in the technology private sector and then step back and make new investment activities. We expect that technologies fall-off will take place over the next 12 to 15 months at which point we will start gradually weighing back in towards technology-invested activities.

We are a taking a very negative outlook view on early-stage company investing right now and will be remaining as same for a period of time. Valuations remain very, very sloppy. We're seeing better investment opportunities investing in public technology companies that we're seeing investing in private technology companies today. We're also seeing stronger evidence of the public companies be able to secure additional rounds of financing in a much more predictable fashion than some of the privately staged venture-backed companies today.

As is in the past, and I want to reinforce again here now, we are non-interested in simply originating to have asset growth for manifestly growing assets and growing earnings. We remain very steadfast in our interest in low part earnings for our shareholders and thereby grow our dividend for our shareholders, but not without taking undue credit risk or unnecessary credit risk to achieve those goals. If that means sacrificing a quarter or chew an earnings purposely to maintain a very strong balance sheet, we will continue to adhere to that.

As a reminder to our shareholders, we are perfectly aligned with your interests. We are an internally managed BDC not an externally managed BDC, thereby we have no real incentives to simply raise capital and build our assets solely for the purpose of management fees or incentive fees.

Moving towards the balance sheet. We continue to work diligently and the framework that we have laid out over two years ago has begun to pay their fruits. Our strategic initiative to diversify and expand our social liquidity has now fully completed or near-fully completed.

To recap, back in April, 2011, we issued our first pivotal bond of $75 million that still goes unrated. During the course of 2012, we completed three senior unsecured bond offerings more commonly referred to baby bonds for a total of approximately $170 million. We then in the fourth quarter executed our first securitization of $130 million rated by Moody's A2.

And now most recently culminating before our call today we received a corporate rating from Kroll as investment grade grading for Hercules of BBB+. This was all part of the strategy that we laid out two years ago and shows you the patience that we have both in credit underwriting, managing our balance sheet and the discipline to continue to pursue long-term strategies to benefit our shareholders by securing these various credit achievements, we're able to lower our cost of capital and thereby increase our margins what's best for our shareholders and our respective portfolio companies benefit as well.

All of this culminated if you are lower funding costs that offers greater flexibility and greater liquidity to continue to pursue investor strategies when we feel that market opportunity is worth pursuing in filling those opportunity to our capital.

We're also continuing to diversify ourselves from liquidity funds by completing a recently $95 million equity capital raise. That equity capital raise was done purposely to ensure that we have optimal flexibility in our balance sheet, in our ratios to continue to leverage the balance sheet if and when needed an offer us a greater degree of flexibility as we continue pursue investment opportunities.

With that said our debt to equity ratio was approximately 95% on a GAAP basis and if you adjust out on a net cash basis, we are approximately 60% debt to equity ratio when you take out $207 million of cash. What this equates to is that we have approximately $250 million of available new investment capital that we can borrow against for our balance sheet for additional growth if we wanted to.

As a reminder and we are not moving away from this ratio, our anticipated optimal leverage-to-equity ratio with entity exemption is approximately 1.4 times. However, we have chosen to self regulate ourselves to about a 1.2 to 1.25 debt to equity ratio, which gives us an abundance of road to continue grow the balance sheet on a leverage basis if we would chose to as we continue to see good investment opportunities to capitalize in those investment opportunities.

Now, turning my attention to the portfolio exits and liquidity events from our warrant and equity portfolios. As I said in my opening remarks, we've had two liquidity events in our portfolio so far this year. Althea, is acquired by Japanese pharmaceutical company, and subsequent to quarter end, Omthera, completing its IPO debut. We also realized $3.6 million in realized gains during the quarter on three exits that we accomplished during the quarter as well.

As a reminder, and you'll see in our press release, we completed the quarter with five portfolio company and currently in IPO registration. As a comparison and based on Thompson Reuters report that came out for the same period of Q1 2013, are 25 venture-stage companies in IPO registration, I am proud to say that 20% of those companies in IPO registration today are currently Hercules companies, a testimony to this team's ability to identify and pick the right companies.

Embedded and within all the Hercules balance sheet, our 117 warrant positions that we have in venture-stage, primarily backed pre-IPO, pre-merger and acquisition companies. Those 117 companies had a value of approximately $33 million. To give you some context historically, we've realized exit multiples of 1x to 10x in our portfolio. And today I think we are averaging approximately 3.7 times multiple on those realized exits in our portfolio today.

Further as a reminder, and continue in our cautious statements, we believe that 50% of our existing warrant portfolio will never monetize in the value. And just to speculate your equations as you look to model the Hercules performance based on the one-fold that we have today.

Let me take a few seconds now to give you an overview of the venture capital marketplace and venture capital activities. Unlike the other company, I think that our investors deserve to have a true picture of the venture capital activity and not some bluffs over perspective of venture capital activities.

The venture capital community and the fund raising efforts had a pretty tremendous first quarter. They raised 65% grater amount raised in Q1 than they raised in Q4 2012. That was a 16% increase in the number of funds. Although, that fund raising efforts continues to be highly concentrated, 43 funds made up $4.2 billion of that capital raise.

As to investments, here is we saw the greatest pullback from the venture capital industry, and one that we've been expecting. In the first quarter only $6.4 billion of investments took place to approximately 750 venture-backed companies, representing an 11% decrease over the same period of 2012. Not alarming situation, but one that we want to track and monitor. Ironically the 11% decrease represents the same decrease of Q4 2012 to Q1 2013. It represents one and first quarters of investment activities by the venture capital community since Q3 2010.

Why this is important? Because if you don't have a history of lending to the venture capital community, you will seize an opportunity of lower capital being invested by the venture capitalist, and try to rush in and still not void. That is where credit losses takes place. Discipline is an important part of that process. All sectors in essence saw a decline in venture capital activities.

That said healthcare and IT still each represented 30% of venture capital investment dollars. Only two sectors experienced an increase in investment activities during the period, business and financial services and consumer goods and services were the only two sectors that saw an increase in allocations of capital.

Healthcare experienced a 16% decline in its capital received during the period of time to $1.9 billion on a 160 companies. Information technology also experienced a decline of approximately 30%, which is why we remain very cautious in technology investing, especially that of early stage companies. We think that early stage company investments, especially experience a 30% decline in investment dollars represent a very to launch risk area to the allocating capital too.

As I said business service and financial services experienced a strong surge, 41% of increase in capital deployed to approximately $1.2 billion. This goes without saying, but is simply true, Northern California continues to dominate the venture capital activities with 229 companies receiving capital making up $2.3 billion of capital investment during the quarter.

Our most recently open office in the mid-Atlantic region in Virginia also saw a very strong surge in capital deployment, seeing a 20% increase in capital deployment to $1.3 billion deployed into the mid-Atlantic region. Our Boston area office continue to at third place, seeing approximately $0.8 billion of capital being deployed into that sector. Hercules has offices in all the major venture capital centers and is well-position to continue to have a local presence, while supporting our local companies in those markets.

Venture capital exits, nothing is lost over here. M&A activities declined 24%. (inaudible) we are encouraged by, but also still higher than zero. We saw 80 successes take place during the quarter for $4.3 billion of exit activity, one of which was Hercules' companies as I indicated earlier. It is a pretty reshelling, but not something we should extrapolate much from at this point. On the IPO on the other hand, equally as a DNOI we had nine complete IPOs raising $640 million, but again as a tested liaison Hercules ability to pick companies, one of those companies was one of our company as well.

We're off to a slow start in the IPO market. I'm not discouraged by it, because it's still a slow start, but nine IPO is none the less in the first quarter is still a good growth on a year-over-year basis. As I said in the beginning of the call, we have 25 venture-staged companies in IPO registration at the end of the quarter, five of those were Hercules companies representing approximately 20%.

In addition to that we also had one of our portfolio companies filed under the JOBS Act, which is an undisclosed filing and we have two or three others that are scoring falling under the JOBS Act as well. Finally, turning my attention to the outlook of 2013 and in the second quarter of 2012, I have said earlier we expect the same quarter to be net up between $30 million to $50 million and that assumes that the early pay-offs do not necessarily benefit themselves as we had indicated earlier.

As a reminder Hercules has become the incumbent lender, always have the option to help mitigate any early portfolio runoff by matching any prices or deciding whether or not they want to adjust it's credits in order to match any company's value looking to pay us off early. It is often the case that we chose to not to do that in order to mitigate and balance our credit risk in our portfolio accordingly.

Our pipeline. Our pipeline remains very, very robust with the venture capital pulling back by $2 billion on quarter-over-quarter basis, demand for capital is unprecedented. These are exactly the times when you want to be cautious, you want to be in control and you want to make sure that you keep it steady head and mature as you're going through navigating these choppy waters and making sure that you are not cutting the quarters on credit.

We have a very robust pipeline, we're very encouraged by it, but again, we will pursue and control growth strategy purposely in Q2 and in early part of Q3. We are looking to have a back-end loaded year for 2013 purposely so. That said, we have over $179 million of science services in this quarter so far that are expected to convert the science services.

For the outlook for the year we're expecting to see a $500 million to $700 million of total growth commitments for the year. As I said, we will adjust that number as the year progresses but right now the confidence level of $500 million to $700 million is quite strong as you'll see in the press release of the deck tables we're already had a $423 million commitment for the year, just what we have in-house today.

In summary, we continue to execute across all business lines and I'm very pleased with the performance of this organization and this team, first on the credit fund, originations fund and picking the right companies, right yield liquidity and M&A events.

We remain very cautious, I know mostly you have now been with us quite a long time and you understand when I adopt a cautious and steady approach it is, one, because it is prudent and one that has worked for us well in the past. I may be being a little over conservative, but I think it's a right strategy to do and continue the net portfolio growth as we've done.

We continue to look to deploy our ample liquidity on our balance sheet. As a matter of an anecdote, if you look at the conversion of our cash liquidity on the balance sheet of $200 million, you would actually see an earnings acceleration of anywhere between $0.50 and $0.20 an earnings, despite deploying the access liquidity we have in our balance sheet.

I can assure you align a net interest but only if it makes sense from a credit point of view. We expect to do that and continue to convert our actual liquidity to earnings assets, but only if it makes sense.

With that, I'll turn the call over to Jessica.

Jessica Baron

Thanks, Manuel, and thanks everyone for listening today. I'd like to remind everyone that we filed our 10-Q, as well as our earnings press release after the market close today. I'll briefly now discus our financial results for the quarter ended March 31, of '13.

Turning to our operating results, we delivered a record total investment income or revenues of $31 million, an increase of 38% when compare to the first quarter of 2012. This year-over-year growth was driven by higher average outstanding balances of yielding assets.

As Manuel mentioned, the GAAP effective yields on our debt investments during the first quarter was 14.3%, excluding the income acceleration impact from early payouts and one-time events, the effective yields for the quarter was 13.8%, up by about approximately 20 basis points relative to the previous quarter.

On a quarter-by-quarter basis, borrowing any notable trends upwards or downwards in yields having a spring of 20 to 30 basis points in yields is reasonable and is expected. Interest expense and loan fees were approximately $8.7 million during the first quarter of '13, as compared to $5 million during the first quarter of 2012. The increase is primarily related to interest and fee expenses related to the $170 million of baby bonds issued in April and September and the $129.3 million of asset-backed notes issued in December, partially offset by a decrease in interest and fees related to our refinancing of approximately $50 million and SBA debentures as transpired over the course of the last year.

Our weighted average cost of debt comprised of interest and fees was approximately 5.9% for the first quarter of 2013 versus 6.8% during the first quarter of '12. The lower weighted average cost of that is primarily attributable to once again, as of refinancing of $50 million of debentures with interest rates increasing from 6.4% to 6.6% with the same total new debentures with an interest rate of 3% to 3.1%.

In addition, the cost of debt of our Class A notes issued with our securitization in December was 4.2% bringing our total cost of debt down.

Offering expenses for the quarter totaled $7.2 million as compared to $6 million in the first quarter of '12. The increase is primarily due to increased headcount, variable compensation accruals and the amortization of stock based employee awards.

Q1 of '13 net investment income was $15 million compared to $11.4 million in the first quarter of '12, representing an increase of approximately 31.5%. Net investment income per share was $0.27 for Q1 of '13 as compared to $0.24 for the same quarter ended 2012.

Our net unrealized depreciation from our loans, warrants, and equity investments for first quarter was $1.7 million, driven by $5.7 million of depreciation from a collateral base impairment in one of our technology company's, partially offset by $4.8 million of appreciation, which was due to market yield adjustments in fair value determinations.

Our net realized gains for the first quarter was approximately $2 million. We recorded realized gains of approximately $3.6 million from the sale of equity and warrant investment in three portfolio companies, which was partially offset by a liquidation of investments in five portfolio companies of approximately $1.6 million.

Our net asset value, as of March 31, was $15.6 million or $10 per share compared to $9.75 per share as of December 31 of '12. We've seen significant growth in our portfolio over the last year, as a result of our debt investment origination activities.

We ended Q1 of '13 with total investment assets including warrants and equity at fair value of approximately $968 million, an increase of $273.5 million or 39.4% from a year ago, reflecting continued growth in net new originations and a recent ebbing of portfolio company early repayments. We note again that earlier payments are very hard to predict. As Manuel mentioned, earlier we could experience anywhere from $20 million to $45 million of total earlier payments in that second quarter of 2013. Our debt portfolio ended the first quarter at $881 million at fair value, an increase of 43% year-over-year.

I'll remind everyone that amortization typically to (inaudible) after nine to 12 month interest-only period on our term loans and is scheduled to occur over 36 to 42 month timeframe. Given the recent growth of our investment portfolio approximately repayments, we now model $30 million to $35 million for normal principal amortization per quarter.

Moving on to credit quality. Our loan portfolio of credit quality remains excellent. The weighted average loan rating on our portfolio was 2.03 as of March 31, reflecting a slight improvement from 2.06 reported at the end of 2012. Into the investments on non-accrual, at the end of the quarter, one with the fair market value of approximately $5.6 million and a cost of interest $10.4 million and one loan with no fair value and a cost basis of approximately $350,000.

Now, on to liquidity. At the end of the first quarter, we had approximately $312 million of available liquidity, including $207 million in cash and $105 million in credit facility availability. Our high cash balance was largely driven by the late quarter and March '13 timing up for $8.1 billion share offering for proceeds at approximately $95.8 million.

As a result of this offering we anticipate a one to two dilutive impact to earnings of $0.02 per share and have to put the additional capital to work. We remain committed to our long-term growth objectives and this capital raise is not only accretive to book value, but would also begin to pay dividend to our shareholders in the form of additional investment portfolio yields in your future.

In closing, the first quarter was a strong start to 2013. Manuel mentioned, we continue to take a cautious and steady approach to on boarding new assets in the second quarter. We remain optimistic about the venture debt market opportunity and our ability to grow our investment portfolio as well as earnings and dividends for our shareholders in 2013.

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

Question-and-Answer Session


(Operator Instructions) Our first question or comment comes from the line of Greg Mason.

Greg Mason - KBW

Manuel, you've talked about the market being pretty sloppy. Are you seeing changes in terms, for example interest-only periods or milestones, covenant changes? What are you seeing embedded in the new debt market?

Manuel Henriquez

Well, certainly we're seeing a bit of frostiness and it's not silliness going on at early stage deals in tech deals and just to give people some solidify comment, firstly, the early-stage exposure is probably less than 1% to 2% over our portfolio and we remain on the sidelines now for probably 24 months in that area.

But the level of silliness going on in early-stage deals and technology deals is to the point of being out of control. We're seeing elongated interest-only periods. We're seeing loosened at the terms, all of which we've decided not to participate, not to play purposely in that area. And we should have waited out, but it's just getting to the point of being silly.

Greg Mason - KBW

What about in the middle stage and later stages. Are you seeing on economical terms or interest-only periods?

Manuel Henriquez

No, we're not seeing that much. Just to remind some of the listeners here, the venture industry could be divide on two very similar barbells. You have early stage deals, which are basically backing a venture capitalist and I guess the cash balance or cash deposit. And on the other side of barbell, you have more of lower market kind of ABL lending activities.

The center part of that market that center chasm is where we operate in. It's a very, very pictorial situation to be in, but you have to have a team of underwriters and not just business development people, but a team of underwriters who actually understand technology trends or life sciences trends in order to underwrite that credit risk. And as has always been the case for many, many years, as new entrance way into that segment of the market, they'll eventually lose a couple hundred million dollars pretty easily, and then eventually pull it back. And so that segment of the market is not yet that profit yet, because very few people are willing to necessarily go into that area.

Greg Mason - KBW

And then one more and I'll hop back in the queue. It looks like that the one credit issue you had in the quarter UPA's holdings, can you talk about that? And what's the prospect there for any type of recovery or potential future deterioration?

Manuel Henriquez

I think as a future deterioration, look we can't talk something that they assume like that they're on their own. And the good news is that a big loan and still exposure to less than $10 million. It's been written down to a level that we feel very comfortable from recoverability point of view. The company is an interexchange (inaudible) carrier. Sorry, I'll make it easy. It's a telecommunications company. And they were going to telecommunication sector and retariffing is one of the issues that caused the margins to change in that company. So it's going through a reassessment of business model related to retariffing and interexchange related cost as enhance our calls to one carrier to another carrier.


Our next question comes from the line of Kyle Joseph from Stephens.

Kyle Joseph - Stephens

You had a $0.03 2012 dividend spillover income, if I recall, since you out earned or since you earned, you have roughly out earned dividend in this quarter, do you still have all of that or was that a portion of this quarter, this dividend?

Manuel Henriquez

No, I think that we still have that and it rather reflected on per cent stages. I think that when you look at the capital rates that we just completed that $0.03 on a weighted basis, the new 8 million shares that we just issued, it's just becoming about $0.022 spillover, if you will. So we still have that. And we've showed and we keep that in our back pocket, until we see how the year progress. So if the year progresses the way we think it will, it is high and likely that could have additional spillover for the benefit of our shareholders or board can opt to further increase the dividend in Q2 and Q3 and beyond. And actually that reserve is still there.

Kyle Joseph - Stephens

And then so going back to competition and we saw 20 bps of yield expansion this quarter, and I know Jessica mentioned 20 bps here or there may happen in the quarter. Do you see competition change it all and has your kind of forecasted yield changed at all. Do you expect kind of yield compression going forward, stability, what are your thoughts there?

Manuel Henriquez

So I'm not aware that many companies will talk about the same breadth of seeing increased competition, while at the same time seeing yields going up. I think it's a testimony to our continued focus on our credit quality, disciplined underwriting and a steadfast disciplined approach to underwritings. So we're less concerned about just reasoning to originate. And this is why you saw our yields actually go up during the quarter.

I think that what we're saying is and I'll repeat it again, that for us to see yields go up or down 20 to 30 basis points is not untypical. And we made that that same forecast in Q4 to Q1 that we thought we'll see a 20% swing in our yield by 20 basis points. I will say it again in Q2 that yield could go up by 20 basis points or down by 20 basis points in the quarter as well. Right now, by remaining disciplined what we're doing, I don't think that will fully come to roost that we'll see that 20 basis point swing in dividend yields, but it's something that could happen. But at this point we're being conservative.

Kyle Joseph - Stephens

And then a few modeling questions, it look like despite it was a very active quarter, but fee income came down q-on-q, is this quarter a good run rate to you as going forward?

Jessica Baron

I think that's a fair estimate as a percentage of our total assets outstanding. There wasn't any atypical events during quarter.

Manuel Henriquez

Kyle, I'll make this quarter from a forecasting point of view, as Jessica just said, more stable. It's probably one of the cleanest quarters that we've had in terms of minimizing early payoff. So it's a more pure reflector of our fee income on a sustained basis. But as I'm sure you're aware of, early payoffs will cause that number to spike either way. And it will spike depending on the maturity of the credit. If the credits are older on our books, then the impact on fee spiking is a lot less; if they're newer credits, they payoff early, you'll see a higher percent of fee income.

Kyle Joseph - Stephens

And then for the asset-backed facility, can we kind of expect that to amortize on a straight line basis or is that all going to just depend on the maturity that the loans backing out facility.

Jessica Baron

Yeah, that is true. I mean, I think your best guess and best effort is to model a straight line amortization, but bear in mind if there happens to be a pay-off of one of the assets in that collateral pool, it will result in a dollar-for-dollar reduction as a securitization balance or at least as per the advance rate of 65%. But I think it's prudent to model it as a straight line amortization.

Kyle Joseph - Stephens

One more and I'll get out of your hair. I know you guys got your investment grade rating today. Have you thought about having institutional debt market? So we saw one BDC do it recently. Have you guys looked at going down that path, not that you need that but?

Manuel Henriquez

Couple of a factors there. We got a Kroll before we run. We were very honored and happy to see Kroll who did an incredible amount of work of understanding the BBC model in particular and more importantly understanding the venture debt model, who took the time and effort to do that. We're not unnecessarily contemplating immediately going on and doing a deal. We just got this credit rating today. It was a surprise to us. We're happy by it. And I think we've kind of digested and look at our capital planning. But certainly leveraging the balance sheet further is one of our goals and one that we'll continue to pursue.


Our next question or comment comes from the line of Robert Dodd from Raymond James.

Robert Dodd - Raymond James

First one, real simple one. Just want to get a click because I think I read it down, on the origination expectations for the quarter, did you say 30% to 50% net or is it 30% to 50% in the net off 20% to 45% in repayments?

Manuel Henriquez

Yeah, so you did not read it wrong and let me take this opportunity to remind people why we're saying that. It's for those who've been with us for a while. Hercules had historically amortization rate between $20 million, $25 million of normal amortization that was taking place. And the last half of 2012, that number increased up to about $25 million to $30 million of amortization that was taking place in the portfolio.

Now other is portfolio is larger and if portfolio is maturing, you will now see that number on normal amortization be in the $30 million to $35 million range. So just waking up in the morning, we have to originate $35 million dollars to stay even with the normal amortization taking place.

On top of that, it is often the case that some times we get heads up that we may have early pay-offs. When you have early pay-offs, for example, say $35 billion, that means you have $70 million of net portfolio that's being paid off, they have to replace. So the net $30 million to $50 million increase already absorbs that $35 million of increased amortization that's higher. If we were to see a $20 million to $40 million pay-off that will take place that $30 million to $50 million number will in fact go down, but we expect that if it occurs and again, it's a big if. If it occurs, it will most likely be at the end of June time period, if it does at all.

Robert Dodd - Raymond James

Coming back to the fee question, obviously, I mean there is the fee line and then obviously there is embedded accelerated amortization point. Looking at the distinction between the 14/3 and the 13/8, am I right, coming around, there is about a million dollars ballpark of accelerated fees in the interest income line that won't occur unless you get the early repayments obviously.

Jessica Baron

It's pretty easy to model taking like the way that you should have purchased by looking at the effective yields with and without acceleration. And the method is how you can back into what the decline was quarter over quarter in early pay-offs, that's correct. Bur bear in mind, as Manuel, mentioned earlier that it's all a matter of where the deal maybe in its life span with respect to the magnitude of the acceleration.

I mean it is a factor there as when we originate the investment, we will from time to time have a discussion about taking a trade off between fees and interest yield, so that all factors into the magnitude of the acceleration. Like I said, it's really more a function of this specific investment that are paying us off, that's really function of the volume of pay-offs, which occur quarter-to-quarter, that's why we kind of broke the record about the difficulty in predicting what the acceleration impacts maybe.

Manuel Henriquez

And also, Robert, to you question because we may have some idea of which credit may paying us off, sometimes we simply have a anonymous comment where it's $20 million to $30 million that may occur unexpectedly. If the credit is now only 24 months of maturity or outstanding with us, that the acceleration will be de minimus as compared to a company that may be on book fully six months and pay us off earlier.

Robert Dodd - Raymond James

Two other questions. Sequestration, looks like it's been normal event for you, frankly, especially since you've got more companies filing IPOs, more ways with the jumps at as well confidentially. I mean has there been any impact at all and do you expect any feature or is it just brought over and it's just not going to affect you.

Manuel Henriquez

Well, I hate to say this, it's like a Congress Act or something, but honestly, it's been somewhat a big yawn.

Robert Dodd - Raymond James

Last question, pricing environment, kind of following up. I mean, either one of your big bank competitors in this space is too old so talking up just the other day that net interest margin expectations. So I mean, you didn't sound too confident that you'd expect the expansion to maintain this year, but I mean, so the thing we're hearing some other guys in the space. I mean, just trying to ask about the quarter a little bit more on kind of really how confident you are that you're going to be seeing expanding March, at a signing interest March?

Manuel Henriquez

Let me be very clear this comment, because if the extrapolation was that I'm somehow concerned of people that surely in the wrong message I will broadcast. I am very confident in the market that we're seeing. We're seeing unprecedented demand for capital, unprecedented. And with that it is our underwriting streams has to become tighter because as you're getting more deal volume through just because you have low hanging fruit, does not mean you should execute or fill that order or pick that fruit.

So what we're doing is we're being a much more judicial when we're seeing an increasing demand of capital that we maintain that ratio kind of skinning the upper cream of all the opportunities we're seeing out there. With that discipline, you will see us continue to have that $500 million to $700 million growth and growths commitment, which will be up from 2012. If you look at the chart that we have in our earnings release today, you'll see here on Page 8 of our earnings release, that on a year-to-date basis with the science terms already, we're at $423 million of commitments.

If I am guiding to a $500 million to $700 million and I still have approximately, you can call it six to seven months of rest of the year, that's a pretty bogie, that's a pretty easy bogie for us to hit at the $500 million or $700 million down level. So I am not worried about hitting the growth numbers, I do worry about the credit quality, I do worry about the mix, which will absolutely skew my effective yields that we're on it. If I wanted to really capture market share, I could lower our yields by 150 basis points and actually originate a lot more transactions. I don't think that's prudent and I think that continuing disciplined in underwriting is the right strategy. And if I lose a $100 million of deals in a quarter, so be it.


Our next question or comment comes from the line of Aaron Deer from Sandler O' Neill.

Aaron Deer - Sandler O' Neill

Manuel, just kind of following-up on your general comments with respect to that lending market, I guess it sounds like there still a lot of opportunities out there that you maybe just pulling back some from maybe you've mentioned a private tech companies. Given that are there other lending verticals where you're seeing increased opportunities and where you're pushing a little harder into?

Manuel Henriquez

We are and for competitive reasons, I am not sure I want to initially show that right now because we're seeing some new voice spaces that are available out there that others are not capitalizing it right now. And I intend to go where all suddenly crowds are going. I go to the other direction. And I think the crowds are off slightly to early-stage tech and we've been running away from early-stage tech for quite sometime now and we'll continue to do weighted out in that category.

But I will tell you that this is why my confidence level in our $500 million to $700 million origination number, I am not wavering on that whatsoever. So you'll see a cycle of the different sectors, but I am not at all concerned about origination activities, I just want to make sure that we don't overspend or make sure we don't just be sillier or sloppy at the last finish simply to get assets of the books. But we are seeing some good new voice spaces to go after.

Aaron Deer - Sandler O' Neill

And then, just kind of if you have the number handy, but do you by chance have the weighted spot grade of your debt at March 31?

Manuel Henriquez

The aggregate?

Aaron Deer - Sandler O' Neill


Manuel Henriquez

I want to say it's on weighted base, I think we're at 520 or 475 on overall, but we'll get that for you, we don't have it right here available just, but I think last when we looked it, its some more in the mid-fives. I think we're in the mid-fives on a weighted base, with securitization and everything else.


Our next question or comment comes from the line of Chris York from JMP Securities.

Chris York - JMP Securities

My question is on the portfolio and the market environments have been asked. So I will turn to my second question, which includes two components. First, how many employees did you end the quarter with? You already referenced in your prepared remarks that you increase headcount. And then secondly given that originations should remain healthy throughout the remainder over the year, do you need to add an investment officer or two or can you utilize your credit investment officers more?

Manuel Henriquez

We ended the quarter in approximately equity equivalent about 60. We are in fact actively, which gives you reinforcement of my optimism. We are actively looking to add headcount. We actually have the total of approximately three to five over vivacious all origination teams, which tells you the deal volume that we're seeing and opportunities that we're seeing in the marketplace. So we're actively doing that. However, we hire like we invest. We take our time. We're very disciplined. We're very methodical about it. And we want to make sure we make the right hires, because a wrong hire could translate into $20 million of credit losses, and I am not losing money, so we will take a very controlled approach to hiring. So we are actively looking to hire more people.

Chris York - JMP Securities

And then, I think previously you stated if you brought on an investment officer, it would take them arguably maybe six to nine months to get up to speed with Hercules platform. Is that somewhat reasonable of an expectation for new originations out of this investment officer?

Manuel Henriquez

That is absolutely correct. We tend to invest in our people that we will allocate a learning curve of a minimum of six months and generally nine months to have that individual become a productive individual, and understand our underwriting methodologies. Again, we don't simply hire somebody and expect them to get out of the box and be originating exits right away. We rather have them be knowledgeable, and how we underwrite and be controlled that how we underwrite. And that will remain the case. So, yes, we're very methodical and very modulated on expectations on a hire for at least six to nine months.

Chris York - JMP Securities

And then lastly, so the potential investment option that you might add, are they in a specific sector? And then are you looking for them to potentially bring on new relationships that you guys don't have, is there an area there that you might want it for?

Manuel Henriquez

The good and bad news is that this whole company is made of a population of individuals from the venture capital industry and the commercial banking industry, private equity and operational background. We don't really love pure commercial bankers and we don't initially purely love pure venture capitalist. You really want to have the background experience at both of those fields. And you want to have a strong technology with life science or other technology background. So it takes a while to find that skill set in that individual that we're looking for and the personality trace that we're looking for.


Our next question or comment is a follow-up from Mr. Greg Mason from KBW.

Greg Mason - KBW

I have one follow-up on the two exits post quarter. Althea I believe is marked around $4.2 million fair value at quarter end. Is there any kind of material difference between that fair value and what you exited? And number two, Omthera, I actually couldn't find that in your portfolio, is that under a different name in your portfolio?

Jessica Baron

Althea is marked to the acquisition price. So that should represent the realized gain we'll see in Q2, once the proceed come in. And with Omthera that investment closed for us, we signed our commitment with them at the end of the quarter. It just so happened so that the warrant agreement was executed at the beginning of April, and that's why you do not see that in our schedule of investments.

Greg Mason - KBW

So would it be the pricing of your warrants, would it be reasonably close to that $8 IPO price?

Jessica Baron

I don't know the specifics of the pricing of the warrant.

Manuel Henriquez

I think we gave this as public within the SEC filings. But I hope you don't take this wrong way, with the 117 portfolio company, 91 one, non-positioned. My ability to have the specificity on each warrant is no longer there.


I'm showing no additional questions and comments in the queue at this time. I'll turn the conference back over to you.

Manuel Henriquez

Thank you, Operator. I thank everyone for your continued support and interest in Hercules Technology Growth Capital. I want to remind our investors and investor community that we'll be presenting at three conferences in the coming weeks here. We have the JMP Conference on May 13; we have the Wells Fargo Conference in New York City, on May 16; and we have the Stephens Spring Conference in New York City, on June 4.

We will be meeting with investors throughout those conferences as well as participating in non-deal roadshows and we'll circle cities around the country. If you have an interest and because you're meeting with us, I would encourage you to reach out and contact our shareholder relations or Investor Relations Department. And I'll just say thank you everybody for your continued support and believe in the Hercules team, and what we've been doing here at Hercules. Thank you very much and have a good day.


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

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