Hercules Capital, Inc. (HTGC) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Hercules Technology Growth Capital Q1 Fiscal Year 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference may be recorded. And now it’s my pleasure to turn the call over to Linda Wells. Please go ahead.

Thank you, operator and good afternoon everyone. On the call today are Manuel Henriquez, Hercules Co-Founder, Chairman and CEO; and Jessica Baron, Vice President of Finance and Chief Financial Officer. Hercules first quarter 2012 financial results are released just after today’s market close. They can be accessed from the company’s website at www.htgc.com. We have arranged for a replay of the call at Hercules' web page, or by using 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 identify from time-to-time in our filings with the Securities and Exchange Commission. Although, we believe that the assumptions on which these forward-looking statements are based on are reasonable, any of those assumptions can prove to be inaccurate and, as a result, the forward-looking statements based on those assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit sec.gov or visit the website, www.htgc.com. I would now like to turn the call over to Manuel Henriquez, Hercules’ Co-Founder, Chairman and CEO, Manuel?

Thank you, Linda and good afternoon everybody and thanks for joining us today. I would like to start the call by pointing out the major milestones that we have had on top of all the major ball-points that you’ve seen in our press release. One of our big accomplishments that I am very proud of is our team today issued and filed the 10-K -- excuse me, the 10-Q part of the earnings call. And I expect that throughout 2012 and beyond that that’s going to be our practice, and now we are going to try drive that into a little earlier in the call as well. I know lot of folks have been asking for that, and we’ve been listening. And I am proud to say that our team executed and delivered on that promise. So thank you for the accounting team and finance team for that hard effort and the work that they did. Now, back to the earnings call and some overview. As typical, I’ll start the agenda by giving a quick overview of the operations— summaries of the operations in Q1. I’ll give you some observations, discussion points on the environment, both on the competitive landscape, on the venture capital marketplace and where I think that we’re going. I’ll give some prospective on the outlook of 2012 and the overall marketplace. Keeping in mind to everybody, an obvious statement here, but it’s an election year and we have lovely issues to deal within the global markets with sovereign debt concerns between France, Greece and more countries in Europe that we have to deal with and be accounted for when look at our cost to capital equations. And then of course, I'll turn over the call to Jessica Baron, our newly-mentioned CFO, and then I’ll start covering the overview of the company. So in the first quarter, I’m happy to say, as most of you’ve seen, that we’ve been very, very busy first quarter. We’ve done an incredible amount of activities on both-- on the capital deployment side, liquidity side from IPO access, from capital rising and continuously harvesting the portfolio and growing the portfolio, including our dividend growth that you saw occur in the first quarter, thanks to our Board of Directors. So we delivered once again total record investment income for the year, as the quarter, very strong. We raised our quarterly dividend by $0.001 to $0.24 and we achieved a number of record liquidity events in the history of this company, and frankly in my career I have never had three IPO events take place in the same week; that’s over a 25 year history it has ever happened. So, another testimony to our team in selecting the right companies. We ended the quarter with a strong total asset position and liquidity position for the company. So extremely well-positioned for additional growth in 2012. I will cover and elaborate further on the call. Asset specifics on Q1. We reported quarterly investment income of $22.4 million up 17% year-over-year, or on a quarterly basis of net investment income or NII of $11.4 million or $0.24 a share through 16.3% increase year-over-year on the period. DNOI, not to be left behind, was also very strong at $0.26 and DNOI over $22.2 million—sorry, $12.2 million in DNOI income reported for the quarter. As I said, the Board of Directors did declare an increase in dividend of 4% or $0.01, which is payable [ph] as we’ll disclose in the following portion of the call itself. Turning my attention to the portfolio growth. Although, I believe and we’ll continue to approach the market in a very conservative and controlled manner, as we've done in the past, I will consistently run the business on a controlled growth looking to originate in the $500 to $700 million of new commitments in fiscal 2012. I will expand on that as I go through the call as well. In keeping with the consistent consumer investment strategy, we maintain a slow and steady growth approach to building assets in the quarter. That said, we had over $101 million of new commitments executed during the quarter which also included the conversion of the Facebook investment. In that quarter, we also had a very strong funding. We had $65 million of funding during the quarter. And we also experienced early pay-offs and just paid the repayments of approximately $16.5 million and $19 million of normal amortization. Our net portfolio growth for the quarter was net approximately $40 million, in line with our expectations, and which will expand our perspective for Q2 net portfolio growth as well. Investment portfolio finished the quarter at approximately $695 million, an impressive 56% of growth year-over-year and consistent with our strategy of continually converting our liquidity on our balance sheet to earning assets in a controlled fashion. Of that $685 million, $615 million of that was in interest-earning loans. Overall, the portfolio growth was met with consistent and strong quarterly credit performance. Currently staying at $2.8 billion, which is consistent where we expect the portfolio to be managed on a risk profile point of view and maintaining a very disciplined credit performance overall. As we mentioned last quarter, we expect to see, and continue to see, yield compression. Despite some of the other commentaries some of the other DCs have said in the marketplace, I want to point out the strong differential between our belief in yield compression, and that I’m not confusing yield compression with reaching down a balance sheet of the cap structure. Hercules maintains, and it will continue to maintain, a level of asset origination that are senior secured first lien assets, not second lien, not last-out senior. We’re seeing a tendency in the marketplace of many BDCs claiming to not see yield compression by reaching down the cap structure. We believe in retaining a very forthright, transparent perspective on the marketplace, and we will continue to see and expect to see 50 to 100 basis point yield compression by maintaining a senior-secured first lien position on the assets that we invested. For modeling purposes, we expect to see yields on new asset originations to be on a 12.5% to 13.5% level. I fully recognize that the range that I am providing is lower than what we’re currently realizing when you see that yields on the first quarter adjusted for one-time events was at 13.7% and not adjusted for one-time events at 14.6%. We believe in providing visibility to what we believe is a consistent dividend yield, hence the transparency and belief of what we continue to say and speak about in the call. We are seeing, however, a compression or slowing down of the yield compression that we expect. Although, we experienced approximately 30 basis points yield compression in the first quarter, we’ve seeing evidence in the second quarter so far of the yield compressions fully down. At this point, I cannot give you assurances of whether or not we will see a full yield compression of 100 basis points throughout the year. But for modeling purposes, we expect to see that, and we want to give this ability to that outcome so far. Turning our attention to the balance sheet. As you have seen, and as we’ve indicated our preference continues to be, and will always be, to leverage the balance sheet first, but also keep the leverage balanced with what our yield or what our expectations on a leverage basis to be. As you saw evidence in the first quarter, and second part of the second quarter we tapped both the equity capital markets for $48 million equity raise in Q1. We also in February repaid $24 million of SBA debenture, which we disclosed in the fourth quarter earnings call, further lowering cost of capital. And most recently, we executed $43 million senior unsecured baby bond offering, 7 year duration, 3 year [indiscernible)] 7%, which is listed on the New York Exchange as well. During the quarter, we also changed listings from the NASDAQ to New York Stock Exchange while maintaining the same stock symbol, HTGC and while also having our now bond offerings listed on New York Stock Exchange on the symbol HTGZC, as in zero. Given our focus on disciplinary growth and liquidity, I’m happy to report that at the end of the quarter, we had a $178 million of liquidity, $48 million of adding cash balances and $130 million of credit facilities. Al I would like to note that $178 million does not, repeat, does not include the baby bond offering completed here in April. If you would include the baby bond offering which is completed, our liquidity position would have been approximately in $225 million on a pro forma basis. Turning my attention to liquidity. We had a very robust Q1. I’m very proud of the team in identifying the companies that we continue to identify in our portfolio of warrants and investment activities. Never in the history have I’ve seen Hercules achieve 6 liquidity events in Q1. It is a record for Hercules ,and it could be a record from my own history in investing-- as an investor, 25 years, having 6 liquidity events in one quarter. Truly speaks to the testimony, and the conviction and hard work of our team in identifying the right companies and working at the right venture capital sponsors. I’m very grateful to the venture capital industry to continue to recognize Hercules as the leader and continue to provide us unprecedented deal flow. On the M&A front, BÂRRX Medical closed the transaction to be acquired, representing a $2.2 million gain for Hercules or a 33% IRR from that investment. NEXX Systems had previously filed an S1 to go public, which is not untypical for technology companies that follow us once and be acquired during the acquisitions, that during the M&A-- excuse me, during the IPO phase. I’m proud to say that also achieved the strong liquidity event with a $5.2 million gain on our investment in NEXX Systems. We also had 4 IPOs-- completed IPOs in the first quarter, 3 of which in the same week. Cempra Systems were effective in February, Annie’s when effective in March, Merrimack in March and Interface in March. Annie’s, Merrimack and Interface all completed IPOs during the same week. I am happy to report that beyond Annie's IPO we were successfully able to sell, shortly after the IPO, our entire position and Annie's for a net realized gain of approximately $2.3 million to $2.4 million, representing an IOR of approximately 28% and a warrant gain of 4.2x multiple on the warrant itself. Notwithstanding a strong showing of liquidity in the first quarter, I'm also happy to report we still have 2 companies at IPO registration, both of which were on road shows this week, one of them being, of course, Facebook, and of course, WageWorks. In fairness to our transparency, we also have 3 companies who had IPO registrations withdrawed all our IPOs, citing adverse market conditions, looking for valuations or different outcomes in the IPO, and it shows the full and incomplete [indiscernible].This is also not untypical in the process. To our liquidity in terms of our warrant portfolio and equity investments we have in Hercules. We continue to have a very strong position, with over a 110 warrant positions and 38 equity positions in technology and life sciences companies. Representing on a value base of $32 million in value for the warrant positions and $48 million in value for the equity positions. As I said a moment ago, the Annie’s warrant multiple is 4.2x. Historically, our warrant portfolio has monetized from a 1x multiple to 8.7x multiples. We do not expect, and nor should you, that those warrant multiples historically will repeat themselves. We continue to believe, and what we have said since we started the company, that at least 50% of warrants will never monetize in value. I may recognize that to be a very conservative number, but I believe it’s a right statement to make and the right outcome to have when you’re looking at the warrant position that we have today. Now let me turn my attention to the venture industry. As of most of you know, no call is complete without giving you some color on the venture industry. Overall, the venture capital industry invested $6.3 billion and over 717 transactions during the first quarter. Although this decline of 18%, we are very comfortable with decline as in the sectors that we share the outlook are being fairly valued or overvalued. The software industry experienced the strongest sector growth quarter-to-quarter, year-over-year. And we expect the software industry in itself continue to have very robust 2012 investment activities. We think that the consumer Internet sector is extremely valued and we were not surprised by the 76% drop in venture capital activity dollars into social networking, merely reflecting our own visibility and our own view points on that segment of the market. Now we’re staying on that segment. On the IT side, overall IT investment activity saw an increase year-over-year of 14%. We remain very bullish on the outlook of technology investing, while we've taken a suddenly more conservative view, almost bearish [ph] view on our life science investments as it cycles through the certain life science investments. The technology sector saw $2 billion investment activities, to 257 companies. While the IT investment of $2 billion, $1.3 of that was invested in the software industry, which saw the most dramatic growth of 60% year-over-year. In terms of our life sciences investment. Life science investment saw an 18% decline year-over-year by the venture industry to $1.5 billion. Interesting enough, our portfolio almost declined to administer [ph] without a venture industry. Once again, pinpointing to our alignment with the venture industry and venture activities. Biopharma experienced the most significant decline, a46% decline in capital to $523 million. Medical device, on the other hand, was basically flat with $748 million of capital being invested in the medical device company. The energy sector, which is a little confusing sector to understand, saw some significant growth. The growth shifted away from renewal into more enabling solutions, $943 million was invested in the clean-tech sector. The renewal side of that equation saw the lion’s share of that capital, of $513 million. As we indicated in Q4 earnings call, we’re cycling our investments activities to a more expansive stage and early stage investment, primarily driven by what we believe is our excessive valuation that we’re seeing on later-stage deals. That obviously coincides with the venture industry activities as well. We saw a 21% increase in first seed [ph] and first stage rounded investments, and the second round companies received a 70% increase. Notwithstanding, late-stage investments still remain robust at 61% of the capital, the venture capital that is invested, for a slight decline of just under 20%. IPO elections. Very happy to see what we saw in the first quarter. 22 venture stage companies achieved liquidity events, raising $1.4 billion. This compares to only 11 companies in the same period last year of 2011, raising $768 million, a tremendous showing and I hope to see greater increased activities especially driven by the JOBS Act passage that recently passed congress. Again, this is the strongest IPO activity that we have seen since 2000 and a record level of venture events for Hercules during the same period of time. We currently have 2 companies on IPO registration that are set already, Facebook and WageWorks. We expect those to come out, assuming market conditions remain strong, in the next week or so. As I turn my attention to other outcomes in the quarter, it's interesting to point that the venture industry finished the quarter with over 50 companies with IPO registration that are ventured back, so a very, very strong showing. Two of those are publicly Hercules companies. We are aware of additional companies that expect to be filing in the second quarter that have yet to file, and we expect to see that occurring here shortly. So mentioning statistics during the quarter, we saw very robust M&A activities. I am somewhat disappointed by some of the reporters writing about the venture capital M&A activity not being robust. I beg to differ with the statistics. 94 companies achieved M&A excess raising over $18 billion, a 40% increase and yes, the number of companies that have achieved M&A events is down, the number that did achieve liquidity, the dollar is significantly higher. What the reporters failed to recognize was, the robust IPO market, would it shift some companies [indiscernible] excess from M&A to IPO and those still saying M&A will get a higher valuation. This is actually a very good sign and something that I think its outstanding to see the marketplace, which we will benefit from given our warrant and equity positions. Interesting enough that occurred in the quarter, was also not written about, was the concentration of M&A activity that took place. For example, Google alone acquired 12 companies during the quarter. In addition to that, not be left behind, Groupon, ironically enough, also acquired 6 companies during the quarter. Those 2 players alone, Google and Groupon, made up of 18 companies that experienced M&A event of the 94. Speaking to the drive for consolidation of technology by established companies looking into the venture industry, the bolts of the technology offerings. We expect to see a much more robust M&A activity in Q2 and beyond. Lastly, venture capital fundraising also experienced a very robust period of growth. $7 billion was raised by 47 funds during the quarter, representing a 34% increase year-over-year. So when I look at the venture industry I am very surprised by activities in a level of investment in exits that we are seeing in our marketplace. Highly encouraging and well-positioning Hercules for that market to continue to manifest itself with exits, whether IPO or M&A events. Now bringing back my attention to Hercules. As you look to 2012 and the second quarter, I have to say, despite my optimism, I remain very cautiously optimistic, and guard and control our investment activities. This is not a sprint, and it is not about originating to make earnings. It’s about credit quality and maintaining a right balance of credit quality and liquidity, as we have shown our abilities for the last 7.5 years. I expect to see 2012 to remain at $500 million or $700 million activities of new commitments. I am happy to report, as evidenced in the press release we share with you today, that assuming the existing signed terms which convert, we were already a $270 million run rate of signed term sheets already, and it’s only the first week in May. More than halfway through the $500 million that we are seeing a low end of the range to $700 million. We expect to see portfolio growth. We expect to see portfolio growth in the second quarter between $40 million to $60 million net portfolio growth. As Jessica will expand upon, we've all seen some early stage or early pay off take place during the quarter, which we're fine with as an incumbent that we properly have chosen not to defend the company position for either credit quality or other concerns that we want to manage out some of that exposure. We will cautiously and continuously do that as we looked at balance of the portfolio by stage, geography, venture capital sponsor and as well as sector concentrations that we do. In summary, Q1 was a very, very strong quarter for us and I am very proud of the team’s accomplishment. We maintain a very disciplined approach. As we indicated, we purposely came out of Q1 on a slow start after very strong 2011, with over $700 million of commitments. We saw a good liquidity in our portfolio, on both exits from M&A and IPO and also recycling of investments that we showed [indiscernible] defend the incumbency. With a closure of baby bond we were $225 million of liquidity available of eight year investments. We will continue to diversify our portfolio, and will continue to balance the portfolio throughout 2012 and beyond. I will stay on a competitive environment during Q&A session and now turn the call over to Jessica.

Thank you Manuel, and thank you everyone for listening today. We filed our 10-K, as Manuel indicated, after the market closed today as well as our earnings press release. And here is a brief recap of our financial results for the first quarter of ‘12. We delivered $22.4 million in total investment income of revenues, a quarterly record and an increase of 16.7% when compared to $19.2 million for the first quarter of 2011. This year-over-year growth was driven by higher average outstanding balance of yielding assets during the quarter. The fair value of our yielding debt investment portfolio at quarter-end was $614.6 million, an increase of 38.1% from the same period a year ago. The effective yield on our portfolio investments during the first quarter was 14.6%, down from 15.6% in the fourth quarter of 2011, excluding the income acceleration impact from early payoffs in one-time events, the effective yields for the quarter was 13.7% or down 30 basis points compared to 14% in the last quarter. We’d like to reiterate that we expect a 50 to 100 basis point decline in our debt portfolio as effective yield during 2012. Excluding early path we expect, as Manuel indicated, in normal run rate for our portfolio 12.5% to 15.5%. I would also like to note that our big [ph] income, which is non cash revenue, which must in turned we paid out to our shareholders in dividends continues to represent a small component of less than 1.3% of our total investment income for the first quarter. Our cost of debt increased to $5 million in Q1 of ‘12, compared to $3.2 million incurred in Q1 of 2011. The increase is primarily due to the $1.6 million of interest and fee expense incurred on the $75 million of senior and unsecured convertible notes issued in April 2011. This also includes an approximately $271,000 non-cash charge attributed to the fair value of the conversion feature accretion. Also to note, during the quarter, we have recognized a one-time fee expense of about $457,000 due to the acceleration of fees on our SBA debentures. As you may recall from our prior quarterly earnings call, we repaid $24.3 million of debentures in February. Our weighted average cost of debt was 6.8% in Q1 of ‘12, which compares to 7.7% in Q1 of 2011. This year-over-year decline is attributed to a decline in the weighted average costs of debt on our SBA debentures year-over-year. It’s now 5.8% in Q1 of ‘12 versus 7.3% in the first quarter of 2011. Operating expenses for the quarter totaled $6 million as compared to $6.2 million in the first quarter of 2011. The decrease is primarily due to year-over-year decreases of approximately 198,000 and 134,000 in accounting and tax work fees and related workout expenses. Q1 of ‘12 net investment income was $11.4 million or $0.24 per share based on $47 million shares outstanding, compared to $9.8 million or $0.23 per share based on $42.7 million shares outstanding in Q1 of ‘11. We have recorded -- as Manuel indicated, we have record activity in terms of liquidity events in our portfolio during the first quarter, with 4 companies completing their IPOs, one being acquired and the one accretive acquisition being announced. Our net unrealized depreciation during the first quarter was $2.8 million, of which $2.7 million was related to net increases in equity investment valuations and $1.6 million was attributable to net increase in the warrant investment valuations. This is partially offset by approximately $1.5 million due to unrealized depreciation on our debt investments related to general changes incurred market interest rates. Our net realized gains for the first quarter was approximately $2.8 million. We recognized the growth gain of $2.2 million from the sale of equity in BARRX and $1.3 million from the sale of equity in Aegerion pharmaceuticals. These gains were partially offset by realized losses of approximately 450,000 from the sale of common stock in 2 of our public portfolio companies and due to a write-off of a warrant in one private portfolio company that has a cost basis of around $355,000. Now moving on to the balance sheet, as I just first provide a summary of the investment portfolio. We’ve seen significant growth in our portfolio over the last year as a result of our debt investment origination activities. As of March 31, 2012, total investment assets were $694.5 million, an increase of $249.5 million or 56.1% since March 31, 2011. During the quarter, we closed that in equity commitments of approximately $101.3 million and funded approximately $65 million to new and existing portfolio companies. Since the end of the first quarter, we’ve closed an additional $46.5 million of commitments, and today we have a $129.7 million of pending commitments with new potential portfolio companies. We maintain a cautious approach to on boarding new assets given the uncertain economic environment. We experienced $35.5 million in principal repayments for the quarter, including $16.5 million of early principal repayments and $19.0 million in scheduled principal repayments. As noted, already in April we have received almost $40 million in early repayments. Regarding the composition of our portfolio at quarter end, over 91% of our loans have floating rates, or floating rates with floors, and over 99% as Manuel indicated of our loan investments are senior debt investments, first lien. We remain pleased with the loan portfolio of credit quality. The weighted average loan rating on our portfolio with 2.08 at March 31, 2012 compared to 2.44 at March 31, 2011. We have only one debt investment on non-accrual at the end of the quarter that has a cost basis of $7.3 million and a carrying value of approximately $675,000. At March 31, 2012, our warrant and equity investments combined at fair value represent approximately 11.5% of our total portfolio versus about 10.3% at the end of 2011. The primary change was the addition of our Facebook equity investment. Our equity investments at fair value as of March 31st totaled approximately $48 million. Our warrant positions in over 110 portfolio companies could provide us with the option to potentially invest $72.4 million of additional capital in our portfolio companies. We believe these assets can provide capital returns for the company in the future. Already in the second quarter, we expect to realize net gains of approximately $2.3 million to $2.4 million from the sale of our warrants in Annie’s and net gains of approximately $5.2 million from the sale of our warrant in equity investments in NEXX systems. Now I describing liquidity at March 31, 2012, we had approximately $178.4 million of availability comprised of $48.4 million of cash and $130 million in borrowing capacity under our credit facilities. We ended the quarter with $200.7 million of SBA debentures outstanding. We have been very active from a capital management perspective so far this year. In January, we completed foreign public offering of 5 million shares of common stock for growth spread fees of approximately $48 million. Also, subsequent to quarter end on April 12, we’ve raised $42 million in aggregate principle and on a 7% unsecured notes due 2019. As a result of adding this traditional leverage, we anticipate at increase in interest and fee expense of approximately $800,000 per quarter, or $0.015 per share. Until that capital was fully deployed, which we anticipate to take one to 2 quarters, this will create a drag on our quarterly earnings. Also we should note that in February 2012 repeat - we repay $24.3 million of SBA debentures that cost of debt approximately 6.6%. We’ve submitted a commitment request to re-borrow these $24.3 million of debentures. And based on the pricing of the debentures at March 2012 pooling, which was less than 3%, we should expect to reduce our cost of debt on these borrowings by approximately 2.5% to 3% over the long-term. We expect the commitment review process to take 2 to 3 months. Our net asset value at March 31 was $485.4 million or $9.76 per share based on 49.7 million shares outstanding as it compared to $431 million or $9.83, less than the $43.4 million shares outstanding at the end of the fourth quarter. The slight decline in annuity during the quarter is attributable to the seasonal restricted stock-based things and due to employee option exercises in the MoneyGram. Finally, moving on to our dividend. As you may have seen from press release issued to we raised our dividend by $0.001 to $0.24 per share payable on May 25 to shareholders of record on May 18. In closing, we had a solid first quarter reporting record revenue and total record assets. Our recent financing activities position us well to service for high demand out there for venture capital debt and build our portfolio 2012. However, we remain disciplined in our investment approach, and given the market uncertainty. Operator. We are now ready to open the call for questions.

[Operator Instructions] Our first questioner on queue is Jason Arnold with RBC Capital Markets.

I just want to ask you if you could update us on our favorite - on your favorite industries niches within venture tech that you're kind of seeing more opportunity in at present, and then perhaps vice versa, what you’re straying away from at present?

So as we indicated earlier, 2012 is a funny year. It’s an election year. With a looming change in administration your investor focuses are skewed with that always in the backdrop. So healthcare investing, for example, becomes a little more risky for the fear of reimbursement risk may change some of these underlying healthcare companies. So where we’re taking a kind of a wait-and-see, or a very conservative underwriting for healthcare investing until a change in administration is evident or not evident, at which point we will accelerate, deaccelerate those investment activities any further. So that’s an area where we remain shy on. On the clean tech side, we are not interested in looking at large capital-intensive models. And so any models that require government subsidies or government grants or some form of government assistance is something that we’re shying away from for the time being, and clearly a change in administration would also change the outlook for renewable energy investing. And not to say that the Republicans will not support levels of renewal investing, but it won’t be to the levels that the current administration is doing. You'll see probably a shift in much more national resources drilling and looking at enabling solutions in that area. On areas that are closely underinvested that we’re looking at that we find extremely attractive. With the advent of the Facebook idea looming and the amount of engine ad-serving they need, I would not be surprised to see additional acquisitions take place in the ad-serving marketplace. And kind of, in essence, in copying or emulating what Google did early on in its process of acquiring multiple ad-serving agents. So I think you’ll some additional investment and consolidation, ad-serving models out there. I think that semiconductor is an area that-- I think America has lost its competitive advantages on. It's too expensive to build foundries, and too expensive to design semis out there. So it’s an area that we're probably being a much more conservative look and see. We’re not necessarily very bullish on semiconductors. Software is a very strong growth area for us, we expect to see a very robust activity in software investments in 2012. And we will continue to invest in metal devices in 2012 as well, and select life sciences. I want to make sure people are going to understand, we’ll not walk it away from Life Sciences at all. We’re looking at balance of portfolio in Life Sciences with an increased activity in tech. So it’s a balancing act of going on by seeing higher activities in tech originations, and also allowing some more mature Life Sciences companies to migrate off the portfolio, as they should, and seek out other points of financing, as we mature in the life cycles.

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

Sure. What I’ve seen isn't any real dramatic changes of terms. I think the things that you’re seeing, are companies would like to have a little more interest only than normal. That of course adds risk to that equation, and we'll evaluate that risk on a risk-reward basis, whether or not we want to underwrite the same risk, without getting more reward from it. It's all credit-dependent, or independent company evaluation process. So I think we are seeing elongated requests for interest-only periods. There is a point of time where we will not do, as we have turned down multiple deals in Q1. We've seen some of our competitors do what I consider to be utterly silly, or borderline ridiculous, doing 24 months, 30 month interest-only, deals of equity in my world. So I have no idea why you are doing a loan of legislated [ph] company has an 18 or 30 months interest-only, that’s approaching silliness. So I think we are seeing a little bit of our competitors kind of searching for deal resignations, and they are doing second-lien deals, senior stretched, very, very long interest only period. And we were very happy to pass on all those deals.

Our next questionnaire in queue is Greg Mason with Stifel, Nicolaus.

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

Yes, to answer to your question. We do expect to do that. In fairness of the team and staffs of the SBI, we work very diligently with them and we will do that later this year, but we will work with that staff before we do that. We are not interested at all in stepping in front of the staff until they are ready to do that. So the intent is yes, to cycle through the next tranche of $25 million and lowering that cost of capital further.

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

Sure, well, couple of things. One, the decline is de minimis, but I’m not making excuses for it. The issue that triggered the most of it was back in 2007, 2008 I believe, I think it was the 2008 grants, if I remember correctly. While the overall B2C market was down, we actually issued stock at the $4.71, I believe—sorry, at $4.21, so a lot of our employees, rightly so, including myself, ended up exercising those options that we had. And I think we have little to none left of those, so that was one of the biggest impacts on driving that decline. On the restricted stock grant, one of the things that we've done is—[indiscernible] our Board of Directors has rightfully, to their credit, embraced a lot of the composition alignments, so we shifted composition policies to be almost skewed half in half in cash and half in stock to make sure that we have an alignment with shareholders, so you will see us have a more controlled cash comp expense and also have that issue with stock to create a greater alignment investing and also long-term retention with our employees.

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

Well, actually it is called out separately on the income statement for a non-cash compensation. And as Manuel indicated, and the typical-- it’s a seasonal step-up with the new vestings and the new grants occurring in the first quarter of the year.

What happens is the way we structured it, we have a one year cleft, so it’s not untypical for most companies like ourselves with the one year cleft-- so every March, April timeframe, you’ll see that clefts issue vest, and then it’s ratably - have ratably invested over the commensurate period of time on a monthly basis. The Q1 is acute.

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

Well, let me be clear. I am a big fan of Mike and Aries, and I think he has done a great job in running that shop. And I think that Mike will maintain a discipline past the resignation [ph], so I applaud him for seeing the value in the venture debt category and also maintaining underwriting discipline. So I actually applaude having sophisticated players such as Aries coming in the asset class and really maintaining and underwriting disciplines. So I think it’s fantastic.

Next questioner in queue is Jonathan Bock with Wells Fargo.

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

It's like I said in the fourth quarter earnings call, all lot of it is really driven by the venture industry wanting to pedal away high value warrants in exchange for reduced interest coverage. And we will do that in certain cases, but when you’re looking at a private company that is valued at $10 billion and they are asking you to take additional warrants on that, for me to look at an exit event that’s worthwhile for our investors, I'm looking at a $30 billion exit. And short of being at another Instagram, good luck with that. There is a point of the social networking asset class and a certain element to tech that I, frankly, think that are overvalued. And with that, we’re happy to say no. And so some players that are only willing to take lower yields, we’re going to simply wait out. And we’re not going to do it. But the banks themselves will always carry-- remain a strong threat there, but we’re not there - they just have their own niche, we have our own little niche that we play in. So it’s not driven so much for a competition, it's more bill [ph]structuring than anything else.

Next question on leverage. Post the April debt rates, can you talk about where you plan to take regulatory leverage over the next 2 to 3 quarters?

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

Okay, so understanding then the 7% retail notes that you just issued, is it your intention that you are going to have a very strong 2Q and that’s why you raised that debt capital ahead of what could be considered to be a really strong quarter for starting to look at your term sheets.

Well, you know me better than that, I am not going to give you guidance on the quarter other than saying that I believe that net originations for us or net asset growth for us is probably going to be in the $40 million or $60 million range, that’s inclusive of the $40 million of early payouts. So, on a pro forma you’re looking at $80 million to $100 million off adjusting downward for the early payout of $40 million, that’s what I think we were going to be achieving to do. As to the capital raise, I will always raise capital in anticipation of need, especially in the election year, I would rather have dry powder that I carry, a negative spread on the income statement for a quarter 2 and be in a position to deploy that capital when others don’t have the capital. So we will always have excess liquidity in the balance sheet by one or 2 quarters as a matter of strategy.

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

Well, let's be clear. The new investment yields at $12.5 million to $13.5 million are unlevered. So we have to start with that equation first. So notwithstanding that comment, I look at cost of capital from a multitude of perspectives I have my SBIC, cost of capital which is running, as Jessica indicated in the earnings call, at 5.8% currently today, that will go down even further, I have the convertible bond offerings are at 6%, in cost of capital. I have the bay bond that’s referred to at 7%. And I have our equity that’s around an 8% - 8.25% yield rate You blend it all together, you are looking at somewhere at 7% to 7.25% weight of cost of capital. So cost of capital is something that every BDC should be looking at, and I think every BDC is looking at it. And we are not probably much different than other BDCs out there when you are looking at it. The only thing we don’t use right now is the short-term bank lines that are probably 200 basis points cheaper, but when you actually factor in the restrictions of single [indiscernible], geographic regions, other restrictions they may have, the [indiscernible] off the capital bank lines are actually higher.

Got it. And then one last question related to the portfolio division between late and mid stage investments. I’m sorry If I missed it. What is that division today and where are you currently looking to take that over the next few quarters?

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

Next questioner in queue is Henry Coffey with Sterne Agee.

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

So Henry, that's what happens when you've been covering us as long as you have, you actually have the benefit of history. That is correct. I’m using part of the play book of 2007 as I go into the outlook on 2008. I am not advocating a credit collapse, however, I am doing very similar load balancing and asset allocations that I applied in 2007, going 2008. So you’re assuming correct on picking up on that. We are purposely not defending certain credits. When I see banks eager to take us out of credits, what most people don't realize is that as the incumbent, you always have the vital last offer on these deals, and we’re choosing not to exercise that vital last offer. And that is because either we feel that we have overly concentrated credit risk in that asset, we feel that that sector may be cycling down or out of favor, or a multitude of different reasons that we choose not to defend an incumbency. So you have astutely picked up on a very important point of our portfolio management that we do here. That’s correct.

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

I've got to be honest, with my bank partners, I think our bank partners are quite good and quite healthy, and quite strong, I mean I am not worried about Wells Fargo, RBC or Union Bank. All 3 of them did fine, and survived just fine through the credit crisis. I think the issue for us is that we are seeing some - we are seeing some thawing of some terms here. The biggest concern for us in these credit lines is the advanced rates coupled with the [indiscernible] caps. I there is some evidence of softing on that issue. It is our intent to use those bank lines. But I think it tends is more and judicial format of BCs which uses bank lines as warehouse facilities and to an eventual conduit of some sort. As we all know the conduit market today, the CLO market, is not necessarily readily available yet. And that’s one of my hesitations to use short-term bank lines beyond that that use short-term nature. So I think they serve as viable purpose, but that I cannot use them to be a long-term source of funding.

So we still need to keep our eye on the CLO market for some really-- I mean it, I know you talked about yields and shifting demands, but the real issue seems to be finding healthy sources of attractively priced capital and then finding that and that-- we trust that you know how to fund the loan, so to speak.

Yes, you're exactly right. BDC, unlike other banks, always has the challenge of cost of capital. Banks today range from 1.8% to 3.4% cost of capital. So we have got to deal with that issue, but they also have the ability to have 7x, 8x leverage on the balance sheet. BDC as a whole have a dividend yield they have to pay out so that is a significant part of source of funding, and those dividend yields today range from 8% to 12%, so that makes it very expensive when [indiscernible] capital base has a cost of capital in that range. So what we’re doing, thanks to our partnership with the SBA, we were able to kind of manage that cost of capital on a blended basis, but it would be a disservice—until I see dividend yields back in the 6.5% range, that I'm going to get our cost of capital much lower than 100 basis points, if I'm lucky.

Our next questioner in queue is Douglas Harter with Credit Suisse.

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

I wish I was. I’m still seeing, we’re still offer historical norms, 75% to 80% conversion of commitments funding. So I still think we’re managing down in the more than 65% to 70% range today. So, we’re still seeing 2 patterns that are continuing, we’re still seeing the rates should be lower than historical norms. And we’re still seeing the phenomena of things closing later in the quarter, and drawing less money at close, especially driven by a robust IPO and M&A market. So what is going on is now everyone's secured a bank line to have it as an insurance policy. And if they go public, they don’t need or if they get acquired, they don’t need it. But everybody wants to have it as an insurance policy on having these bank lines available from us in order to fund their business. So it’s a good problem to have.

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

So, I think I initiated [ph] for the fourth quarter [indiscernible], we are in the midst of looking at a higher 3 to - I guess, I guess, 3 to 5 individuals over the next 12 months or so. We’re not in a sprint to get it done; we’re focusing on the right caliber individuals. We’re really keenly focused on individuals that have sector expertise or stage expertise that we’re looking for. So it’s a methodical process of--just like investing, it’s controlled hiring. I mean we’re constantly interviewing people. We’re very selective on how we interview, our expectations for those candidates is quite high, and we have a very, very solid team in place here that those new individuals have to have the caliber and the expertise, and the experience our existing legacy team does. We have higher experiencing originators and they are not going to tolerate marginal guys who are not going to be contributing pretty quickly on day one, so it’s a high threshold.

Next questioner in queue is Aaron Deer with Sandler O’Neill.

Actually just following up on that-- your previous response about the timing of the fundings. You mentioned that a lot it comes in the back half of the quarter, is that part of what is giving me the confidence, that you're going to kind of start in on a net down basis here given the pay downs to [indiscernible] earlier in the quarter, that you think that you’re going to be able make up so much ground here by the end of the quarter?

Well, let's be clear. I think you look at Page 10 of the earnings release, I believe it is-- on page 10, we give you an outline that as, unlike other BCs who will give you visibility already, that we have closed commitments so far in Q2, representing $47 million of closed commitments already. And we have signed terms in the quarter of approximately $130 million already in-house. So I also have $125 billion dollars of unfunded commitments. So the $40 million, we will absorb that quite easily. And we deploy that capital within a quarter or so afterwards. The $40 million is what the answer is causing the $0.015 to $0.02 decline in our Q2 outlook because of the interest expense and the early payouts of these assets, it will take us a quarter to 2 quarters to complete deploy the capital out there. But I’m not worried about given our pipeline that-- I don’t think I've disclose it, but I will say now we have about $1.35 billion pipeline right now transactions. So my concern is I don’t have enough staff onboard to go through all these opportunities that we have that we’re looking and we need to attack. I have the opposite problem. I’m not worried about deal flow, I’m worried about insuring that we continue to scale our team with the right level of investor professionals that we’re looking for.

That’s great. And then on the-- circling back to the yield discussion, the guidance you gave seemed a little low, I just wanted to put a little bit more color on that if you can give kind of where - what the year-to-date or the first quarter pay downs. So what the yield was on those paydowns relative to what they knew that-- that’s been onboard, that it is coming on.

Jessica has that...

Yes, I don’t have that information and I can get it shortly.

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

So I just...

Not all senior, senior.

Right, I understand, I’m just trying to what the delta is between what’s coming off versus what’s coming on.

We’ll get you the answer, but I suspect it will be about 100 basis points delta. But I'll give you an answer.

Our final questioner comes from Greg Mason.

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

Well, let me be clear. I mean that that’s true, but this may be painfully obvious, but I feel I need to make this statement. An early stage deal is only $2 million to $3 million transaction in size while a mid-stage deal expansion has probably $7 million to $12 million, and a later stage deal or a latter-stage company is going to be in the $12 million to $20 million in size. So you got a factor by stage you're going from 2X to 3X in terms of capital. So one late stage deal is probably 2 to 3 mid stage deals and 5 early stage deals. So it requires a lot more throughput. And you’ve got to call through a lot of more companies. There is a lot of early-stage companies out there. That doesn’t make them all good. Unlike a bank, we’re not interested in market share. I have no idea on what market share means where you invest. So we’re focused on quality companies and companies that have good management teams and have good venture support. With that is a more methodical process to build the portfolio out to move the needle significantly as a year processed to re-balance it by stages. It's a slow, methodical process because of the smaller transaction side, it takes a lot more small deals that move one-- to move the needle.

Thank you. And at this time there no additional questions in the queue. I’d like to turn the program back over to management for any additional or closing remarks.

Thank you, operator. And thank you everyone for your continued support and interest and belief in Hercules. If you would like to arrange a meeting, or just have questions, still free contact our investor relationships department. I also would like to remind you that but we’re participating in the JMP Conference next Tuesday in San Francisco and the Wells Fargo Conference in May 23 in New York City, which will be happening with me and investors. If you have an interest in meeting with us on either of the 2 conferences, please let us know, and we’ll try to arrange for scheduling. Again, thank you very much for your being our shareholders and for your continued support on Hercules and thank you for the team for the hard work and dedication. Thank you operator.

Thank you sir. Ladies and gentlemen this does conclude today’s program. Thank you for your participation and have a wonderful day. Attendees you may disconnect at this time.