Hercules Technology Growth Capital's CEO Discusses Q1 2014 Results - Earnings Call Transcript

May. 1.14 | About: Hercules Capital, (HTGC)

Hercules Technology Growth Capital (NYSE:HTGC)

Q1 2014 Results Earnings Conference Call

May 01, 2014, 05:00 p.m. ET

Executives

Jessica Baron – VP, Finance and Chief Financial Officer

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

Analysts

John Hecht – Stephens.

Greg Mason – KBW

Ron Jewsikow – Wells Fargo

Aaron Deer – Sandler O’Neill & Partners

Chris Yolk – JMP Securities

Finian O'shea – Raymond James

Douglas Harter – Credit Suisse

Andrew Kerai – National Securities

Operator

Good day, ladies and gentlemen. Thank you for standing by and welcome to the Hercules Technology Growth Capital First Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded.

I would like to turn the conference to our host, Miss Jessica Baron. Ma’am, you may begin.

Jessica Baron

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

Hercules' first quarter 2014 financial results were released just after today's market closed. They can be accessed from the company's website at www.htgc.com. We have arranged for a replay of the call at Hercules' webpage 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 comprising 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 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 can also 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 these 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' Co-Founder, Chairman and CEO.

Manuel Henriquez

Good afternoon, everyone and thank you for joining us today on the call. I like to start by once you are going to attempting to make this call more [sync] in our prepared remarks and focus on the key highlights. I tried that in the first and fourth quarter and that’s going to work as quite as well -- so like it so I’m going to try it again today.

So I will try a new format to try to reduce our reputation of the information release in our earnings first release and then allow for greater time for Q&A for the investors on this call and participants on this call. With that, I please encourage everyone to send us feedback on this call and I want -- continue to improve this call and then moves us on a forward basis for the benefit of our investors.

So as of today, the agenda I want to speak briefly about our operating performance for Q1, 2014 an overview of the current market conditions, including - capital activities and IPL and M&A activities, our perspective or outlook for investment activities are key to and investor 2014 and then I will turn the call over to Jessica Baron our CFO who will go into the financial details and results of our performance for the first quarter 2014.

Highlight of operating performance of Q1. The first quarter was outstanding start for a great year 2014. We delivered a healthy growth in earnings increased the credit quality of our invested portfolio while maintaining a high degree of credit outlook and performance in our credit portfolio, recognized some significant gains from our existing 110 plus -- positions during the first quarter.

We achieved a solid performance of approximately 22% year-over-year growth in net investment income of approximately $18.3 or $0.30 per share. We also increased the first quarter DNOI by approximately 23% year-over-year to $19.9 million or $0.33 per share.

Net commitments were also robust at $156 billion while fundings were also equally strong at approximately $112 million for the first quarter of 2014. We also achieved an impressive showing for IPO access during this quarter with five Hercules portfolio companies completing their IPO debuts in the first quarter 2014, which is a great testimony to our investor professionals and identifying their right companies in which to invest in. In addition, I am very happy to report that we have chosen to begin the deployment of our access liquidity offer -- of nearly $225 million in cash into new interest earnings investment.

Although this process has just begun in the second quarter of 2014, we do not expect to see it to impact to our earnings growth until the second half of 2014 and certainly do not expect to see much impact in Q2 2014 earnings as most of the new investments are expected to close at the end of the quarter and fund at the end of the second quarter.

I am also very encouraged and we anticipate that the portfolio will grow in the second quarter by approximately to $20 million to $40 million up and early or unanticipated pay-offs during the quarter to continuously decline and decline to a level of $17 million to $18 million in our current forecast what we know today excluding the -- amortization of approximately $35 million. The punch line of that ball point is we expect $20 million to $40 million up in growth in the portfolio in the second quarter. We also expect to continue to deploy nearly – excuse me, we also expect to continue to deploy our excess reporting of [$229] million in cash on a more aggressive pace in the second half of 2014 and we expect to convert at least $150 million to $200 million of this $225 million into new interest earning assets as we turn to the second half of 2014 and more heavily weighed in the fourth quarter as it has been historically due to seasonality on the investment activities.

We also declared a $0.31 dividend per share in the first quarter consistent with the prior dividend declared in the fourth quarter. This represents our 35th consecutive dividend since interception. Now, let me turn my attention to liquidity events in our portfolio. As I indicated earlier, we had five completed exit in our portfolio between M&A and IPO events. On the IPO front as I indicated earlier, we had five completed our public offerings in the first quarter of 2014 and we finished the quarter with approximately four companies covering the IPO registration of which one completed its additional IPO post the end of the quarter. Despite the recent and (indiscernible) collection in valuation, many of you may recall that the last two quarters Q3 and Q4 we have been advocating caution regarding the tax valuation that exist in the market place, subsequent to this period of time, we’ve now seen the unfortunate but anticipated correction in valuations that most technology companies of Life Science have experienced to 25 to 30% decline in valuation. This actually bodes well for our business as demand for capital has actually increased due to the cooling of the IPO market as of late.

Now turning my attention to M&A. We have three completed IPOs excuse me, we had three completed M&A events during the first quarter. This actually helps to reinforce our continuous selections of the right companies and continue liquidity within our portfolio itself. Now let me turn my attention briefly to the venture capital activity.

In the first quarter, the venture capitalist invested a incredibly – very large amount of $11 billion by the venture capitalists well in access of my own anticipated forecast for the first quarter of 2011. This data provided to us by Dow Jones VentureSource of the $11 billion Dow has invested 860 companies benefited from the new capital invested by venture capitalists. This represents an 18% increase over capital deployed over the same period last quarter.

In terms of access, IPOs to begin with. An astonishing and impressive first quarter of 2014 IPO activities with 38 companies completed an IPO offering raising a whopping $2.9 billion of capital. What makes this so important is, this is the highest level of IPO activities that we have seen since the third quarter of 2000, and that is 2010 -- IPO offering. IPO highlights of the 30 IPO offerings, five of those were Hercules portfolio companies during the quarter. As I indicated earlier, M&A activity was also robust and also very impressively strong for the quarter. We saw 119 companies’ complete M&A events during the quarter garnering $19 billion in valuations. Not to be left behind with the IPO also the highest M&A recorded since the Q3 of 2000, where $238 million in valuations were realized during that period of time.

Finally venture capital fund raising activities, also very impressive number. The venture capitals raised $9.6 billion to 73 new venture capital funds. This date is important because it gives us ability to look at the longevity and durability of the venture capital investment activities on a go-forward basis which represents a primary source repayment in much of our dead investments into innovative venture capital backed companies.

Now, turning my attention to our outlook for Q2 and the remainder of 2014. We -- making many critical changes to our organization as we set the foundation to our next ten years of growth. Having recently completed our ten year anniversary culminating in a tremendous accomplishment for our investors in their commensurate ten year period of time, we actually took a deep evaluation of how we have done our business over that ten year period of time and look to make changes to ensure that we are in the proper setting for the next ten years of our growth.

As expected, many of these changes manifest itself and continued into generating high quality invested portfolio and more importantly increased our income generation by seeing earnings growth which should translate into higher dividend growth for our shareholders. We have made a conscious decision to make investments choices to accelerate our investment pace and actually convert much of our liquidity in our balance sheet into interest earning assets.

Part of this innovation of our own company is very much like our own portfolio companies due everyday. We are looking to take a different approach on how we have done business over the last ten years. We are doing this for multiple reasons. Many competitors have entered into this space much of which are doing the investment activities I mentioned that we deem to be incorrectly and will eventually have to do only credit challenges in the market place. We want to remain the leaders in the asset class and we want to be the leaders and innovating on continued offering new invested vehicles and invested products for portfolio companies and to drive earnings growth for our shareholders.

With that said, we are targeting portfolio growth of approximately 20% to 25% over 2015 and 2014 and hope to finishing with an investment portfolio by the end of the year at approximately $950 million to $1 billion subject of course to market conditions remaining robust. This represents as I indicated a 20% to 25% increase over the invested portfolio currently of approximately $800 million today. As we focus on this portfolio growth and earnings growth we expect our overall yields to gradually compress as we continue to build earnings in our portfolio compressed by approximately 30 to 50 basis points per quarter as we convert our access liquidity into interest earning assets. This is a significant competitive advantage that we have in the market place by being able to use yields to our benefit without compromising credit quality given the robust high levels of yields that we have accomplished historically and continue to see in the market place today.

As a result, we believe this will drive additional four to six sets in quarterly earnings in the second half of 2014 as we continue to deploy this liquidity over the second half of 2014. As with May 1st, the pipeline it remains very robust. We have over $1.2 billion of transactions in the pipeline today of which $171 million of that is represented by signed term sheets today giving you some very good visibility for continued portfolio growth, however I have done many times in the past, not all signed term sheets will convert into earning assets and not all signed term sheets that – will convert to commitment that will actually fund. As part of this environment we have increased the use of milestones in our commitments and therefore we do not expect immediately for our commitments to translate into earning assets. We will remain optimistic if these companies achieve the milestones of which we establish those unfunded commitments should begin to convert in the second half of 2014.

So far in the first quarter, excuse me so far in the second quarter 2014, we have closed $60 million of transactions already and funded $27 million of that which is represented of the comment I just shared with your earlier that the funding rate [issues] to commitments for funding will continue to lag driven in part by our own risk mitigation strategies. We have signed as I said earlier -- dollars of signed term sheets that we expect to close and convert into earnings assets over the next two to three quarters translate that into higher increased earnings as I indicated by $0.03 to $0.04 as we continue to deploy our liquidities.

We finished nearly with a $190 million of unfunded commitments. This is a very significant number and a very important number. This unfunded commitment number also gives us visibility and strong visibility into future earning assets that would convert upon the drawdown of our unfunded commitments in the second half of 2014. We are quite optimistic and we’re very-very bullish on our outlook now that much that we’ve been anticipating on a frostiness valuations have taken place and we are seeing an increased demand for capital as we look to deploy that capital for the benefit of our shareholders and increase earnings.

With that, I will turn the call over to Jessica.

Jessica Baron

Thanks, Manuel. I would like to remind everyone that we filed our 10-Q as well as our earnings press release after the market closed. I will briefly discuss now financials for the first quarter 2014.

Turning to our operating result, we delivered total investment income or revenues of $35.8 million, an increase of 15.5% when compared to the first quarter of 2013. This year-over-year growth was driven by increased interest income from higher average asset balances outstanding and due to a repay off. We also reported increased income attributable to the early path as I noted which totaled $89 million during the first quarter.

Note that our period and debt investment balance on a cost basis is $887.7 million a decline of $18.6 million from our 2013 year on balance. The all end and effective yields of our debt investments during the first quarter was 17.9%, approximately up 280 basis points relative to the previous quarter, this increase is primarily due to the fact of the restorations that early past as well -- restructuring.

Interest expense and loan fees were approximately $9.2 million during the first quarter of 2014 as compared to $8.7 million during the first quarter of 2013. The year-over-year increase is primarily attributed to the separation of the amortization related to the early path of the $34.8 million of SBA debentures and due to the paydowns of $26 million of our fixed securation of during the quarter.

As a result of these the amortization has been targeted by reductions and liabilities the way -- of that increased to 6.9% in the first quarter ’14 versus 5.9% during the first quarter of 2013. Operating expenses for the quarter were $8.2 million or compared to $2.7 million in the first quarter of ’13. This increase reflects the [turbulence] due to an increase in full time headcount from 331 ’13 to 331 ’14 and due to restricted stock years investing attributable to higher share count and award their value.

In Q1 of 2014, net investment income was $18.3 million compared to $15 million in the first quarter of 2013, representing an increase of approximately 22%. Net investment income per share was $0.30 for the first quarter of ‘14, as compared to $0.27 for the same quarter ended 2013.

We recorded approximately $1 million of net unrealized appreciation from our investments during the quarter. We recognized $7.4 million of depreciation due to (indiscernible) impairments on that investment with your portfolio companies. We also recorded $9.7 million of depreciation to – previously realized unrealized appreciation on investments that were sold during the quarter. This was offset by $16.1 million of appreciation due to market yield adjustments for other fair value determinations.

Our net realized gains for the first quarter was approximately $4.9 million. We recorded $5.4 million of growth gains from the sale of warrant and equity of investments in five portfolio companies. These gains were offset by approximately $0.5 million in warrants and….

We ended Q1 of 2014 with total investment assets including warrants and equity at half basis of approximately $887.7 million. This was met down by $18.6 million from our investment portfolio accounts of $106.3 million as of December 31, 2013. The first quarter portfolio defined on a comp basis was above the principal and debt repayments of $132.6 million, $1.8 million of same store issue due to early pay offs and $2.7 million of reductions due to sale and write off of investments. These reductions were offset by approximately $114 million of new debt equity and warrant additions to the portfolio as well as $4.6 million in net fee accretion.

I like to remind everyone that amortization typically [commensurates] nine to 12 month after an interest-only period we have on our term loans and the amortization that is scheduled to occur over 36 to 42 month timeframe. Apart from early repayment, we currently have scheduled amortization of $30 million to $40 million on our portfolio on a quarterly basis.

Moving on to credit quality. Our loan portfolio of credit quality remains very solid. The weighted average loan rating of our portfolio was 2.05 as of March 31, 2014 reflecting an improvement from 2.02 reported at the end of Q4. We had three investments on non-accrual at the end of the quarter, with the cost basis of $24 million and the total fair value of $7.7 million representing less than 1% of the total investment portfolio of fair value.

Turning to liquidity. At the end of the first quarter, we had approximately $329.5 million in available liquidity, which included $225 million of cash and then $105 million of credit facility availability. As of March 31, our bet to equity leverage ratio including our stated ventures was 76.1%, lower than 85.8% as of December 31, 2013 due to the SBA debentures in asset back note paid.

As a reminder, $119.2 million of this SBA debentures that are outstanding are excluded for regulatory leverage calculation. The exemption effectively allows us to lever beyond the one to one debt to equity ratio to 1.29 to one which means that at the end of the first quarter we had additional capacity at $350 million of leverage to our balance sheet.

Our net leverage, which is calculated, based on total debt minus cash is approximately 41.7% at the end of March. Our net asset value at March 31st was $653 million, or $10.58 per share compared to approximately $650 million or $10.51 per shares as of December 31.

Finally, in the first quarter we’ll be distributing a dividend of $0.31 to our shareholders and the same is scheduled for May 19. The first thing as Manuel mentioned, we continue to take a cautious and steady approach to on-boarding assets in the second quarter of 2014 and beyond. The specs are -- portfolios to be up approximately $20 million to $40 million in the second quarter. We remain committed to our share view of controlled growth and we intend to continue to apply a stringent underwriting standard which has resulted in our first quarter solid performance and our first tenure solid performance.

So with that operator, we are now ready to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question in queue is from John Hecht of Stephens. Please go ahead.

John Hecht – Stephens

Afternoon guys, thanks very much. Forgive me if you mention this because you did have a lot of figures in the presentation here, ex the prepayment and other related fees what would normally yield to bend in this quarter and what are trends there?

Jessica Baron

Yeah our effective yields for the quarter were slightly down on a normalized basis relative to the previous quarter. There wasn’t a fundamental material change in that, in that number.

John Hecht – Stephens

Do you have that number, [Andy].

Unidentified Company Speaker

I think the number is 14% , 14.1%.

Jessica Baron

Right.

Manuel Henriquez

Let me really speak to that. I have got a lot of invested feedback on that comment. And what we were doing historically was creating a level of transparency higher than the peer group. And since no one else is bothering to report non normalized yields, meaning back in our one time events, we hear people ask this questions, why our yields were lower and so that’s where we have now reverted back to reporting apples-to-apples like everyone reporting bits of the GAAP yields which is at 17.9 which we all understand realize is not reputable because it has a bunch of noise there for one time events. But unfortunately it’s what the industry is doing as a whole and so we have reverted to these reporting as everyone else is doing right now.

John Hecht – Stephens

Okay. And you talked about you know deploying access capital, accretion earnings a couple we are going to share, but you also mentioned expect the yields to come down by say 20 or 30 basis points a quarter, is it the yields are that now under 14.1 wish you can take it – take it down and then either obviously augment that as you would get ongoing prepayment activity?

Manuel Henriquez

I think that there is no question that we’ve been very clear here that we look at the non-noise level of one time events. As you consistently apply a 14, [14.2] yield if you will as a base, you will definitely see and again yield compression will only happen if we choose to be more aggressive on earning accelerating earnings growth which we are doing as we speak. So as it is as we decide to reach down to be more dependent upon yields you would see the overall portfolio of the Hercules decline anywhere between 30 to 50 basis points per quarter as we deploy the access liquidity which then that would translate to higher earnings per share. So for example, if we do a $100 million a lower yield stretch for example then our historic levels you would see yields compress by 30 basis points but you will see earnings go up by $0.03 to $0.05 per quarter on a go-forward basis.

John Hecht – Stephens

Understood thanks. And your pending commitments from – I’m sure this is in constant with your strategy did to begin to deploy capital on the New Year, what’s going on in the market place, where you are seeing the opportunities what verticals are you focused on, and what’s going on with competition?

Manuel Henriquez

Well a lot has changed since earnings call, much of which we have been advocating or expecting and that is the frothiness and valuations that unfortunately a lot of people were obsessed that it was being sold in about the visibility in the market place but unfortunately has manifested itself exactly as we anticipated with much of the high profile to down the companies even the public ones seen valuations compress between 30% and 50% in some cases, which unfortunately what it does is, it causes a lot of the investments that have been made lately to now be presented under water by evaluations point of view which is what we’ve been expecting to down within the market place. So what you will see us do in the next few quarters is begin to deploy our capital very selectively into those companies that we now feel have a much better valuation than reset and also offer a high level of credit integrity.

And secondly, what we are doing is we are expanding our product offerings. We are now being much more competitive with banks that we had historically have done without top writing credit quality and what we are doing is we are offering now a much broader suite of financing solutions to our companies given our capability and size of our balance sheet we are now able to do much more blended rates of financing through a portfolio company by offering a strip for example [ABO] lending offering a strip would or just either working capital purposes structured term loans or other investment products to provide the company a one stop solution without breaching down the cap structure of that company to take out more risk.

There’s a lot of BCs out who are waiting into the venture desk space by doing second lien deals and I’ve spoken about this many times in the past. Second lien lending in venture space is quite dangerous and it’s not the same as doing lower amount of market lending and that would – here surely as credit things surfaces for some of those other BCs doing that type of lending.

John Hecht – Stephens

Okay, so it sounds like even though it will be blended, the blended financing products were off or you know such as the working capital, they will continue to be asset based in nature?

Manuel Henriquez

Oh they are absolutely. Infact the biggest challenge will be for some of the smaller BC venture debt players of the market place as we decide to use our source of strength on our balance sheet to actually drive earnings growth by being able to lower yields. It’s going to cause industry wide yield compressions much more severe than whatever effect – that we are starting from a basis. You know either 19 or 79 or [14, 3] are normalized basis. So we have decided to really start with earnings growth for the second half of 2014, that’s what you will see.

John Hecht – Stephens

Thanks. Thank you very much.

Operator

Our next question comes from Greg Mason with KBW. Please go ahead.

Greg Mason – KBW

Great, thank you. Could you talk a little bit about the early repayments the last four quarters you’ve been running $90 million to $100 million of early repayments each quarter. You know can you talk about first, what you are seeing in 2Q and long term where do you see that run rate kind of leveling out?

Manuel Henriquez

Sure. So most of the folks on this call and investors have been with us a long time. When we take a, when we start seeing our cash balance that is being built up as you saw us do, we do that purposely because we think that there is fishes in the market. And so one of the things that we also take advantage of we see that we will not see encourage any multiple credit to leave off our balance sheet. And so, to answer your questions that most of 2013 the run rate on early pay offs is despite running a $100 million and at some quarters actually exceeded $140 million. That said, because we’ve now dramatically improved the credit outlook of the portfolio by divesting ourselves from some of these marginal credits you will see the portfolio now normalizing itself to probably a $70 million to $80 million potential early pay-offs in Q2 and I think that will taper off quite dramatically further in Q3 and Q4 and the only time that we’ll see additionally pay off take place will be probably driven by exit events, meaning IPO or M&A.

And so right now, we expect that that level of activities to start dropping off pretty dramatically after Q2.

Greg Mason - KBW

Great. And then the prospects for growth that you are looking at, do you expect any new headcount additions to also supplement this growth and where do you think about the compensation line. In 2012, you had $13.3 million in comp and benefit last year $16.1, you are kind of a $17 million run rate in the first quarter. Any kind of color you can give us on the comp?

Manuel Henriquez

Absolutely. The answer to your question and the order you ask it. Yes, we expect to see a fairly significant increase in headcount throughout 2014. In fact we are actively in a market right now looking to bring on board anywhere between 5 to 7 individuals across the organization, that’s part of the restructuring that we have done or in the midst of doing to align ourselves for the next ten years is that we have gone through a fairly meticulous process of revaluating our organization and really bolstering up our investor professionals, both on the originations side and also on the operations side of the equation.

I will be honest, I probably expect to see one or two more turnovers take place that are probably controlled by us as well as continue to hiring of new – the new professionals in that. So I think when you look at the normalized run rate compensation because we actually operate on a pay for performance basis meaning that depending on the outlook and the credit performance or your investments, the investment professionals will benefit for some of that origination activity. So as the compensation numbers going up is because earnings are going up along with us and so this often takes place.

So if you look at the numbers I said that we expect to see the investment portfolio rise between 20% to 25% which we now in year end to the tune of 950 or $1 billion, I think that you will see variable compensation probably go up by commensurat5e $1 million to $2 million on a variable comp basis from what we know right now.

Greg Mason - KBW

Great. And then finally one last question and I’ll hop back in the queue. You’ve got a number of public equity stocks now in your portfolio and a lot of those will be rolling off of their six month lock up period. Given where the public tech markets have gone, what is your thought about exiting those and you know previous guidance of you know I believe it was $30 million to $60 million of realized gains in 2014?

Manuel Henriquez

Sure. The number I’ve indicated earlier was $20 million to $60 million in realized gains. And there is no question about it that A, the range that I provided is one that is you still feel confident and which means that the mid range is probably somewhere in the neighborhood of this $40 million or so. And so with $5 million under our belt already in Q1, it is absolutely very clear. You will see from a schedule, excuse me a schedule of investments that we’ve also seen an adjustment in valuations given the recent pull back from some of the technology and Life Sciences companies. Now, that pull back also is temporary if you will so the fundamentals of the company that we invested, we remain very strong. We don’t need to simply sell to sell those assets to realized gains but we intend to continue to approach with seeking exits on those investments as the opportunity gives rise to windows of capital depreciation or stock appreciation there.

Greg Mason - KBW

Great. Thanks, Manuel.

Operator

Our next question comes from Ron Jewsikow from Wells Fargo. Please go ahead.

Ron Jewsikow - Wells Fargo

Yeah, good afternoon and thank you for taking my questions. Kind of following up on Greg’s question about some of the – sold in the public market. Has the recent volatility changed how you view some of the public [offerings] and reference what you kind of were active in 2013 or are you still viewing that as an attractive place to invest?

Manuel Henriquez

Well there is no question of having a little bit of air let out of the balloon surely it makes these opportunities a little more attractive because what happens is the underlying companies now have the cost of equity being even higher for them to issue. So this is just an evaluation in the market place is actually very positive, because it only increases demands for debt. So we think its’ actually a good thing and that’s one of the reasons why we are weighing back into the market the way we are.

The more important part of it is, on a later stage side much of our competitors who were eagerly looking to brick up of the word get in the third and fourth quarter on valuations is they now probably look back and we say it didn’t have the best with its act in the market which we were diligently waiting for this adjusted in value going on right now. So we actually think that this letting of the air out of the balloon if you will from the valuation prospect is actually very good for the industry and very good for ultimate long term investments. So we are encouraged by that.

Ron Jewsikow - Wells Fargo

And then just kind of circling back to the kind of shift in to maybe slightly lower yielding investment using your cost of capital and liquidity position. Would we expect any change in the terms outside of yield such as higher warrant coverage or maybe these are higher quality BC borrowers?

Manuel Henriquez

You know I think it’s too early to call that, because what we are going to be doing is well as that we are going to be increasing our investment activities into early stage companies. So you will see a very concerted effort across the development stage of these companies. Well we are going to make a much more forceful investment now in our technology portfolio pursuing later stage valuation companies who now have had evaluation correction. So you will see us increase our exposure significantly more in Q2 of 2014 to the technology. And you will see that the increase on investment activities into earlier stage life sciences and earlier stage technology companies as well as we go into the third and fourth quarter of next year. So we think both are quite attractive candidates right now. We are seeing a lot of demand for our capital and because of our store –on the balance sheet we are able to invest across the spectrum of the development stage of these companies without really compromising much significant yield. Let’s be clear. Our current yield today is running about 14-1 or 14-2 and so as we decide to continue to accelerate earnings growth by merely giving up 30 to 40 basis points per quarter you are looking at an annual basis giving up maybe if we decide to be as aggressive or 120 basis points in total over our yield and deploy almost $200 million of capital that we’re translating to some in the neighborhood of around $0.08 or more in quarterly earnings. So it’s a very powerful impact and we are approaching that very selectively. But that is our intent.

Ron Jewsikow - Wells Fargo

Yeah, makes total sense. Thanks for taking my question.

Manuel Henriquez

You’re welcome.

Operator

Our next question comes from Aaron Deer from Sandler O’Neill & Partners. Please go ahead.

Aaron Deer - Sandler O’Neill & Partners

Hey good afternoon guys.

Manuel Henriquez

Hi Aaron.

Aaron Deer - Sandler O’Neill & Partners

Just kind of following up on that same line of thought, what kind of the yields are you seeing out there now where you are still feeling compelled to walk away, is it – it sounds like you are getting more aggressive on pricing, so what kind of structure issues are you running into?

Manuel Henriquez

Well I honestly want to give us a – us a competitive advantages or strategic perspective what we are doing here is that, one of the wonderful things that’s going on is that look I’ve been here for almost 30 years and providing equity capital and measure debt to go into your Life Sciences companies. And one of the things that I know is when I see frothiness in the trend or stillness in deal structures I’m going to simply pull back and let our competitors fill their coffers with marginally structured deals. And I think a lot of that, I think a place right now and they will manifest itself here in an extra 12 to 18 months or some of our competitor or some of these yield structures. So one of the things that we will not do is that they are yield terms out there doing 24 and 30 month interest only into venture debt companies that in my role that’s called equity and a lot of our competitors are waiting into a stage providing debt capital and taking on equity risks by achieving a debt return, that is a very silly and very dangerous thing to do when you don’t have a significant capital loss you have no margins to recoup from that.

But you know I don’t run those other BDCs, they do what they want to do and we do what we are very good at which is controlled investments driving earnings growth for our shareholders and maintaining a very strong credit book as we have done historically. As it sounds like to that, when you actually look at the numbers which are a little bit shocking to me, when you actually look at our net credit losses you are looking at something of 9 basis point on a net basis over an actualized 10 year period of time. It’s a point of being a little too low.

Aaron Deer - Sandler O’Neill & Partners

Okay. And then Jess, just a question for you on the unrealized deprecation within the loan book itself, for again there was this 7.2 million which is in fact to a credit impairment and then the 4.8 million listed under three level assets, what is that?

Jessica Baron

The one we have an investment that has a –as you know we are supposed to apply [ASD] training where we are supposed to mark all of our loans based upon our valuation methodologies and if we have a premium of finding that loan which happens to pay us off, we have to reverse that premium on that product and the same goes through with loans which you might have marked at a discount. So those, those changes are what those reversals are and basically when those loans are paying a profit how we (indiscernible) and find whatever appreciation or deprecation we might have on that.

Aaron Deer - Sandler O’Neill & Partners

So that’s effectively a recovery there?

Jessica Baron

Sure.

Aaron Deer - Sandler O’Neill & Partners

Okay. Thank you. Thanks for taking the question.

Operator

Our next question comes from Chris Yolk of JMP Securities. Please go ahead.

Chris Yolk - JMP Securities

Good afternoon, most of my questions have been asked but I did want to get a follow up. Last quarter you talked about strategic initiatives. Could you give me a little bit color on that and did that include potentially expanding into product offering that you talked about like ABL and working capital loans?

Manuel Henriquez

Absolutely, part of that strategic discussion that we eluded to in Q4 is in fact on going underway right now that in more – by the way more will come. By time I expect to have our second quarter earnings call. I think much of the strategic things, changes that we are doing to enhance the company and enhance our operating capabilities will have been completed by then, but yes, one of those items is in fact extending our product offering to the needs of our portfolio companies. So why being our capital capabilities we are working to lower cost of capital even further to pass both of those savings on to our portfolio companies and also present to our shareholders with increase in dividends. We are adding indispensable staff, we are expanding potential geographic footprint. We will be – we are looking at without – things possible acquisitions. Among many other things that we are actively involved in right now.

I am working with the board and my management team are looking at setting the foundation for the next ten years of growth and repeating the success we have the last ten years on the prospective ten years going forward. As you may realize many acquisitions look attractive until you end up doing due diligence and often times the case they don’t necessarily work out the way we like them to be or they are excessively over valued and will pass on them. But we have been very active in that market for evaluating opportunities and we expect to continue to be doing that as well on a go-forward basis.

Chris Yolk - JMP Securities

Now Hercules as a great brand and thinking about your ten year strategy and expanding some of these product offerings, do you need to increase marketing spend or awareness to get that in the market place that you guys are now expanding into new offerings?

Manuel Henriquez

You know one of the thing about Hercules is its employees and the integrity and reputation of its employees and our brand and the venture capital market place is one of the highest of any institutions out there. There is absolutely unprecedented that just in ten years we have deployed our $4.2 billion of capital to technology life science companies. And that is a no small part with the brand name and reputation that we established at Hercules. So I don’t believe that we need to spend, which we haven’t really done historically much money on that fund whatsoever. Our reputation, our employees names, their reputations are great sources (indiscernible) flow the winners that we work with are phenomenal to the launch winners who continuously provide us with additional deal flow and so I expect that to continue and this is where size does matter and reputation does matter.

Chris Yolk - JMP Securities

Thanks for that color. And then last when you hear is just to get some clarification in the prepared remarks that you were expecting in the second half of the year $0.04 to $0.06 in quarterly earnings growth, is that from this and net investment income level?

Manuel Henriquez

Yeah as if you may recall and you look at our investor present take you to actually that’s available on our website. We have provided an illustration of hypotheticals on what $100 million of capital being deployed at an 8% yield if you will and no we are not advocating that we’ll be doing deals at 8%, but the show that means the impact. So for example, if we do $100 million at 8% you would actually look at annually $0.13 in earnings for that $100 million that we deployed. On the other side of that spectrum if I would deploy the same $100 million at 14% yields pay for current yields today, we would see a 23% annual contribution in earnings. So you can actually summarize that our new investment activities is actually working within the tolerances of 8% and 14% and that’s where you start getting into the $0.05 to $0.06 in quarterly earnings as we convert the cash on our balance sheets earnings assets which drives our dividend growth rush eventually for our shareholders as well.

And we do expect that to start really taking hold in the second half of 2014 probably really seeing itself come to ahead in Q3 and beyond.

Chris Yolk - JMP Securities

Okay, Manuel that color is extremely helpful. Lastly just as a comment just wanted to say congrats Scott on the promotion.

Manuel Henriquez

Well Scott will probably be on his calls on a go-forward now, so Scott has been a great partner of ours and I’m very proud of his work as with his performance and I look forward to having him be my Chief Investment Officer and partner as we venture into the future of growth for Hercules.

Chris Yolk - JMP Securities

Great. Thanks again.

Operator

Our next question comes from Finian O'shea of Raymond James. Please go ahead.

Finian O'shea - Raymond James

Hi guys, thank you (indiscernible) that two equities come down a bit, do you see that to continue to drift down or as you kind of ramp up the portfolio this year?

Manuel Henriquez

So to make sure we calibrate the terminologies apples and apples here, our current GAAP yield is approximately 76%. I think it is Jessica. On a GAAP basis which includes the SCA. When you actually back out the $225 million of cash leverage that we have and also back out the SVA you are looking at somewhere around 41% or 42% leverage. Now, as we indicated we expect to convert about $150 million or $200 million of that $225 million in current cash on our balance sheet into earnings asset between now and the end of the year, being a little more back end weighted. And when you do that, you will probably see a pro forma leverage somewhere in the neighborhood of 73% to 75%. Leverage mean that we expect to maintain anywhere between $25 million to $50 million of cash, it’s typically what we like to do.

You will see up ramping up our leverage. On page 25 our investor deck which is available on our website, you will see that Hercules has the ability on the regulatory assumption with the SEC. We have the ability to go to full pro forma of 1.2 to [200%] leverage. However, we have indicated historically that our willingness to increase leverage is probably more in the neighborhood of 1.1 to 1.2 subject to the capital markets and the debt markets being open and predictable. If those markets are not as open and predictable you will see that leverage kind of – around 0.8 to 0.9 if those markets are not as predictable and stable.

Finian O'shea - Raymond James

Okay. Thank you.

Operator

Our next question comes from Douglas Harter from Credit Suisse. Please go ahead

Douglas Harter - Credit Suisse

Thanks. And then just a little more color and exactly where you think we are and kind of the revaluation that you are seeing in deals and just want to hear your thoughts on that?

Manuel Henriquez

You know unfortunately use a hockey better for, but given the sad (indiscernible) base law. We are probably in the first inning of the correction process. I think that as Twitter reported recently, I think that you have a little more – sorry LinkedIn was today a little more shake out to occur. I think that the shake out is actually good for the industry. People try to get me and to say that we are in a bubble. Having lifted the ’97 ’98 ’99 and 2000 timeframe, I don’t think we are in above all in terms of a broader technology and market place, but I do think that we have segments within a technology sector that have bubblish characteristics to him, that’s good because I think they're letting about 20% of the air out of evaluation. A balloon is probably a good thing and I think that has happened.

You have seen some of the more high profile companies have evaluation correction, so it's much as 50%. Unfortunately, folks like a Nimble Storage have seen some significant corrections or even (indiscernible). I mean these business models have not fundamentally changed that much, so it's just investors changing their perspective or appetite, but these companies saw a very good fundamentals. So I think that we are in the (indiscernible) earning and I think that we probably have another 15 to 20 points on some tech sectors to go and then I think we will start seeing it – start going back up again.

Douglas Harter - Credit Suisse

So may I guess with that backdrop, you guys were rightly cautious to miss the beginning of that. I guess how do you weigh the thoughts of waiting a little bit longer versus the desire to put some of your cash to work?

Manuel Henriquez

Well, remember my focus right now is moving more towards earlier stage deal, so you will see us to be much more aggressive on earlier stage deals because we think that those are attractively priced these days, but some or later stage rounds right now, especially how we structure deals we can mitigate a lot of the volatility in terms of evaluation by how we structure deals.

We are not going to necessarily share with the streak, how we mitigate the evaluation structure because a lot of our competitors who tend to – want to emulate what we do and that's why we're being a little more cautious on how we describe our investment activities because we know what we do well and we're the leaders in this category in this asset class and we intend to remain in that level and we intend to defend and grow our portfolio and we will proceed cautiously as we have done historically into that areas, but if you are small, $100 million, $200 million venture debt provider you are going to be feeling the squeeze of margin much more than we are because our ability to deploy $100 million of cash at a very low yield perspective, for example is only a 50-60 base points impact on us and to them it could be 200 to 300 base point impact on their portfolio.

Douglas Harter - Credit Suisse

That makes sense. Thank you Manuel.

Operator

Our next question comes from Andrew Kerai from National Securities. Please go ahead.

Andrew Kerai - National Securities

Hi, good afternoon. Thank you for taking my questions. Most of what I had is already been answered but just wanted to – if I could just chat about the SBIC debt. So you guys – you obviously paid down about $35 million in Q1, so given that there is still 25 million of cash on your balance sheet, obviously, you guys still look like you need the capital just one in time, but the other side of that obviously is the 10-year at roughly 2.7%. Like I – kind of depending on your view point for the 10 year moves, SBA debt – looking at the cost of SBA putting there I think one would reasonably assume would increase probably throughout maybe later in 2014 or 2015, so I mean I guess with that being said how do you guys would think about the potential to sort of issue that 35 million of SBA debt given where the rates are versus the fact that you don’t necessarily need the capital given the high level of cash.

Manuel Henriquez

So Andrew you hit a very important nail in the head strategically what we are doing and why we did what we did, because we have taken a very controlled outlook on investment activities historically we are carrying some legacy debt. So the 35ish million of SBA debt you referred had a historical cost to capital attributed to somewhere near of 6.5%, 6.3% and so one of these that we have been working in great partnership with the SBA and the SBA staff who had been and to be honestly very, very great people to work with.

We have been working with them because we are going to be applying for a third license here and eventually seek additional SBA financings by having the ability to draw down instead of having outstanding on our balance sheet. So we will have adjusted time to availability under our new SBA license that as you may or may not know it could take another 3-6 months to get, which is fine with us and as we work with the SBA staff the intent is to retire some of those older SBA debentures and position ourselves to build to then in the future (indiscernible) our new SBA debentures at a much more cost effective rate for 10 years. So this is a very controlled and cautious move on our part for main strategic reasons for long-term lowering cost to capital.

Andrew Kerai - National Securities

Right. No, thank you, it makes a lot of sense. Then if I be just touch on dividend policy for a second as well, I think pretty clearly you guys generate a higher level of NII to deploy the cash and certainly appreciate the color on that. Kind of given your outlook for the $20 million to $60 million of net realized gains this year along with sort of the increase and presumably above you know the $0.31 quarterly dividend payout this time, I know historically you haven't showing us preference for special dividend, but is that something that you talked about and kind of just weighing the distribution of realized gains sort of versus applying some of your remaining loss carry forward as well, so just any color on that would be helpful if you could provide.

Manuel Henriquez

Well, I am not to give you legal response but I think you asked an answer to your own question. Well, I think you are actually right. I think the mindset of our board rightfully so has been to first absorb the capital losses that we have, which we'll see in our 10-Ks are quickly vanishing because our profitability and our capital gain, so this is a good thing which means that you're organically building book value. Eventually, we will exhausts all those tax loss carry forwards and we will be faced with an ever increasing potential to have a special dividend. If our board so deems that to be the right steps, I do not want to at all preempt my board's discourse or dialogue with respect to making that decision.

Andrew Kerai - National Securities

Sure.

Unidentified Company Speaker

I think that is an option now we have been studying and are certainly having contemplating that may come to ahead here in 2014 with our increased profitability, increased outlook and we will probably revisit that in most likely Q3 or probably Q4.

Andrew Kerai - National Securities

Great, thank you. And then just last question I have too on the acquisitions front. I know that you, Manuel have mentioned that there's sort of something that you are considering from a strategic initiative standpoint on the last call as well too. Are you thinking buying up slices of portfolio sort of whole portfolios or maybe even acquiring a smaller competitor in terms of sort of acquiring the company as a whole for the just a portfolio.

Unidentified Company Speaker

I would add all of the above and plus we've been approached by acquiring a whole entire origination team. We've been approached by many different permutations of strategic moves to look at. We have spent pretty significant time in the fourth quarter and the first quarter on evaluating some significant targets.

Andrew Kerai - National Securities

Sure.

Unidentified Company Speaker

We are very much committed to continue to push on that endeavor, but likely underwrite credits on the front end we are very, very picky and very, very selective and I guess one of the things that we are not buying into or (indiscernible) is that we believe some of the evaluation inflations that we are seeing in some of the other especially financed companies similar targets is approaching the level of (indiscernible) is that we are just happy to walk away because it doesn't make any sense.

So we care about our cultural fit. We care about the culture of underwriting. We care about the accretion to earnings and you could find a great team that's overvalued, that's not accretive. We are not going to do it.

Andrew Kerai - National Securities

Sure. It makes sense. Thank you for taking my questions guys.

Unidentified Company Speaker

You are welcome. Alright, operator, I think with that, well, I think we are done with Q&A session. I would like to look forward to investor meetings. In the coming weeks, we will have many investor conference coming up, in particular the Wells Fargo's especially finance conference in New York on May 21st in Manhattan and we also have the Stephens Spring investor conference in June 3rd, and we also have been recently invited to Raymond James conference and I apologize for not having that date here, but you certainly give a call to our investment relations department and they will be happy to do that. In the course of May, I will be traveling to Boston in New York and possibly Chicago and Baltimore and I will be happy if I have a time to meet with investors along with my team if it's appropriate from our schedule.

With that thank you very much and I appreciate you continue being our shareholders and investors in Hercules.

Operator

Ladies and gentlemen, it does conclude today's conference. Thank you for your attendance. You may now disconnect. Everyone have a great day.

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