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HTGC > SEC Filings for HTGC > Form 10-Q on 8-May-2012All Recent SEC Filings

Show all filings for HERCULES TECHNOLOGY GROWTH CAPITAL INC

Form 10-Q for HERCULES TECHNOLOGY GROWTH CAPITAL INC


8-May-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The matters discussed in this report, as well as in future oral and written statements by management of Hercules Technology Growth Capital, Inc., that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "could," "intends," "target," "projects," "contemplates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of these terms or other similar words. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, the availability of additional capital, and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this report should not be regarded as a representation by us that our plans or objectives will be achieved. The forward-looking statements contained in this report include statements as to:

our future operating results;

our business prospects and the prospects of our prospective portfolio companies;

the impact of investments that we expect to make;

the impact of a protracted decline in the liquidity of credit markets on our business;

our informal relationships with third parties including in the venture capital industry;

the expected market for venture capital investments and our addressable market;

the dependence of our future success on the general economy and its impact on the industries in which we invest;

our ability to access debt markets and equity markets;

the ability of our portfolio companies to achieve their objectives;

our expected financings and investments;

our regulatory structure and tax status;

our ability to operate as a BDC, a SBIC and a RIC;

the adequacy of our cash resources and working capital;

the timing of cash flows, if any, from the operations of our portfolio companies;

the timing, form and amount of any dividend distributions;

the impact of fluctuations in interest rates on our business;

the valuation of any investments in portfolio companies, particularly those having no liquid trading market; and

our ability to recover unrealized losses.


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For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this report, please see the discussion under Item 1A-"Risk Factors" of Part II of this quarterly report on Form 10-Q as well as Item 1A-"Risk Factors" of our annual report on Form 10-K. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this report.

The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this report. In addition to historical information, the following discussion and other parts of this report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Item 1A-"Risk Factors" of Part II of this quarterly report on Form 10-Q, Item 1A-"Risk Factors" of our annual report on Form 10-K, and "Forward-Looking Statements" of this Item 2.

Overview

We are a specialty finance firm providing customized loans to public and private technology-related companies, including clean technology, life science and select lower middle market technology companies at all stages of development. We primarily finance privately-held companies backed by leading venture capital and private equity firms, and also may finance certain publicly-traded companies that lack access to public capital or are sensitive to equity ownership dilution. We source our investments through our principal office located in Silicon Valley, as well as through additional offices in Boston, MA, Boulder, CO, and McLean, VA.

Our goal is to be the leading structured debt financing provider of choice for venture capital and private equity backed technology-related companies requiring sophisticated and customized financing solutions. Our strategy is to evaluate and invest in a broad range of technology-related companies including clean technology, life science and select lower middle market technology companies and to offer a full suite of growth capital products up and down the capital structure. We invest primarily in structured debt with warrants and, to a lesser extent, in senior debt and equity investments. We use the term "structured debt with warrants" to refer to any debt investment, such as a senior or subordinated secured loan, that is coupled with an equity component, including warrants, options or rights to purchase common or preferred stock. Our structured debt with warrants investments will typically be secured by some or all of the assets of the portfolio companies.

Our investment objective is to maximize our portfolio total return by generating current income from our debt investments and capital appreciation from our equity-related investments. Our primary business objectives are to increase our net income, net operating income and net asset value by investing in structured debt with warrants and equity of venture capital and private equity backed technology-related companies with attractive current yields and the potential for equity appreciation and realized gains. Our structured debt investments typically include warrants or other equity interests, giving us the potential to realize equity-like returns on a portion of our investments. Our equity ownership in our portfolio companies may represent a controlling interest. In some cases, we receive the right to make additional equity investments in our portfolio companies in connection with future equity financing rounds. Capital that we provide directly to venture capital and private equity backed technology-related companies is generally used for growth and general working capital purposes as well as in select cases for acquisitions or recapitalizations.

We are an internally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company under the 1940 Act. As a business development company, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in "qualifying assets," including securities of private U.S. companies, cash, cash equivalents, and high-quality debt investments that mature in one year or less.

From incorporation through December 31, 2005, we were taxed as a corporation under Subchapter C of the Internal Revenue Code, or the Code. As of January 1, 2006, we have elected to be treated for federal income tax purposes as a regulated investment company, or a RIC, under Subchapter M of the Code. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income that we distribute to our stockholders. However, such an election and qualification to be treated as a RIC requires that we comply with certain requirements contained in Subchapter M of the Code. For example, a RIC must meet certain requirements, including source-of income, asset diversification and income distribution requirements. The income source requirement mandates that we receive 90% or more of our income from qualified earnings, typically referred to as "good income." Qualified earnings may exclude such income as management fees received in connection with our SBIC or other potential outside managed funds and certain other fees.


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Our portfolio is comprised of, and we anticipate that our portfolio will continue to be comprised of, investments primarily in technology-related companies at various stages of their development. Consistent with regulatory requirements, we invest primarily in United States based companies and to a lesser extent in foreign companies. Our investing emphasis has been primarily on private companies following or in connection with a subsequent institutional round of equity financing, which we refer to as expansion-stage companies and private companies in later rounds of financing and certain public companies, which we refer to as established-stage companies and select lower middle market technology companies. We have focused our investment activities in private companies following or in connection with the first institutional round of financing, which we refer to as emerging-growth companies.

Portfolio and Investment Activity

The total value of our investment portfolio was $694.5 million at March 31, 2012 as compared to $652.9 million at December 31, 2011.

During the three month period ended March 31, 2012 we made debt and equity commitments to new and existing portfolio companies, including restructured loans, totaling $101.3 million. Debt commitments for the quarter ended March 31, 2012 included commitments of approximately $42.6 million to six new portfolio companies and $46.8 million to five existing companies. Equity commitments for the quarter ended March 31, 2012 included commitments of approximately $9.6 million to one new portfolio company and $2.3 million to two existing companies.

During the three month period ended March 31, 2011 we made debt commitments to new and existing portfolio companies, including restructured loans, totaling $97.5 million. Debt commitments for the quarter ended March 31, 2012 included commitments of approximately $50.0 million to three new portfolio companies and $47.5 million to three existing companies.

During the three-month periods ended March 31, 2012 and 2011, we funded investments in debt securities, totaling approximately $62.9 million and $85.5 million, respectively. During the three-month periods ended March 31, 2012 and 2011, we funded equity investments of approximately $2.1 million and $500,000 respectively. During the three-month period ended March 31, 2012, the Company converted approximately $356,000 of debt to equity in one portfolio company. In addition, in December 2011, Hercules entered into an agreement to acquire shares of Facebook, Inc. common stock for approximately $9.6 million through a secondary marketplace. The investments were subject to a Facebook, Inc. right of first refusal, which expired thirty days after the date of investment. At December 31, 2011 these assets were held as Other Assets. In February 2012, Hercules was notified that Facebook Inc. had not exercised its repurchase right with respect to any of the shares and had executed all documents necessary to fully transfer the ownership of the shares to Hercules. Accordingly, during the quarter ended March 31, 2012, the investment in Facebook, Inc. was transferred from Other Assets to Investments.

At March 31, 2012, we had unfunded contractual commitments of approximately $125.4 million to 24 new and existing companies. Approximately $40.1 million of these unfunded origination activity commitments are dependent upon the portfolio company reaching certain milestones before the Hercules debt commitment becomes available.

These commitments will be subject to the same underwriting and ongoing portfolio maintenance as the on-balance sheet financial instruments that we hold. Since these commitments may expire without being drawn, unfunded commitments do not necessarily represent future cash requirements. In addition, we have approximately $59.3 million of non-binding term sheets outstanding to eight new and existing companies at March 31, 2012. Non-binding outstanding term sheets are subject to completion of our due diligence and final approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.

The fair value of the loan portfolio at March 31, 2012 was approximately $614.6 million, compared to a fair value of approximately $396.6 million at March 31, 2011. The fair value of the equity portfolio at March 31, 2012 and 2011 was approximately $47.9 million and $27.0 million, respectively. The fair value of our warrant portfolio at March 31, 2012 and 2011 was approximately $32.0 million and $21.5 million, respectively.

We receive payments in our loan portfolio based on scheduled amortization of the outstanding balances. In addition, we receive repayments of some of our loans prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period. During the three-month period ended March 31, 2012, we received approximately $35.5 million of principal repayments, including normal principal amortization repayments of approximately $19.0 million, and early repayments and working line of credit pay-downs of approximately $16.5 million. During the quarter ended March 31, 2012, we restructured our debt investments in one portfolio company for approximately $22.8 million and converted $356,000 of debt to equity.


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Total portfolio investment activity as of March 31, 2012 (unaudited) and for the year ended December 31, 2011 is as follows:

(in millions)                                     March 31, 2012             December 31, 2011
Beginning Portfolio                              $          652.9           $             472.0
Purchase of debt investments                                 62.9                         433.4
Equity Investments                                            2.1                           1.9
Sale of Investments                                          (4.4 )                       (18.5 )
Principal payments received on
investments                                                 (19.0 )                       (65.2 )
Early pay-offs and recoveries                               (16.5 )                      (182.1 )
Accretion of loan discounts and
paid-in-kind principal                                        4.1                           6.6
Net change in unrealized depreciation in
investments                                                   2.7                           4.8
Net change in unrealized appreciation
(depreciation) in Citigroup participation                     0.1                          (0.2 )
Conversion of Debt and Other Assets to
Equity                                                        9.6                           0.2
Restructure fundings                                           -                           16.1
Restructure payoffs                                            -                          (16.1 )

Ending Portfolio                                 $          694.5           $             652.9

The following table shows the fair value of our portfolio of investments by asset class as of March 31, 2012 (unaudited) and December 31, 2011 (excluding unearned income).

                                                          March 31, 2012                                               December 31, 2011
                                         Investments at Fair           Percentage of Total             Investments at Fair            Percentage of Total
(in thousands)                                  Value                       Portfolio                         Value                        Portfolio
Senior secured debt with warrants       $             552,415                          79.5 %        $               482,268                          73.9 %
Senior secured debt                                    94,186                          13.6 %                        133,544                          20.4 %
Preferred stock                                        27,250                           3.9 %                         30,181                           4.6 %
Common Stock                                           20,613                           3.0 %                          6,877                           1.1 %

                                        $             694,464                         100.0 %        $               652,870                         100.0 %

A summary of our investment portfolio at value by geographic location is as follows:

                                                   March 31, 2012                                          December 31, 2011
                                    Investments at Fair           Percentage of             Investments at Fair           Percentage of Total
(in thousands)                             Value                 Total Portfolio                   Value                       Portfolio
United States                      $             681,345                     98.1 %       $               634,736                         97.2 %
England                                            7,771                      1.1 %                         8,266                          1.3 %
Iceland                                            5,198                      0.8 %                         4,970                          0.7 %
Ireland                                              150                      0.0 %                         3,842                          0.6 %
Canada                                                -                       0.0 %                           672                          0.1 %
Israel                                                -                       0.0 %                           384                          0.1 %

                                   $             694,464                    100.0 %       $               652,870                        100.0 %

Our portfolio companies are primarily privately held expansion-and established-stage companies in the drug discovery, internet consumer and business services, clean technology, drug delivery, media/content/info, software, specialty pharmaceuticals, healthcare services, communications and networking, information services, consumer and business products, therapeutic, medical device and equipment, semiconductors, surgical devices, biotechnology tools, diagnostic, and electronics and computer hardware industry sectors. These sectors are characterized by high margins, high growth rates, consolidation and product and market extension opportunities. Value is often vested in intangible assets and intellectual property.


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The largest portfolio companies vary as new loans are recorded and loans pay off. Loan revenue, consisting of interest, fees, and recognition of gains on equity interests, can fluctuate dramatically when a loan is paid off or a related equity interest is sold. Revenue recognition in any given year can be highly concentrated among several portfolio companies. As of both March 31, 2012 and December 31, 2011, our ten largest portfolio companies represented approximately 37.9% of the total fair value of our investments in portfolio companies. At both March 31, 2012 and December 31, 2011, we had seven investments that represented 5% or more of our net assets. At March 31, 2012, we had four equity investments representing approximately 59.2% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments. At December 31, 2011, we had three equity investments which represented approximately 48.0 % of the total fair value of our equity investments, and each represented 5% or more of the total fair value of such investments.

As of March 31, 2012, approximately 52.7% of the fair value of our portfolio was composed of investments in four industries: 19.8% was composed of investments in the drug discovery and development industry, 12.7% was composed of investments in the internet consumer and business services industry; 11.8% was composed of investments in the clean technology industry and 8.4% was composed of investments in the drug delivery industry.

As of March 31, 2012, over 99% of our debt investments were in a senior secured first lien position, and more than 91.1% of the debt investment portfolio was priced at floating interest rates or floating interest rates with a Prime or LIBOR based interest rate floor. Our investments in senior secured debt with warrants have equity enhancement features, typically in the form of warrants or other equity-related securities designed to provide us with an opportunity for capital appreciation. Our warrant coverage generally ranges from 3% to 20% of the principal amount invested in a portfolio company, with a strike price equal to the most recent equity financing round at the time of issuance. As of March 31, 2012, we held warrants in 110 portfolio companies, with a fair value of approximately $32.0 million. The fair value of the warrant portfolio has increased by approximately 6.4% as compared to the fair value of $30.0 million at December 31, 2011. These warrant holdings would require us to invest approximately $72.4 million to exercise such warrants.

Warrants may appreciate or depreciate in value depending largely upon the underlying portfolio company's performance and overall market conditions. Of the warrants which have monetized since inception, we have realized warrant gain multiples in the range of approximately 1.04x to 8.74x based on the historical rate of return on our investments. However, our current warrants may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our warrant interests. The value of our senior secured debt (without warrants) at March 31, 2012 was approximately $94.2 million compared to approximately $133.5 million at December 31, 2011. The increase in 2011 was primarily attributable to two new investments in lower middle market technology companies, which typically do not have equity enhancement features.

As required by the 1940 Act, we classify our investments by level of control. "Control investments" are defined in the 1940 Act as investments in those companies that we are deemed to "control." Generally, under the 1940 Act, we are deemed to "control" a company in which we have invested if we own 25% or more of the voting securities of such company or have greater than 50% representation on its board. "Affiliate investments" are investments in those companies that are "affiliated companies" of us, as defined in the 1940 Act, which are not control investments. We are deemed to be an "affiliate" of a company in which we have invested if we own 5% or more but less than 25% of the voting securities of such company. "Non-control/ non-affiliate investments" are investments that are neither control investments nor affiliate investments.


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The following table summarizes our realized and unrealized gain and loss and changes in our unrealized appreciation and depreciation on control and affiliate investments for the three months ended March 31, 2012 and March 31, 2011:

(in thousands)                                                                               March 31, 2012
Portfolio Company                                                                                                                 Reversal  of
                                                                 Fair Value at                             Unrealized              Unrealized           Realized
                                                                   March 31,           Investment        (Depreciation)          (Depreciation)          Gain/
                                               Type                  2012                Income           /Appreciation          /Appreciation           (Loss)
MaxVision Holding, LLC.                Control                  $           675       $         13       $            26        $             -        $       -
E-Band Communications, Corp.           Affiliate investment               1,094                  6                 1,076                      -                -

Total                                                           $         1,769       $         19       $         1,102        $             -        $       -


(in thousands)                                                                               March 31, 2011
Portfolio Company                                                                                                                 Reversal of
                                                                 Fair Value at                             Unrealized              Unrealized           Realized
                                                                   March 31,           Investment        (Depreciation)          (Depreciation)          Gain/
                                               Type                  2011                Income           /Appreciation          /Appreciation           (Loss)
E-Band Communications, Corp.           Affiliate investment     $         2,032       $         -        $        (1,037 )      $             -        $       -

Total                                                           $         2,032       $         -        $        (1,037 )      $             -        $       -

The following table shows the fair value of our portfolio by industry sector at March 31, 2012 (unaudited) and December 31, 2011:

                                                          March 31, 2012                                        December 31, 2011
                                            Investments at          Percentage of Total            Investments at           Percentage of Total
(in thousands)                                Fair Value                 Portfolio                   Fair Value                  Portfolio
Drug Discovery & Development               $        137,364                         19.8 %       $          131,428                         20.1 %
Internet Consumer & Business Services                88,094                         12.7 %                  117,542                         18.0 %
Clean Tech                                           81,938                         11.8 %                   64,587                          9.9 %
Drug Delivery                                        58,006                          8.4 %                   62,665                          9.6 %
Media/Content/Info                                   49,518                          7.1 %                   38,476                          5.9 %
Software                                             43,788                          6.3 %                   27,850                          4.3 %
. . .
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