ITEM 2.
|
MANAGEMENTS 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.
|
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 1ARisk
Factors of Part II of this quarterly report on Form 10-Q as well as Item 1ARisk 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 1ARisk Factors of Part II of this quarterly report on Form 10-Q, Item 1ARisk
Factors of our annual report on Form 10-K, and Forward-Looking Statements of this Item 2.
57
Overview
We are a specialty finance company focused on providing senior secured loans to venture capital-backed companies in technology-related
markets, including technology, biotechnology, life science, and clean-technology industries at all stages of development. We source our investments through our principal office located in Silicon Valley, as well as through its 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-backed companies in technology-related markets requiring sophisticated and customized financing solutions. Our strategy is to evaluate and invest in a broad range of technology-related markets including technology, biotechnology,
life science, and clean-technology industries 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-backed companies in technology-related markets 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-backed companies in technology-related markets 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.
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.
We regularly engage in discussions with third parties in respect of various potential
transactions. We may acquire an investment or a portfolio of investments or an entire company or sell a portion of our portfolio on an opportunistic basis. We or our subsidiaries may also agree to manage certain other funds that invest in debt,
equity or provide other financing or services to companies in a variety of industries for which we may earn management or other fees for our services. We may also invest in the equity of these funds, along with other third parties, from which we
would seek to earn a return and/or future incentive allocations. Some of these transactions could be material to our business. Consummation of any such transaction will be subject to completion of due diligence, finalization of key business and
financial terms (including price) and negotiation of final definitive documentation as well as a number of other factors and conditions including, without limitation, the approval of our board of directors and required regulatory or third party
consents and, in certain cases, the approval of our stockholders. Accordingly, there can be no assurance that any such transaction would be consummated. Any of these transactions or funds may require significant management resources either during
the transaction phase or on an ongoing basis depending on the terms of the transaction.
58
Portfolio and Investment Activity
The total value of our investment portfolio was $774.5 million at September 30, 2012 as compared to $652.9 million at
December 31, 2011.
Portfolio Activity
During the nine-month period ended September 30, 2012 we made debt and equity commitments to new and existing portfolio companies,
including restructured loans, totaling $359.3 million and $17.4 million, respectively. Debt commitments for the nine-month period ended September 30, 2012 included commitments of approximately $241.3 million to 25 new portfolio companies and
$118.0 million, including restructured loans, to 21 existing companies. Equity commitments for the nine-month period ended September 30, 2012 included commitments of approximately $14.6 million to two new portfolio companies and $2.8 million to
three existing companies.
During the three and nine-month periods ended September 30, 2012, we funded investments in
debt securities, totaling approximately $90.8 million and $260.6 million, respectively. During the three and nine-month periods ended September 30, 2012, we funded equity investments of approximately $589,000 and $7.7 million, respectively.
During the nine-month period ended September 30, 2012, the Company converted approximately $356,000 of debt to equity in one portfolio company, and the investment in Facebook, Inc. of approximately $9.6 million was transferred from Other Assets
to Investments.
At September 30, 2012, we had unfunded contractual commitments of approximately $66.0 million to 18 new
and existing companies. Approximately $39.5 million of these unfunded origination activity commitments are dependent upon the portfolio company reaching certain milestones before our debt commitment becomes available to the portfolio company.
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 $133.5 million of non-binding term sheets
outstanding to 13 new and existing companies at September 30, 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 September 30, 2012 was approximately $693.8 million, compared to a fair value of approximately $513.4 million at September 30, 2011. The fair value of the
equity portfolio at September 30, 2012 and 2011 was approximately $47.8 million and $35.8 million, respectively. The fair value of our warrant portfolio at September 30, 2012 and 2011 was approximately $32.9 million and $27.3 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 nine-month period ended September 30, 2012,
we received approximately $167.2 million of principal repayments, including normal principal amortization repayments of approximately $94.8 million, and early repayments and of approximately $70.4 million. During the nine-month period ended
September 30, 2012, we restructured our debt investments in seven portfolio companies for approximately $68.7 million and converted $356,000 of debt to equity.
During the three-month period ended September 30, 2012, one of our portfolio companies completed an initial public offering. On September 19, 2012, Trulia Inc. completed its initial public
offering of 6.0 million shares of common stock at a price to the public of $17.00 per share.
As of
September 30, 2012, we held warrants or equity positions in four companies which have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings, including Glori Energy, Inc., iWatt, Inc.,
Paratek Pharmaceuticals and one company that filed a registration statement confidentially under the JOBS Act. There can be no assurance that these companies will complete their initial public offerings in a timely manner or at all.
59
Total portfolio investment activity for the nine-month period ended September 30, 2012
(unaudited) and for the year ended December 31, 2011 is as follows:
|
|
|
|
|
|
|
|
|
(in millions)
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
Beginning Portfolio
|
|
$
|
652.9
|
|
|
$
|
472.0
|
|
New fundings
|
|
|
268.3
|
|
|
|
433.8
|
|
Warrants not related to current period fundings
|
|
|
1.3
|
|
|
|
1.5
|
|
Restructure fundings
|
|
|
46.7
|
|
|
|
16.1
|
|
Principal payments received on investments
|
|
|
(94.8
|
)
|
|
|
(65.2
|
)
|
Early payoffs
|
|
|
(70.4
|
)
|
|
|
(182.1
|
)
|
Restructure payoffs
|
|
|
(13.8
|
)
|
|
|
(16.1
|
)
|
Accretion of loan discounts and loan fees
|
|
|
16.1
|
|
|
|
17.0
|
|
New loan fees
|
|
|
(9.1
|
)
|
|
|
(10.4
|
)
|
Conversion of Other Assets
|
|
|
9.6
|
|
|
|
0.2
|
|
Proceeds from sale of investments
|
|
|
(6.6
|
)
|
|
|
(20.6
|
)
|
Net realized (loss) gain on investments
|
|
|
(11.0
|
)
|
|
|
2.1
|
|
Net change in unrealized appreciation/(depreciation)
|
|
|
(14.7
|
)
|
|
|
4.6
|
|
|
|
|
|
|
|
|
|
|
Ending Portfolio
|
|
$
|
774.5
|
|
|
$
|
652.9
|
|
|
|
|
|
|
|
|
|
|
The following table shows the fair value of our portfolio of investments by asset class as of
September 30, 2012 (unaudited) and December 31, 2011 (excluding unearned income).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
(in thousands)
|
|
Investments at Fair
Value
|
|
|
Percentage of Total
Portfolio
|
|
|
Investments at Fair
Value
|
|
|
Percentage of Total
Portfolio
|
|
Senior secured debt with warrants
|
|
$
|
574,301
|
|
|
|
74.2
|
%
|
|
$
|
482,268
|
|
|
|
73.9
|
%
|
Senior secured debt
|
|
|
152,346
|
|
|
|
19.6
|
%
|
|
|
133,544
|
|
|
|
20.4
|
%
|
Preferred stock
|
|
|
31,675
|
|
|
|
4.1
|
%
|
|
|
30,181
|
|
|
|
4.6
|
%
|
Common Stock
|
|
|
16,137
|
|
|
|
2.1
|
%
|
|
|
6,877
|
|
|
|
1.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
774,459
|
|
|
|
100.0
|
%
|
|
$
|
652,870
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
(in thousands)
|
|
Investments at Fair
Value
|
|
|
Percentage of Total
Portfolio
|
|
|
Investments at Fair
Value
|
|
|
Percentage of Total
Portfolio
|
|
United States
|
|
$
|
766,610
|
|
|
|
99.0
|
%
|
|
$
|
634,736
|
|
|
|
97.2
|
%
|
England
|
|
|
3,313
|
|
|
|
0.4
|
%
|
|
|
8,266
|
|
|
|
1.3
|
%
|
Iceland
|
|
|
4,431
|
|
|
|
0.6
|
%
|
|
|
4,970
|
|
|
|
0.7
|
%
|
Ireland
|
|
|
105
|
|
|
|
0.0
|
%
|
|
|
3,842
|
|
|
|
0.6
|
%
|
Canada
|
|
|
|
|
|
|
0.0
|
%
|
|
|
672
|
|
|
|
0.1
|
%
|
Israel
|
|
|
|
|
|
|
0.0
|
%
|
|
|
384
|
|
|
|
0.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
774,459
|
|
|
|
100.0
|
%
|
|
$
|
652,870
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in Portfolio
We generate revenue in the form of interest income, primarily from our investments in debt securities, and commitment and facility fees.
Fees generated in connection with our debt investments are recognized over the life of the loan or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related
securities that we acquire from our portfolio companies. Our investments generally range from $1.0 million to $25.0 million. Our debt investments have a term of between two and seven years and typically bear interest at a rate ranging from Prime to
approximately 13.85% as of September 30, 2012. In addition to the cash yields received on our loans, in some instances, our loans may also include any of the following: end-of-term payments, exit fees, balloon payment fees, commitment fees,
success fees, PIK provisions or prepayment fees which may be required to be included in income prior to receipt.
60
Loan origination and commitment fees received in full at the inception of a loan are
deferred and amortized into fee income as an enhancement to the related loans yield over the contractual life of the loan. We recognize nonrecurring fees amortized over the remaining term of the loan commencing in the quarter relating to
specific loan modifications. Loan exit fees to be paid at the termination of the loan are accreted into interest income over the contractual life of the loan. We had approximately $2.8 million and $4.5 million of unamortized fees at
September 30, 2012 and December 31, 2011, respectively, and approximately $5.6 million and $4.4 million in exit fees receivable at September 30, 2012 and December 31, 2011, respectively. We recognize nonrecurring fees amortized
over the remaining term of the loan relating to specific loan modifications. Certain fees may still be recognized as one-time fees, including prepayment penalties, fees related to select covenant default waiver fees and acceleration of previously
deferred loan fees and original issue discount (OID) related to early loan pay-off or material modification of the specific debt outstanding.
We have loans in our portfolio that contain a PIK provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded
as interest income. To maintain our status as a RIC, this non-cash source of income must be paid out to stockholders in the form of dividends even though we have not yet collected the cash. Amounts necessary to pay these dividends may come from
available cash or the liquidation of certain investments. We recorded approximately $866,000 and $1.4 million in PIK income in the nine-month periods ended September 30, 2012 and 2011. In certain investment transactions, we may provide
advisory services. For services that are separately identifiable and external evidence exists to substantiate fair value, income is recognized as earned, which is generally when the investment transaction closes. We had no income from advisory
services in the nine-month period ended September 30, 2012.
In some cases, we collateralize our investments by obtaining
a first priority security interest in a portfolio companys assets, which may include their intellectual property. In other cases, we may obtain a negative pledge covering a companys intellectual property. At September 30, 2012,
approximately 64.4% our portfolio company loans were secured by a first priority security in all of the assets of the portfolio company (including their intellectual property), 34.9% of portfolio company loans were to portfolio companies that were
prohibited from pledging or encumbering their intellectual property and 0.7% of portfolio company loans had an equipment only lien.
Interest on debt securities is generally payable monthly, with amortization of principal typically occurring over the term of the security for emerging-growth, expansion-stage and established-stage
companies. In addition, certain loans may include an interest-only period ranging from three to eighteen months for emerging-growth and expansion-stage companies and longer for established-stage companies. In limited instances in which we choose to
defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest become due at the maturity date.
The effective yield on our debt investments for the three-month periods ended September 30, 2012 and 2011 was 14.4% and 16.8%,
respectively. This yield was lower period over period due to fewer fee accelerations attributed to early payoffs and one-time events during the current year as compared to the prior year. The effective yield excluding payoffs on our debt investments
for the three-month periods ended September 30, 2012 and 2011 was 13.9% and 14.3%, respectively. The decline in this rate is due primarily to the repayments of debt investments that had higher effective yields than the debt investments made in
the past three to four quarters because of the lower interest rate environment.
The overall weighted average yield to
maturity of our loan investments was approximately 12.85% and 12.64% at September 30, 2012 and December 31, 2011, respectively. The weighted average yield to maturity is computed using the interest rates in effect at the inception of each
of the loans, and includes amortization of the loan facility fees, commitment fees and market premiums or discounts over the expected life of the debt investments, weighted by their respective costs when averaged and based on the assumption that all
contractual loan commitments have been fully funded and held to maturity.
Portfolio Composition
Our portfolio companies are primarily privately held expansion-and established-stage companies in the drug discovery and development,
internet consumer and business services, clean technology, software, drug delivery, medical device and equipment, media/content/info, communications and networking, information services, healthcare services, diagnostic, specialty pharmaceuticals,
biotechnology tools, surgical devices, consumer and business products, semiconductors, electronics and computer hardware and therapeutic 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.
As of
September 30, 2012, approximately 63.5% of the fair value of our portfolio was composed of investments in five industries: 19.2% was composed of investments in the drug discovery and development industry, 15.6% was composed of investments in
the internet consumer and business services industry, 11.0% was composed of investments in the clean technology industry, 9.2% was composed of investments in the software industry and 8.5% was composed of investments in the drug delivery industry.
61
The following table shows the fair value of our portfolio by industry sector at
September 30, 2012 (unaudited) and December 31, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
(in thousands)
|
|
Investments at
Fair Value
|
|
|
Percentage of Total
Portfolio
|
|
|
Investments at
Fair Value
|
|
|
Percentage of Total
Portfolio
|
|
Drug Discovery & Development
|
|
$
|
148,646
|
|
|
|
19.2
|
%
|
|
$
|
131,428
|
|
|
|
20.1
|
%
|
Internet Consumer & Business Services
|
|
|
120,789
|
|
|
|
15.6
|
%
|
|
|
117,542
|
|
|
|
18.0
|
%
|
Clean Technology
|
|
|
85,445
|
|
|
|
11.0
|
%
|
|
|
64,587
|
|
|
|
9.9
|
%
|
Software
|
|
|
71,040
|
|
|
|
9.2
|
%
|
|
|
27,850
|
|
|
|
4.3
|
%
|
Drug Delivery
|
|
|
65,811
|
|
|
|
8.5
|
%
|
|
|
62,665
|
|
|
|
9.6
|
%
|
Medical Device & Equipment
|
|
|
47,077
|
|
|
|
6.1
|
%
|
|
|
|
|
|
|
0.0
|
%
|
Media/Content/Info
|
|
|
45,330
|
|
|
|
5.9
|
%
|
|
|
38,476
|
|
|
|
5.9
|
%
|
Communications & Networking
|
|
|
40,175
|
|
|
|
5.2
|
%
|
|
|
28,618
|
|
|
|
4.4
|
%
|
Information Services
|
|
|
37,448
|
|
|
|
4.8
|
%
|
|
|
45,850
|
|
|
|
7.0
|
%
|
Healthcare Services, Other
|
|
|
36,145
|
|
|
|
4.6
|
%
|
|
|
|
|
|
|
0.0
|
%
|
Diagnostic
|
|
|
16,650
|
|
|
|
2.1
|
%
|
|
|
15,158
|
|
|
|
2.3
|
%
|
Specialty Pharmaceuticals
|
|
|
12,945
|
|
|
|
1.7
|
%
|
|
|
39,384
|
|
|
|
6.0
|
%
|
Biotechnology Tools
|
|
|
11,596
|
|
|
|
1.5
|
%
|
|
|
18,693
|
|
|
|
2.9
|
%
|
Surgical Devices
|
|
|
11,463
|
|
|
|
1.5
|
%
|
|
|
11,566
|
|
|
|
1.8
|
%
|
Consumer & Business Products
|
|
|
11,391
|
|
|
|
1.5
|
%
|
|
|
4,186
|
|
|
|
0.6
|
%
|
Semiconductors
|
|
|
7,204
|
|
|
|
0.9
|
%
|
|
|
9,733
|
|
|
|
1.5
|
%
|
Electronics & Computer Hardware
|
|
|
5,304
|
|
|
|
0.7
|
%
|
|
|
1,223
|
|
|
|
0.2
|
%
|
Therapeutic
|
|
|
|
|
|
|
0.0
|
%
|
|
|
35,911
|
|
|
|
5.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
774,459
|
|
|
|
100.0
|
%
|
|
$
|
652,870
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industry and sector concentrations 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 warrant or equity interest is sold. Revenue recognition in any given year can be highly concentrated among
several portfolio companies. As of September 30, 2012 and December 31, 2011, our ten largest portfolio companies represented approximately 36.2% and 37.9%, respectively, of the total fair value of our investments in portfolio companies. At
both September 30, 2012 and December 31, 2011, we had seven investments, respectively, that represented 5% or more of our net assets. At September 30, 2012, we had five equity investments representing approximately 67.0% 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 seven equity investments which represented approximately 63.8% 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 September 30,
2012, over 99.0% of our debt investments were in a senior secured first lien position, and more than 99.0% 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 September 30, 2012, we held warrants in 117
portfolio companies, with a fair value of approximately $32.9 million. The fair value of the warrant portfolio has increased by approximately 9.4% as compared to the fair value of the warrant portfolio of $30.0 million at December 31, 2011. The
increase was primarily driven by our investment in 20 new portfolio companies in 2012, partially offset by the disposal of 12 portfolio companies held at December 2011. These warrant holdings would require us to invest approximately $77.0 million to
exercise such warrants.
Warrants may appreciate or depreciate in value depending largely upon the underlying portfolio
companys performance and overall market conditions. Of the warrants which have monetized since inception, we have realized warrant and equity gain multiples in the range of approximately 1.04x to 10.17x 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.
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.
62
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 and nine-months ended September 30, 2012 and September 30, 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three months ended September 30, 2012
|
|
|
Nine months ended September 30, 2012
|
|
Portfolio Company
|
|
Type
|
|
Fair Value at
September 30,
2012
|
|
|
Investment
Income
|
|
|
Unrealized
(Depreciation)/
Appreciation
|
|
|
Reversal
of
Unrealized
(Depreciation)/
Appreciation
|
|
|
Realized
Gain/
(Loss)
|
|
|
Investment
Income
|
|
|
Unrealized
(Depreciation)/
Appreciation
|
|
|
Reversal
of
Unrealized
(Depreciation)/
Appreciation
|
|
|
Realized
Gain/
(Loss)
|
|
E-Band Communications, Corp.
|
|
Non-Controlled
Affiliate
|
|
|
1,483
|
|
|
|
|
|
|
|
21
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
(1,466
|
)
|
|
|
|
|
|
|
|
|
Gelesis
|
|
Non-Controlled
Affiliate
|
|
|
1,792
|
|
|
|
239
|
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
683
|
|
|
|
(799
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
3,275
|
|
|
$
|
239
|
|
|
$
|
113
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
687
|
|
|
$
|
(2,265
|
)
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three months ended September 30, 2011
|
|
|
Nine months ended September 30, 2011
|
|
Portfolio Company
|
|
Type
|
|
Fair Value at
September 30,
2011
|
|
|
Investment
Income
|
|
|
Unrealized
(Depreciation)/
Appreciation
|
|
|
Reversal
of
Unrealized
(Depreciation)/
Appreciation
|
|
|
Realized
Gain/
(Loss)
|
|
|
Investment
Income
|
|
|
Unrealized
(Depreciation)/
Appreciation
|
|
|
Reversal
of
Unrealized
(Depreciation)/
Appreciation
|
|
|
Realized
Gain/
(Loss)
|
|
MaxVision Holding, LLC.
|
|
Control
|
|
$
|
2,983
|
|
|
$
|
10
|
|
|
$
|
14
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
861
|
|
|
$
|
(3,546
|
)
|
|
$
|
|
|
|
$
|
|
|
E-Band Communications, Corp.
|
|
Non-Controlled
Affiliate
|
|
|
|
|
|
|
5
|
|
|
|
(53
|
)
|
|
|
|
|
|
|
|
|
|
|
9
|
|
|
|
(3,425
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
$
|
2,983
|
|
|
$
|
15
|
|
|
$
|
(39
|
)
|
|
$
|
|
|
|
$
|
|
|
|
$
|
870
|
|
|
$
|
(6,971
|
)
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2012, we did not hold any Control Investments. Our investment in MaxVision Holding,
L.L.C., a company that was a Control Investment as of December 31, 2011, was liquidated during the three-months ended September 30, 2012. On July 31, 2012, we received payment of $2.0 million for our total debt investments in Maxvision Holding,
L.L.C. Approximately $8.7 million of realized losses and $10.5 million of net change in unrealized appreciation was recognized on this control debt and equity investment during the nine-month period ended September 30, 2012.
Portfolio Grading
We use an investment grading system, which grades each debt investment on a scale of 1 to 5, to characterize and monitor our expected level of risk on the debt investments in our portfolio with 1 being
the highest quality. The following table shows the distribution of our outstanding debt investments on the 1 to 5 investment grading scale at fair value as of September 30, 2012 (unaudited) and December 31, 2011, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
(in thousands)
|
|
Investments at
Fair Value
|
|
|
Percentage of Total
Portfolio
|
|
|
Investments at
Fair Value
|
|
|
Percentage of Total
Portfolio
|
|
Investment Grading
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
|
$
|
117,001
|
|
|
|
16.9
|
%
|
|
$
|
104,516
|
|
|
|
17.8
|
%
|
2
|
|
|
418,490
|
|
|
|
60.3
|
%
|
|
|
403,114
|
|
|
|
68.8
|
%
|
3
|
|
|
139,344
|
|
|
|
20.1
|
%
|
|
|
70,388
|
|
|
|
12.0
|
%
|
4
|
|
|
16,440
|
|
|
|
2.4
|
%
|
|
|
6,722
|
|
|
|
1.2
|
%
|
5
|
|
|
2,500
|
|
|
|
0.3
|
%
|
|
|
1,027
|
|
|
|
0.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
693,775
|
|
|
|
100.0
|
%
|
|
$
|
585,767
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2012, our investments had a weighted average investment grading of 2.12 as
compared to 2.01 at December 31, 2011. Our policy is to lower the grading on our portfolio companies as they approach the point in time when they will require additional equity capital. Additionally, we may downgrade our portfolio companies if
they are not meeting our financing criteria and their respective business plans. Various companies in our portfolio will require additional funding in the near term or have not met their business plans and have therefore been downgraded until their
funding is complete or their operations improve. At September 30, 2012, 47 portfolio companies were graded 2, 19 portfolio companies were graded 3, three portfolio companies were graded 4, and two portfolio companies were graded 5 as compared
to 43 portfolio companies that were graded 2, 12 portfolio companies that were graded 3, two portfolio companies that were grade 4, and two portfolio companies that were graded 5 at December 31, 2011.
At September 30, 2012, there was one portfolio company on non-accrual status with a fair value of zero. There was one portfolio
company on non-accrual status as of December 31, 2011 with a fair value of approximately $1.0 million.
63
Results of Operations
Comparison of the three and nine-month periods ended September 30, 2012 and 2011
Investment Income
Total investment income for the three and nine-month periods ended September 30, 2012 totaled approximately $23.9 million and $70.1 million, respectively, compared to $18.7 million and $58.7
million for the three and nine-month periods ended September 30, 2011, respectively.
Interest income for the three and
nine-month periods ended September 30, 2012 totaled approximately $21.7 million and $63.2 million, respectively, compared to $16.4 million and $50.9 million for the three and nine-month periods ended September 30, 2011, respectively. The
increase in interest income is attributable to an increase of loan interest income of approximately $4.9 million and $11.7 million for the three and nine-month periods ended September 30, 2012, respectively. The increase in interest income is
attributable to growth in the overall loan portfolio.
Income from commitment, facility and loan related fees for the three
and nine-month periods ended September 30, 2012 totaled approximately $2.2 million and $6.9 million, respectively, compared to $2.3 million and $7.7 million for the three and nine-month periods ended September 30, 2011, respectively. The
decrease in income from commitment, facility and loan related fees is primarily the result of a decrease in one time fees and amendment revenue of approximately $805,000 and $2.0 million for the three and nine-month periods ended September 30,
2012, respectively, partially offset by an increase in commitment fees and facilities fees of approximately $710,000 and $1.2 million for the three and nine-month periods ended September 30, 2012, respectively.
The following table shows the PIK-related activity for the nine-months ended September 30, 2012 and 2011, at cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended
September 30,
|
|
(in thousands)
|
|
2012
|
|
|
|
|
2011
|
|
Beginning PIK loan balance
|
|
$
|
2,041
|
|
|
|
|
$
|
3,955
|
|
PIK interest capitalized during the period
|
|
|
1,125
|
|
|
|
|
|
1,801
|
|
Payments received from PIK loans
|
|
|
|
|
|
|
|
|
(3,567
|
)
|
PIK converted to other securities
|
|
|
|
|
|
|
|
|
(440
|
)
|
Realized Loss
|
|
|
(291
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending PIK loan balance
|
|
$
|
2,875
|
|
|
|
|
$
|
1,749
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in payments received from PIK loans and PIK interest capitalized during the nine-months
ended September 30, 2012 is due to approximately $1.4 million, $1.0 million, $493,000, $302,000, and $268,000 of PIK collected in conjunction with the sale of our investment in Infologix, Inc. and the early payoffs of IPA Holdings, LLC., Unify
Corporation, HighJump Acquisition, LLC., and Velocity Technology Solutions, Inc., respectively, in the nine-months ended September 30, 2011. The decrease in PIK converted to other securities during the nine-months September 30, 2012 is due
to approximately $440,000 related to the conversion of MaxVision Holding, LLC. debt to equity in nine-months period ended September 30, 2011.
In certain investment transactions, we may provide advisory services. For services that are separately identifiable and external evidence exists to substantiate fair value, income is recognized as earned,
which is generally when the investment transaction closes. We had no income from advisory services in the three and nine-month periods ended September 30, 2012 and 2011, respectively.
64
Operating Expenses
Operating expenses, which are comprised of interest and fees on borrowings, general and administrative and employee compensation, totaled
approximately $12.6 million and $10.1 million during the three month periods ended September 30, 2012 and 2011, respectively. Operating expenses totaled approximately $35.1 million and $29.9 million during the nine-month periods ended
September 30, 2012 and 2011, respectively.
Interest and fees on borrowings totaled approximately $6.1 million and $16.3
million during the three and nine-month periods ended September 30, 2012, respectively, and approximately $4.3 million and $11.3 million during the three and nine-months periods ended September 30, 2011, respectively. The increase is
primarily attributed to interest and fee expenses of $1.3 million and $3.8 million during the three and nine-month periods ended September 30, 2012, respectively, related to the $75.0 million of Convertible Senior Notes issued on April 15,
2011 and approximately $1.6 million and $2.3 million during the three and nine-month periods ended September 30, 2012, respectively, related to the $84.5 million of the April 2019 Notes and the $75.0 million of the September 2019 Notes,
respectively. Additionally, we incurred approximately $271,000 and $812,000 of non-cash interest expense during the three and nine-month periods ended September 30, 2012, respectively, and $271,000 and $496,000 during the three and nine-month
periods ended September 30, 2011 attributed to the accretion of the fair value of the conversion feature on the Convertible Senior Notes. Additionally, we recognized accelerations of approximately $457,000 and $416,000 of unamortized fees in
connection with the pay down of $24.25 million SBA debentures in February 2012 and $24.75 million in SBA debentures in August 2012, respectively.
We had a weighted average cost of debt comprised of interest and fees of approximately 6.7% at September 30, 2012, as compared to 6.5% during the third quarter of 2011. The increase was primarily
attributed to the weighted average cost of debt on the 2019 Notes of 7.5%, which closed in April and September 2012. As of September 30, 2012 the weighted average debt outstanding was approximately $322.2 million.
General and administrative expenses include legal fees, consulting fees, accounting fees, printer fees, insurance premiums, rent, workout
and various other expenses. Expenses increased to $2.4 million from $1.7 million for the three month periods ended September 30, 2012 and 2011, respectively. These increases were primarily due to increases of approximately $338,000 and $170,000
for accounting and legal expenses, respectively, for the three month period ended September 30, 2012. Expenses decreased to $6.1 million from $6.2 million for the nine-month periods ended September 30, 2012 and 2011, respectively.
Employee compensation and benefits totaled approximately $2.9 million and $3.3 million during the three month periods ended
September 30, 2012 and 2011, respectively, and approximately $9.6 million and $9.9 million during the nine month periods ended September 30, 2012 and 2011, respectively. The decrease was primarily attributable to the reduction in headcount
from 56 employees at September 30, 2011 to 52 employees at September 30, 2012. Stock-based compensation totaled approximately $1.1 million and $870,000 during the three-month periods ended September 30, 2012 and 2011, respectively, and
approximately $3.1 million and $2.5 million during the nine-month periods ended September 30, 2012 and 2011, respectively. These increases were due primarily to the expense on restricted stock grants of approximately 672,000 shares issued in
the first quarter of 2012. See Financial Condition, Liquidity, and Capital Resources for disclosure of additional expenses.
Net Investment Income Before Investment Gains and Losses
Net
investment income per share was $0.23 for the quarter ended September 30, 2012 compared to $0.20 per share in the quarter ended September 30, 2011, based on 48,749,975 and 43,071,223 weighted average shares outstanding, respectively. Net
investment income before investment gains and losses for the three and nine-month periods ended September 30, 2012 totaled approximately $11.4 million and $35.0 million, respectively, as compared to $8.6 million and $28.8 million in the three
and nine-month periods ended September 30, 2011, respectively. The changes are made up of the items described above under Investment Income and Operating Expenses.
Net Investment Realized Gains and Losses and Unrealized Appreciation and Depreciation
Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the
investment without regard to unrealized appreciation or depreciation previously recognized, and includes investments charged off during the period, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the
change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.
65
During the three and nine-month periods ended September 30, 2012, we recognized net
realized losses of approximately $9.1 million and net realized gains of approximately $2.0 million, respectively, on the portfolio. During the quarter ended September 30, 2012, we recorded realized losses of approximately $8.7 million, $672,000
and $463,000, respectively, from the liquidation of our investments in MaxVision Holding, L.L.C, Zeta Interactive Corporation and Magi.com (pka Hi5 Networks, Inc.), respectively. These losses were partially offset by realized gains in the third
quarter related to a milestone payment of approximately $825,000 from Covidien PLCs acquisition of our portfolio company, B RRX Medical, Inc. in the first quarter of 2012. Under the terms of the acquisition agreement, additional
milestone payments may be received within sixty days of the eighteen month and second anniversaries of the closing. These milestone payments are subject to performance factors and, therefore, their future receipt cannot be reasonably assured at
this time.
During the three and nine-months ended September 30, 2011 the Company recognized total net realized gains of
approximately $10.1 million from the sale of common stock in its public portfolio companies and realized losses of approximately $1.6 million and approximately $6.7 million from equity, loan, and warrant investments in portfolio companies that have
been liquidated.
A summary of realized gains and losses for the three and nine-month periods ended September 30, 2012
and 2011 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
(in thousands)
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
Realized gains
|
|
$
|
948
|
|
|
$
|
316
|
|
|
$
|
13,122
|
|
|
$
|
10,580
|
|
Realized losses
|
|
$
|
(10,039
|
)
|
|
$
|
(1,916
|
)
|
|
$
|
(11,073
|
)
|
|
$
|
(7,151
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gains (losses)
|
|
$
|
(9,091
|
)
|
|
$
|
(1,600
|
)
|
|
$
|
2,049
|
|
|
$
|
3,429
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The net unrealized appreciation and depreciation of our investments is based on fair value of each
investment determined in good faith by our Board of Directors.
The following table itemizes the change in net unrealized
appreciation/depreciation of investments for the three and nine-month periods ended September 30, 2012 and 2011:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ending
September 30,
|
|
|
Nine Months Ending
September 30,
|
|
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
(in thousands)
|
|
Amount
|
|
|
Amount
|
|
|
Amount
|
|
|
Amount
|
|
Gross unrealized appreciation on portfolio investments
|
|
$
|
15,000
|
|
|
$
|
11,928
|
|
|
$
|
40,531
|
|
|
$
|
41,945
|
|
Gross unrealized depreciation on portfolio investments
|
|
|
(23,845
|
)
|
|
|
(11,423
|
)
|
|
|
(56,190
|
)
|
|
|
(38,833
|
)
|
Reversal of prior period net unrealized appreciation upon a realization
|
|
|
(80
|
)
|
|
|
(3,323
|
)
|
|
|
(11,666
|
)
|
|
|
(13,225
|
)
|
Reversal of prior period net unrealized depreciation upon a realization
|
|
|
11,503
|
|
|
|
1,913
|
|
|
|
12,122
|
|
|
|
7,519
|
|
Citigroup Warrant Participation
|
|
|
(93
|
)
|
|
|
136
|
|
|
|
16
|
|
|
|
(229
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net unrealized appreciation (depreciation) on portfolio investments
|
|
$
|
2,485
|
|
|
$
|
(769
|
)
|
|
$
|
(15,187
|
)
|
|
$
|
(2,823
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During the three month period ended September 30, 2012, we recorded approximately $2.6 million of
net unrealized appreciation from our loans, equity and warrant investments. Approximately $3.9 million and $2.0 million is attributed to net unrealized appreciation on equity and warrants, respectively, of which approximately $4.1 million and
$457,000 is due to the reversal of prior period net unrealized depreciation upon being realized as a loss.
We recorded
approximately $3.3 million net unrealized depreciation on our debt investments, partially offset by approximately $6.9 million due to the reversal of prior period net unrealized depreciation upon being realized as a loss.
66
The following table itemizes the change in net unrealized appreciation/(depreciation) in the
investment portfolio by category for the three month period ended September 30, 2012.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2012
|
|
(in millions)
|
|
Loans
|
|
|
Equity
|
|
|
Warrants
|
|
|
Other Assets
|
|
|
Total
|
|
|
|
|
|
|
|
Collateral based impairments
|
|
$
|
(8.7
|
)
|
|
$
|
(2.1
|
)
|
|
$
|
(1.2
|
)
|
|
$
|
|
|
|
$
|
(12.0
|
)
|
|
|
|
|
|
|
Reversals due to Loan Payoffs & Warrant/Equity sales
|
|
|
6.9
|
|
|
|
4.1
|
|
|
|
0.4
|
|
|
|
|
|
|
|
11.4
|
|
|
|
|
|
|
|
Fair Value Market/Yield Adjustments*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 & 2 Assets
|
|
|
|
|
|
|
(1.5
|
)
|
|
|
0.6
|
|
|
|
|
|
|
|
(0.9
|
)
|
Level 3 Assets
|
|
|
(1.5
|
)
|
|
|
3.4
|
|
|
|
2.2
|
|
|
|
|
|
|
|
4.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Fair Value Market/Yield Adjustments
|
|
|
(1.5
|
)
|
|
|
1.9
|
|
|
|
2.8
|
|
|
|
|
|
|
|
3.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Unrealized Appreciation/(Depreciation)
|
|
$
|
(3.3
|
)
|
|
$
|
3.9
|
|
|
$
|
2.0
|
|
|
$
|
|
|
|
$
|
2.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
Level 1 assets are generally equities listed in active markets and level 2 assets are generally warrants held in a public company. Observable market prices are
typically the primary input in valuing level 1 and 2 assets. Level 3 asset valuations require inputs that are both significant and unobservable. Generally, level 3 assets are debt investments and warrants and equities held in a private company. See
Note 2 to the financial statements discussing ASC 820.
|
During the nine-month period ended September 30,
2012, we recorded approximately $15.2 million of net unrealized depreciation from our loans, equity and warrant investments. Approximately $1.6 million is attributed to net unrealized appreciation on equity investments and approximately $2.3 million
is attributed to net unrealized depreciation on warrant investments. Approximately $497,000 million and $6.0 million is due to the reversal of prior period net unrealized appreciation on equity and warrants respectively, upon being realized as a
gain. Additionally, we recorded approximately $500,000 of unrealized depreciation attributed to reduced expectations of escrow proceeds previously anticipated to be collected.
We recorded approximately $12.6 million net unrealized depreciation on our debt investments related to fluctuations in current market interest rates.
The following table itemizes the change in net unrealized appreciation/(depreciation) in the investment portfolio by category for the
nine-month period ended September 30, 2012.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2012
|
|
(in millions)
|
|
Loans
|
|
|
Equity
|
|
|
Warrants
|
|
|
Other Assets
|
|
|
Total
|
|
|
|
|
|
|
|
Collateral based impairments
|
|
$
|
(9.3
|
)
|
|
$
|
(2.1
|
)
|
|
$
|
(1.2
|
)
|
|
$
|
|
|
|
$
|
(12.6
|
)
|
|
|
|
|
|
|
Reversals due to Loan Payoffs & Warrant/Equity sales
|
|
|
7.9
|
|
|
|
(0.5
|
)
|
|
|
(6.0
|
)
|
|
|
(0.5
|
)
|
|
|
0.9
|
|
|
|
|
|
|
|
Fair Value Market/Yield Adjustments*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 & 2 Assets
|
|
|
|
|
|
|
(5.7
|
)
|
|
|
2.1
|
|
|
|
|
|
|
|
(3.6
|
)
|
Level 3 Assets
|
|
|
(12.6
|
)
|
|
|
9.9
|
|
|
|
2.8
|
|
|
|
|
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Fair Value Market/Yield Adjustments
|
|
|
(12.6
|
)
|
|
|
4.2
|
|
|
|
4.9
|
|
|
|
|
|
|
|
(3.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Unrealized Appreciation/(Depreciation)
|
|
$
|
(14.0
|
)
|
|
$
|
1.6
|
|
|
$
|
(2.3
|
)
|
|
$
|
(0.5
|
)
|
|
$
|
(15.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
Level 1 assets are generally equities listed in active markets and level 2 assets are generally warrants held in a public company. Observable market prices are
typically the primary input in valuing level 1 and 2 assets. Level 3 asset valuations require inputs that are both significant and unobservable. Generally, level 3 assets are debt investments and warrants and equities held in a private company. See
Note 2 to the financial statements discussing ASC 820.
|
As of September 30, 2012, the net unrealized
appreciation recognized by us was increased by approximately $93,000 due to the warrant participation agreement with Citigroup. For a more detailed discussion of the warrant participation agreement, see the discussion set forth under Note 4 to the
Consolidated Financial Statements.
67
During the three-month period ended September 30, 2011, we recorded approximately
$769,000 of net unrealized depreciation from our loans, warrant and equity investments. During the nine-month period ended September 30, 2011, we recorded approximately $2.8 million of net unrealized depreciation from our loans, warrant and
equity investments.
Income and Excise Taxes
We account for income taxes in accordance with the provisions of ASC 740, Income Taxes, which requires that deferred income taxes be
determined based upon the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax law. Valuation allowances are used to reduce deferred tax assets to
the amount likely to be realized.
Net Increase in Net Assets Resulting from Operations and Change in Net Assets per
Share
For the three and nine-months ended September 30, 2012, the net increase in net assets resulting from
operations totaled approximately $4.7 million and $21.9 million, respectively. For the three and nine-months ended September 30, 2011, the net increase in net assets resulting from operations totaled approximately $6.2 million and $29.4
million, respectively. These changes are made up of the items previously described.
Both the basic and fully diluted net
change in net assets per common share was $0.09 and $0.44, respectively, for the three and nine-month periods ended September 30, 2012.
Both the basic and fully diluted net change in net assets per common share was $0.14 and $0.67, respectively, for the three and nine-month periods ended September 30, 2011.
Financial Condition, Liquidity, and Capital Resources
Our liquidity and capital resources are derived from our credit facilities, SBA debentures, Convertible Senior Notes, April 2019 Notes,
September 2019 Notes and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and payments of fees and other operating expenses
we incur. We have used, and expect to continue to use, our borrowings and the proceeds from the rotation of our portfolio and from public and private offerings of securities to finance our investment objectives. We may raise additional equity or
debt capital through both registered offerings off a shelf registration and private offerings of securities, by securitizing a portion of our investments or borrowing, including from the SBA through our SBIC subsidiaries.
At September 30, 2012, we had $75.0 million of Convertible Senior Notes payable, $84.5 million of April 2019 Notes, $75.0 million of
September 2019 Notes and $200.25 million of SBA debentures payable. We had no borrowings outstanding under either the Wells Facility or the Union Bank Facility. See Subsequent Events below.
During the nine-months ended September 30, 2012, our operating activities used $88.6 million of cash and cash equivalents, compared to
$72.6 million provided during the nine-months ended September 30, 2011. The $16.0 million decrease in cash provided by operating activities resulted primarily from a reduction of principal payments received on investments of approximately $58.0
million, partially offset by an increase in net unrealized appreciation of $12.4 million and a decrease in purchase of investments of $35.0 million during the nine-month period ended September 30, 2012. During the nine-months ended September 30,
2012, our financing activities provided $131.3 million of cash, compared to $62.0 million provided during the nine-months ended September 30, 2011. This $69.3 million increase in cash provided by financing activities was primarily attributed to net
proceeds from the issuance of common stock of $46.6 million and our issuance of the 2019 Notes of $159.5 million, offset by a $49.3 million increase in the repayments of borrowings compared to prior year and a reduction of $75.0 million attributed
to the issuance of Convertible Senior Notes in 2011.
As of September 30, 2012, net assets totaled $469.1 million, with a
net asset value per share of $9.42. We intend to generate additional cash primarily from cash flows from operations, including income earned from investments in our portfolio companies and, to a lesser extent, from the temporary investment of cash
in other high-quality debt investments that mature in one year or less as well as from future borrowings as required to meet our lending activities. Our primary use of funds will be investments in portfolio companies and cash distributions to
holders of our common stock.
68
In January 2012, we completed a follow-on public offering of 5.0 million shares of
common stock for proceeds of approximately $48.05 million, before deducting offering expenses, to us. See Subsequent Events below.
Additionally, we expect to raise additional capital to support our future growth through future equity and debt offerings, and/or future borrowings, to the extent permitted by the 1940 Act. To the extent
we determine to raise additional equity through an offering of our common stock at a price below net asset value, existing investors will experience dilution. During our 2012 Annual Shareholder Meeting held on May 30, 2012, our stockholders
authorized us, with the approval of our Board of Directors, to sell up to 20% of our outstanding common stock at a price below our then current net asset value per share and to offer and issue debt with warrants or debt convertible into shares of
our common stock at an exercise or conversion price that will not be less than the fair market value per share but may be below the then current net asset value per share. There can be no assurance that these capital resources will be available.
On July 25, 2012, we approved the extension of the stock repurchase plan as previously approved under the same terms and
conditions that allows us to repurchase up to $35.0 million of our common stock. Unless renewed, the stock repurchase plan will expire on February 26, 2013.
As required by the 1940 Act, our asset coverage must be at least 200% after each issuance of senior securities. As of September 30, 2012 our asset coverage ratio under our regulatory requirements as
a business development company was 383.8%, excluding our SBA debentures as a result of our exemptive order from the SEC which allows us to exclude all SBA leverage from our asset coverage ratio. Total leverage when including our SBA debentures was
207.0% at September 30, 2012. As a result of the SEC exemptive order, our ratio of total assets on a consolidated basis to outstanding indebtedness may be less than 200%, which while providing increased investment flexibility, also may increase
our exposure to risks associated with leverage.
Outstanding Borrowings
At September 30, 2012 (unaudited) and December 31, 2011, we had the following borrowing capacity and outstanding amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
(in thousands)
|
|
Total
Available
|
|
|
Carrying
Value
(1)
|
|
|
Total
Available
|
|
|
Carrying
Value
(1)
|
|
Union Bank Facility
|
|
$
|
55,000
|
|
|
$
|
|
|
|
$
|
55,000
|
|
|
$
|
|
|
Wells Facility
|
|
|
75,000
|
|
|
|
|
|
|
|
75,000
|
|
|
|
10,187
|
|
April 2019 Notes
|
|
|
84,490
|
|
|
|
84,490
|
|
|
|
|
|
|
|
|
|
September 2019 Notes
(2)
|
|
|
75,000
|
|
|
|
75,000
|
|
|
|
|
|
|
|
|
|
Convertible Senior Notes
(3)
|
|
|
75,000
|
|
|
|
71,165
|
|
|
|
75,000
|
|
|
|
70,353
|
|
SBA Debentures
(4)
|
|
|
225,000
|
|
|
|
200,250
|
|
|
|
225,000
|
|
|
|
225,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
589,490
|
|
|
$
|
430,905
|
|
|
$
|
430,000
|
|
|
$
|
305,540
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Except for the Convertible Senior Notes, all carrying values are the same as the principal amount outstanding.
|
(2)
|
In October 2012, the underwriters exercised their over-allotment option for
an additional $10.9 million of the September 2019 Notes, bringing the total amount of the September 2019 Notes issued to approximately $85.9 million in aggregate principal amount.
|
(3)
|
Represents the aggregate principal amount outstanding of the Convertible Senior Notes less the unaccreted discount initially recorded upon issuance of
the Convertible Senior Notes. The total unaccreted discount for the Convertible Senior Notes was $3.8 million at September 30, 2012.
|
(4)
|
In February 2012, we repaid $24.3 million of SBA debentures under HT II, priced at approximately 6.63%, including annual fees. In June 2012, the SBA
approved a $24.3 million dollar commitment for HT III. In August 2012, the Company repaid $24.75 million of SBA debentures under HT II, $12.0 million priced at 6.43%, including annual fees, and $12.75 million priced at 6.38%, including annual fees.
In September 2012, the SBA approved a $24.75 million dollar commitment for HT III bringing the total available borrowings to $225.0 million, of which $76.0 million was available in HT II and $149.0 million was available in HT III.
|
We believe that our current cash and cash equivalents, cash generated from operations, and funds available
from the credit facilities will be sufficient to meet our working capital and capital expenditure commitments for at least the next 12 months.
Commitments
In the normal course of business, we are party to
financial instruments with off-balance sheet risk. These consist primarily of unfunded commitments to extend credit, in the form of loans, to our portfolio companies. Unfunded commitments to provide funds to portfolio companies are not reflected on
our balance sheet. Our unfunded commitments may be significant from time to time. As of September 30, 2012, we had unfunded commitments of approximately $66.0 million. Approximately $39.5 million of these unfunded debt commitments are dependent
upon the portfolio company reaching certain milestones before the debt commitment becomes available. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that
we hold. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Closed commitments generally fund 70-80% of the committed amount in aggregate over the life of
the commitment. We intend to use cash flow from normal and early principal repayments, and proceeds from borrowings and notes to fund these commitments. However, there can be no assurance that we will have sufficient capital available to fund these
commitments as they come due.
69
In addition, we had approximately $133.5 million of non-binding term sheets outstanding to
13 new and existing companies, which generally convert to contractual commitments within approximately 45 to 60 days of signing. 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.
Contractual Obligations
The following table shows our contractual obligations as of September 30, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments due by period
(in
thousands)
|
|
Contractual
Obligations
(1)(2)
|
|
Total
|
|
|
Less than
1 year
|
|
|
1 - 3
years
|
|
|
3 - 5
years
|
|
|
After 5
years
|
|
Borrowings
|
|
$
|
430,905
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
71,165
|
(4)
|
|
$
|
359,740
|
(3)
|
Operating Lease Obligations
(5)
|
|
|
9,146
|
|
|
|
1,277
|
|
|
|
2,802
|
|
|
|
3,025
|
|
|
|
2,042
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
440,051
|
|
|
$
|
1,277
|
|
|
$
|
2,802
|
|
|
$
|
74,190
|
|
|
$
|
361,782
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Excludes commitments to extend credit to our portfolio companies.
|
(2)
|
The Company also has a warrant participation agreement with Citigroup. See Note 4.
|
(3)
|
Includes $200.25 million in borrowings under the SBA debentures, $84.5 million in aggregate principal amount of the April 2019 Notes, and $75.0 million
in aggregate principal amount of the September 2019 Notes. See Subsequent Events below.
|
(4)
|
Except for the Convertible Senior Notes, all carrying values are the same as the principal amount outstanding. The aggregate principal amount
outstanding of the Convertible Senior Notes less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes was $3.8 million at September 30, 2012.
|
(5)
|
Long-term facility leases.
|
We and our executives and directors are covered by Directors and Officers Insurance, with the directors and officers being indemnified by us to the maximum extent permitted by Maryland law subject to the
restrictions in the 1940 Act.
Borrowings
Long-term SBA Debentures
On September 27, 2006, HT II received a license to operate as a SBIC under the SBIC program and is able to borrow funds from the SBA against eligible investments and regulatory capital. Under the
Small Business Investment Company Act and current SBA policy applicable to SBICs, a SBIC can have outstanding at any time SBA guaranteed debentures up to twice the amount of its regulatory capital. HT II has a total of $76.0 million of SBA
guaranteed debentures outstanding as of September 30, 2012 and has paid the SBA commitment fees of approximately $1.5 million. As of September 30, 2012, the Company held investments in HT II in 52 companies with a fair value of
approximately $162.1 million, accounting for approximately 20.9% of our total portfolio at September 30, 2012.
On
May 26, 2010, HT III received a license to operate as a SBIC under the SBIC program and is able to borrow funds from the SBA against eligible investments and additional contributions to regulatory capital. With our net investment of $74.5
million in HT III as of September 30, 2012, HT III has the capacity to issue a total of $149.0 million of SBA guaranteed debentures, subject to SBA approval, of which $124.25 million was outstanding as of September 30, 2012. As of
September 30, 2012, HT III has paid commitment fees of approximately $1.5 million. As of September 30, 2012, we held investments in HT III in 32 companies with a fair value of approximately $195.4 million accounting for approximately 25.2%
of our total portfolio at September 30, 2012.
There is no assurance that HT II or HT III will be able to draw up to the
maximum limit available under the SBIC program.
SBICs are designed to stimulate the flow of private equity capital to
eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $18.0 million and have average annual fully taxed net income not exceeding $6.0 million for the two
most recent fiscal years. In addition, SBICs must devote 25.0% of its investment activity to smaller concerns as defined by the SBA. A smaller concern is one that has a tangible net worth not exceeding $6.0 million and has average annual
fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are
based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory
services. Through its wholly-owned subsidiaries HT II and HT III, we plan to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.
70
HT II and HT III are periodically examined and audited by the SBAs staff to determine
their compliance with SBA regulations. If HT II or HT III fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit HT IIs or HT IIIs use of debentures, declare
outstanding debentures immediately due and payable, and/or limit HT II or HT III from making new investments. In addition, HT II or HT III may also be limited in their ability to make distributions to us if they do not have sufficient capital in
accordance with SBA regulations. Such actions by the SBA would, in turn, negatively affect us because HT II and III are our wholly owned subsidiaries. HT II and HT III were in compliance with the terms of the SBICs leverage as of
September 30, 2012 as a result of having sufficient capital as defined under the SBA regulations.
The rates of
borrowings under various draws from the SBA beginning in April 2007 are set semiannually in March and September and range from 2.25% to 5.73%. Interest payments on SBA debentures are payable semi-annually. There are no principal payments required on
these issues prior to maturity and no prepayment penalties. Debentures under the SBA generally mature ten years after being borrowed. Based on the initial draw down date of April 2007, the initial maturity of SBA debentures will occur in April 2017.
In addition, the SBA charges a fee that is set annually, depending on the Federal fiscal year the leverage commitment was delegated by the SBA, regardless of the date that the leverage was drawn by the SBIC. The annual fees related to HT II
debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year in which the underlying commitment was closed. The annual fees related to HT III debentures that pooled on September 19, 2012 were 0.804%. The
annual fees on other debentures have been set at 0.906%. The average amount of debentures outstanding for the quarter ended September 30, 2012 for HT II was approximately $88.9 million with an average interest rate of approximately 4.83%.
The average amount of debentures outstanding for the quarter ended September 30, 2012 for HT III was approximately $110.8 million with an average interest rate of approximately 3.3%.
In January 2011, we repaid $25.0 million of SBA debentures under HT II, priced at approximately 6.63%, including annual fees. In April
2011, the SBA approved a $25.0 million dollar commitment for HT III.
In February 2012, we repaid $24.3 million of SBA
debentures under HT II, priced at 6.63%, including annual fees. In June 2012, the SBA approved a $24.3 million dollar commitment for HT III.
In August 2012, the Company repaid $24.75 million of SBA debentures under HT II, $12.0 million priced at 6.43%, including annual fees and $12.75 million priced at 6.38%, including annual fees.
As of September 30, 2012, the maximum statutory limit on the dollar amount of outstanding SBA guaranteed debentures issued by a
single SBIC is $150.0 million, subject to periodic adjustments by the SBA, and a maximum amount of $225.0 million for funds under common control, subject to periodic adjustments by the SBA. In the aggregate, at September 30, 2012 there was
$200.25 million principal amount of indebtedness outstanding incurred by our SBIC subsidiaries, and in September 2012 the SBA approved an additional $24.75 million commitment under HT III, bringing us to the maximum statutory limit on the dollar
amount of SBA guaranteed debentures under the SBIC program.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
Issuance/Pooling Date
|
|
Maturity Date
|
|
|
Interest
Rate
(1)
|
|
|
September
30
2012
|
|
|
December 31,
2011
|
|
SBA Debentures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 26, 2007
|
|
|
September 1, 2017
|
|
|
|
6.43
|
%
|
|
$
|
|
|
|
$
|
12,000
|
|
March 26, 2008
|
|
|
March 1, 2018
|
|
|
|
6.38
|
%
|
|
|
34,800
|
|
|
|
58,050
|
|
September 24, 2008
|
|
|
September 1, 2018
|
|
|
|
6.63
|
%
|
|
|
|
|
|
|
13,750
|
|
March 25, 2009
|
|
|
March 1, 2019
|
|
|
|
5.53
|
%
|
|
|
18,400
|
|
|
|
18,400
|
|
September 23, 2009
|
|
|
September 1, 2019
|
|
|
|
4.64
|
%
|
|
|
3,400
|
|
|
|
3,400
|
|
September 22, 2010
|
|
|
September 1, 2020
|
|
|
|
3.62
|
%
|
|
|
6,500
|
|
|
|
6,500
|
|
September 22, 2010
|
|
|
September 1, 2020
|
|
|
|
3.50
|
%
|
|
|
22,900
|
|
|
|
22,900
|
|
March 29, 2011
|
|
|
March 1, 2021
|
|
|
|
4.37
|
%
|
|
|
28,750
|
|
|
|
28,750
|
|
September 21, 2011
|
|
|
September 1, 2021
|
|
|
|
3.16
|
%
|
|
|
25,000
|
|
|
|
25,000
|
|
March 21, 2012
|
|
|
March 1, 2022
|
|
|
|
3.05
|
%
|
|
|
11,250
|
|
|
|
11,250
|
|
March 21, 2012
|
|
|
March 1, 2022
|
|
|
|
3.28
|
%
|
|
|
25,000
|
|
|
|
25,000
|
|
September 19, 2012
|
|
|
September 1, 2022
|
|
|
|
3.05
|
%
|
|
|
24,250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total SBA Debentures
|
|
|
|
|
|
|
|
|
|
$
|
200,250
|
|
|
$
|
225,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
71
Wells Facility
In August 2008, we entered into a $50.0 million two-year revolving senior secured credit facility with Wells Fargo Capital Finance (the
Wells Facility). On June 20, 2011, we renewed the Wells Facility. Under this three-year senior secured facility, Wells Fargo Capital Finance has made commitments of $75.0 million. The facility contains an accordion feature, in which
we can increase the credit line up to an aggregate of $300.0 million, funded by additional lenders and with the agreement of Wells Fargo Capital Finance and subject to other customary conditions. We expect to continue discussions with various other
potential lenders to join the new facility; however, there can be no assurances that additional lenders will join the Wells Facility.
On August 1, 2012, we entered into an amendment to the Wells Facility. The amendment reduces the interest rate floor by 75 basis points to 4.25% and extends the maturity date by one year to August
2015. Additionally, an amortization period of 12 months was added to pay down the principal balance as of the maturity date, and the unused line fee was reduced.
Borrowings under the Wells Facility will generally bear interest at a rate per annum equal to LIBOR plus 3.50%, with a floor of 4.25% and an advance rate of 50% against eligible loans. The Wells Facility
is secured by loans in the borrowing base. The Wells Facility requires payment of a non-use fee on a scale of 0.0% to 0.50% of the average monthly outstanding balance. The monthly payment of a non-use fee thereafter shall depend on the average
balance that was outstanding on a scale between 0.0% and 0.50%. For the three-month period ended September 30, 2012, this non-use fee was approximately $112,000. On June 20, 2011 we paid an additional $1.1 million in structuring fees in
connection with the Wells Facility which is being amortized through the end of the term. At September 30, 2012, there were no borrowings outstanding on this facility.
The Wells Facility includes various financial and operating covenants applicable to us and our subsidiaries, in addition to those applicable to Hercules Funding II, LLC. These covenants require us to
maintain certain financial ratios and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $362.0 million plus 90% of the cumulative amount of equity raised after June 30, 2012. In
addition, the tangible net worth covenant will increase by 90 cents on the dollar for every dollar of equity capital that we subsequently raise. The Wells Facility provides for customary events of default, including, but not limited to, payment
defaults, breach of representations or covenants, bankruptcy events and change of control. We were in compliance with all covenants at September 30, 2012.
Union Bank Facility
On February 10, 2010, we entered a $20.0
million one-year revolving senior secured credit facility with Union Bank (the Union Bank Facility). On November 2, 2011, we renewed and amended the Union Bank Facility and added a new lender under the Union Bank Facility. Union
Bank and RBC Capital Markets have made commitments of $30.0 million and $25.0 million, respectively. The Union Bank Facility contains an accordion feature, in which we can increase the credit line up to an aggregate of $150.0 million, funded by
additional lenders and with the agreement of Union Bank and subject to other customary conditions. We expect to continue discussions with various other potential lenders to join the new facility; however, there can be no assurances that additional
lenders will join the Union Bank Facility.
On March 30, 2012 we entered into an amendment to the Union Bank Facility
which permitted us to issue additional senior notes relating to the offer and sale of our 2019 Notes. On September 17, 2012, we entered into an amendment to the Union Bank Facility. Pursuant to the terms of the amendment, we are permitted to
increase our unsecured indebtedness by an aggregate original principal amount not to exceed $200.0 million incurred after March 30, 2012 in one or more issuances, provided certain conditions are satisfied for each issuance.
Borrowings under the Union Bank Facility will generally bear interest at a rate per annum equal to LIBOR plus 2.25% with a floor of 4.0%.
The Union Bank Facility requires the payment of a non-use fee of 0.50% annually. For the three-month period ended September 30, 2012, this nonuse fee was approximately $70,000. The Union Bank Facility is collateralized by debt investments in
our portfolio companies, and includes an advance rate equal to 50.0% of eligible loans placed in the collateral pool. The Union Bank Facility generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity.
At September 30, 2012, there were no borrowings outstanding on this facility.
The Union Bank Facility requires various
financial and operating covenants. These covenants require us to maintain certain financial ratios and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $314.0 million plus 90% of
the amount of net cash proceeds received from the sale of common stock after March 31, 2011. As of September 30, 2012, the minimum tangible net worth covenant has increased to $356.5 million as a result of the January 2012 follow-on public
offering of 5.0 million shares of common stock for net proceeds of approximately $47.2 million. The Union Bank Facility will mature on November 2, 2014, approximately three years from the date of issuance, revolving through the first 24
months with a term out provision for the remaining 12 months. Union Bank Facility also provides for customary events of default, including, but not limited to, payment defaults, breach of representations or covenants, bankruptcy events and change of
control. We were in compliance with all covenants at September 30, 2012.
72
Citibank Credit Facility
We, through Hercules Funding Trust I, an affiliated statutory trust, had a securitized credit facility (the Citibank Credit
Facility) with Citigroup Global Markets Realty Corp. which expired under normal terms. During the first quarter of 2009, we paid off all principal and interest owed under the Citibank Credit Facility. Citigroup has an equity participation
right through a warrant participation agreement on the pool of loans and warrants collateralized under the Citibank Credit Facility. Pursuant to the warrant participation agreement, we granted to Citigroup a 10% participation in all warrants held as
collateral. However, no additional warrants were included in collateral subsequent to the facility amendment on May 2, 2007. As a result, Citigroup is entitled to 10% of the realized gains on the warrants until the realized gains paid to
Citigroup pursuant to the agreement equal $3,750,000 (the Maximum Participation Limit). The obligations under the warrant participation agreement continue even after the Citibank Credit Facility is terminated until the Maximum
Participation Limit has been reached. The value of their participation right on unrealized gains in the related equity investments was approximately $699,000 as of September 30, 2012 and is included in accrued liabilities. There can be no
assurances that the unrealized appreciation of the warrants will not be higher or lower in future periods due to fluctuations in the value of the warrants, thereby increasing or reducing the effect on the cost of borrowing. Since inception of the
agreement, we have paid Citigroup approximately $1.1 million under the warrant participation agreement thereby reducing our realized gains by this amount. We will continue to pay Citigroup under the warrant participation agreement until the Maximum
Participation Limit is reached or the warrants expire. Warrants subject to the Citigroup participation agreement are set to expire between December 2012 and January 2017.
Convertible Senior Notes
In April 2011, we issued $75.0 million in
aggregate principal amount of 6.00% convertible senior notes (the Convertible Senior Notes) due 2016. As of September 30, 2012, the carrying value of the Convertible Senior Notes, comprised of the aggregate principal amount
outstanding less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes, is approximately $71.2 million.
The Convertible Senior Notes mature on April 15, 2016 (the Maturity Date), unless previously converted or repurchased in accordance with their terms. The Convertible Senior Notes bear
interest at a rate of 6.00% per year payable semiannually in arrears on April 15 and October 15 of each year, commencing on October 15, 2011. The Convertible Senior Notes are our senior unsecured obligations and rank senior in
right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Senior Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated;
effectively junior in right of payment to any of our secured indebtedness (including unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future
indebtedness (including trade payables) incurred by our subsidiaries, financing vehicles or similar facilities.
Prior to the
close of business on the business day immediately preceding October 15, 2015, holders may convert their Convertible Senior Notes only under certain circumstances set forth in the Indenture. On or after October 15, 2015 until the close of
business on the scheduled trading day immediately preceding the Maturity Date, holders may convert their Convertible Senior Notes at any time. Upon conversion, we will pay or deliver, as the case may be, at our election, cash, shares of our common
stock or a combination of cash and shares of our common stock. The conversion rate will initially be 84.0972 shares of common stock per $1,000 principal amount of Convertible Senior Notes (equivalent to an initial conversion price of approximately
$11.89 per share of common stock). The conversion rate will be subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the
conversion rate will be increased for converting holders.
We may not redeem the Convertible Senior Notes prior to maturity.
No sinking fund is provided for the Convertible Senior Notes. In addition, if certain corporate events occur, holders of the Convertible Senior Notes may require us to repurchase for cash all or part of their Convertible Senior Notes at a repurchase
price equal to 100% of the principal amount of the Convertible Senior Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.
In accounting for the Convertible Senior Notes, we estimated that the values of the debt and the embedded conversion feature of the
Convertible Senior Notes were approximately 92.8% and 7.2%, respectively. The original issue discount of 7.2% attributable to the conversion feature of the Convertible Senior Notes has initially been recorded in capital in excess of par
value in the consolidated statement of assets and liabilities. As a result, we record interest expense comprised of both stated interest expense as well as accretion of the original issue discount resulting in an estimated effective interest
rate of approximately 7.9%.
73
As of September 30, 2012, the components of the carrying value of the Convertible
Senior Notes were as follows:
|
|
|
|
|
(in thousands)
|
|
As of September 30, 2012
|
|
Principal amount of debt
|
|
$
|
75,000
|
|
Original issue discount, net of accretion
|
|
|
(3,835
|
)
|
|
|
|
|
|
Carrying value of debt
|
|
$
|
71,165
|
|
|
|
|
|
|
For the three and nine-months ended September 30, 2012, the components of interest expense, fees and
cash paid for interest expense for the Convertible Senior Notes were as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three Months Ended
September
2012
|
|
|
Nine Months Ended
September
2012
|
|
Stated interest expense
|
|
$
|
1,125
|
|
|
$
|
3,375
|
|
Accretion of original issue discount
|
|
|
271
|
|
|
|
812
|
|
Amortization of debt issuance cost
|
|
|
144
|
|
|
|
433
|
|
|
|
|
|
|
|
|
|
|
Total interest expense and fees
|
|
$
|
1,540
|
|
|
$
|
4,620
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest expense
|
|
$
|
|
|
|
$
|
2,250
|
|
As of September 30, 2012, we are in compliance with the terms of the indentures governing the
Convertible Senior Notes. See Note to our consolidated financial statements for more detail on the Convertible Senior Notes.
2019 Notes Payable
On March 6, 2012, we and U.S. Bank National Association (the Trustee) entered into an indenture (the Base Indenture). On April 17, 2012, we and the Trustee entered into
the First Supplemental Indenture to the Base Indenture (the Base Indenture), dated April 17, 2012, relating to our issuance, offer and sale of $43.0 million aggregate principal amount of 7.00% senior notes due 2019 (the April
2019 Notes). The sale of the April 2019 Notes generated net proceeds, before expenses, of approximately $41.7 million.
On September 24, 2012, we and the Trustee, entered into the Second Supplemental Indenture to the Base Indenture, dated as of
September 24, 2012, relating to our issuance, offer and sale of $75.0 million aggregate principal amount of 7.00% senior notes due 2019 (the September 2019 Notes). The sale of the September 2019 Notes generated net proceeds, before
expenses, of approximately $72.75 million.
April 2019 Notes
The 2019 Notes will mature on April 30, 2019 and may be redeemed in whole or in part at our option at any time or from time to time
on or after April 30, 2015, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and
unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The April 2019 Notes bear interest at a rate of 7.00% per year payable quarterly on
January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2012, and trade on the New York Stock Exchange under the trading symbol HTGZ.
The 2019 Notes will be our direct unsecured obligations and will rank: (i)
pari passu
with our other outstanding and future
senior unsecured indebtedness, including without limitation, the $75.0 million in aggregate principal amount of the Convertible Senior Notes; (ii) senior to any of our future indebtedness that expressly provides it is subordinated to the April
2019 Notes; (iii) effectively subordinated to all our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such
indebtedness, including without limitation, borrowings under our credit facilities; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, including without limitation, the
indebtedness of Hercules Technology II, L.P. and Hercules Technology III, L.P. and borrowings under our revolving senior secured credit facility with Wells Fargo Capital Finance, LLC.
The Indenture, as supplemented by the First Supplemental Indenture, contains certain covenants including covenants requiring our
compliance with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the Investment Company Act of 1940, as amended, to comply with the restrictions on
dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the Investment Company Act of 1940, as amended, and to provide financial information to the holders of the April
2019 Notes and the Trustee if the Company should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. These covenants are subject to important limitations and exceptions that are described in the Indenture,
as supplemented by the First Supplemental Indenture. The Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding April 2019 Notes in a series may
declare such April 2019 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period.
74
The April 2019 Notes were sold pursuant to an underwriting agreement dated April 11,
2012 among us and Stifel, Nicolaus & Company, Incorporated, as representative of the several underwriters named in the underwriting agreement.
In July 2012, we reopened our April 2019 Notes and issued an additional $41.5 million in aggregate principal amount of April 2019 Notes, which includes exercise of an over-allotment option, bringing the
total amount of the April 2019 Notes issued to approximately $84.5 million in aggregate principal amount.
September 2019
Notes
The September 2019 Notes will mature on September 30, 2019 and may be redeemed in whole or in part at our
option at any time or from time to time on or after September 30, 2015, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding
principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The September 2019 Notes bear interest at a rate of
7.00% per year payable quarterly on March 30, June 30, September 30 and December 30 of each year, commencing on December 30, 2012, and trade on the New York Stock Exchange under the trading symbol
HTGY.
The September 2019 Notes will be the Companys direct unsecured obligations and will rank:
(i)
pari passu
with our other outstanding and future senior unsecured indebtedness, including without limitation, the $75 million in aggregate principal amount of the Convertible Senior Notes; (ii) senior to any of our future
indebtedness that expressly provides it is subordinated to the September 2019 Notes; (iii) effectively subordinated to all our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently
grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under our credit facilities; (iv) structurally subordinated to all existing and future indebtedness and other
obligations of any of our subsidiaries, including without limitation, the indebtedness of Hercules Technology II, L.P. and Hercules Technology III, L.P. and borrowings under our revolving senior secured credit facility with Wells Fargo Capital
Finance.
The Base Indenture, as supplemented by the Second Supplemental Indenture, contains certain covenants including
covenants requiring the Company to comply with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the Investment Company Act of 1940, as amended, to
comply with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the Investment Company Act of 1940, as amended, and to provide financial information
to the holders of the September 2019 Notes and the Trustee if the Company should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. These covenants are subject to important limitations and exceptions that
are described in the Indenture, as supplemented by the Second Supplemental Indenture. The Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding
September 2019 Notes in a series may declare such September 2019 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period.
The September 2019 Notes were sold pursuant to an underwriting agreement dated as of September 19, 2012 (the Underwriting
Agreement) among the Company and Stifel, Nicolaus & Company, Incorporated, as representative of the several underwriters named in the underwriting agreement.
In October 2012, the underwriters exercised their over-allotment option for an additional $10.9 million of the September 2019 Notes, bringing the total amount of the September 2019 Notes issued to
approximately $85.9 million in aggregate principal amount.
For the three months and nine-months ended September 30,
2012, the components of interest expense and cash paid for interest expense for the April 2019 Notes and September 2019 Notes are as follows:
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
Three Months
Ended
September 30, 2012
(1)
|
|
|
Nine Months
Ended
September 30, 2012
(1)
|
|
Stated interest expense
|
|
$
|
1,509
|
|
|
$
|
2,128
|
|
Amortization of debt issuance cost
|
|
|
130
|
|
|
|
179
|
|
|
|
|
|
|
|
|
|
|
Total interest expense and fees
|
|
$
|
1,639
|
|
|
$
|
2,307
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest expense
|
|
$
|
|
|
|
$
|
|
|
(1)
|
Includes the April 2019 Notes and the September 2019 Notes.
|
As of September 30, 2012, we are in compliance with the terms of the indenture governing the April 2019 Notes and the September 2019 Notes. See Note 4 to our consolidated financial statements for
more detail on the 2019 Notes.
75
Outstanding Borrowings
At September 30, 2012 (unaudited) and December 31, 2011, we had the following borrowing capacity and outstanding borrowings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2012
|
|
|
December 31, 2011
|
|
(in thousands)
|
|
Total
Available
|
|
|
Carrying
Value
(1)
|
|
|
Total
Available
|
|
|
Carrying
Value
(1)
|
|
Union Bank Facility
|
|
$
|
55,000
|
|
|
$
|
|
|
|
$
|
55,000
|
|
|
$
|
|
|
Wells Facility
|
|
|
75,000
|
|
|
|
|
|
|
|
75,000
|
|
|
|
10,187
|
|
April 2019 Notes
|
|
|
84,490
|
|
|
|
84,490
|
|
|
|
|
|
|
|
|
|
September 2019 Notes
(2)
|
|
|
75,000
|
|
|
|
75,000
|
|
|
|
|
|
|
|
|
|
Convertible Senior Notes
(3)
|
|
|
75,000
|
|
|
|
71,165
|
|
|
|
75,000
|
|
|
|
70,353
|
|
SBA Debentures
(4)
|
|
|
225,000
|
|
|
|
200,250
|
|
|
|
225,000
|
|
|
|
225,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
589,490
|
|
|
$
|
430,905
|
|
|
$
|
430,000
|
|
|
$
|
305,540
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Except for the Convertible Senior Notes, all carrying values are the same as the principal amount outstanding.
|
(2)
|
In October 2012, the underwriters exercised their over-allotment option for an additional $10.9 million of the September 2019 Notes, bringing the total
amount of the September 2019 Notes issued to approximately $85.9 million in aggregate principal amount.
|
(3)
|
Represents the aggregate principal amount outstanding of the Convertible Senior Notes less the unaccreted discount initially recorded upon issuance of
the Convertible Senior Notes. The total unaccreted discount for the Convertible Senior Notes was $3.8 million at September 30, 2012.
|
(4)
|
In February 2012, we repaid $24.3 million of SBA debentures under HT II, priced at approximately 6.63%, including annual fees. In June 2012, the SBA
approved a $24.3 million dollar commitment for HT III. In August 2012, the Company repaid $24.75 million of SBA debentures under HT II, $12.0 million priced at 6.43%, including annual fees, and $12.75 million priced at 6.38%, including annual fees.
In September 2012, the SBA approved a $24.75 million dollar commitment for HT III bringing the total available borrowings to $225.0 million, of which $76.0 million was available in HT II and $149.0 million was available in HT III.
|
76
Dividends
The following table summarizes our dividends declared and paid or to be paid on all shares, including restricted stock, to date:
|
|
|
|
|
|
|
|
|
Date Declared
|
|
Record Date
|
|
Payment Date
|
|
Amount Per Share
|
|
October 27, 2005
|
|
November 1, 2005
|
|
November 17, 2005
|
|
$
|
0.03
|
|
December 9, 2005
|
|
January 6, 2006
|
|
January 27, 2006
|
|
|
0.30
|
|
April 3, 2006
|
|
April 10, 2006
|
|
May 5, 2006
|
|
|
0.30
|
|
July 19, 2006
|
|
July 31, 2006
|
|
August 28, 2006
|
|
|
0.30
|
|
October 16, 2006
|
|
November 6, 2006
|
|
December 1, 2006
|
|
|
0.30
|
|
February 7, 2007
|
|
February 19, 2007
|
|
March 19, 2007
|
|
|
0.30
|
|
May 3, 2007
|
|
May 16, 2007
|
|
June 18, 2007
|
|
|
0.30
|
|
August 2, 2007
|
|
August 16, 2007
|
|
September 17, 2007
|
|
|
0.30
|
|
November 1, 2007
|
|
November 16, 2007
|
|
December 17, 2007
|
|
|
0.30
|
|
February 7, 2008
|
|
February 15, 2008
|
|
March 17, 2008
|
|
|
0.30
|
|
May 8, 2008
|
|
May 16, 2008
|
|
June 16, 2008
|
|
|
0.34
|
|
August 7, 2008
|
|
August 15, 2008
|
|
September 19, 2008
|
|
|
0.34
|
|
November 6, 2008
|
|
November 14, 2008
|
|
December 15, 2008
|
|
|
0.34
|
|
February 12, 2009
|
|
February 23, 2009
|
|
March 30, 2009
|
|
|
0.32
|
*
|
May 7, 2009
|
|
May 15, 2009
|
|
June 15, 2009
|
|
|
0.30
|
|
August 6, 2009
|
|
August 14, 2009
|
|
September 14, 2009
|
|
|
0.30
|
|
October 15, 2009
|
|
October 20, 2009
|
|
November 23, 2009
|
|
|
0.30
|
|
December 16, 2009
|
|
December 24, 2009
|
|
December 30, 2009
|
|
|
0.04
|
|
February 11, 2010
|
|
February 19, 2010
|
|
March 19, 2010
|
|
|
0.20
|
|
May 3, 2010
|
|
May 12, 2010
|
|
June 18, 2010
|
|
|
0.20
|
|
August 2, 2010
|
|
August 12, 2010
|
|
September 17, 2010
|
|
|
0.20
|
|
November 4, 2010
|
|
November 10, 2010
|
|
December 17, 2010
|
|
|
0.20
|
|
March 1, 2011
|
|
March 10, 2011
|
|
March 24, 2011
|
|
|
0.22
|
|
May 5, 2011
|
|
May 11, 2011
|
|
June 23, 2011
|
|
|
0.22
|
|
August 4, 2011
|
|
August 15, 2011
|
|
September 15, 2011
|
|
|
0.22
|
|
November 3, 2011
|
|
November 14, 2011
|
|
November 29, 2011
|
|
|
0.22
|
|
February 27, 2012
|
|
March 12, 2012
|
|
March 15, 2012
|
|
|
0.23
|
|
April 30, 2012
|
|
May 18, 2012
|
|
May 25, 2012
|
|
|
0.24
|
|
July 30, 2012
|
|
August 17, 2012
|
|
August 24, 2012
|
|
|
0.24
|
|
October 26, 2012
|
|
November 14, 2012
|
|
November 21, 2012
|
|
|
0.24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
7.64
|
|
|
|
|
|
|
|
|
|
|
*
|
Dividend paid in cash and stock.
|
77
On October 26, 2012 the Board of Directors declared a cash dividend of $0.24 per share
to be paid on November 21, 2012 to shareholders of record as of November 14, 2012. This dividend represents the Companys twenty-ninth consecutive quarterly dividend declaration since its initial public offering, and will bring the
total cumulative dividend declared to date to $7.64 per share.
Our Board of Directors maintains a variable dividend policy
with the objective of distributing four quarterly distributions in an amount that approximates 90 - 100% of our taxable quarterly income or potential annual income for a particular year. In addition, at the end of the year, we may also pay an
additional special dividend or fifth dividend, such that we may distribute approximately all of our annual taxable income in the year it was earned, while maintaining the option to spill over our excess taxable income.
Distributions in excess of our current and accumulated earnings and profits would generally be treated first as a return of capital to
the extent of the stockholders tax basis, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable
income for the full year and distributions paid for the full year, therefore a determination made on a quarterly basis may not be representative of the tax attributes of our 2012 distributions to stockholders. If we had determined the tax attributes
of our distributions year-to-date as of September 30, 2012, approximately 100.0% would be from ordinary income and spillover earnings from 2011.
Each year a statement on Form 1099-DIV identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of
paid-in-capital surplus which is a nontaxable distribution) is mailed to our stockholders. To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of those distributions may be deemed a tax
return of capital to our stockholders.
We operate to qualify to be taxed as a RIC under the Code. Generally, a RIC is
entitled to deduct dividends it pays to its shareholders from its income to determine taxable income. Taxable income includes our taxable interest, dividend and fee income, as well as taxable net capital gains. Taxable income generally
differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in
taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally
results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes
in accrued and reinvested interest and dividends, which includes contractual payment-in-kind interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual PIK interest or the amortization of discounts
and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation and amortization expense.
We intend to distribute quarterly dividends to our stockholders. In order to avoid certain excise taxes imposed on RICs, we currently
intend to distribute during each calendar year an amount at least equal to the sum of (1) 98% of our ordinary income for the calendar year, (2) 98.2% of our capital gains in excess of capital losses for the one year period ending on
October 31 of the calendar year, and (3) any ordinary income and net capital gains for the preceding year that were not distributed during such year. We will not be subject to excise taxes on amounts on which we are required to pay
corporate income tax (such as retained net capital gains). In order to obtain the tax benefits applicable to RICs, we will be required to distribute to our stockholders with respect to each taxable year at least 90% of our ordinary income and
realized net short-term capital gains in excess of realized net long-term capital losses.
We can offer no assurance that we
will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the
1940 Act or if distributions are limited by the terms of any of our borrowings. See Regulation.
We maintain an
opt-out dividend reinvestment plan for our common stockholders. As a result, if we declare a dividend, cash dividends will be automatically reinvested in additional shares of our common stock unless the stockholder specifically
opts out of the dividend reinvestment plan and chooses to receive cash dividends. See Dividend Reinvestment Plan.
Our ability to make distributions will be limited by the asset coverage requirements under the 1940 Act.
Critical Accounting Policies
The preparation of consolidated
financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent
assets and liabilities at the date of the consolidated financial statements, and revenues and expenses during the period reported. On an ongoing basis, our management evaluates its estimates and assumptions, which are based on historical experience
and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Changes in our estimates and assumptions could materially impact our results of operations and financial
condition.
Valuation of Portfolio Investments.
The most significant estimate inherent in the
preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.
78
Our investments are carried at fair value in accordance with the 1940 Act and Accounting
Standards Codification (ASC) topic 820 Fair Value Measurements and Disclosures (formerly known as SFAS No. 157, Fair Value Measurements). At September 30, 2012, approximately 85.2% of the Companys total assets represented
investments in portfolio companies that are valued at fair value by the Board of Directors. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily
available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Our debt securities are primarily invested in venture capital-backed companies in technology-related markets, including
technology, biotechnology, life science and clean technology industries. Given the nature of lending to these types of businesses, our investments in these portfolio companies are generally considered Level 3 assets under ASC 820 because there is no
known or accessible market or market indexes for these investment securities to be traded or exchanged. As such, it values substantially all of its investments at fair value as determined in good faith pursuant to a consistent valuation policy and
our Board of Directors in accordance with the provisions of ASC 820 and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of our investments
determined in good faith by our Board may differ significantly from the value that would have been used had a readily available market existed for such investments, and the differences could be material.
Our Board of Directors may from time to time engage an independent valuation firm to provide us with valuation assistance with respect to
certain of our portfolio investments on a quarterly basis. We intend to continue to engage an independent valuation firm to provide us with assistance regarding our determination of the fair value of selected portfolio investments each quarter
unless directed by the Board of Directors to cancel such valuation services. The scope of the services rendered by an independent valuation firm is at the discretion of the Board of Directors. Our Board of Directors is ultimately and solely
responsible for determining the fair value of our investments in good faith.
With respect to investments for which market
quotations are not readily available or when such market quotations are deemed not to represent fair value, our Board of Directors has approved a multi-step valuation process each quarter, as described below:
(1) our quarterly valuation process begins with each portfolio company or investment being initially valued by the investment
professionals responsible for the portfolio investment;
(2) preliminary valuation conclusions are then documented and business
based assumptions are discussed with our investment committee;
(3) the valuation committee of the Board of Directors reviews
the preliminary valuation of the investment committee which incorporates the results of the independent valuation firm as appropriate.
(4) the Board of Directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the input of, where applicable, the respective independent
valuation firm and the valuation committee.
We adopted ASC 820 on January 1, 2008. ASC 820 establishes a framework for
measuring the fair value of the assets and liabilities and outlines a fair value hierarchy which prioritizes the inputs used to measure fair value and the effect of fair value measures on earnings. ASC 820 also enhances disclosure requirements for
fair value measurements based on the level within the hierarchy of the information used in the valuation. ASC 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of
fair value in any new circumstances. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
We have categorized all investments recorded at fair value in accordance with ASC 820 based upon the level of judgment associated with
the inputs used to measure their fair value. Hierarchical levels, defined by ASC 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:
Level 1Inputs are unadjusted, quoted prices in active markets for identical assets at the measurement date. The types of assets
carried at Level 1 fair value generally are equities listed in active markets.
Level 2Inputs (other than quoted prices
included in Level 1) are either directly or indirectly observable for the asset in connection with market data at the measurement date and for the extent of the instruments anticipated life. Fair valued assets that are generally included in
this category are warrants held in a public company.
Level 3Inputs reflect managements best estimate of what
market participants would use in pricing the asset at the measurement date. It includes prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. Generally, assets carried at fair value and
included in this category are the debt investments and warrants and equities held in a private company.
79
In accordance with ASU 2011-04, the following table provides quantitative information about
our Level 3 fair value measurements of our investments as of September 30, 2012. In addition to the techniques and inputs noted in the table below, according to our valuation policy we may also use other valuation techniques and methodologies
when determining our fair value measurements. The below table is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to our fair value measurements.
Quantitative Information about Level 3 Fair Value Measurements of Debt Investments
|
|
|
|
|
|
|
|
|
|
|
Investment Type - Level Three Debt Investments
|
|
Fair Value
at
September 30, 2012
|
|
|
Valuation Techniques/
Methodologies
|
|
Unobservable Input
(a)
|
|
Range
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
Pharmaceuticals - Debt
|
|
$
|
220,641
|
|
|
Market Comparable Companies
|
|
Hypothetical Market Yield
Premium/(Discount)
|
|
14.0% - 16.8%
(2.0%) -
1.5%
|
|
|
|
|
|
|
Option Pricing Model
(b)
|
|
Average Industry Volatility
(c)
Risk Free Interest Rate
|
|
57.62%
0.23%
18.2
|
Medical Devices - Debt
|
|
|
39,613
|
|
|
Market Comparable Companies
|
|
Hypothetical Market Yield
Premium
|
|
14.1%
0.0% -
1.0%
|
|
|
|
|
|
Technology - Debt
|
|
|
137,473
|
|
|
Market Comparable Companies
|
|
Hypothetical Market Yield
Premium/(Discount)
|
|
13.3% - 17.9%
(1.5%) -
1.0%
|
|
|
|
|
|
Clean Tech - Debt
|
|
|
82,267
|
|
|
Market Comparable Companies
|
|
Hypothetical Market Yield
Premium
|
|
16.46%
0.0% -
1.0%
|
Lower Middle Market - Debt
|
|
|
213,781
|
|
|
Market Comparable Companies
|
|
Hypothetical Market Yield
Premium
|
|
10.8% - 19.5%
0.0% -
5.0%
|
|
|
|
|
|
|
Broker Quote
(d)
|
|
Price Quotes
|
|
90.0% - 99% of par
|
|
|
|
|
|
|
Liquidation
|
|
Investment Collateral
|
|
$1.0 - $5.0 million
|
|
|
|
|
|
|
|
|
|
|
|
Total Level Three Debt Investments
|
|
$
|
693,775
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
The significant unobservable inputs used in the fair value measurement of our debt securities are hypothetical market yields and premiums/(discounts). The hypothetical
market yield is defined as the exit price of an investment in a hypothetical market to hypothetical market participants where buyers and sellers are willing participants. The premiums (discounts) relate to company specific characteristics such as
underlying investment performance, security liens, and other characteristics of the investment. Significant increases (decreases) in the inputs in isolation would result in a significantly lower (higher) fair value measurement, depending on the
materiality of the investment. Debt investments in the industries noted in our Schedule of Investments are included in the industries note above as follows:
|
Pharmaceuticals, above, is comprised of debt investments in the Therapeutic, Specialty Pharmaceuticals, Drug Discovery and Development, Drug Delivery, and Diagnostics and Biotechnology industries in the
Schedule of Investments.
Medical Devices, above, is comprised of debt investments in the Therapeutic, Surgical Devices,
Medical Devices and Equipment and Biotechnology Tools industries in the Schedule of Investments.
Technology, above, is
comprised of debt investments in the Software, Semiconductors, Internet Consumer and Business Services, Information Services, and Communications and Networking industries in the Schedule of Investments.
Lower Middle Market, above, is comprised of debt investments in the Communications and Networking, Electronics and Computer Hardware,
Healthcare Services - Other, Information Services, Internet Consumer and Business Services, Media/Content/Info, and Specialty Pharmaceuticals industries in the Schedule of Investments.
Clean Tech, above, aligns with the Clean Tech Industry in the Schedule of Investments.
(b)
|
An option pricing model valuation technique was used to derive the fair value conversion feature of convertible notes.
|
(c)
|
Represents the range of industry volatility used by market participants when pricing the investment.
|
(d)
|
A broker quote valuation technique was used to derive the fair value of loans which are part of a syndicated facility.
|
80
Quantitative Information about Level 3 Fair Value Measurements of Warrants and Equity
Investments
|
|
|
|
|
|
|
|
|
|
|
Investment Type -
|
|
Fair Value at
September 30, 2012
|
|
|
Valuation Techniques/
Methodologies
|
|
Unobservable Input
(a)
|
|
Range
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
Level Three Warrant and Equity Investments
|
|
$
|
57,603
|
|
|
Market Comparable Companies
|
|
EBITDA Multiple
(b)
|
|
5.6x - 22.1x
|
|
|
|
|
|
|
|
|
Revenue Multiple
(b)
|
|
0.6x - 19.6x
|
|
|
|
|
|
|
|
|
Discount for Lack of Marketability
(c)
|
|
10.4% - 25.8%
|
|
|
|
|
|
Warrant positions additionally subject to:
|
|
|
|
|
|
Option Pricing Model
|
|
Average Industry Volatility
(d)
|
|
46.49% - 139.22%
|
|
|
|
|
|
|
|
|
Risk-Free Interest Rate
|
|
0.17% - 0.61%
|
|
|
|
|
|
|
|
|
Estimated Time to Exit (in months)
|
|
12 - 48
|
|
|
|
|
|
|
|
|
|
|
|
Total Level Three Warrant and Equity Investments
|
|
$
|
57,603
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
|
The significant unobservable inputs used in the fair value measurement of the Companys warrant and equity-related securities are revenue and/or EBITDA multiples
and discounts for lack of marketability. Additional inputs used in the Black Scholes option pricing model include industry volatility, risk free interest rate and estimated time to exit. Significant increases (decreases) in the inputs in isolation
would result in a significantly higher (lower) fair value measurement, depending on the materiality of the investment. For some investments, additional consideration may be given to data from the last round of financing or merger/acquisition events
near the measurement date.
|
(b)
|
Represents amounts used when the Company has determined that market participants would use such multiples when pricing the investments.
|
(c)
|
Represents amounts used when the Company has determined market participants would take into account these discounts when pricing the investments.
|
(d)
|
Represents the range of industry volatility used by market participants when pricing the investment.
|
81
Debt Investments
Our debt securities are primarily invested in venture capital-backed companies in technology-related markets including technology,
biotechnology, life science and clean-technology industries at all stages of development. Given the nature of lending to these types of businesses, our investments in these portfolio companies are considered Level 3 assets under ASC 820 because
there is no known or accessible market or market indexes for these investment securities to be traded or exchanged.
We apply
a procedure for debt investments that assumes a sale of investment in a hypothetical market to a hypothetical market participant where buyers and sellers are willing participants. The hypothetical market does not include scenarios where the
underlying security was simply repaid or extinguished, but includes an exit concept. Under this process, we also evaluate the collateral for recoverability of the debt investments as well as apply all of its historical fair value analysis. We use
pricing on recently issued comparable debt securities to determine the baseline hypothetical market yields as of the measurement date. We consider each portfolio companys credit rating, security liens and other characteristics of the
investment to adjust the baseline yield to derive a hypothetical yield for each investment as of the measurement date. The anticipated future cash flows from each investment are then discounted at the hypothetical yield to estimate each
investments fair value as of the measurement date.
Our process includes, among other things, the underlying investment
performance, the current portfolio companys financial condition and market changing events that impact valuation, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. If
there is a significant deterioration of the credit quality of a debt investment, we may consider other factors than those a hypothetical market participant would use to estimate fair value, including the proceeds that would be received in a
liquidation analysis.
We record unrealized depreciation on investments when we believe that an investment has decreased in
value, including where collection of a loan is doubtful or if under the in exchange premise when the value of a debt security were to be less than amortized cost of the investment. Conversely, where appropriate, we record unrealized appreciation if
we believe that the underlying portfolio company has appreciated in value and, therefore, that our investment has also appreciated in value or if under the in exchange premise the value of a debt security were to be greater than amortized cost.
When originating a debt instrument, we generally receive warrants or other equity-related securities from the borrower. We
determine the cost basis of the warrants or other equity-related securities received based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and warrants or other equity-related securities
received. Any resulting discount on the loan from recordation of the warrant or other equity instruments is accreted into interest income over the life of the loan.
Equity-Related Securities and Warrants
Securities that are traded in the
over-the-counter markets or on a stock exchange will be valued at the prevailing bid price at period end. We have a limited number of equity securities in public companies. In accordance with the 1940 Act, unrestricted publicly traded securities for
which market quotations are readily available are valued at the closing market quote on the measurement date.
We estimate the
fair value of warrants using a Black Scholes pricing model. At each reporting date, privately held warrant and equity-related securities are valued based on an analysis of various factors including, but not limited to, the portfolio companys
operating performance and financial condition and general market conditions, price to enterprise value or price to equity ratios, discounted cash flow, valuation comparisons to comparable public companies or other industry benchmarks. When an
external event occurs, such as a purchase transaction, public offering, or subsequent equity sale, the pricing indicated by that external event is utilized to corroborate our valuation of the warrant and equity-related securities. We periodically
review the valuation of our portfolio companies that have not been involved in a qualifying external event to determine if the enterprise value of the portfolio company may have increased or decreased since the last valuation measurement date.
Income Recognition.
We record interest income on the accrual basis and we recognize it as earned in accordance with the contractual terms of the loan agreement to the extent that such amounts are expected to be collected.
Original Issue Discount (OID) initially represents the value of detachable equity warrants obtained in conjunction with the acquisition of debt securities and is accreted into interest income over the term of the loan as a yield
enhancement. When a loan becomes 90 days or more past due, or if management otherwise does not expect the portfolio company to be able to service its debt and other obligations, we will generally place the loan on non-accrual status and cease
recognizing interest income on that loan until all principal has been paid. Any uncollected interest related to prior periods is reversed from income in the period that collection of the interest receivable is determined to be doubtful. However, we
may make exceptions to this policy if the investment has sufficient collateral value and is in the process of collection. As of September 30, 2012, we had one portfolio company on non-accrual status with an approximate cost of $347,000 and zero
fair value. There was one portfolio company on non-accrual status with an approximate cost of $7.7 million and a fair value of approximately $1.0 million as of December 31, 2011.
82
Paid-In-Kind and End of Term Income.
Contractual paid-in-kind (PIK) interest, which represents contractually deferred interest added to the loan balance that is
generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We will generally cease accruing PIK interest if there is insufficient value to support the accrual or we
do not expect the portfolio company to be able to pay all principal and interest due. In addition, we may also be entitled to an end-of-term payment that we amortize into income over the life of the loan. To maintain our status as a RIC, PIK and
end-of-term income must be paid out to stockholders in the form of dividends even though we have not yet collected the cash. Amounts necessary to pay these dividends may come from available cash or the liquidation of certain investments. We recorded
approximately $297,000 and $866,000 in PIK income in the three and nine-month periods ended September 30, 2012, respectively. We recorded approximately $285,000 and $1.4 million in the same periods ended September 30, 2011, respectively.
Fee Income.
Fee income, generally collected in advance, includes loan commitment and facility fees for due diligence and structuring, as well as fees for transaction services and management services rendered by us to
portfolio companies and other third parties. Loan and commitment fees are amortized into income over the contractual life of the loan. Management fees are generally recognized as income when the services are rendered. Loan origination fees are
capitalized and then amortized into interest income using the effective interest rate method. In certain loan arrangements, warrants or other equity interests are received from the borrower as additional origination fees.
We recognize nonrecurring fees amortized over the remaining term of the loan commencing in the quarter relating to specific loan
modifications. Certain fees may still be recognized as one-time fees, including prepayment penalties, fees related to select covenant default waiver fees and acceleration of previously deferred loan fees and original issue discount (OID) related to
early loan pay-off or material modification of the specific debt outstanding.
Equity Offering Expenses
Our offering costs are charged against the proceeds from equity offerings when received.
Debt Issuance Costs
Debt issuance costs are being amortized over the life of the related debt instrument using the straight line method, which closely approximates the effective yield method.
Stock-Based Compensation.
We have issued and may, from time to time, issue additional stock options and restricted stock to employees under our 2004 Equity Incentive Plan and Board members under our 2006 Equity Incentive Plan. We
follow ASC 718, formally known as FAS 123R
Share-Based Payments
to account for stock options granted. Under ASC 718, compensation expense associated with stock-based compensation is measured at the grant date based on the fair
value of the award and is recognized over the vesting period.
Federal Income Taxes.
We intend to operate so as to qualify to be taxed as a RIC under Subchapter M of the Code and, as such, will not be subject to federal
income tax on the portion of our taxable income and gains distributed to stockholders. To qualify as a RIC, we are required to distribute at least 90% of our investment company taxable income, as defined by the Code. We are subject to a
non-deductible federal excise tax if we do not distribute at least 98% of our taxable income and 98.2% of our capital gain net income for each one year period ending on October 31. At December 31, 2011, 2010 and 2009, no excise tax was
recorded. At December 31, 2008, we recorded a liability for excise tax of approximately $203,000 on income and capital gains of approximately $5.0 million which was distributed in 2009. Because federal income tax regulations differ from
accounting principles generally accepted in the United States, distributions in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. Differences may be permanent or
temporary. Permanent differences are reclassified among capital accounts in the financial statement to reflect their tax character. Temporary differences arise when certain items of income, expense, gain or loss are recognized at some time in the
future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes.
83
Recent Accounting Pronouncement
In May 2011, the Financial Accounting Standards Board (FASB) issued
Accounting Standards Update No. 2011-04Fair
Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS
, or ASU 2011-04. ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements,
changes the application of some requirements for measuring fair value and requires additional disclosure for fair value measurements. The highest and best use valuation premise is only applicable to non-financial assets. In addition, the disclosure
requirements are expanded to include for fair value measurements categorized in Level 3 of the fair value hierarchy: (1) a quantitative disclosure of the unobservable inputs and assumptions used in the measurement; (2) a description of the
valuation processes in place; and (3) a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs. ASU 2011-04 is effective for interim and annual periods beginning
after December 15, 2011, for public entities and as such we have adopted this ASU beginning with our quarter ended March 31, 2012. We have increased our disclosures related to Level 3 fair value measurement, in addition to other required
disclosures. There were no related impacts on our financial position or results of operations.
Departure of Chief
Compliance Officer and Secretary
Effective August 20, 2012, H. Scott Harveys employment as our Chief Legal
Officer, Chief Compliance Officer and Secretary ended, and K. Nicholas Martitsch was appointed as our Associate General Counsel, Chief Compliance Officer and Secretary.
Subsequent Events
Liquidity and Capital Resources
In October 2012, we completed a follow-on public offering of 3.1 million shares of common stock for proceeds of
approximately $33.6 million, before deducting offering expenses.
In October 2012, in connection with the recent public
offering of $75.0 million in aggregate principal amount of our 7.00% senior unsecured notes due 2019 (the September 2019 Notes), which closed on September 24, 2012, the underwriters have exercised their over-allotment option for an
additional $10.9 million of the September 2019 Notes, bringing the total size of the offering to $85.9 million.
Dividend
Declaration
On October 26, 2012 the Board of Directors declared a cash dividend of $0.24 per share that will be
payable on November 21, 2012 to shareholders of record as of November 14, 2012. This dividend represents the Companys twenty-ninth consecutive dividend declaration since its initial public offering, bringing the total cumulative
dividend declared to date to $7.64 per share.
Portfolio Company Developments
In October 2012, our portfolio company Nextwave Pharmaceuticals, reached a definitive agreement to be acquired by Pfizer Inc. (NYSE: PFE).
Pfizer is exercising the option to acquire NextWave and will make a payment of $255 million to NextWave shareholders at the close of the deal. NextWave shareholders are eligible to receive additional payments of up to $425 million if certain sales
milestones are met.
Closed and Pending Commitments
1. As of October 30, 2012, Hercules has:
|
a.
|
Closed commitments of approximately $73.6 million to new and existing portfolio companies, and funded approximately $29.2 million since the close of the third quarter.
|
|
b.
|
Pending commitments (signed non-binding term sheets) of approximately $166.0 million.
|
The table below summarizes our year-to-date closed and pending commitments as follows:
|
|
|
|
|
Closed Commitments and Pending Commitments (in millions)
|
|
January 1- September 30, 2012 Closed Commitments
|
|
$
|
376.7
|
|
Q4-12 Closed Commitments (as of October 30, 2012)
|
|
$
|
73.6
|
|
Total year-to-date 2012 Closed Commitments(a)
|
|
$
|
450.3
|
|
Pending Commitments (as of October 30, 2012)(b)
|
|
$
|
166.0
|
|
Total year-to-date
|
|
$
|
616.3
|
|
Notes:
|
a.
|
Not all Closed Commitments result in future cash requirements. Commitments generally fund over the two succeeding quarters from close.
|
|
b.
|
Not all pending commitments (signed non-binding term sheets) are expected to close and do not necessarily represent any future cash requirements.
|
84