Quarterly Report on Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended March 31, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 814-00702

 

 

HERCULES TECHNOLOGY GROWTH

CAPITAL, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Maryland   743113410

(State or Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification No.)

 

400 Hamilton Ave., Suite

310 Palo Alto, California 94301

  94301
(Address of Principal Executive Offices)   (Zip Code)

(650) 289-3060

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer   ¨       Accelerated Filer   x
Non-Accelerated Filer   ¨       Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

On May 9, 2011, there were 43,799,440 shares outstanding of the Registrant’s common stock, $0.001 par value.

 

 

 


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

FORM 10-Q TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION      3   

Item 1.

  

Consolidated Financial Statements

     3   
  

Consolidated Statement of Assets and Liabilities as of March 31, 2011 (unaudited) and December 31, 2010

     3   
  

Consolidated Schedule of Investments as of March 31, 2011 (unaudited)

     4   
  

Consolidated Schedule of Investments as of December 31, 2010

     19   
  

Consolidated Statement of Operations for the three month period ended March 31, 2011 and 2010 (unaudited)

     32   
  

Consolidated Statement of Changes in Net Assets for the three-month periods ended March 31, 2011 and 2010 (unaudited)

     33   
  

Consolidated Statement of Cash Flows for the three-month periods ended March 31, 2011 and 2010 (unaudited)

     34   
  

Notes to Consolidated Financial Statements (unaudited)

     35   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     55   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     76   

Item 4.

  

Controls and Procedures

     77   
PART II. OTHER INFORMATION      78   

Item 1.

  

Legal Proceedings

     78   

Item 1A.

  

Risk Factors

     78   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     89   

Item 3.

  

Defaults Upon Senior Securities

     89   

Item 4.

  

Reserved

     89   

Item 5.

  

Other Information

     89   

Item 6.

  

Exhibits

     90   
SIGNATURES      91   

 

2


Table of Contents

PART I: FINANCIAL INFORMATION

In this Quarterly Report, the “Company,” “Hercules,” “we,” “us” and “our” refer to Hercules Technology Growth Capital, Inc. and its wholly owned subsidiaries and its affiliated securitization trusts unless the context otherwise requires.

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES

(unaudited)

(dollars in thousands, except per share data)

 

     March 31,
2011
(unaudited)
    December 31,
2010
 

Assets

    

Investments:

    

Non-Control/Non-Affiliate investments (cost of $465,896 and $445,782, respectively)

   $   443,022      $ 428,782   

Affiliate investments (cost of $2,880 and $2,880, respectively)

     2,032        3,069   

Control investments (cost of $0 and $31,743, respectively)

     —          40,181   
                

Total investments, at value (cost of $468,776 and $480,405, respectively)

     445,054        472,032   

Cash and cash equivalents

     114,435        107,014   

Interest receivable

     4,306        4,520   

Other assets

     10,611        7,681   
                

Total assets

   $ 574,406      $ 591,247   
                

Liabilities

    

Accounts payable and accrued liabilities

   $ 7,449      $ 8,716   

Long-term SBA Debentures

     163,750        170,000   
                

Total liabilities

     171,199        178,716   

Net assets:

    

Common stock, par value

     43        43   

Capital in excess of par value

     478,959        477,549   

Unrealized depreciation on investments

     (23,390     (8,038

Accumulated realized losses on investments

     (46,663     (51,033

Distributions in excess of investment income

     (5,742     (5,990
                

Total net assets

     403,207        412,531   
                

Total liabilities and net assets

   $ 574,406      $ 591,247   
                

Shares of common stock outstanding ($0.001 par value, 60,000,000 authorized)

     43,804        43,444   
                

Net asset value per share

   $ 9.20      $ 9.50   
                

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

Acceleron Pharmaceuticals, Inc.

   Drug Discovery    Preferred Stock Warrants       $ 69       $ 601   
      Preferred Stock Warrants         35         128   
      Preferred Stock Warrants         39         59   
      Preferred Stock         1,341         1,693   
                          

Total Acceleron Pharmaceuticals, Inc.

              1,484         2,481   

Anthera Pharmaceuticals inc.

   Drug Discovery    Senior Debt         
     

Matures September 2014

Interest rate Prime + 7.3% or

Floor rate of 10.55%

   $ 25,000         23,786         23,786   
      Common Stock Warrants         541         571   

Total Anthera Pharmaceuticals inc.

      Common Stock Warrants         443         467   
                          
              24,770         24,824   

Aveo Pharmaceuticals, Inc.

   Drug Discovery    Senior Debt         
     

Matures September 2013

Interest rate Prime + 7.15% or

Floor rate of 11.9%

   $ 25,000         26,186         26,728   
      Preferred Stock Warrants         190         530   
      Preferred Stock Warrants         104         128   
      Preferred Stock Warrants         24         46   
      Preferred Stock Warrants         288         650   
      Preferred Stock Warrants         236         532   
                          

Total Aveo Pharmaceuticals, Inc.

              27,028         28,614   

Dicerna Pharmaceuticals, Inc.

   Drug Discovery    Senior Debt         
     

Matures July 2012

Interest rate Prime + 9.20% or

Floor rate of 12.95%

   $ 4,020         4,042         4,083   
      Preferred Stock Warrants         206         161   
      Preferred Stock Warrants         31         29   
      Preferred Stock Warrants         28         23   
      Preferred Stock         503         503   
                          

Total Dicerna Pharmaceuticals, Inc.

              4,810         4,799   

EpiCept Corporation

   Drug Discovery    Common Stock Warrants         4         71   
      Common Stock Warrants         40         6   
                          

Total EpiCept Corporation

              44         77   

Horizon Therapeutics, Inc.

   Drug Discovery    Preferred Stock Warrants         231         57   
                          

Total Horizon Therapeutics, Inc.

              231         57   

Inotek Pharmaceuticals Corp.

   Drug Discovery    Preferred Stock         1,500         —     
                          

Total Inotek Pharmaceuticals Corp.

              1,500         —     
Merrimack Pharmaceuticals, Inc.    Drug Discovery    Preferred Stock Warrants         155         139   
      Preferred Stock         2,000         1,497   
                          
Total Merrimack Pharmaceuticals, Inc.               2,155         1,636   
Paratek Pharmaceuticals, Inc.    Drug Discovery    Preferred Stock Warrants         137         94   
      Preferred Stock         1,000         1,000   
                          
Total Paratek Pharmaceuticals, Inc.               1,137         1,094   

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

  

Principal
Amount

    

Cost(2)

    

Value(3)

 
PolyMedix, Inc.    Drug Discovery   

Senior Debt

Matures September 2013

Interest rate Prime + 7.1% or

Floor rate of 12.35%

   $ 9,224       $ 8,893       $ 9,170   
      Preferred Stock Warrants         480         167   
                          
Total PolyMedix, Inc.               9,373         9,337   
Portola Pharmaceuticals, Inc.    Drug Discovery   

Senior Debt

Matures April 2011

Interest rate Prime + 2.16%

   $ 416         791         791   
      Preferred Stock Warrants         152         533   
                          
Total Portola Pharmaceuticals, Inc.               943         1,324   
                          
Total Drug Discovery (18.41%)*               73,475         74,243   
                          
Affinity Videonet, Inc    Communications & Networking    Preferred Stock Warrants         102         169   
                          
Total Affinity Videonet, Inc.               102         169   
E-band Communications, Corp.(6)    Communications & Networking    Preferred Stock         2,880         2,032   
                          
Total E-Band Communications, Corp.               2,880         2,032   
IKANO Communications, Inc.    Communications & Networking    Preferred Stock Warrants         45         —     
      Preferred Stock Warrants         72         —     
                          
Total IKANO Communications, Inc.               117         —     
Intelepeer, Inc.    Communications & Networking   

Senior Debt

Matures May 2013

Interest rate Prime + 8.125%

   $ 7,271         7,137         7,094   
      Preferred Stock Warrants         102         103   
                          
Total Intelepeer, Inc.               7,239         7,197   
Neonova Holding Company    Communications & Networking    Preferred Stock Warrants         94         14   
      Preferred Stock         250         165   
                          
Total Neonova Holding Company               344         179   

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

  

Principal
Amount

    

Cost(2)

    

Value(3)

 
Opsource, Inc.               
   Communications & Networking    Preferred Stock Warrants       $ 223       $ 21   
                          
Total Opsource, Inc.               223         21   
Pac-West Telecomm, Inc.    Communications & Networking   

Senior Debt

Matures April 2013

Interest rate Prime + 7.5% or

Floor rate of 11.50%

   $ 4,500         4,175         4,138   
      Preferred Stock Warrants         121         138   
                          
Total Pac-West Telecomm, Inc.               4,296         4,276   
PeerApp, Inc.    Communications & Networking   

Senior Debt

Matures April 2013

Interest rate Prime + 7.5% or

Floor rate of 11.50%

   $ 2,638         2,610         2,582   
      Preferred Stock Warrants         61         61   
                          
Total PeerApp, Inc.               2,671         2,643   
Peerless Network, Inc.    Communications & Networking    Preferred Stock Warrants         95         123   
      Preferred Stock         1,000         1,280   
                          
Total Peerless Network, Inc.               1,095         1,403   
Ping Identity Corporation    Communications & Networking    Preferred Stock Warrants         52         2   
                          
Total Ping Identity Corporation               52         2   
Purcell Systems, Inc.    Communications & Networking    Preferred Stock Warrants         123         301   
                          
Total Purcell Systems, Inc.               123         301   
Seven Networks, Inc.    Communications & Networking    Preferred Stock Warrants         174         —     
                          
Total Seven Networks, Inc.               174         —     
Stoke, Inc(4)    Communications & Networking   

Senior Debt

Matures May 2013

Interest rate Prime + 7.0% or

Floor rate of 10.25%

   $ 3,865         3,770         3,798   
      Preferred Stock Warrants         53         199   
      Preferred Stock Warrants         65         127   
      Preferred Stock         500         500   
                          
Total Stoke, Inc.               4,388         4,624   

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

  

Principal
Amount

    

Cost(2)

    

Value(3)

 
Tectura Corporation    Communications
& Networking
  

Senior Debt

Matures December 2012

Interest rate 11%

   $ 5,625       $ 5,668       $ 5,668   
     

Revolving Line of Credit

Matures July 2011

Interest rate 11%

   $ 17,477         18,563         18,563   
      Preferred Stock Warrants         51         1   
                          
Total Tectura Corporation               24,282         24,232   
                          
Total Communications & Networking (11.68%)*               47,986         47,079   
                          
Atrenta, Inc.    Software    Preferred Stock Warrants         102         17   
      Preferred Stock Warrants         34         5   
      Preferred Stock Warrants         95         10   
      Preferred Stock         250         131   
                          
Total Atrenta, Inc.               481         163   
Blurb, Inc.    Software   

Senior Debt

Matures June 2011

Interest rate Prime + 3.50% or

Floor rate of 8.5%

   $ 590         835         835   
      Preferred Stock Warrants         25         347   
      Preferred Stock Warrants         299         215   
                          
Total Blurb, Inc.               1,159         1,397   
Braxton Technologies, LLC.    Software    Preferred Stock Warrants         188         —     
                          
Total Braxton Technologies, LLC.               188         —     
Bullhorn, Inc.    Software    Preferred Stock Warrants         43         232   
                          
Total Bullhorn, Inc.               43         232   
Clickfox, Inc.    Software   

Senior Debt

Matures July 2013

Interest rate Prime + 6.00% or

Floor rate of 11.25%

   $ 5,648         5,484         5,484   
     

Revolving Line of Credit

Matures July 2011

Interest rate Prime + 5.00% or

Floor rate of 12.00%

   $ 2,000         1,999         1,999   
      Preferred Stock Warrants         177         623   
      Preferred Stock Warrants         152         616   
                          
Total Clickfox, Inc.               7,812         8,722   

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

  

Principal
Amount

    

Cost(2)

    

Value(3)

 
Forescout Technologies, Inc.    Software    Preferred Stock Warrants       $ 99       $ 4   
                          
Total Forescout Technologies, Inc.               99         4   
GameLogic, Inc.    Software    Preferred Stock Warrants         92         —     
                          
Total GameLogic, Inc.               92         —     

HighJump Acquisition, LLC.

   Software   

Senior Debt

Matures May 2013

Interest rate Libor + 8.75% or

Floor rate of 12.00%

   $ 17,500         17,502         17,201   
                          
Total HighJump Acquisition, LLC.               17,502         17,201   
HighRoads, Inc.    Software    Preferred Stock Warrants         44         77   
                          
Total HighRoads, Inc.               44         77   
Rockyou, Inc.    Software    Preferred Stock Warrants         117         48   
                          
Total Rockyou, Inc.               117         48   
Sportvision, Inc.    Software    Preferred Stock Warrants         39         —     
                          
Total Sportvision, Inc.               39         —     
Unify Corporation    Software   

Senior Debt

Matures June 2015

Interest rate Libor + 8.25% or

Floor rate of 10.25%

   $ 23,700         22,212         22,682   
     

Revolving Line of Credit

Matures June 2015

Interest rate Libor + 7.25% or

Floor rate of 9.25%

   $ 2,950         2,932         2,621   
      Preferred Stock Warrants         1,434         561   
                          
Total Unify Corporation               26,578         25,864   
WildTangent, Inc.    Software    Preferred Stock Warrants         238         6   
                          
Total WildTangent, Inc.               238         6   
                          
Total Software (13.32%)*               54,392         53,714   
                          
Luminus Devices, Inc.    Electronics &
Computer Hardware
   Preferred Stock Warrants         183         —     
      Preferred Stock Warrants         84         —     
      Preferred Stock Warrants         334         —     
                          
Total Luminus Devices, Inc.               601         —     

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

Maxvision Holding, LLC.

   Electronics &
Computer Hardware
  

Senior Debt

Matures October 2012

Interest rate Prime + 7.25% or

Floor rate of 10.75%

   $ 5,000       $ 5,427       $ 291   
     

Senior Debt

Matures April 2012

Interest rate Prime + 5.0% or

Floor rate of 8.5%

   $ 3,159         3,141         1,777   
     

Revolving Line of Credit

Matures April 2012

Interest rate Prime + 5.0% or

Floor rate of 8.5%

   $ 3,100         3,168         3,168   
     

Common Stock

        81         —     
                          

Total Maxvision Holding, LLC

              11,817         5,236   

Shocking Technologies, Inc.

   Electronics &
Computer Hardware
   Preferred Stock Warrants         63         77   
                          

Total Shocking Technologies, Inc.

              63         77   

Spatial Photonics, Inc.

      Preferred Stock Warrants         130         —     
   Electronics &
Computer Hardware
  

Preferred Stock

        767         350   
                          

Total Spatial Photonics Inc.

              897         350   

VeriWave, Inc.

   Electronics &
Computer Hardware
   Preferred Stock Warrants         54         —     
     

Preferred Stock Warrants

        46         4   
                          

Total VeriWave, Inc.

              100         4   
                          

Total Electronics & Computer Hardware (1.41%)*

              13,478         5,667   
                          

Aegerion Pharmaceuticals, Inc.

   Specialty
Pharmaceuticals
  

Senior Debt

Matures September 2014

Interest rate Prime + 5.65% or

Floor rate of 10.40%

   $ 10,000         9,977         9,977   
     

Preferred Stock Warrants

        69         922   
     

Common Stock

        1,475         3,064   
                          

Total Aegerion Pharmaceuticals, Inc.

              11,521         13,963   

Althea Technologies, Inc.

   Specialty
Pharmaceuticals
  

Senior Debt

Matures October 2013

Interest rate Prime + 7.70% or

Floor rate of 10.95%

   $ 12,000         11,779         11,326   
     

Preferred Stock Warrants

        309         —     
                          

Total Althea Technologies, Inc.

              12,088         11,326   

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
     Cost(2)      Value(3)  
Chroma Therapeutics, Ltd.(5)    Specialty Pharmaceuticals   

Senior Debt

Matures September 2013

Interest rate Prime + 7.75% or

Floor rate of 12.00%

   $ 10,000       $ 9,900       $ 10,047   
      Preferred Stock Warrants         490         587   
                          
Total Chroma Therapeutics, Ltd.               10,390         10,634   
Pacira Pharmaceuticals, Inc.    Specialty Pharmaceuticals   

Senior Debt

Matures May 2014

Interest rate Prime + 6.25% or

Floor rate of 10.25%

   $ 11,250         11,154         11,154   
     

Senior Debt

Matures May 2014

Interest rate Prime + 8.65% or

Floor rate of 12.65%

   $ 15,000         13,936         13,936   
      Preferred Stock Warrants         1,086         391   
                          
Total Pacira Pharmaceuticals, Inc.               26,176         25,481   
QuatRx Pharmaceuticals Company    Specialty Pharmaceuticals   

Senior Debt

Matures October 2011

Interest rate Prime + 8.90% or

Floor rate of 12.15%

   $ 7,639         7,865         7,865   
      Convertible Senior Debt         
     

Matures March 2012

   $ 1,888         1,888         1,888   
      Preferred Stock Warrants         220         —     
      Preferred Stock Warrants         307         —     
      Preferred Stock         750         116   
                          
Total Quatrx Pharmaceuticals Company               11,030         9,869   
                          
Total Specialty Pharmaceuticals (17.68%)*               71,205         71,273   
                          
Annie’s, Inc.   

Consumer &

Business

Products

   Preferred Stock Warrants         321         45   
                          
Total Annie’s, Inc.               321         45   
IPA Holdings, LLC (4)   

Consumer &

Business

Products

  

Senior Debt

Matures November 2012

Interest rate Prime + 6.75% or

Floor rate of 11.0%

   $ 7,875         8,128         7,849   
     

Senior Debt

Matures May 2013

Interest rate Prime + 9.75% or

Floor rate of 14.0%

   $ 6,500         7,041         6,979   
     

Revolving Line of Credit

Matures November 2012

Interest rate Prime + 6.25% or

Floor rate of 10.50%

   $ 856         842         842   
      Preferred Stock Warrants         275         —     
      Common Stock         500         —     
                          
Total IPA Holding, LLC               16,786         15,670   

See notes to Consolidated Financial Statements (unaudited)

 

10


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
     Cost(2)      Value(3)  
Market Force Information, Inc.      

Preferred Stock Warrants

      $ 24       $ 77   
   Consumer & Business Products   

Preferred Stock

        500         459   
                          
Total Market Force Information, Inc.               524         536   
Wageworks, Inc.      

Preferred Stock Warrants

        252         1,452   
   Consumer & Business Products   

Preferred Stock

        250         287   
                          
Total Wageworks, Inc.               502         1,739   
                          
Total Consumer & Business Products (4.46%)*               18,133         17,990   
                          
Enpirion, Inc.    Semiconductors   

Preferred Stock Warrants

        157         —     
                          
Total Enpirion, Inc.               157         —     
iWatt, Inc.    Semiconductors   

Preferred Stock Warrants

        46         5   
     

Preferred Stock Warrants

        51         25   
     

Preferred Stock Warrants

        73         35   
     

Preferred Stock Warrants

        458         374   
     

Preferred Stock

        490         951   
                          
Total iWatt, Inc.               1,118         1,390   
NEXX Systems, Inc.    Semiconductors   

Preferred Stock Warrants

        297         1,080   
     

Preferred Stock

        277         704   
                          
Total NEXX Systems, Inc.               574         1,784   
Quartics, Inc.    Semiconductors   

Preferred Stock Warrants

        53         —     
                          
Total Quartics, Inc.               53         —     
Solarflare Communications, Inc.    Semiconductors   

Preferred Stock Warrants

        83         —     
     

Common Stock

        641         —     
                          
Total Solarflare Communications, Inc.               724         —     
                          
Total Semiconductors (0.79%)*               2,626         3,174   
                          
Alexza Pharmaceuticals, Inc. (4)    Drug Delivery   

Senior Debt
Matures October 2013
Interest rate Prime + 6.5% or
Floor rate of 10.75%

   $ 14,207         13,877         14,044   
     

Preferred Stock Warrants

        645         290   
                          
Total Alexza Pharmaceuticals, Inc.               14,522         14,334   
BIND Biosciences, Inc.    Drug Delivery   

Preferred Stock Warrants

        53         48   
                          
Total BIND Biosciences, Inc.               53         48   

See notes to Consolidated Financial Statements (unaudited)

 

11


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

Labopharm USA, Inc. (5)

   Drug Delivery    Senior Debt         
     

Matures December 2012

Interest rate 10.95%

   $ 17,766       $ 17,731       $ 17,856   
     

Common Stock Warrants

        635         69   
                          

Total Labopharm USA, Inc.

              18,366         17,925   

Transcept Pharmaceuticals, Inc.

   Drug Delivery    Common Stock Warrants         36         74   
     

Common Stock Warrants

        51         33   
     

Common Stock

        500         340   
                          

Total Transcept Pharmaceuticals, Inc.

              587         447   
                          

Total Drug Delivery (8.12%)*

              33,528         32,754   
                          

BARRX Medical, Inc.

   Therapeutic    Senior Debt         
     

Mature December 2011

Interest rate 11.00%

   $ 2,209         2,693         2,693   
     

Preferred Stock Warrants

        76         60   
     

Preferred Stock

        1,500         1,571   
                          

Total BARRX Medical, Inc.

              4,269         4,324   

EKOS Corporation

   Therapeutic    Preferred Stock Warrants         175         —     
     

Preferred Stock Warrants

        153         —     
                          

Total EKOS Corporation

              328         —     

Gelesis, Inc. (7)

   Therapeutic    Senior Debt         
     

Matures May 2012

Interest rate Prime + 7.5% or

Floor rate of 10.75%

   $ 2,771         2,807         —     
                          

Total Gelesis, Inc.

              2,807         —     

Gynesonics, Inc.

   Therapeutic    Senior Debt         
     

Mature October 2013

Interest rate Prime + 8.25% or

Floor rate of 11.50%

   $ 6,500         6,328         6,255   
     

Preferred Stock Warrants

        228         197   
     

Preferred Stock

        532         462   
                          

Total Gynesonics, Inc.

              7,088         6,914   

Light Science Oncology, Inc.

   Therapeutic    Preferred Stock Warrants         99         69   
                          

Total Light Science Oncology, Inc.

              99         69   

Novasys Medical, Inc.

   Therapeutic    Preferred Stock Warrants         71         —     
     

Preferred Stock Warrants

        54         2   
     

Preferred Stock

        1,000         1,001   
                          

Total Novasys Medical, Inc.

              1,125         1,003   

See notes to Consolidated Financial Statements (unaudited)

 

12


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

Pacific Child & Family Associates, LLC

   Therapeutic    Senior Debt         
     

Matures January 2015

Interest rate LIBOR + 8.0% or

Floor rate of 10.50%

   $ 6,254       $ 6,137       $ 5,589   
     

Senior Debt

        
     

Matures January 2015

Interest rate LIBOR + 10.50% or

Floor rate of 13.0%

   $ 5,900         6,067         6,067   
                          

Total Pacific Child & Family Associates, LLC

              12,204         11,656   
                          

Total Therapeutic (5.94%)*

              27,920         23,966   
                          

Cozi Group, Inc.

   Internet Consumer & Business Services    Preferred Stock Warrants         147         139   
     

Preferred Stock

        177         292   
                          

Total Cozi Group, Inc.

              324         431   

Invoke Solutions, Inc.

   Internet Consumer & Business Services    Preferred Stock Warrants         56         —     
     

Preferred Stock Warrants

        26         —     
                          

Total Invoke Solutions, Inc.

              82         —     

InXpo, Inc.

   Internet Consumer & Business Services    Senior Debt         
     

Matures March 2014

Interest rate Prime + 7.5% or

Floor rate of 10.75%

   $ 1,575         1,523         1,523   
     

Preferred Stock Warrants

        98         85   
                          

Total InXpo, Inc.

              1,621         1,608   

Prism Education Group, Inc.

   Internet Consumer & Business Services    Preferred Stock Warrants         43         32   
                          

Total Prism Education Group, Inc.

              43         32   

RazorGator Interactive Group, Inc.

   Internet Consumer & Business Services    Preferred Stock Warrants         13         —     
     

Preferred Stock Warrants

        28         —     
     

Preferred Stock Warrants

        1,183         —     
     

Preferred Stock

        1,000         —     
                          

Total RazorGator Interactive Group, Inc.

              2,224         —     

Reply! Inc. (4)

   Internet Consumer & Business Services    Senior Debt         
     

Matures June 2013

Interest rate Prime + 6.5% or

Floor rate of 9.75%

   $ 4,553         4,318         4,414   
     

Senior Debt

        
     

Matures December 2013

Interest rate Prime + 6.5% or

Floor rate of 9.75%

   $ 700         710         673   
     

Preferred Stock Warrants

        320         480   
                          

Total Reply! Inc.

              5,348         5,567   

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

ScriptSave

(Medical Security Card Company, LLC)

   Internet Consumer & Business Services   

Senior Debt

Matures February 2016

Interest rate Prime + 8.75% or

Floor rate of 11.25%

   $ 20,500       $ 20,027       $ 20,027   
                          

Total ScriptSave

              20,027         20,027   
                          

Total Internet Consumer & Business Services (6.86%)

              29,669         27,665   
                          

Lilliputian Systems, Inc.

   Energy    Preferred Stock Warrants         106         1   
     

Common Stock Warrants

        48         —     
                          

Total Lilliputian Systems, Inc.

              154         1   
                          

Total Energy (0.00%)*

              154         1   
                          

Box.net, Inc.

   Information Services   

Senior Debt

Matures May 2011

Interest rate Prime + 1.50% or

Floor rate of 7.50%

   $ 92         144         144   
     

Senior Debt

Matures September 2011

Interest rate Prime + 0.50% or

Floor rate of 6.50%

   $ 86         105         105   
     

Senior Debt

Matures September 2011

Interest rate Prime + 5.25% or

Floor rate of 8.50%

   $ 1,590         1,582         1,582   
     

Preferred Stock Warrants

        73         679   
     

Preferred Stock Warrants

        117         423   
     

Preferred Stock

        500         1,234   
     

Preferred Stock

        500         500   
                          

Total Box.net, Inc.

              3,021         4,667   

Buzznet, Inc.

   Information Services    Preferred Stock Warrants         9         —     
     

Preferred Stock

        250         37   
                          

Total Buzznet, Inc.

              259         37   

XL Education Corp.

   Information Services    Common Stock         880         881   
                          

Total XL Education Corp.

              880         881   

hi5 Networks, Inc.

   Information Services    Preferred Stock Warrants         213         —     
     

Preferred Stock

        250         247   
                          

Total hi5 Networks, Inc.

              463         247   

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

Jab Wireless, Inc.

   Information Services    Preferred Stock Warrants       $ 265       $ 91   
                          

Total Jab Wireless, Inc.

              265         91   

Solutionary, Inc.

   Information Services    Preferred Stock Warrants         94         —     
      Preferred Stock Warrants         2         —     
      Preferred Stock         250         77   
                          

Total Solutionary, Inc.

              346         77   

Intelligent Beauty, Inc.

   Information Services   

Senior Debt

Matures March 2013

Interest rate Prime + 8.0% or

Floor rate of 11.25%

   $ 5,236         5,099         5,138   
     

Senior Debt

Matures October 2013

Interest rate Prime + 8.0% or

Floor rate of 11.25%

   $ 1,895         1,849         1,849   
      Preferred Stock Warrants         230         27   
                          

Total Intelligent Beauty, Inc.

              7,178         7,014   

Good Technologies, Inc.

   Information Services    Common Stock         603         150   
                          

Total Good Technologies, Inc.

              603         150   

Coveroo, Inc.

   Information Services    Preferred Stock Warrants         7         —     
                          

Total Coveroo, Inc.

              7         —     

Zeta Interactive Corporation

   Information Services    Preferred Stock Warrants         172         4   
      Preferred Stock         500         231   
                          

Total Zeta Interactive Corporation

              672         235   
                          

Total Information Services (3.32%)

              13,694         13,399   
                          

Novadaq Technologies, Inc.(5)

   Diagnostic    Common Stock         1,415         603   
                          

Total Novadaq Technologies, Inc.

              1,415         603   

Optiscan Biomedical, Corp.

   Diagnostic   

Senior Debt

Matures June 2011

Interest rate 10.25%

   $ 10,750         10,534         10,403   
      Preferred Stock Warrants         1,069         718   
      Preferred Stock         3,655         2,202   
                          

Total Optiscan Biomedical, Corp.

              15,258         13,323   
                          

Total Diagnostic (3.45%)*

              16,673         13,926   
                          

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

Kamada, LTD.

   Biotechnology Tools    Common Stock       $ 427       $ 651   
                          

Total Kamada, LTD.

              427         651   

Labcyte, Inc.

   Biotechnology Tools   

Senior Debt

Matures May 2013

Interest rate Prime + 8.6% or

Floor rate of 11.85%

   $ 3,532         3,451         3,522   
      Common Stock Warrants         192         170   
                          

Total Labcyte, Inc.

              3,643         3,692   

NuGEN Technologies, Inc.

   Biotechnology Tools    Preferred Stock Warrants         45         289   
      Preferred Stock Warrants         33         15   
      Preferred Stock         500         500   
                          

Total NuGEN Technologies, Inc.

              578         804   
                          

Total Biotechnology Tools (1.28%)*

              4,648         5,147   
                          

Crux Biomedical, Inc.

   Surgical Devices    Preferred Stock Warrants         37         —     
      Preferred Stock         250         —     
                          

Total Crux Biomedical, Inc.

              287         —     

Transmedics, Inc. (4)

   Surgical Devices   

Senior Debt

Matures February 2014

Interest rate Prime + 9.70% or

Floor rate of 12.95%

   $ 8,375         8,994         4,520   
      Preferred Stock Warrants         225         —     
      Preferred Stock         1,100         —     
                          

Total Transmedics, Inc.

              10,319         4,520   
                          

Total Surgical Devices (1.12%)*

              10,606         4,520   
                          

Glam Media, Inc.

   Media/Content/ Info    Preferred Stock Warrants         482         307   
                          

Total Glam Media, Inc.

              482         307   

Waterfront Media, Inc. (Everyday Health)

      Preferred Stock Warrants         60         630   
      Preferred Stock         1,000         1,310   
                          

Total Everyday Health

              1,060         1,940   
                          

Total Media/Content/Info (0.56%)*

              1,542         2,247   
                          

See notes to Consolidated Financial Statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment (1)

   Principal
Amount
     Cost(2)      Value(3)  

BrightSource Energy, Inc.

   Clean Tech   

Senior Debt

Matures December 2011

Interest rate Prime + 7.75% or

Floor rate of 11.0%

   $ 11,250       $ 10,945       $ 10,945   
     

Senior Debt

Matures June 2012

Interest rate Prime + 9.55% or

Floor rate of 12.80%

   $ 13,750         13,369         13,369   
     

Preferred Stock Warrants

        675         583   
                          

Total BrightSource Energy, Inc.

              24,989         24,897   

Calera, Inc.

   Clean Tech   

Senior Debt

Matures July 2013

Interest rate Prime + 7.0% or

Floor rate of 10.25%

   $ 3,409         3,043         3,043   
     

Preferred Stock Warrants

        513         432   
                          

Total Calera, Inc.

              3,556         3,475   

EcoMotors, Inc.

   Clean Tech   

Senior Debt

Matures February 2014

Interest rate Prime + 6.1% or

Floor rate of 9.35%

   $ 971         950         950   
     

Preferred Stock Warrants

        154         155   
     

Common Stock Warrants

        154         155   
                          

Total EcoMotors, Inc.

              1,258         1,260   

GreatPoint Energy, Inc.

   Clean Tech   

Senior Debt

Matures October 2013

Interest rate Prime + 8.2% or

Floor rate of 11.45%

   $ 5,000         4,466         4,423   
     

Preferred Stock Warrants

        548         384   
                          

Total GreatPoint Energy, Inc.

              5,014         4,807   

Propel Biofuels, Inc.

   Clean Tech   

Senior Debt

Matures September 2013

Interest rate 11.0%

   $ 1,925         1,773         1,621   
     

Preferred Stock Warrants

        211         57   
                          

Total Propel Biofuels, Inc.

              1,984         1,678   

See notes to Consolidated Financial Statements (unaudited)

 

17


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

March 31, 2011

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

    

Type of Investment (1)

  

Principal
Amount

    

Cost(2)

    

Value(3)

 

Solexel, Inc.

     Clean Tech      

Senior Debt

Matures June 2013

Interest rate Prime + 8.25% or

Floor rate of 11.50%

   $ 1,005       $ 976       $ 976   
     

Senior Debt

Matures June 2013

Interest rate Prime + 7.25% or

Floor rate of 10.50%

   $ 11,062         10,514         10,514   
      Preferred Stock Warrants         335         293   
      Preferred Stock Warrants         259         222   
                          

Total Solexel, Inc.

              12,084         12,005   

Trilliant, Inc.

     Clean Tech       Preferred Stock Warrants         89         92   
      Preferred Stock Warrants         73         75   
                          

Total Trilliant, Inc.

              162         167   
                          

Total Clean Tech (11.98%)*

              49,047         48,289   
                          

Total Investments

            $ 468,776       $ 445,054   
                          

 

* Value as a percent of net assets
(1) Preferred and common stock, warrants, and equity interests are generally non-income producing.
(2) Gross unrealized appreciation, gross unrealized depreciation, and net depreciation for federal income tax purposes totaled and $13,537, $38,755 and $25,218 respectively. The tax cost of investments is $469,678.
(3) Except for warrants in ten publicly traded companies and common stock in four publicly traded companies, all investments are restricted at March 31, 2011. No unrestricted securities of the same issuer are outstanding. The Company uses the Standard Industrial Code for classifying the industry grouping of its portfolio companies.
(4) Debt investments of this portfolio company have been pledged as collateral under the Wells Facility.
(5) Non-U.S. company or the company’s principal place of business is outside the United States.
(6) Affiliate investment that is defined under the Investment Company Act of 1940 as companies in which HTGC owns as least 5% but not more than 25% of the voting securities of the company.
(7) Debt is on non-accrual status at March 31, 2011, and is therefore considered non-income producing.

See notes to Consolidated Financial Statements (unaudited)

 

18


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  
         

Acceleron Pharmaceuticals, Inc.

  Drug Discovery   Preferred Stock Warrants     $ 69      $ 922   
   

Preferred Stock Warrants

      35        189   
   

Preferred Stock Warrants

      39        99   
   

Preferred Stock

      1,341        2,316   
                     

Total Acceleron Pharmaceuticals, Inc.

  

    1,484        3,526   

Aveo Pharmaceuticals, Inc.

  Drug Discovery  

Senior Debt
Matures September 2013
Interest rate Prime + 7.15% or
Floor rate of 11.9%

  $ 25,000        26,108        26,108   
   

Preferred Stock Warrants

      190        686   
   

Preferred Stock Warrants

      104        165   
   

Preferred Stock Warrants

      24        58   
   

Preferred Stock Warrants

      288        770   
   

Preferred Stock Warrants

      236        630   
                     

Total Aveo Pharmaceuticals, Inc.

  

    26,950        28,417   

Dicerna Pharmaceuticals, Inc.

  Drug Discovery  

Senior Debt
Matures July 2012
Interest rate Prime + 9.20% or
Floor rate of 12.95%

  $ 4,699        4,678        4,706   
   

Preferred Stock Warrants

      205        182   
   

Preferred Stock Warrants

      30        33   
   

Preferred Stock Warrants

      28        25   
   

Preferred Stock

      503        503   
                     

Total Dicerna Pharmaceuticals, Inc.

  

    5,444        5,449   

EpiCept Corporation

  Drug Discovery   Common Stock Warrants       4        112   
   

Common Stock Warrants

      40        10   
                     

Total EpiCept Corporation

  

    44        122   

Horizon Therapeutics, Inc.

  Drug Discovery   Preferred Stock Warrants       231        —     
                     

Total Horizon Therapeutics, Inc.

  

    231        —     

Inotek Pharmaceuticals Corp.

  Drug Discovery   Preferred Stock       1,500        —     
                     

Total Inotek Pharmaceuticals Corp.

  

    1,500        —     

Merrimack Pharmaceuticals, Inc.

  Drug Discovery   Preferred Stock Warrants       155        170   
   

Preferred Stock

      2,000        1,547   
                     

Total Merrimack Pharmaceuticals, Inc.

  

    2,155        1,717   
         

Paratek Pharmaceuticals, Inc.

  Drug Discovery   Preferred Stock Warrants       137        155   
   

Preferred Stock

      1,000        999   
                     

Total Paratek Pharmaceuticals, Inc.

  

    1,137        1,154   

PolyMedix, Inc.

  Drug Discovery  

Senior Debt
Matures September 2013
Interest rate Prime + 7.1% or
Floor rate of 12.35%

  $ 10,000        9,605        9,605   
   

Preferred Stock Warrants

      480        248   
                     

Total PolyMedix, Inc.

  

    10,085        9,853   

 

See notes to consolidated financial statements.

 

19


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Portola Pharmaceuticals, Inc.

  Drug Discovery  

Senior Debt
Matures April 2011
Interest rate Prime + 2.16%

  $ 1,666      $ 2,033      $ 2,033   
   

Preferred Stock Warrants

      152        506   
                     

Total Portola Pharmaceuticals, Inc.

  

    2,185        2,539   
                     

Total Drug Discovery (12.79%)*

  

    51,215        52,777   
                     

Affinity Videonet, Inc.

  Communications &
Networking
  Preferred Stock Warrants       102        180   
                     

Total Affinity Videonet, Inc.

  

    102        180   

E-band Communications, Corp.(6)

  Communications &
Networking
  Preferred Stock       2,880        3,069   
                     

Total E-Band Communications, Corp.

  

    2,880        3,069   

IKANO Communications, Inc.

  Communications &
Networking
 

Senior Debt
Matures August 2011
Interest rate 12.00%

  $ 1,654        1,953        1,953   
   

Preferred Stock Warrants

      45        —     
   

Preferred Stock Warrants

      72        —     
                     

Total IKANO Communications, Inc.

  

    2,070        1,953   

Intelepeer, Inc.

  Communications &
Networking
 

Senior Debt
Matures May 2013
Interest rate Prime + 8.125%

  $ 7,624        7,468        7,459   
   

Preferred Stock Warrants

      102        111   
                     

Total Intelepeer, Inc.

  

    7,570        7,570   

Neonova Holding Company

  Communications &
Networking
  Preferred Stock Warrants       94        12   
   

Preferred Stock

      250        140   
                     

Total Neonova Holding Company

  

    344        152   

Opsource, Inc.(4)

  Communications &
Networking
 

Senior Debt
Matures June 2013
Interest rate Prime + 7.75% or
Floor rate of 11.00%

  $ 5,000        4,888        4,888   
   

Senior Debt
Matures October 2013
Interest rate Prime + 7.25% or
Floor rate of 10.50%

  $ 2,000        1,944        1,905   
   

Revolving Line of Credit
Matures June 2011
Interest rate Prime + 5.25% or
Floor rate of 8.50%

  $ 1,500        1,458        1,458   
   

Preferred Stock Warrants

      223        105   
                     

Total Opsource, Inc.

  

    8,513        8,356   

 

See notes to consolidated financial statements.

 

20


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Pac-West Telecomm, Inc.

  Communications
& Networking
 

Senior Debt
Matures April 2014
Interest rate Prime + 7.5% or
Floor rate of 12.0%

  $ 10,000      $ 9,634      $ 9,634   
   

Preferred Stock Warrants

      121        147   
                     

Total Pac-West Telecomm, Inc.

  

    9,755        9,781   

PeerApp, Inc.

  Communications
& Networking
 

Senior Debt
Matures April 2013
Interest rate Prime + 7.5% or
Floor rate of 11.50%

  $ 2,911        2,855        2,792   
   

Preferred Stock Warrants

      61        65   
                     

Total PeerApp, Inc.

  

    2,916        2,857   

Peerless Network, Inc.

  Communications
& Networking
  Preferred Stock Warrants       95        138   
   

Preferred Stock

      1,000        1,930   
                     

Total Peerless Network, Inc.

  

    1,095        2,068   

Ping Identity Corporation

  Communications
& Networking
  Preferred Stock Warrants       52        6   
                     

Total Ping Identity Corporation

  

    52        6   

Purcell Systems, Inc.

  Communications
& Networking
  Preferred Stock Warrants       123        330   
                     

Total Purcell Systems, Inc.

  

    123        330   

Seven Networks, Inc.

  Communications
& Networking
  Preferred Stock Warrants       174        40   
                     

Total Seven Networks, Inc.

  

    174        40   

Stoke, Inc.(4)

  Communications
& Networking
 

Senior Debt
Matures May 2013
Interest rate Prime + 7.0% or
Floor rate of 10.25%

  $ 4,000        3,883        3,883   
   

Preferred Stock Warrants

      53        210   
   

Preferred Stock Warrants

      65        133   
   

Preferred Stock

      500        500   
                     

Total Stoke, Inc.

  

    4,501        4,726   

Tectura Corporation

  Communications
& Networking
 

Senior Debt
Matures December 2012
Interest rate 11%

  $ 5,625        5,512        5,512   
   

Revolving Line of Credit
Matures July 2011
Interest rate 11%

  $ 17,477        18,488        18,488   
   

Preferred Stock Warrants

      50        10   
                     

Total Tectura Corporation

  

    24,050        24,010   
                     

Total Communications & Networking (15.78%)*

  

    64,145        65,098   
                     

 

See notes to consolidated financial statements.

 

21


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Atrenta, Inc.

  Software   Preferred Stock Warrants     $ 102      $ 46   
   

Preferred Stock Warrants

      34        15   
   

Preferred Stock Warrants

      95        22   
   

Preferred Stock

      250        143   
                     

Total Atrenta, Inc.

  

    481        226   

Blurb, Inc.

  Software  

Senior Debt
Matures June 2011
Interest rate Prime + 3.50% or
Floor rate of 8.5%

  $ 1,162        1,392        1,392   
   

Preferred Stock Warrants

      25        349   
   

Preferred Stock Warrants

      299        228   
                     

Total Blurb, Inc.

  

    1,716        1,969   

Braxton Technologies, LLC.

  Software   Preferred Stock Warrants       188        —     
                     

Total Braxton Technologies, LLC.

  

    188        —     

Bullhorn, Inc.

  Software   Preferred Stock Warrants       43        234   
                     

Total Bullhorn, Inc.

  

    43        234   

Clickfox, Inc.

  Software  

Senior Debt
Matures July 2013
Interest rate Prime + 6.00% or
Floor rate of 11.25%

  $ 6,000        5,801        5,801   
   

Revolving Line of Credit
Matures July 2011
Interest rate Prime + 5.00% or
Floor rate of 12.00%

  $ 2,000        1,997        1,996   
   

Preferred Stock Warrants

      177        643   
   

Preferred Stock Warrants

      152        643   
                     

Total Clickfox, Inc.

  

    8,127        9,083   

Forescout Technologies, Inc.

  Software   Preferred Stock Warrants       99        14   
                     

Total Forescout Technologies, Inc.

  

    99        14   

GameLogic, Inc.

  Software   Preferred Stock Warrants       92        —     
                     

Total GameLogic, Inc.

  

    92        —     

HighJump Acquisition, LLC.

  Software  

Senior Debt
Matures May 2013
Interest rate Libor + 9.25% or
Floor rate of 12.50%

  $ 17,500        17,386        17,386   
                     

Total HighJump Acquisition, LLC.

  

    17,386        17,386   

HighRoads, Inc.

  Software   Preferred Stock Warrants       44        65   
                     

Total HighRoads, Inc.

  

    44        65   

 

See notes to consolidated financial statements.

 

22


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

 

Industry

  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Infologix, Inc. (7)

 

Software

  

Senior Debt
Matures November 2013
Interest rate 18.00%

  $ 5,500      $ 5,162      $ 5,162   
    

Convertible Senior
Debt Matures November 2014
Interest rate 12.00%

      1,111        1,127   
    

Revolving Line of Credit
Matures May 2011
Interest rate 12.00%

    $12,317        12,317        12,317   
    

Senior Debt
Matures December 2010
Interest rate 18.00%

    $2,178        2,178        2,178   
    

Senior Debt
Matures April 2013
Interest rate 8.00%

    $1,350        1,350        1,350   
    

Senior Debt
Matures September 2011
Interest rate 10.00%

    $500        509        509   
    

Preferred Stock Warrants

      725        1,394   
    

Common Stock

      5,000        9,620   
    

Common Stock

      36        69   
    

Common Stock

      3,355        6,455   
                      

Total Infologix, Inc.

      31,743        40,181   

PSS Systems, Inc.

  Software   

Preferred Stock Warrants

      51        17   
                      

Total PSS Systems, Inc.

      51        17   

Rockyou, Inc.

  Software   

Preferred Stock Warrants

      117        186   
                      

Total Rockyou, Inc.

      117        186   

Sportvision, Inc.

  Software   

Preferred Stock Warrants

      39        —     
                      

Total Sportvision, Inc.

      39        —     

Unify Corporation

  Software   

Senior Debt
Matures June 2015
Interest rate Libor + 8.50% or
Floor rate of 10.50%

  $ 24,000        22,248        22,968   
    

Revolving Line of Credit
Matures June 2015
Interest rate Libor + 7.50% or
Floor rate of 9.50%

    $3,750        3,731        3,476   
    

Preferred Stock Warrants

      1,434        693   
                      

Total Unify Corporation

  

    27,413        27,137   

WildTangent, Inc.

  Software   

Preferred Stock Warrants

      238        10   
                      

Total WildTangent, Inc.

  

    238        10   
                      

Total Software (23.39%)*

  

    87,777        96,508   
                      

Luminus Devices, Inc.

  Electronics & Computer Hardware   

Senior Debt
Matures December 2011
Interest rate 11.875%

  $ 540        540        540   
    

Preferred Stock Warrants

      183        —     
    

Preferred Stock Warrants

      84        —     
    

Preferred Stock Warrants

      334        —     
                      

Total Luminus Devices, Inc.

  

    1,141        540   

 

See notes to consolidated financial statements.

 

23


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

 

Industry

  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Maxvision Holding, LLC.

  Electronics & Computer Hardware   

Senior Debt
Matures October 2012
Interest rate Prime + 7.25% or
Floor rate of 10.75%

  $ 5,000      $ 5,377      $ 377   
    

Senior Debt
Matures April 2012
Interest rate Prime + 5.0% or
Floor rate of 8.5%

  $ 3,409        3,382        3,382   
    

Revolving Line of Credit
Matures April 2012
Interest rate Prime + 5.0% or
Floor rate of 8.5%

  $ 3,100        3,163        3,163   
    

Common Stock

      81        —     
                      

Total Maxvision Holding, LLC.

  

    12,003        6,922   

Shocking Technologies, Inc.

  Electronics & Computer Hardware   

Preferred Stock Warrants

      63        90   
                      

Total Shocking Technologies, Inc.

  

    63        90   

Spatial Photonics, Inc.

  Electronics & Computer Hardware   

Preferred Stock Warrants

      129        —     
    

Preferred Stock

      767        267   
                      

Total Spatial Photonics, Inc.

  

    896        267   

VeriWave, Inc.

  Electronics & Computer Hardware   

Preferred Stock Warrants

      54        —     
    

Preferred Stock Warrants

      46        —     
                      

Total VeriWave, Inc.

  

    100        —     
                      

Total Electronics & Computer Hardware (1.90%)*

  

    14,203        7,819   
                      

Aegerion Pharmaceuticals, Inc.

  Specialty Pharmaceuticals   

Preferred Stock Warrants

      69        761   
    

Preferred Stock

      1,475        2,206   
                      

Total Aegerion Pharmaceuticals, Inc.

  

    1,544        2,967   

Althea Technologies, Inc.

  Specialty Pharmaceuticals   

Senior Debt
Matures October 2013
Interest rate Prime + 7.70% or
Floor rate of 10.95%

  $ 12,000        11,661        11,661   
    

Preferred Stock Warrants

      309        276   
                      

Total Althea Technologies, Inc.

  

    11,970        11,937   

Chroma Therapeutics, Ltd.(5)

  Specialty Pharmaceuticals   

Senior Debt
Matures September 2013
Interest rate Prime + 7.75% or
Floor rate of 12.00%

  $ 10,000        9,797        10,021   
    

Preferred Stock Warrants

      490        632   
                      

Total Chroma Therapeutics, Ltd.

  

    10,287        10,653   

 

See notes to consolidated financial statements.

 

24


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Pacira Pharmaceuticals, Inc. (4)

  Specialty
Pharmaceuticals
 

Senior Debt
Matures May 2014
Interest rate Prime + 6.25% or
Floor rate of 10.25%

  $ 11,250      $ 11,105      $ 11,105   
   

Senior Debt
Matures May 2014
Interest rate Prime + 8.65% or
Floor rate of 12.65%

  $ 15,000        13,749        13,749   
   

Preferred Stock Warrants

      1,086        1,255   
                     

Total Pacira Pharmaceuticals, Inc.

  

    25,940        26,109   

QuatRx Pharmaceuticals Company

  Specialty
Pharmaceuticals
 

Senior Debt
Matures October 2011
Interest rate Prime + 8.90% or
Floor rate of 12.15%

  $ 9,306        9,474        9,474   
   

Convertible Senior Debt
Interest Rate of 8.0%
Matures March 2012

  $ 1,888        1,888        2,467   
   

Preferred Stock Warrants

      220        —     
   

Preferred Stock Warrants

      307        —     
   

Preferred Stock

      751        —     
                     

Total QuatRx Pharmaceuticals Company

  

    12,640        11,941   
                     

Total Specialty Pharmaceuticals (15.42%)*

  

    62,381        63,607   
                     

Annie’s, Inc.

  Consumer &
Business Products
  Preferred Stock Warrants       321        75   
                     

Total Annie’s, Inc.

  

    321        75   

IPA Holdings, LLC. (4)

  Consumer &
Business Products
 

Senior Debt
Matures November 2012
Interest rate Prime + 6.75% or
Floor rate of 11.0%

  $ 8,250        8,505        8,160   
   

Senior Debt
Matures May 2013
Interest rate Prime + 9.75% or
Floor rate of 14.0%

  $ 6,500        7,019        6,995   
   

Revolving Line of Credit
Matures November 2012
Interest rate Prime + 6.25% or
Floor rate of 10.50%

  $ 856        761        761   
   

Preferred Stock Warrants

      275        —     
   

Common Stock

      500        —     
                     

Total IPA Holdings, LLC.

  

    17,060        15,916   

Market Force Information, Inc.

  Consumer &
Business Products
  Preferred Stock Warrants       24        60   
   

Preferred Stock

      500        439   
                     

Total Market Force Information, Inc.

  

    524        499   

Trading Machines, Inc. (8)

  Consumer &
Business Products
 

Senior Debt
Matures January 2014
Interest rate Prime + 10.25% or
Floor rate of 13.50%

  $ 9,812        8,644        4,000   
   

Preferred Stock Warrants

      878        —     
   

Preferred Stock

      50        —     
                     

Total Trading Machines, Inc.

  

    9,572        4,000   

 

See notes to consolidated financial statements.

 

25


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Velocity Technology Solutions, Inc.

  Consumer &
Business Products
 

Senior Debt
Matures February 2015
Interest rate LIBOR + 8% or
Floor rate of 11.00%

  $ 15,417      $ 15,072      $ 14,574   
   

Senior Debt
Matures February 2015
Interest rate LIBOR + 10% or
Floor rate of 13.00%

  $ 8,333        8,317        8,526   
                     

Total Velocity Technology Solutions, Inc.

  

    23,389        23,100   

Wageworks, Inc.

  Consumer &
Business Products
  Preferred Stock Warrants       253        1,443   
   

Preferred Stock

      250        283   
                     

Total Wageworks, Inc.

  

    503        1,726   
                     

Total Consumer & Business Products (10.98%)*

  

    51,369        45,316   
                     

Enpirion, Inc.

  Semiconductors   Preferred Stock Warrants       157        1   
                     

Total Enpirion, Inc.

  

    157        1   

iWatt, Inc.

  Semiconductors   Preferred Stock Warrants       46        1   
   

Preferred Stock Warrants

      51        33   
   

Preferred Stock Warrants

      73        44   
   

Preferred Stock Warrants

      458        391   
   

Preferred Stock

      490        940   
                     

Total iWatt, Inc.

  

    1,118        1,409   

NEXX Systems, Inc.

  Semiconductors   Preferred Stock Warrants       297        1,113   
   

Preferred Stock

      277        704   
                     

Total NEXX Systems, Inc.

  

    574        1,817   

Quartics, Inc.

  Semiconductors   Preferred Stock Warrants       53        —     
                     

Total Quartics, Inc.

  

    53        —     

Solarflare Communications, Inc.

  Semiconductors   Preferred Stock Warrants       83        —     
   

Common Stock

      642        —     
                     

Total Solarflare Communications, Inc.

  

    725        —     
                     

Total Semiconductors (0.78%)*

  

    2,627        3,227   
                     

Alexza Pharmaceuticals, Inc. (4)

  Drug Delivery  

Senior Debt
Matures October 2013
Interest rate Prime + 6.5% or
Floor rate of 10.75%

  $ 15,000        14,526        14,472   
   

Preferred Stock Warrants

      645        193   
                     

Total Alexza Pharmaceuticals, Inc.

  

    15,171        14,665   

Labopharm USA, Inc. (5)

  Drug Delivery  

Senior Debt
Matures December 2012
Interest rate 10.95%

  $ 20,000        19,872        19,872   
   

Common Stock Warrants

      635        329   
                     

Total Labopharm USA, Inc.

  

    20,507        20,201   

 

See notes to consolidated financial statements.

 

26


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Transcept Pharmaceuticals, Inc.

  Drug Delivery   Common Stock Warrants     $ 36      $ 60   
   

Common Stock Warrants

      51        16   
   

Common Stock

      500        308   
                     

Total Transcept Pharmaceuticals, Inc.

  

    587        384   
                     

Total Drug Delivery (8.54%)*

  

    36,265        35,250   
                     

BARRX Medical, Inc.

  Therapeutic  

Senior Debt
Mature December 2011
Interest rate 11.00%

  $ 2,901        3,350        3,350   
   

Preferred Stock Warrants

      76        70   
   

Preferred Stock

      1,500        1,890   
                     

Total BARRX Medical, Inc.

  

    4,926        5,310   

EKOS Corporation

  Therapeutic   Preferred Stock Warrants       174        —     
   

Preferred Stock Warrants

      153        —     
                     

Total EKOS Corporation

  

    327        —     

Gelesis, Inc.(8)

  Therapeutic  

Senior Debt
Matures May 2012
Interest rate Prime + 7.5% or
Floor rate of 10.75%

  $ 2,771        2,800        45   
                     

Total Gelesis, Inc.

  

    2,800        45   

Gynesonics, Inc.

  Therapeutic  

Senior Debt
Mature October 2013
Interest rate Prime + 8.25% or
Floor rate of 11.50%

  $ 6,500        6,277        6,277   
   

Preferred Stock Warrants

      228        221   
   

Preferred Stock

      532        456   
                     

Total Gynesonics, Inc.

  

    7,037        6,954   

Light Science Oncology, Inc.

  Therapeutic   Preferred Stock Warrants       99        26   
                     

Total Light Science Oncology, Inc.

  

    99        26   

Novasys Medical, Inc.

  Therapeutic   Preferred Stock Warrants       71        1   
   

Preferred Stock Warrants

      54        7   
   

Preferred Stock

      1,000        1,159   
                     

Total Novasys Medical, Inc.

  

    1,125        1,167   

Pacific Child & Family Associates, LLC.

  Therapeutic  

Senior Debt
Matures January 2015
Interest rate LIBOR + 8.0% or
Floor rate of 10.50%

  $ 6,539        6,392        5,802   
   

Senior Debt
Matures January 2015
Interest rate LIBOR + 10.50% or
Floor rate of 13.0%

  $ 5,900        5,996        5,996   
                     

Total Pacific Child & Family Associates, LLC.

  

    12,388        11,798   
                     

Total Therapeutic (6.13%)*

  

    28,702        25,300   
                     

 

See notes to consolidated financial statements.

 

27


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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Cozi Group, Inc.

  Internet Consumer &
Business Services
  Preferred Stock Warrants     $ 147      $ —     
   

Preferred Stock

      177        292   
                     

Total Cozi Group, Inc.

  

    324        292   

Invoke Solutions, Inc.

  Internet Consumer &
Business Services
  Preferred Stock Warrants       56        74   
   

Preferred Stock Warrants

      26        18   
                     

Total Invoke Solutions, Inc.

  

    82        92   

Prism Education Group, Inc.

  Internet Consumer &
Business Services
  Preferred Stock Warrants       43        50   
                     

Total Prism Education Group, Inc.

  

    43        50   

RazorGator Interactive Group, Inc. (4)

  Internet Consumer &
Business Services
 

Revolving Line of Credit
Matures October 2011
Interest rate Prime + 9.50% or
Floor rate of 14.00%

  $ 2,108        1,855        1,855   
   

Preferred Stock Warrants

      13        —     
   

Preferred Stock Warrants

      28        —     
   

Preferred Stock Warrants

      1,183        —     
   

Preferred Stock

      1,000        —     
                     

Total RazorGator Interactive Group, Inc.

  

    4,079        1,855   

Reply! Inc. (4)

  Internet Consumer &
Business Services
 

Senior Debt
Matures June 2013
Interest rate Prime + 6.5% or
Floor rate of 9.75%

  $ 5,000        4,646        4,646   
   

Preferred Stock Warrants

      320        320   
                     

Total Reply! Inc.

  

    4,966        4,966   
                     

Total Internet Consumer & Business Services (1.76%)*

  

    9,494        7,255   
                     

Lilliputian Systems, Inc.

  Energy   Preferred Stock Warrants       106        3   
   

Common Stock Warrants

      49        —     
                     

Total Lilliputian Systems, Inc.

  

    155        3   
                     

Total Energy (0.00%)*

  

    155        3   
                     

Box.net, Inc.

  Information Services  

Senior Debt
Matures May 2011
Interest rate Prime + 1.50% or
Floor rate of 7.50%

  $ 213        270        270   
   

Senior Debt
Matures September 2011
Interest rate Prime + 0.50% or
Floor rate of 6.50%

  $ 127        139        139   
   

Preferred Stock Warrants

      73        184   
   

Preferred Stock Warrants

      117        117   
   

Preferred Stock

      500        500   
                     

Total Box.net, Inc.

  

    1,099        1,210   

 

See notes to consolidated financial statements.

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Buzznet, Inc.

  Information Services   Preferred Stock Warrants     $ 9      $ —     
    Preferred Stock       250        37   
                     

Total Buzznet, Inc.

  

    259        37   

XL Education Corp.

  Information Services   Common Stock       880        880   
                     

Total XL Education Corp.

  

    880        880   

hi5 Networks, Inc.

  Information Services   Preferred Stock Warrants       213        —     
    Preferred Stock       250        247   
                     

Total hi5 Networks, Inc.

  

    463        247   

Jab Wireless, Inc.

  Information Services   Preferred Stock Warrants       265        122   
                     

Total Jab Wireless, Inc.

  

    265        122   

Solutionary, Inc.

  Information Services   Preferred Stock Warrants       94        —     
    Preferred Stock Warrants       2        —     
    Preferred Stock       250        50   
                     

Total Solutionary, Inc.

  

    346        50   

Intelligent Beauty, Inc.

  Information Services  

Senior Debt
Matures March 2013
Interest rate Prime + 8.0% or
Floor rate of 11.25%

  $ 5,812        5,563        5,557   
   

Senior Debt
Matures October 2013
Interest rate Prime + 8.0%
or Floor rate of 11.25%

  $ 2,000        1,942        1,942   
    Preferred Stock Warrants       230        230   
                     

Total Intelligent Beauty, Inc.

  

    7,735        7,729   

Good Technologies, Inc.

  Information Services   Common Stock       603        150   
                     

Total Good Technologies, Inc.

  

    603        150   

Coveroo, Inc.

  Information Services   Preferred Stock Warrants       7        —     
                     

Total Coveroo, Inc.

  

    7        —     

Zeta Interactive Corporation

  Information Services   Preferred Stock Warrants       172        57   
    Preferred Stock       500        375   
                     

Total Zeta Interactive Corporation

  

    672        432   
                     

Total Information Services (2.63%)*

  

    12,329        10,857   
                     

Novadaq Technologies, Inc.(5)

  Diagnostic   Common Stock       1,415        675   
                     

Total Novadaq Technologies, Inc.

  

    1,415        675   

 

See notes to consolidated financial statements.

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry  

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

Optiscan Biomedical Corp.

  Diagnostic  

Senior Debt
Matures December 2013
Interest rate Prime + 7.0% or
Floor rate of 10.25%

  $ 10,750      $ 10,392      $ 10,392   
   

Preferred Stock Warrants

      1,069        637   
   

Preferred Stock

      3,656        3,207   
                     

Total Optiscan Biomedical Corp.

  

    15,117        14,236   
                     

Total Diagnostic (3.61%)*

  

    16,532        14,911   
                     

Kamada, LTD.(5)

  Biotechnology Tools   Preferred Stock Warrants       159        164   
   

Common Stock

      752        1,754   
                     

Total Kamada, LTD.

  

    911        1,918   

Labcyte, Inc.

  Biotechnology Tools  

Senior Debt
Matures May 2013
Interest rate Prime + 8.6% or
Floor rate of 11.85%

  $ 3,885        3,761        3,821   
   

Common Stock Warrants

      192        —     
                     

Total Labcyte, Inc.

  

    3,953        3,821   

NuGEN Technologies, Inc.

  Biotechnology Tools   Preferred Stock Warrants       45        44   
   

Preferred Stock Warrants

      33        1   
   

Preferred Stock

      500        203   
                     

Total NuGEN Technologies, Inc.

  

    578        248   
                     

Total Biotechnology Tools (1.45%)*

  

    5,442        5,987   
                     

Crux Biomedical, Inc.

  Surgical Devices   Preferred Stock Warrants       37        —     
   

Preferred Stock

      250        —     
                     

Total Crux Biomedical, Inc.

  

    287        —     

Transmedics, Inc. (4)

  Surgical Devices  

Senior Debt
Matures February 2014
Interest rate Prime + 9.70% or
Floor rate of 12.95%

  $ 8,375        8,913        8,913   
   

Preferred Stock Warrants

      224        159   
   

Preferred Stock

      1,100        1,100   
                     

Total Transmedics, Inc.

  

    10,237        10,172   
                     

Total Surgical Devices (2.47%)*

  

    10,524        10,172   
                     

Glam Media, Inc.

  Media/Content/ Info   Preferred Stock Warrants       482        283   
                     

Total Glam Media, Inc.

  

    482        283   

Everyday Health, Inc.

  Media/Content/ Info   Preferred Stock Warrants       60        630   
   

Preferred Stock

      1,000        1,310   
                     

Total Everyday Health, Inc.

  

    1,060        1,940   
                     

Total Media/Content/Info (0.54%)*

  

    1,542        2,223   
                     

 

See notes to consolidated financial statements.

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS—(Continued)

December 31, 2010

(dollars in thousands)

 

Portfolio Company

  Industry    

Type of Investment(1)

  Principal
Amount
    Cost(2)     Value(3)  

BrightSource Energy, Inc. (4)

    Clean Tech     

Senior Debt
Matures December 2011
Interest rate Prime + 7.75% or
Floor rate of 11.0%

  $ 3,750      $ 3,265      $ 3,265   
   

Senior Debt
Matures June 2012
Interest rate Prime + 9.55% or
Floor rate of 12.80%

  $ 4,583        4,156        4,156   
   

Preferred Stock Warrants

      675        674   
                     

Total BrightSource Energy, Inc.

  

    8,096        8,095   

Calera, Inc.

    Clean Tech     

Senior Debt
Matures July 2013
Interest rate Prime + 7.0% or
Floor rate of 10.25%

  $ 3,621        3,109        3,109   
   

Preferred Stock Warrants

      513        527   
                     

Total Calera, Inc.

  

    3,622        3,636   

GreatPoint Energy, Inc.

    Clean Tech     

Senior Debt
Matures October 2013
Interest rate Prime + 8.2% or
Floor rate of 11.45%

  $ 5,000        4,322        4,322   
   

Preferred Stock Warrants

      548        627   
                     

Total GreatPoint Energy, Inc.

  

    4,870        4,949   

Propel Biofuels, Inc.

    Clean Tech     

Senior Debt
Matures September 2013
Interest rate 11.0%

  $ 2,118        1,880        1,850   
   

Preferred Stock Warrants

      211        192   
                     

Total Propel Biofuels, Inc.

  

    2,091        2,042   

Solexel, Inc.

    Clean Tech     

Senior Debt
Matures June 2013
Interest rate Prime + 8.25% or
Floor rate of 11.50%

  $ 1,109        1,010        1,010   
   

Senior Debt
Matures June 2013
Interest rate Prime + 7.25% or
Floor rate of 10.50%

  $ 6,000        5,519        5,519   
   

Preferred Stock Warrants

      335        292   
                     

Total Solexel, Inc.

  

    6,864        6,821   

Trilliant, Inc.

    Clean Tech      Preferred Stock Warrants       88        99   
    Preferred Stock Warrants       72        80   
                     

Total Trilliant, Inc.

  

    160        179   
                     

Total Clean Tech (6.24%)*

  

    25,703        25,722   
                     

Total Investments

  

  $ 480,405      $ 472,032   
                     

 

* Value as a percent of net assets
(1) Preferred and common stock, warrants, and equity interests are generally non-income producing.
(2) Gross unrealized appreciation, gross unrealized depreciation, and net depreciation for federal income tax purposes totaled $22,458, $32,232 and $9,774 respectively. The tax cost of investments is $481,432
(3) Except for warrants in ten publicly traded companies and common stock in five publicly traded companies, all investments are restricted at December 31, 2010 and were valued at fair value as determined in good faith by the Board of Directors. No unrestricted securities of the same issuer are outstanding. The Company uses the Standard Industrial Code for classifying the industry grouping of its portfolio companies.
(4) Debt investments of this portfolio company have been pledged as collateral under the Wells Facility.
(5) Non-U.S. company or the company’s principal place of business is outside the United States.
(6) Affiliate investment that is defined under the Investment Company Act of 1940 as companies in which HTGC owns as least 5% but not more than 25% of the voting securities of the company.
(7) Control investment that is defined under the Investment Company Act of 1940 as companies in which HTGC owners as least 25% but no more than 50% of the voting securities of the company
(8) Debt is on non-accrual status at December 31, 2010, and is therefore considered non-income producing.

 

See notes to consolidated financial statements.

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(unaudited)

(dollars in thousands, except per share data)

 

     Three Months Ended March 31,  
     2011     2010  

Investment income:

    

Interest income

    

Non Control/Non Affiliate investments

   $ 16,456      $ 10,430   

Control investments

     —          805   
                

Total interest income

     16,456        11,235   
                

Fees

    

Non Control/Non Affiliate investments

     2,695        1,113   

Control investments

     —          172   
                

Total fees

     2,695        1,285   
                

Total investment income

     19,151        12,520   

Operating expenses:

    

Interest

     2,233        2,026   

Loan fees

     934        298   

General and administrative

     2,206        1,889   

Employee Compensation:

    

Compensation and benefits

     3,253        2,238   

Stock-based compensation

     721        457   
                

Total employee compensation

     3,974        2,695   
                

Total operating expenses

     9,347        6,908   

Net investment income

     9,804        5,612   

Net realized gain (loss) on investments

     4,370        362   

Net increase (decrease) in unrealized depreciation on investments

     (15,352     (260
                

Net realized and unrealized gain (loss)

     (10,982     102   
                

Net increase (decrease) in net assets resulting from operations

   $ (1,178   $ 5,714   
                

Net investment income before investment gains and losses per common share:

    

Basic

   $ 0.23      $ 0.16   
                

Change in net assets per common share:

    

Basic

   $ (0.03   $ 0.16   
                

Diluted

   $ (0.03   $ 0.16   
                

Weighted average shares outstanding

    

Basic

     42,737        35,181   
                

Diluted

     42,737        35,813   
                

See notes to Consolidated Financial Statements (unaudited).

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

(unaudited)

(dollars and shares in thousands)

 

    Common Stock     Capital in
Excess

of Par Value
    Unrealized
Accumulated
(Depreciation)
on Investments
    Accumulated
Realized
Gains (Losses)
on Investments
    Distributions
in Excess of
Investment
Income
    Provision for
Income Taxes
on Investment
Gains
    Net
Assets
 
    Shares     Par Value              

Balance at December 31, 2009

    35,634      $ 35      $ 409,036      $ (10,028   $ (28,129   $ (4,057   $ (342   $ 366,515   

Net increase in net assets resulting from operations

    —          —          —          (260     362        5,612        —          5,714   

Issuance of common stock

    81        —          446        —          —          —          —          446   

Issuance of common stock under restricted stock plan

    491        —          —          —          —          —          —          —     

Acquisition of common stock under stock repurchase plan

    (25     —          (234     —          —          —          —          (234

Issuance of common stock under dividend reinvestment plan

    67        —          620        —          —          —          —          620   

Dividends declared

    —          —          —          —          —          (7,130     —          (7,130

Stock-based compensation

    —          —          481        —          —          —          —          481   
                                                               

Balance at March 31, 2010

    36,248      $ 35      $ 410,349      $ (10,288   $ (27,767   $ (5,575   $ (342   $ 366,412   
                                                               

Balance at December 31, 2010

    43,444      $ 43      $ 477,549      $ (8,038   $ (51,033   $ (5,648   $ (342   $ 412,531   

Net decrease in net assets resulting from operations

    —          —          —          (15,352     4,370        9,804        —          (1,178

Issuance of common stock

    3        —          15        —          —          —          —          15   

Issuance of common stock under restricted stock plan

    297        —          —          —          —          —          —          —     

Acquisition of common stock under repurchase plan

    —          —          —          —          —          —          —          —     

Issuance of common stock as stock dividend

    61        —          668        —          —          —          —          668   

Retired shares from net issuance

    (1     —          (9     —          —          —          —          (9

Dividends declared

    —          —          —          —          —          (9,556     —          (9,556

Stock-based compensation

    —          —          736        —          —          —          —          736   
                                                               

Balance at March 31, 2011

    43,804      $ 43      $ 478,959      $ (23,390   $ (46,663   $ (5,400   $ (342   $ 403,207   
                                                               

See notes to Consolidated Financial Statements (unaudited).

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

(dollars in thousands)

 

     Three Months Ended
March 31,
 
     2011     2010  

Cash flows from operating activities:

    

Net increase (decrease) in net assets resulting from operations

   $ (1,178   $ 5,714   

Adjustments to reconcile net increase in net assets resulting from operations to net cash used in and provided by operating activities:

    

Purchase of investments

     (85,024     (68,401

Principal payments received on investments

     85,988        59,700   

Proceeds from sale of investments

     16,897        2,090   

Net unrealized depreciation on investments

     15,352        260   

Net realized gain on investments

     (4,370     (362

Accretion of paid-in-kind principal

     (890     (568

Accretion of loan discounts

     (1,740     (588

Accretion of loan exit fees

     —          (568

Depreciation

     89        95   

Stock-based compensation

     167        176   

Amortization of restricted stock grants

     569        305   

Change in deferred loan origination revenue

     (1,852     (639

Change in operating assets and liabilities:

    

Interest receivable

     22        (614

Prepaid expenses and other assets

     2,071        (788

Accounts payable

     (406     (112

Income tax payable/receivable

     —          8   

Accrued liabilities

     (870     (7,764
                

Net cash provided by (used in) operating activities

     24,825        (12,056

Cash flows from investing activities:

    

Purchases of capital equipment

     (27     (50

Other long-term assets

     (1,788     153   
                

Net cash provided by (used in) investing activities

     (1,815     103   

Cash flows from financing activities:

    

Proceeds from issuance of common stock, net

     6        383   

Stock repurchase program

     —          (234

Dividends paid

     (8,890     (6,510

Borrowings of credit facilities

     18,750        —     

Repayments of credit facilities

     (25,000     —     

Fees paid for credit facilities and debentures

     (455     (376
                

Net cash used in financing activities

     (15,589     (6,737
                

Net increase (decrease) in cash

     7,421        (18,690

Cash and cash equivalents at beginning of period

     107,014        124,828   
                

Cash and cash equivalents at end of period

   $ 114,435      $ 106,138   
                

See notes to Consolidated Financial Statements (unaudited).

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Description of Business and Unaudited Interim Consolidated Financial Statements Basis of Presentation

Hercules Technology Growth Capital, Inc. (the “Company”) is a specialty finance company that provides debt and equity growth capital to technology-related companies at various stages of development, which include select publicly listed companies and lower middle market companies. The Company sources its investments through its principal office located in Silicon Valley, as well as through its additional offices in Boston, Massachusetts and Boulder, Colorado. The Company was incorporated under the General Corporation Law of the State of Maryland in December 2003.

The Company is an internally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). From incorporation through December 31, 2005, the Company was taxed as a corporation under Subchapter C of the Internal Revenue Code of 1986, (the “Code”). Effective January 1, 2006, the Company has elected to be treated for tax purposes as a regulated investment company, or RIC, under the Code (see Note 5).

The Company formed Hercules Technology II, L.P. (“HT II”), which was licensed on September 27, 2006, and Hercules Technology III, L.P. (“HT III”), which was licensed on May 26, 2010 to operate as small business investment companies (“SBICs”) under the authority of the Small Business Administration (“SBA”). As SBICs, HT II and HT III are subject to a variety of regulations concerning, among other things, the size and nature of the companies in which they may invest and the structure of those investments. The Company also formed Hercules Technology SBIC Management, LLC (“HTM”), a limited liability company. HTM is a wholly-owned subsidiary of the Company. The Company is the sole limited partner of HT II and HT III and HTM is the general partner of HT II and HT III (see Note 4).

The Company also established wholly owned subsidiaries, all of which are structured as Delaware corporations and limited liability companies, to hold portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities). The Company currently qualifies as a RIC for federal income tax purposes, which allows the Company to avoid paying corporate income taxes on any income or gains that the Company distributes to our stockholders. The purpose of establishing these entities is to satisfy the RIC tax requirement that at least 90% of the Company’s gross income for income tax purposes is investment income.

The consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. In accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and the Securities and Exchange Act of 1934, the Company does not consolidate portfolio company investments. The accompanying consolidated interim financial statements are presented in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information, and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X under the Securities Act of 1933 and the Securities Exchange Act of 1934. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with U.S. GAAP are omitted. In the opinion of management, all adjustments consisting solely of normal recurring accruals considered necessary for the fair presentation of consolidated financial statements for the interim periods, have been included. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the year. Therefore, the interim unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the period ended December 31, 2010. Financial statements prepared on a U.S. GAAP basis require management to make estimates and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.

Certain prior period information has been reclassified to conform to the current period presentation.

 

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2. Valuation of Investments

The Company’s 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 March 31, 2011 77.5% of the Company’s 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. The Company’s debt securities are primarily invested in equity sponsored technology, life science and clean technology companies. Given the nature of lending to these types of businesses, the Company’s 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. As such, the Company values substantially all of its investments at fair value as determined in good faith pursuant to a consistent valuation policy and the Company’s 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 the Company’s investments determined in good faith by its 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 the Company with valuation assistance with respect to certain of the Company’s portfolio investments on a quarterly basis. The Company intends to continue to engage an independent valuation firm to provide management with assistance regarding the Company’s 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 services rendered by an independent valuation firm is at the discretion of the Board of Directors. The Company’s Board of Directors is ultimately and solely responsible for determining the fair value of the Company’s 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, the Company’s Board of Directors has approved a multi-step valuation process each quarter, as described below:

(1) the Company’s 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 discussed with the Company’s investment committee;

(3) the valuation committee of the Board of Directors reviews the preliminary valuation of the investment committee and that of the independent valuation firm and responds to the valuation recommendation of the independent valuation firm to reflect any comments, if any; and

(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.

The Company 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

 

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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.

The Company has 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 1—Inputs 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 2—Inputs (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 instrument’s anticipated life. Fair valued assets that are generally included in this category are warrants held in a public company.

Level 3—Inputs reflect management’s 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.

Debt Investments

The Company follows the guidance set forth in ASC 820 which establishes a framework for measuring the fair value of 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. The Company’s debt securities are primarily invested in equity sponsored technology, life science and clean technology companies. Given the nature of lending to these types of businesses, the Company’s 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.

The Company applies a procedure 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, the Company also evaluates the collateral for recoverability of the debt investments as well as apply all of its historical fair value analysis excluding its interest rate sensitivity analysis, which was replaced by the hypothetical market participant method, as discussed above. The Company uses pricing on recently issued comparable debt securities to determine the baseline hypothetical market yields as of the measurement date. The Company considers each portfolio company’s credit rating, security liens and other characteristics of the investment to adjust the baseline yield to derive a hypothetical yield for each investment. The anticipated future cash flows from each investment are then discounted at the hypothetical yield to estimate each investment’s fair value as of the measurement date.

The Company’s process includes, among other things, the underlying investment performance, the current portfolio company’s

 

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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, the Company may consider other factors to estimate fair value, including the proceeds that would be received in a liquidation analysis.

The Company records unrealized depreciation on investments when it believes 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, the Company records unrealized appreciation if it believes that the underlying portfolio company has appreciated in value and, therefore, that its 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, the Company generally receives warrants or other equity-related securities from the borrower. The Company determines 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 valuation date.

The Company estimates 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 company’s 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 the Company’s valuation of the warrant and equity related. The Company periodically reviews the valuation of its 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.

 

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Investments measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations as of March 31, 2011 (unaudited) and as of December 31, 2010:

 

            Investments at Fair Value as of March 31, 2011  

(in thousands)

Description

   3/31/2011      Quoted Prices In
Active Markets For
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Senior secured debt

   $ 372,252       $ —         $ —         $ 372,252   

Subordinated debt

     24,313         —           —           24,313   

Preferred stock

     21,333         —           —           21,333   

Common stock

     5,689         4,658         —           1,031   

Warrants

     21,467         —           5,507         15,960   
                                   
   $ 445,054       $ 4,658       $ 5,507       $ 434,889   
                                   
            Investments at Fair Value as of December 31, 2010  

(in thousands)

Description

   12/31/2010      Quoted Prices In
Active Markets For
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Senior secured debt

   $ 394,198       $ —         $ —         $ 394,198   

Subordinated debt

     7,420         —           —           7,420   

Preferred stock

     24,607         —           —           24,607   

Common stock

     22,117         4,943         16,144         1,030   

Warrants

     23,690         —           6,289         17,401   
                                   
   $ 472,032       $ 4,943       $ 22,433       $ 444,656   
                                   

 

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The table below presents a reconciliation for all financial assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3) for the three months ended March 31, 2011 (unaudited) and for the year ended December 31, 2010.

 

(in thousands)

  Balance,
January 1, 2011
    Net Realized  Gains
(losses)(1)
    Net change in
unrealized
appreciation or
depreciation(2)
    Purchases       Sales       Repayments     Exit     Gross
Transfers
into
Level 3(1)
    Gross
Transfers
out of
Level 3(3)
    Balances,
March 31, 2011
 

Senior Debt

  $ 394,198      $ (4,301   $ (1,801   $ 70,144      $ —        $ (85,988     —        $ —        $ —          372,252   

Subordinated Debt

    7,420        —          —          16,893        —          —          —          —          —          24,313   

Preferred Stock

    24,607        (50     (3,724     500        —          —          —          —          —          21,333   

Common Stock

    1,030        —          1        —          —          —          —          —          —          1,031   

Warrants

    17,401        (878     26        717        —          —          (51     —          (1,255     15,960   
                                                                               

Total

  $ 444,656      $ (5,229   $ (5,498   $ 88,254      $ —        $ (85,988   $ (51     —        $ (1,255   $ 434,889   
                                                                               

 

(in thousands)

   Balances,
January 1,
2010
     Net
Realized
Gains
(losses)(1)
    Net change in
unrealized
appreciation or
depreciation(2)
    Purchases,
sales,
repayments,
and exit, net
    Transfer in
& out of
Level 3
    Balances,
December 31, 2010
 

Senior Debt

   $ 319,129       $ (12,835   $ (3,076   $ 98,058      $ (7,078   $ 394,198   

Subordinated Debt

     —           —          —          7,420        —          7,420   

Senior Debt-Second Lien

     6,005         —          —          (6,005     —          —     

Preferred Stock

     22,875         (1,250     (995     2,603        1,374        24,607   

Common Stock

     1,773         (15,037     (743     15,037        —          1,030   

Warrants

     11,076         (1,225     568        8,650        (1,668     17,401   
                                                 

Total

   $ 360,858       $ (30,347   $ (4,246   $ 125,763      $ (7,372   $ 444,656   
                                                 

 

(1)

Includes net realized gains (losses) recorded as realized gains or losses in the accompanying consolidated statements of operations.

(2)

Included in change in net unrealized appreciation or depreciation in the accompanying consolidated statements of operations.

(3) 

Transfers out of Level 3 warrants relates to the Pacira Pharmaceutical IPO.

For the quarter ended March 31, 2011, approximately $1.8 million, $3.8 million and $885,000 in unrealized depreciation was recorded for debt, equity and warrant Level 3 investments, respectively, relating to assets still held at the reporting date.

For the year ended December 31, 2010, approximately $3.1 million, $3.0 million and $461,000 in unrealized depreciation was recorded for debt, equity and warrant Level 3 investments, respectively, relating to assets still held at the reporting date.

 

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As required by the 1940 Act, the Company classifies its investments by level of control. “Control Investments” are defined in the 1940 Act as investments in those companies that the Company is deemed to “Control”. Generally, under the 1940 Act, the Company is deemed to “Control” a company in which it has invested if it owns 25% or more of the voting securities of such company or has greater than 50% representation on its board. “Affiliate Investments” are investments in those companies that are “Affiliated Companies” of the Company, as defined in the 1940 Act, which are not Control Investments. The Company is deemed to be an “Affiliate” of a company in which it has invested if it owns 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.

At March 31, 2011, the Company did not hold any Control Investments. The Company’s investment in InfoLogix, Inc., a company that was a Control Investment as of December 31, 2010, was sold to Stanley Black & Decker (NYSE:SWK) in January 2011. Approximately $8.3 million of realized gains and $8.4 million of net change in unrealized depreciation was recognized on this control investment during the three-month period ended March 31, 2011.

At March 31, 2011 and 2010, the Company had an investment in one portfolio company deemed to be an Affiliate. No income was derived from this investment as this is a non-income producing equity investment. No realized gains were related to this investment, and approximately $1.0 million and $52,000 of net change in unrealized depreciation was recognized on this control investment during the three-month periods ended March 31, 2011 and 2010, respectively.

 

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A summary of the composition of the Company’s investment portfolio as of March 31, 2011 (unaudited) and December 31, 2010 at fair value is shown as follows:

 

     March 31, 2011     December 31, 2010  
(in thousands)    Investments at
Fair Value
     Percentage of Total
Portfolio
    Investments at Fair
Value
     Percentage of Total
Portfolio
 

Senior Secured Debt with warrants

   $ 359,042         80.7   $ 357,963         75.8

Senior Secured Debt

     34,093         7.6     59,251         12.6

Subordinated Debt

     24,897         5.6     8,094         1.7

Preferred Stock

     21,333         4.8     26,813         5.7

Common Stock

     5,689         1.3     19,911         4.2
                                  
   $ 445,054         100.0   $ 472,032         100.0
                                  

A summary of the Company’s investment portfolio, at value, by geographic location as of March 31, 2011 (unaudited) and as of December 31, 2010 is shown as follows:

 

     March 31, 2011     December 31, 2010  
(in thousands)    Investments at Fair
Value
     Percentage of Total
Portfolio
    Investments at Fair
Value
     Percentage of Total
Portfolio
 

United States

   $ 415,241         93.3   $ 438,585         92.9

Canada

     18,528         4.2     20,876         4.4

England

     10,634         2.4     1,918         0.4

Israel

     651         0.1     10,653         2.3
                                  
   $ 445,054         100.0   $ 472,032         100.0
                                  

 

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The following table shows the fair value of our portfolio by industry sector at March 31, 2011 (unaudited) and December 31, 2010:

 

     March 31, 2011     December 31, 2010  
(in thousands)    Investments at Fair
Value
     Percentage of Total
Porfolio
    Investments at Fair
Value
     Percentage of Total
Porfolio
 

Drug Discovery

   $ 74,243         16.7   $ 52,777         11.2

Specialty Pharma

     71,273         16.0     63,607         13.5

Software

     53,714         12.1     96,508         20.4

Clean Tech

     48,289         10.8     25,722         5.4

Communications & Networking

     47,080         10.6     65,098         13.8

Drug Delivery

     32,754         7.4     35,250         7.5

Internet Consumer & Business Services

     27,665         6.2     7,255         1.5

Therapeutic

     23,966         5.4     25,300         5.4

Consumer & Business Products

     17,990         4.0     45,316         9.6

Diagnostic

     13,926         3.1     14,911         3.2

Information Services

     13,399         3.0     10,857         2.3

Electronics & Computer Hardware

     5,667         1.3     7,819         1.6

Biotechnology Tools

     5,146         1.2     5,987         1.3

Surgical Devices

     4,520         1.0     10,172         2.1

Semiconductors

     3,174         0.7     3,227         0.7

Media/Content/Info

     2,247         0.5     2,223         0.5

Energy

     1         —          3         —     
                                  
   $ 445,054         100   $ 472,032         100
                                  

During the three-month periods ended March 31, 2011 and 2010, the Company made investments in debt securities totaling approximately $83.9 million and $87.3 million, respectively, and funded equity investments of approximately $500,000 in the three-month period ended March 31, 2011. The Company funded $16.1 million of equity investments, which included restructured loans investments during the three month period ended March 31, 2010

During the three months ended March 31, 2011, the Company recognized net realized gains of approximately $9.6 million from the sale of common stock in its public portfolio companies and realized losses of approximately $5.2 million from equity and warrant investments in portfolio companies that have been liquidated. During the three-month period ended March 31, 2010, the Company recognized net realized gains of approximately $151,000 from the sale of common stock in public companies, approximately $644,000 from mergers of private portfolio companies and realized losses of approximately $433,000 from equity and warrant investments in portfolio companies that have been liquidated.

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 loan’s yield over the contractual life of the loan. The Company recognizes 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. The Company had approximately $4.8 million and $6.3 million of unamortized fees at March 31, 2011 and December 31, 2010, respectively, and approximately $5.9 million and $5.1 million in exit fees receivable at March 31, 2011 and December 31, 2010, respectively.

The Company has loans in its portfolio that contain a payment-in-kind (“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 the Company’s status as a RIC, this non-cash source of income must be paid out to stockholders in the form of dividends even though the Company has not yet collected the cash. Amounts necessary to pay these dividends may come from available cash or the liquidation of certain investments. The Company recorded approximately $556,000 and $568,000 in PIK income in the three-month periods ended March 31, 2011 and 2010, respectively.

In certain investment transactions, the Company 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. The Company had no income from advisory services in the quarter ended March 31, 2011.

 

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In some cases, the Company collateralizes its investments by obtaining a first priority security interest in a portfolio company’s assets, which may include their intellectual property. In other cases, the Company may obtain a negative pledge covering a company’s intellectual property. At March 31, 2011, approximately 63.7% of the Company’s portfolio company loans were secured by a first priority security in all of the assets of the portfolio company, 29.4% of portfolio company loans were prohibited from pledging or encumbering their intellectual property, 6.1% of portfolio company loans were secured by a second priority security in all of the assets of the portfolio company and 0.8% of portfolio company loans had an equipment only lien.

3. Fair Value of Financial Instruments

Fair value estimates are made at discrete points in time based on relevant information. These estimates may be subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. The Company believes that the carrying amounts of its financial instruments, consisting of cash and cash equivalents, receivables, accounts payable and accrued liabilities approximate the fair values of such items due to the short maturity of such instruments. The SBIC debentures remain a strategic advantage due to their flexible structure, long-term duration, and low fixed interest rates. Calculated based on the net present value of payments over the term of the notes using estimated market rates for similar notes and remaining terms, the fair value of its SBIC debentures would be approximately $169.8 million, compared to the carrying amount of $163.8 million as of March 31, 2011.

See the accompanying Consolidated Schedule of Investments for the fair value of the Company’s investments. The methodology for the determination of the fair value of the Company’s investments is discussed in Note 1.

4. Borrowings

Citibank Credit Facility

The Company, through Hercules Funding Trust I, an affiliated statutory trust, had a securitized credit facility (the “Citibank Credit Facility”) with Citigroup Global Markets Realty Corp. (“Citigroup”) which expired under normal terms. During the first quarter of 2009, the Company paid off all remaining 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, the Company 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 was 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 $444,000 as of March 31, 2011 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. Since inception of the agreement, the Company has paid Citigroup approximately $1.1 million under the warrant participation agreement thereby reducing its realized gains by this amount. The Company will continue to pay Citigroup under the warrant participation agreement until the Maximum Participation Limit is reached or the warrants expire.

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. As of March 31, 2011, 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. The Company’s net investment of $75.0 million in HT II as of March 31, 2011 fully funds the required regulatory capital for HT II. In January 2011, HT II repaid $25.0 million of debentures. HT II has a total of $125.0 million of SBA guaranteed debentures outstanding as of March 31, 2011 and has paid the SBA commitment fees of approximately $1.5 million. As of March 31, 2011, the Company held investments in HT II in 54 companies with a fair value of approximately $158.6 million, accounting for approximately 35.6% of the Company’s total portfolio.

 

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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 the Company’s net investment of $37.5 million in HT III as of March 31, 2011, HT III has the capacity to issue a total of $75.0 million of SBA guaranteed debentures, subject to SBA approval, of which $38.75 million was outstanding as of March 31, 2011. As of March 31, 2011, HT III has paid commitment fees of approximately $750,000. 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. As of March 31, 2011, the Company held investments in HT III in 11 companies with a fair value of approximately $73.5 million, accounting for approximately 16.5% of the Company’s total portfolio. See note 12.

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 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, the Company plans to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.

HT II and HT III are periodically examined and audited by the SBA’s 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 II’s or HT III’s 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 the Company if they do not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would, in turn, negatively affect the Company because HT II and III are the Company’s wholly owned subsidiaries. HT II and HT III were in compliance with the terms of the SBIC’s leverage as of March 31, 2011 as a result of having sufficient capital as defined under the SBA regulations. As of March 31, 2011, HT II and HT III could draw up to $25.0 million and $36.25 million, respectively, of additional leverage from SBA.

The rates of borrowings under various draws from the SBA beginning in April 2007 are set semiannually in March and September and range from 3.22% 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 fee related to HT III debentures that pooled on March 29, 2011 was 0.285%. The annual fees related to HT II debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year the underlying commitment was closed in. The annual fees on other debentures have been set at 0.906%. The average amount of debentures outstanding for the quarter ended March 31, 2011 for HT II was approximately $126.9 million with an average interest rate of approximately 5.0%. The average amount of debentures outstanding for the quarter ended March 31, 2011 for HT III was approximately $37.5 million with an average interest rate of approximately 4.08%.

Wells Facility

On August 25, 2008, the Company, through a special purpose wholly-owned subsidiary of the Company, Hercules Funding II, LLC, entered into a two-year revolving senior secured credit facility with an optional one-year extension with total commitments of $50.0 million, with Wells Fargo Capital Finance as a lender and as an arranger and administrative agent (the “Wells Facility”). The Wells Facility has the capacity to increase to $300 million if additional lenders are added to the syndicate. The Wells Facility expires in August 2011. Borrowings under the Wells Facility will generally bear interest at a rate per annum equal to LIBOR plus 3.25% or PRIME plus 2.0%, but not less than 5.0%. The Wells Facility requires the payment of a non-use fee of 0.3% annually. The Wells Facility is collateralized by debt investments in our portfolio companies, and includes an advance rate equal to 50% of eligible loans placed in the collateral pool. The Wells Facility generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity. The Company has paid a total of approximately $1.1 million in structuring fees in connection with the Wells

 

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Facility which is being amortized through August 2011. There was no outstanding debt under the Wells Facility at March 31, 2011.

The Wells Facility requires various financial and operating covenants. These covenants require the Company to maintain certain financial ratios and a minimum tangible net worth of $250.0 million, contingent upon the Company’s total commitments under all lines of credit not exceeding $250 million. To the extent our total commitment exceeds $250.0 million, the minimum tangible net worth covenant will increase on a pro rata basis commensurate with our net worth on a dollar for dollar basis. In addition, the tangible net worth covenant will increase by 90 cents on the dollar for every dollar of equity capital subsequently raised by the Company. 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. The Company was in compliance with all covenants at March 31, 2011.

Union Bank Facility

On February 10, 2010, the Company entered a $20.0 million one-year revolving senior secured credit facility with Union Bank (the “Union Bank Facility”). 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%, an advance rate of 50% against eligible loans, and secured by loans in the borrowing base. At March 31, 2011, there were no borrowings outstanding on this facility. The Union Bank Facility requires the payment of a non-use fee of 0.25% annually. The Union Bank Facility is collateralized by debt investments in the Company’s 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. In February 2011, the maturity date of the facility was extended from May 1, 2011 to July 31, 2011.

At March 31, 2011 (unaudited) and December 31, 2010, the Company had the following borrowing capacity and outstanding borrowings:

 

     March 31, 2011      December 31, 2010  
     Facility Amount      Amount
Outstanding
     Facility Amount      Amount
Outstanding
 

Union Bank Facility

   $ 20,000       $ —         $ 20,000       $ —     

Wells Facility

     50,000         —           50,000         —     

SBA Debenture(1)

     200,000         163,750         225,000         170,000   
                                   

Total

   $ 270,000       $ 163,750       $ 295,000       $ 170,000   
                                   

 

(1)

The Company has the ability to borrow $36.25 million subject to SBA approval and compliance with SBIC regulations. See note 12.

5. Income taxes

The Company intends 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 taxable income and gains distributed to stockholders.

To qualify as a RIC, the Company is required to meet certain income and asset diversification tests in addition to distributing at least 90% of its investment company taxable income, as defined by the Code. The amount to be paid out as a dividend is determined by the Board of Directors each quarter and is based upon the annual earnings estimated by the management of the Company. To the extent that the Company’s earnings fall below the amount of dividends declared, however, a portion of the total amount of the Company’s dividends for the fiscal year may be deemed a return of capital for tax purposes to the Company’s stockholders.

Taxable income includes the Company’s 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.

 

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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.

For the quarter ended March 31, 2011, the Company declared a distribution of $0.22 per share. The determination of the tax attributes of the Company’s distributions is made annually as of the end of the Company’s fiscal year based upon its taxable income for the full year and distributions paid for the full year. As a result, a determination made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full year. If the Company had determined the tax attributes of its distributions year-to-date as of March 31, 2011, approximately 91% would be from ordinary income and spill over earnings from 2010 and 9% would be a return of capital. However there can be no certainty to shareholders that this determination is representative of what the tax attributes of its 2011 distributions to shareholders will actually be.

As a RIC, the Company will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless the Company distributes in a timely manner an amount at least equal to the sum of (1) 98% of our ordinary income for each calendar year, (2) 98.2% of our capital gain net income for the 1-year period ending October 31 in that calendar year and (3) any income realized, but not distributed, in the preceding year (the “Excise Tax Avoidance Requirements”). The Company will not be subject to excise taxes on amounts on which the Company is required to pay corporate income tax (such as retained net capital gains). Depending on the level of taxable income earned in a tax year, the Company may choose to carry over taxable income in excess of current year distributions from such taxable income into the next tax year and pay a 4% excise tax on such income, as required. The maximum amount of excess taxable income that may be carried over for distribution in the next year under the Code is the total amount of dividends paid in the following year, subject to certain declaration and payment guidelines. To the extent we choose to carry over taxable income into the next tax year, dividends declared and paid by us in a year may differ from taxable income for that year as such dividends may include the distribution of current year taxable income, the distribution of prior year taxable income carried over into and distributed in the current year, or returns of capital.

Taxable income for the three-month period ended March 31, 2011 was approximately $8.2 million or $0.19 per share. Taxable net realized gains for the same period were $5.8 million or approximately $0.13 per share. Taxable income for the three-month period ended March 31, 2010 was approximately $5.6 million or $0.16 per share. Taxable net realized losses for the same period were approximately $6.6 million or approximately $0.19 loss per share.

6. Shareholders’ Equity

At March 31, 2011, the Company was authorized to issue 60 million shares of common stock with a par value of $0.001. On April 5, 2011, the Board of Directors approved increasing the number of authorized shares to 100 million shares. Each share of common stock entitles the holder to one vote.

On January 27, 2011, the Company approved the extension of the stock repurchase plan as previously approved on February 8, 2010 under the same terms and conditions that allows the Company to repurchase up to $35.0 million of its common stock set to expire on February 11, 2011 for an additional six month period with a new expiration date of August 26, 2011. During the three month period ended March 31, 2011, the Company did not repurchase any common stock.

The Company has issued stock options for common stock subject to future issuance, of which 5,014,527 and 4,729,849 were outstanding at March 31, 2011 and December 31, 2010, respectively.

 

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7. Equity Incentive Plan

The Company and its stockholders have authorized and adopted the 2004 Equity Incentive Plan (the “2004 Plan”) for purposes of attracting and retaining the services of its executive officers and key employees. Under the 2004 Plan, the Company is authorized to issue 7,000,000 shares of common stock. Unless terminated earlier by the Company’s Board of Directors, the 2004 Plan will terminate on June 9, 2014, and no additional awards may be made under the 2004 Plan after that date.

The Company and its stockholders have authorized and adopted the 2006 Non-Employee Director Plan (the “2006 Plan” and, together with the 2004 Plan, the “Plans”) for purposes of attracting and retaining the services of its Board of Directors. Under the 2006 Plan, the Company is authorized to issue 1,000,000 shares of common stock. Unless terminated earlier by the Company’s Board of Directors, the 2006 Plan will terminate on May 29, 2016 and no additional awards may be made under the 2006 Plan after that date. The Company filed an exemptive relief request with the Securities and Exchange Commission (“SEC”) to allow options to be issued under the 2006 Plan which was approved on October 10, 2007.

On June 21, 2007, the shareholders approved amendments to the 2004 Plan and the 2006 Plan allowing for the grant of restricted stock. The amended Plans limit the combined maximum amount of restricted stock that may be issued under both Plans to 10% of the outstanding shares of the Company’s stock on the effective date of the Plans plus 10% of the number of shares of stock issued or delivered by Hercules during the terms of the Plans. The amendments further specify that no one person shall be granted awards of restricted stock relating to more than 25% of the shares available for issuance under the 2004 Plan. Further, the amount of voting securities that would result from the exercise of all of the Company’s outstanding warrants, options and rights, together with any restricted stock issued pursuant to the Plans, at the time of issuance shall not exceed 25% of its outstanding voting securities, except that if the amount of voting securities that would result from such exercise of all of the Company’s outstanding warrants, options and rights issued to Hercules directors, officers and employees, together with any restricted stock issued pursuant to the Plans, would exceed 15% of the Company’s outstanding voting securities, then the total amount of voting securities that would result from the exercise of all outstanding warrants, options and rights, together with any restricted stock issued pursuant to the Plans, at the time of issuance shall not exceed 20% of our outstanding voting securities.

In conjunction with the amendment and in accordance with the exemptive order, on June 21, 2007 the Company made an automatic grant of shares of restricted common stock to Messrs. Badavas, Chow and Woodward, the independent members of its Board of Directors, in the amounts of 1,667, 1,667 and 3,334 shares, respectively. In May 2008, the Company issued restricted shares to Messrs. Badavas and Chow in the amount of 5,000 shares each. In June 2009, the Company issued 5,000 restricted stock shares to Mr. Woodward. The shares were issued pursuant to the 2006 Plan and vest 33% on an annual basis from the date of grant and deferred compensation cost will be recognized ratably over the three year vesting period.

 

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A summary of common stock options activity under the Company’s 2006 and 2004 Plans for the three months ended March 31, 2011 and 2010 (unaudited) is as follows:

 

    For the three month period ended March 31,  
    2011     2010  
    Common Stock
Options
    Common Stock
Options
 

Outstanding at Beginning of Period

    4,729,849        4,924,405   

Granted

    295,700        242,250   

Exercised

    (3,542     (80,634

Cancelled

    (7,480     —     
               

Outstanding at End of Period

    5,014,527        5,086,021   
               

Weighted-average exercise price

  $ 11.33      $ 10.79   
               

 

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Options generally vest 33% one year after the date of grant and ratably over the succeeding 24 months. All options may be exercised for a period ending seven years after the date of grant. At March 31, 2011, options for approximately 3.8 million shares were exercisable at a weighted average exercise price of approximately $12.20 per share with a weighted average remaining contractual term of 2.76 years.

The Company determined that the fair value of options granted under the 2006 and 2004 Plans during the three-month periods ended March 31, 2011 and 2010 was approximately $568,000 and $442,000 respectively. During the three-month periods ended March 31, 2011 and 2010, approximately $167,000 and $171,000 of share-based cost due to stock option grants was expensed, respectively. As of March 31, 2011, there was approximately $1.5 million of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a weighted average period of 2.42 years. The fair value of options granted is based upon a Black-Scholes option pricing model using the assumptions in the following table for each of the three-month periods ended March 31, 2011 and 2010 (unaudited):

 

     2011     2010  

Expected Volatility

     46.70     46.39

Expected Dividends

     10     10

Expected term (in years)

     4.5        4.5   

Risk-free rate

     1.65% - 2.15     2.13% - 2.36

The following table summarizes stock options outstanding and exercisable at March 31, 2011 (unaudited):

 

(Dollars in thousands, except exercise price)

   Options outstanding      Options exercisable  

Range of exercise prices

   Number of
shares
     Weighted
average
remaining
contractual
life
     Aggregate
intrinsic
value
     Weighted
average
exercise
price
     Number of
shares
     Weighted
average
remaining
contractual
life
     Aggregate
intrinsic
value
     Weighted
average
exercise
price
 

$4.21 - $6.74

     647,658         4.96       $ 4,395       $ 4.21         283,612         4.96       $ 1,925       $ 4.21   

$8.49 - $12.84

     2,447,606         4.53         644         11.45         1,611,867         3.49         129         11.97   

$13.00 - $15.00

     1,919,263         1.82         0         13.57         1,919,263         1.82         0         13.57   
                                                                       

$4.21 - $15.00

     5,014,527         3.55       $ 5,039       $ 11.33         3,814,742         2.76       $ 2,054       $ 12.20   
                                                                       

During the three months ended March 31, 2011 and 2010, respectively, the Company granted approximately 296,600 and 491,500 shares of restricted stock pursuant to the Plans. Each restricted stock award granted in 2011 and 2010 is subject to lapse as to 25% of the award one year after the date of grant and ratably over the succeeding 36 months subject to a four year forfeiture schedule. The restricted stock awarded in 2008 vests 25% annually on the anniversary date of the award. Share based compensation cost will be recognized ratably over the four year vesting period. No restricted stock was granted pursuant to the 2004 Plan prior to 2008. The Company determined that the fair value of restricted stock granted under the 2006 and 2004 Plans during the quarters ended March 31, 2011 and 2010, was approximately $3.3 million and $5.1 million, respectively. During the three-month periods ended March 31, 2011 and 2010, the Company expensed approximately $569,000 and $287,000 of compensation expense related to restricted stock, respectively. As of March 31, 2011, there was approximately $5.1 million of total unrecognized compensation costs related to restricted stock. These costs are expected to be recognized over a weighted average period of 2.59 years.

 

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The Securities and Exchange Commission, through an exemptive order granted on June 22, 2010, approved amendments to the Plans which allow participants to elect to have the Company withhold shares of the Company’s common stock to pay for the exercise price and applicable taxes with respect to an option exercise (“net issuance exercise”). The exemptive order also permits the holders of restricted stock to elect to have the Company withhold shares of Hercules stock to pay the applicable taxes due on restricted stock at the time of vesting. Each individual can make, and does not preclude the participant from electing to make, a cash payment at the time of option exercise or to pay taxes on restricted stock.

8. Earnings Per Share

In 2008, the FASB issued ASC 260, Earnings Per Share formerly known as FASB Staff Position (FSP) EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. Under this standard, unvested awards of share-based payments with non-forfeitable rights to receive dividends or dividend equivalents, such as the Company’s restricted stock issued under the Plans, are considered participating securities for purposes of calculating change in net assets per share. Under the two-class method a portion of net increase in net assets resulting from operations is allocated to these participating securities and therefore is excluded from the calculation of change in net assets per share allocated to common stock, as shown in the table below. The standard was effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company adopted this standard beginning with financial statements ended March 31, 2009. The adoption of this standard did not result in a change to the previously reported basic change in net assets per share and diluted change in net assets per share.

 

     Quarter Ended March 31,  

(in thousands, except per share data)

   2011     2010  
     (unaudited)  

Numerator

    

Net increase in net assets resulting from operations

   $ (1,178   $ 5,714   

Less: Dividends declared-common and restricted shares

     9,558        7,130   
                

Undistributed earnings

     (10,736     (1,416
                

Undistributed earnings-common shares

     (10,736     (1,416

Add: Dividend declared-common shares

     9,401        7,031   
                

Numerator for basic and diluted change in net assets per common share

     (1,335     5,615   
                

Denominator

    

Basic weighted average common shares outstanding

     42,737        35,181   

Common shares issuable

     —          632   
                

Weighted average common shares outstanding assuming dilution

     42,737        35,813   

Change in net assets per common share

    

Basic

   $ (0.03   $ 0.16   

Diluted

   $ (0.03   $ 0.16   

The calculation of change in net assets per common share—assuming dilution, excludes all anti-dilutive shares. For the three month period ended March 31, 2011 and 2010, the number of anti-dilutive shares, as calculated based on the weighted average closing price of the Company’s common stock for the periods, were approximately 2.4 million and 3.8 million shares, respectively.

 

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9. Financial Highlights

Following is a schedule of financial highlights for the three months ended March 31, 2011 and 2010:

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

FINANCIAL HIGHLIGHTS

(unaudited)

(dollars in thousands, except per share amounts)

 

     For the Three Months Ended
March 31,
 
         2011                 2010        

Per share data:

    

Net asset value at beginning of period

   $ 9.50      $ 10.29   

Net investment income

     0.23        0.16   

Net realized gain (loss) on investments

     0.10        0.01   

Net unrealized appreciation (depreciation) on investments

     (0.36     (0.01
                

Total from investment operations

     (0.03     0.16   

Net increase/(decrease) in net assets from capital share transactions

     (0.07     (0.15

Distributions

     (0.22     (0.20

Stock-based compensation expense included in investment income(1)

     0.02        0.01   
                

Net asset value at end of period

   $ 9.20      $ 10.11   
                

Ratios and supplemental data:

    

Per share market value at end of period

   $ 11.00      $ 10.59   

Total return(2)

     8.33 %       3.81

Shares outstanding at end of period

     43,804        36,248   

Weighted average number of common shares outstanding

     42,737        35,181   

Net assets at end of period

   $ 403,207      $ 366,412   

Ratio of operating expense to average net assets

     9.17     7.19

Ratio of net investment income before provision for income tax expense and investment gains and losses to average net assets

     9.62     5.84

Average debt outstanding

   $ 164,444      $ 130,600   

Weighted average debt per common share

   $ 3.85      $ 3.71   

Portfolio turnover

     4.50     0.20

 

(1)

Stock option expense is a non-cash expense that has no effect on net asset value. Pursuant to ASC 718, net investment loss includes the expense associated with the granting of stock options which is offset by a corresponding increase in paid-in capital. The total return equals the change in the ending market value over the beginning of period price per share plus dividends paid per share during the period, divided by the beginning price.

(2)

The total return equals the increase or decrease of ending market value over beginning market value, plus distributions, dividend by the beginning market value, assuming dividend reinvestment prices obtained under the Company’s dividend reinvestment plan.

 

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10. Commitments and Contingencies

In the normal course of business, the Company is party to financial instruments with off-balance sheet risk. These instruments consist primarily of unused commitments to extend credit, in the form of loans to the Company’s portfolio companies. The balance of unfunded commitments to extend credit at March 31, 2011 totaled approximately $131.1 million. Since a portion of these commitments may expire without being drawn, unfunded commitments do not necessarily represent future cash requirements. In addition, the Company had approximately $73.0 million of non-binding term sheets outstanding. Non-binding outstanding term sheets are subject to completion of the Company’s 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.

Certain premises are leased under agreements which expire at various dates through December 2013. Total rent expense amounted to approximately $276,000 and $237,000 during the three month periods ended March 31, 2011 and 2010, respectively.

Future commitments under the credit facility and operating leases as of March 31, 2011 (unaudited) were as follows:

 

     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(3)

   $ 163,750       $ —         $ —         $ —         $ 163,750   

Operating Lease Obligations(4)

     3,070         1,211         1,859         —           —     
                                            

Total

   $ 166,820       $ 1,211       $ 1,859       $ —         $ 163,750   
                                            

 

(1)

Excludes commitments to extend credit to our portfolio companies.

(2) 

The Company also has a warrant participation obligation with Citigroup. See Note 4.

(3) 

Includes borrowings under the SBA debentures. There were no outstanding borrowings under the Wells Facility or the Union Bank Facility at March 31, 2011.

(4)

Long-term facility leases.

The Company and its executives and directors are covered by Directors and Officers Insurance, with the directors and officers being indemnified by the Company to the maximum extent permitted by Maryland law subject to the restrictions in the 1940 Act.

 

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11. Recent Accounting Pronouncement

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (“ASU 2010-06”), which amends ASC 820 and requires additional disclosure related to recurring and nonrecurring fair value measurements with respect to transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. The update also clarifies existing disclosure requirements related to the level of disaggregation and disclosure about inputs and valuation techniques. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009 except for disclosures related to activity in Level 3 fair value measurements which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted the requirements of ASU-2010-06 in the fourth quarter of 2009 and its adoption did not have a material effect on our consolidated financial statements.

12. Subsequent Events

Convertible Debt Offering

In April 2011, the Company issued and priced $75.0 million in aggregate principle amount of 6.00% convertible senior notes (the “Convertible Senior Notes”) due 2016.

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 the Company’s senior unsecured obligations and rank senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Senior Notes; equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness (including unsecured indebtedness that the Company later secures) 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 the Company’s 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 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, the Company will pay or deliver, as the case may be, at its election, cash, shares of its common stock or a combination of cash and shares of its 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.

The Company 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 in respect of the Company, holders of Convertible Senior Notes may require the Company 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, the Company estimated that the values of the debt and equity components of the notes were approximately 92.8% and 7.2%, respectively. The original issue discount equal to the estimated equity component of 7.2% of the Convertible Senior Notes will initially be recorded in “capital in excess of par value” in the consolidated statement of assets and liabilities. As a result, the Company will 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%.

Portfolio Company Developments

In April 2011, two additional portfolio companies, BrightSource Energy, Inc. and Wageworks, Inc., filed their S-1 registration statements to complete their respective IPOs. The pricing range for these two companies is not currently available. In total, as of May 9, 2011, the Company holds investments in five companies in IPO registration. There can be no assurances that these companies will complete their IPOs in a timely manner or at all.

 

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

Forward-Looking Statements

The matters discussed in this report, as well as in future oral and written statements by management of Hercules Technology Growth Capital, 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 the credit markets on our business;

 

   

our informal relationships with third parties;

 

   

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 the debt 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 business development company and a regulated investment company;

 

   

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;

 

   

impact of fluctuation of interest rates on our business;

 

   

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 1A—“Risk Factors” of Part II of this quarterly report on Form 10-Q as well as Item 1A—“Risk Factors” of our annual report of 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

 

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information, the following discussion and other parts of this report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Item 1A—“Risk Factors” of Part II of this quarterly report on Form 10-Q, Item 1A—“Risk Factors” of our annual report on Form 10-K, and “Forward-Looking Statements” of this Item 2.

Overview

We are a specialty finance company that provides debt and equity growth capital to technology-related companies at various stages of development from seed and emerging growth to expansion and established stages of development, which include select publicly listed companies and lower middle market companies. We primarily finance privately-held companies backed by leading venture capital and private equity firms, and also may finance certain publicly-traded companies that lack access to public capital or are sensitive to equity ownership dilution. We source our investments through our principal office located in Silicon Valley, as well as through additional offices in Boston and Boulder.

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

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

We are an internally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company under the 1940 Act. As a business development company, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in “qualifying assets,” including securities of private U.S. companies, cash, cash equivalents, U.S. government securities 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 are treated for federal income tax purposes as a regulated investment company, or a RIC, under Subchapter M of the Code. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income that we distribute to our stockholders. However, such an election and qualification to be treated as a RIC requires that we comply with certain requirements contained in Subchapter M of the Code. For example, a RIC must meet certain requirements, including source-of income, asset diversification and income distribution requirements. The income source requirement mandates that we receive 90% or more of our income from qualified earnings, typically referred to as “good income.” Qualified earnings may exclude such income as management fees received in connection with our SBIC or other potential outside managed funds and certain other fees.

 

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Our portfolio is comprised of, and we anticipate that our portfolio will continue to be comprised of, investments primarily in technology-related companies at various stages of their development. Consistent with regulatory requirements, we invest primarily in United States based companies and to a lesser extent in foreign companies. Since 2007, 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 lower middle market companies. We have also historically focused our investment activities in private companies following or in connection with the first institutional round of financing, which we refer to as emerging-growth companies.

Portfolio and Investment Activity

The total value of our investment portfolio was $445.1 million at March 31, 2011 as compared to $472.0 million at December 31, 2010. During the three month period ended March 31, 2011 we made debt commitments totaling $97.5 million and funded approximately $83.9 million. Debt commitments for the quarter ended March 31, 2011 included commitments of approximately $50.0 million to three new portfolio companies and $47.5 million to three existing companies. During the three month period ended March 31, 2011 we made and funded equity commitments of $500,000 to one company. These commitments further diversify our portfolio by stage and industry sector. During the quarter ended March 31, 2010 we made debt commitments totaling $93.5 million and funded approximately $87.3 million, respectively. During the quarter ended March 31, 2010 we made and funded an equity commitment of approximately $1.1 million to one company.

At March 31, 2011, we had unfunded contractual commitments of $131.1 million to 18 portfolio companies. 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 executed approximately $73.0 million of non-binding term sheets outstanding to five new and existing companies at March 31, 2011. Non-binding outstanding term sheets are subject to completion of our due diligence and final approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.

The fair value of the loan portfolio at March 31, 2011 was approximately $396.6 million, compared to a fair value of approximately $325.8 million at March 31, 2010. The fair value of the equity portfolio at March 31, 2011 and 2010 was approximately $27.0 million and $45.2 million, respectively. The fair value of our warrant portfolio at March 31, 2011 and 2010 was approximately $21.5 million and $13.2 million, respectively.

We receive payments in our loan portfolio based on scheduled amortization of the outstanding balances. In addition, we receive repayments of some of our loans prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period. During the three-month period ended March 31, 2011, we received normal principal amortization repayments of $21.7 million, and early repayments and working line of credit pay-downs totaling $64.3 million. Total portfolio investment activity for the quarter ended March 31, 2011 and for the year ended December 31, 2010 is as follows:

 

(in millions)

   March 31,
2011
    December 31,
2010
 

Beginning Portfolio

   $ 472.0      $ 374.7   

Purchase of debt investments

     84.3        320.4   

Equity Investments

     0.8        2.3   

Sale of Investments

     (15.1     (34.2

Principal payments received on investments

     (24.6     (81.6

Early pay-offs and recoveries

     (61.4     (114.5

Accretion of loan discounts and paid-in-kind principal

     4.6        3.3   

Net change in unrealized depreciation in investments

     (15.3     1.6   
                

Ending Portfolio

   $ 445.1      $ 472.0   
                

 

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The following table shows the fair value of our portfolio of investments by asset class:

 

     March 31, 2011     December 31, 2010  
(in thousands)    Investments at Fair
Value
     Percentage of Total
Portfolio
    Investments at Fair
Value
     Percentage of Total
Portfolio
 

Senior Secured Debt with Warrants

   $ 359,042         80.7   $ 357,963         75.8

Senior Secured Debt

     34,093         7.6     59,251         12.6

Subordinated Debt

     24,897         5.6     8,094         1.7

Preferred Stock

     21,333         4.8     26,813         5.7

Common Stock

     5,689         1.3     19,911         4.2
                                  
   $ 445,054         100.0   $ 472,032         100.0
                                  

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

 

     March 31, 2011     December 31, 2010  
(in thousands)    Investments at Fair
Value
     Percentage of Total
Portfolio
    Investments at Fair
Value
     Percentage of Total
Portfolio
 

United States

   $ 415,241         93.3   $ 438,585         92.9

Canada

     18,528         4.2     20,876         4.4

England

     10,634         2.4     1,918         0.4

Israel

     651         0.1     10,653         2.3
                                  
   $ 445,054         100.0   $ 472,032         100.0
                                  

Our portfolio companies are primarily privately-held expansion and established-stage companies in the biopharmaceutical, clean technology, communications and networking, consumer and business products, electronics and computers, energy, information services, internet consumer and business services, medical devices, semiconductor and software 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 required by the 1940 Act, the Company classifies its investments by level of control. “Control Investments” are defined in the 1940 Act as investments in those companies that the Company is deemed to “Control”. Generally, under the 1940 Act, the Company is deemed to “Control” a company in which it has invested if it owns 25% or more of the voting securities of such company or has greater than 50% representation on its board. “Affiliate Investments” are investments in those companies that are “Affiliated Companies” of the Company, as defined in the 1940 Act, which are not Control Investments. The Company is deemed to be an “Affiliate” of a company in which it has invested if it owns 5% or more but less than 25% of the voting securities of such company. “Non-Control/Non-Affiliate Investments” are investments that are neither Control Investments nor Affiliate Investments.

 

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As of March 31, 2011, the Company did not hold any Control Investments. The Company’s investment in InfoLogix, Inc., a company that was a Control Investment as of December 31, 2010, was sold to Stanley Black & Decker (NYSE:SWK) in January 2011. Approximately $8.3 million of realized gains and $8.4 million of net unrealized depreciation was recognized on this control investment during the three-month period ended March 31, 2011.

At March 31, 2011 and 2010, the Company had an investment in one portfolio company deemed to be an Affiliate. No income was derived from this investment as this is a non-income producing equity investment. No realized gains were related to this investment, and approximately $1.0 million and $52,000 of net unrealized depreciation was recognized on this control investment during the three-month periods ended March 31, 2011 and 2010, respectively.

 

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The following table shows the fair value of our portfolio by industry sector at March 31, 2011 and December 31, 2010:

 

    March 31, 2011     December 31, 2010  
(in thousands)   Investments at
Fair Value
    Percentage of Total
Porfolio
    Investments at
Fair Value
    Percentage of Total
Porfolio
 

Drug Discovery

  $ 74,243        16.7   $ 52,777        11.2

Specialty Pharma

    71,273        16.0     63,607        13.5

Software

    53,714        12.1     96,508        20.4

Clean Tech

    48,289        10.8     25,722        5.4

Communications & Networking

    47,080        10.6     65,098        13.8

Drug Delivery

    32,754        7.4     35,250        7.5

Internet Consumer & Business Services

    27,665        6.2     7,255        1.5

Therapeutic

    23,966        5.4     25,300        5.4

Consumer & Business Products

    17,990        4.0     45,316        9.6

Diagnostic

    13,926        3.1     14,911        3.2

Information Services

    13,399        3.0     10,857        2.3

Electronics & Computer Hardware

    5,667        1.3     7,819        1.6

Biotechnology Tools

    5,146        1.2     5,987        1.3

Surgical Devices

    4,520        1.0     10,172        2.1

Semiconductors

    3,174        0.7     3,227        0.7

Media/Content/Info

    2,247        0.5     2,223        0.5

Energy

    1        —          3        —     
                               
  $ 445,054        100   $ 472,032        100
                               

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 March 31, 2011 and December 31, 2010.

 

     March 31, 2011     December 31, 2010  
(in thousands)    Investments at
Fair Value
     Percentage of Total     Investments at
Fair Value
     Percentage of Total  

Investment Grading

          

1

   $ 32,878         8.3   $ 65,345         16.3

2

     205,997         52.0     232,713         57.9

3

     146,313         36.9     90,739         22.6

4

     6,141         1.5     8,776         2.2

5

     5,236         1.3     4,045         1.0
                                  
   $ 396,565         100.0   $ 401,618         100.0
                                  

As of March 31, 2011, our investments had a weighted average investment grading of 2.44 as compared to 2.21 at December 31, 2010. 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 March 31, 2011, 12 portfolio companies were graded 3, 2 portfolio companies were graded 4, and 2 portfolio companies were graded 5 as compared to 8 portfolio companies that were graded 3, 2 portfolio companies that were graded 4 and 2 portfolio companies that were graded 5 at December 31, 2010.

 

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At March 31, 2011, there was one portfolio company on non-accrual status with a fair value of zero. There were two loans on non-accrual status as of December 31, 2010 with a fair value of approximately $4.0 million.

The effective yield on our debt investments for the three month periods ended March 31, 2011 and 2010 was 18.1% and 14.5%, respectively. This yield was higher period over period due to unearned income accelerations attributed to early payoffs and due to higher interest rate yield enhancers on new loans originated in 2011 relative to the loans that have been paid off or have amortized.

The overall weighted average yield to maturity of our loan obligations was approximately 13.7% and 13.9% at March 31, 2011 and December 31, 2010. 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.

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 18% as of March 31, 2011. 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, PIK provisions, prepayment fees, and diligence fees, which may be required to be included in income prior to receipt.

We funded $16.1 million of equity investments, which included restructured loans investments during the three month period ended March 31, 2010.

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 loan’s 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 $4.8 million and $6.6 million of unamortized fees at March 31, 2011 and December 31, 2010, respectively, and approximately $5.9 million and $5.1 million in exit fees receivable at March 31, 2011 and December 31, 2010, respectively.

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 $556,000 in PIK income in the three month period ended March 31, 2011.

In some cases, the Company collateralizes its investments by obtaining a first priority security interest in a portfolio company’s assets, which may include their intellectual property. In other cases, the Company may obtain a negative pledge covering a company’s intellectual property.

At March 31, 2011, approximately 63.7% of our portfolio company loans were secured by a first priority security in all of the assets of the portfolio company, 29.4% of portfolio company loans were prohibited from pledging or encumbering their intellectual property, 6.1% of portfolio company loans were secured by a second priority security in all of the assets of the portfolio company and 0.8% 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.

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. As of March 31, 2011, we held warrants in 91 technology and life science portfolio companies, with a fair value of approximately $21.5 million. These warrant holdings would require us to invest approximately $68.1 million to exercise such warrants. However, these 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.

 

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Results of Operations

Comparison of the three-month periods ended March 31, 2011 and 2010

Investment Income

Interest income totaled approximately $16.5 for the three month period ended March 31, 2011, compared with $11.2 million for the three-month period ended March 31, 2010. Income from commitment, facility and loan related fees totaled approximately $2.7 million for the three-month period ended March 31, 2011, compared with $1.3 million for the same periods ended March 31, 2010, respectively. The increase in interest income is attributable to a higher average interest earning investment portfolio and income from early repayments. Income from commitment, facility and loan related fees are primarily the result of an increase in accelerated one-time and early repayment fees.

Operating Expenses

Operating expenses, which are comprised of interest and fees, general and administrative and employee compensation, totaled approximately $9.3 million and $6.9 million during the three month periods ended March 31, 2011 and 2010, respectively

Interest and fees totaled approximately $3.2 million and $2.3 million during the three-month periods ended March 31, 2011 and 2010, respectively. This $900,000 year-over-year increase is primarily attributable to an increase in interest expense on higher borrowings under our SBA debentures and an increase in amortization of deferred financing fees associated with the early repayment of certain SBA guaranteed debentures in the quarter ended March 31, 2011.

General and administrative expenses include legal, consulting and accounting fees, insurance premiums, rent, workout and various other expenses. Expenses increased to $2.2 million from $1.9 million for the three month periods ended March 31, 2011 and 2010, respectively, primarily due to accounting, auditing and tax-related expenses.

Employee compensation and benefits totaled approximately $3.3 million and $2.2 million during the three-month periods ended March 31, 2011 and 2010, respectively. This increase is primarily due to an increase in employee headcount and increased salary as compared to the same period of 2010. We expect to continue to hire to meet growth. Stock-based compensation totaled approximately $721,000 and $457,000 during the three month periods ended March 31, 2011 and 2010, respectively. These increases were due to the expense on restricted stock grants issued in the first quarter of 2011. 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 March 31, 2011 compared to $0.16 per share in the quarter ended March 31, 2010. 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.

During the quarter ended March 31, 2010, we recognized net realized gains of approximately $151,000 from the sale of common stock in public companies, approximately $644,000 from mergers of private portfolio companies and realized losses of approximately $433,000 from equity and warrant investments in portfolio companies that have been liquidated. We recorded net gains from the sales of equity investments in two portfolio companies that totaled $9.6 million, of which InfoLogix, Inc. represented a gain of $8.3 million and Kamada, LTD. a gain of $1.3 million. These gains were partially offset by realized losses due to the write off of warrant, equity and debt investments totaling $5.2 million in one portfolio company, Trading Machines, Inc. Cumulative net realized losses on investments since October 2004 to date totals $48.5 million. When compared to total commitments of approximately $2.2 billion over the same period, the net realized loss represents approximately 2.2% of total commitments, or an annualized loss rate of approximately 33 basis points.

 

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A summary of realized gains and losses for the three month periods ended March 31, 2011 and 2010 is as follows:

 

     Three Months Ended
March 31,
 
     2011     2010  

(in thousands)

   Amount     Amount  

Realized gains

   $ 9,599      $ 856   

Realized losses

     (5,229     (494
                

Net realized gains

   $ 4,370      $ 362   
                

During the three-month periods ended March 31, 2011 and March 31, 2010, net change in unrealized depreciation totaled approximately $15.3 million and $260,000, respectively.

The change in net unrealized appreciation and depreciation of our investments is based on portfolio asset valuations determined in good faith by our Board of Directors. This change in net unrealized depreciation was primarily comprised of decreases in the fair value of our portfolio companies due to company performance and market conditions of approximately $17.9 million and the reclassification of unrealized appreciation to net realized gains of $9.4 million. For the quarter ended March 31, 2011 approximately $1.8 million, $11.4 million and $2.1 million of the net change in unrealized depreciation recognized was attributable to debt, equity and warrant investments based on company performance. Included in these amounts are unrealized depreciation of approximately $9.6 million in debt and equity investments attributable to the reversal of prior period net unrealized appreciation upon being realized as a gain and approximately $5.2 million in debt, equity and warrant investments attributable to the reversal of prior period net unrealized depreciation upon being realized as a loss. As of March 31, 2011, the net change in unrealized appreciation recognized by the Company was increased by approximately $37,000 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.

The following table itemizes the change in net unrealized depreciation of investments for the three-month periods ended March 31, 2011 and 2010:

 

     Three Months Ended
March 31,
 
     2011     2010  

(in thousands)

   Amount     Amount  

Gross unrealized appreciation on portfolio investments

   $ 6,340      $ 10,596   

Gross unrealized depreciation on portfolio investments

     (17,889     (11,823

Reversal of prior period net unrealized appreciation upon realization

     (9,446     928   

Reversal of prior period net unrealized depreciation upon realization

     5,606        —     

Citigroup Warrant Participation

     37        38   
                

Net increase (decrease) in unrealized depreciation on portfolio investments

   $ (15,352   $ (260
                

 

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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 months ended March 31, 2011, the net decrease in net assets resulting from operations totaled approximately $1.2 million. For the three-months ended March 31, 2010 the net increase in net assets resulting from operations totalled approximately $5.7 million. These changes are made up of the items previously described.

Basic and fully diluted net change in net assets per common share for the three month periods ended March 31, 2011 and 2010 was $(0.03) and $0.16, respectively.

Financial Condition, Liquidity, and Capital Resources

At March 31, 2011, we had approximately $114.4 million in cash and cash equivalents and available borrowing capacity of approximately $50.0 million under the Wells Facility, $20.0 million under the Union Bank Facility and $36.25 million under the SBA program, subject to existing terms and advance rates and regulatory requirements. We primarily invest cash on hand in interest bearing deposit accounts.

As of March 31, 2011, net assets totaled $403.2 million, with a net asset value per share of $9.20. 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 U.S. government securities and 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. Additionally, we expect to raise additional capital to support our future growth through future equity offerings, issuances of senior securities 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 2010 Annual Shareholder Meeting held on June 9, 2010, our shareholders 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. However, there can be no assurance that these capital resources will be available given the credit constraints of the banking and capital markets.

As required by the 1940 Act, our asset coverage must be at least 200% after each issuance of senior securities. Our asset coverage as of March 31, 2011 was 0%, excluding SBA leverage, based on our exemptive order from the SEC which allows us to exclude all SBA leverage from our asset coverage ratio. Total leverage when excluding the SEC exemptive order is approximately 350.8% at March 31, 2011. Total leverage including our SBIC debentures is approximately 40.4% at March 31, 2011.

 

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At March 31, 2011 and December 31, 2010, we had the following borrowing capacity and outstanding amounts:

 

     March 31, 2011      December 31, 2010  
     Facility Amount      Amount
Outstanding
     Facility Amount      Amount
Outstanding
 

Union Bank Facility

   $ 20,000       $ —         $ 20,000       $ —     

Wells Facility

     50,000         —           50,000         —     

SBA Debenture(1)

     200,000         163,750         225,000         170,000   
                                   

Total

   $ 270,000       $ 163,750       $ 295,000       $ 170,000   
                                   

 

(1) 

The Company has the ability to borrow $36.25 million subject to SBA approval and compliance with SBIC regulations. In April 2011, the SBA approved a $25.0 million commitment request.

On September 27, 2006, HT II received a license and on May 26, 2010 HT III received a license to operate as Small Business Investment Companies under the SBIC program and are able to borrow funds from the SBA against eligible investments. As of March 31, 2011, all required contributed capital from the Company has been invested into HT II and HT III. The Company is the sole limited partner of HT II and HT III and HTM is the general partner. HTM is a wholly-owned subsidiary of the Company. 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 II’s or HT III’s 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 HT III are our wholly owned subsidiaries. HT II and HT III were in compliance with the terms of the SBIC’s leverage as of March 31, 2011 as a result of having sufficient capital as defined under the SBA regulations. The portfolios of HT II and HT III accounted for approximately 52.0% of our total portfolio at March 31, 2011.

With our net investment of $75.0 million in HT II as of March 31, 2011, HT II has the capacity to issue a total of $150.0 million of SBA guaranteed debentures, of which $125.0 million was outstanding following a repayment of $25.0 million on debentures in January 2011. As of March 31, 2011, 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. As of March 31, 2011, we held investments in HT II in 54 companies with a fair value of approximately $158.6 million, accounting for approximately 35.6% of our total portfolio at March 31, 2011.

 

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As of March 31, 2011, the maximum statutory limit on the dollar amount of combined outstanding SBA guaranteed debentures is $225.0 million, subject to periodic adjustments by the SBA. As of March 31, 2011, HT III had the potential to borrow up to $75.0 million of SBA-guaranteed debentures under the SBIC program. With our net investment of $37.5 million in HT III as of March 31, 2011, HT III has the capacity to issue a total of $ 75.0 million of SBA guaranteed debentures, subject to SBA approval, of which $38.75 million was outstanding at March 31, 2011. As of March 31, 2011, HT III has paid the SBA commitment fees of approximately $750,000. As of March 31, 2011, we held investments in HT III in 11 companies with a fair value of approximately $73.5 million accounting for approximately 16.5% of our total portfolio at March 31, 2011. In April 2011, the SBA approved a $25.0 million dollar commitment for HT III bringing the total available borrowings to $225.0 million, of which $125.0 million was available in HT II and $100.0 million was available in HT III. See “—Subsequent Events.”

Current Market Conditions

The global capital markets have experienced a period of disruption as evidenced by a lack of liquidity in the debt capital markets, write-offs in the financial services sector, the re-pricing of credit risk and the failure of certain major financial institutions. Despite actions of the United States federal government and foreign governments, these events contributed to worsening general economic conditions that have materially and adversely impacted the broader financial and credit markets and reduced the availability of debt and equity capital for the market as a whole and financial services firms in particular. While indicators suggest improvement in the capital markets, these conditions could deteriorate in the future. During such market disruptions, we may have difficulty raising debt or equity capital especially as a result of regulatory constraints.

At the same time, the venture capital market for the technology-related companies in which we invest has been active and is continuing to show signs of increased investment activity. Therefore, to the extent we have capital available, we believe this is an opportune time to invest in the structured lending market for technology-related companies. Today’s economy creates potentially new attractive lending opportunities and we believe that the market for technology-related companies in 2011 is improving as evidenced by the improved IPO market in 2010 and 2011 as compared to the previous two years.

We may acquire a portfolio of investments or sell a portion of our portfolio on an opportunistic basis. We, from time to time, engage in discussions with counterparties in respect of various potential transactions. 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 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.

We periodically review and assess investment portfolio acquisition opportunities of target companies that would be accretive to us. In the future, we may determine to acquire such portfolios which could affect our liquidity position and necessitate our need to raise additional capital to fund our growth.

 

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Off Balance Sheet Arrangements

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 origination activity unfunded commitments may be significant from time to time. As of March 31, 2011, we had unfunded commitments of approximately $131.1 million. 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, SBA debentures, our Wells Facility and our Union Bank Facility 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.

In addition, we had approximately $73.0 million of non-binding term sheets outstanding, which generally convert to contractual commitments within approximately 45 to 60 days of signing. Non-binding outstanding term from prior release 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 March 31, 2011:

 

     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(3)

   $ 163,750       $ —         $ —         $ —         $ 163,750   

Operating Lease Obligations(4)

     3,070         1,211         1,859         —           —     
                                            

Total

   $ 166,820       $ 1,211       $ 1,859       $ —         $ 163,750   
                                            

 

(1) Excludes commitments to extend credit to our portfolio companies.
(2) We also have a warrant participation obligation with Citigroup. See Note 4 to the Consolidated Financial Statements.
(3) Includes borrowings under the SBA debentures. There were no outstanding borrowings under the Wells Facility or the Union Bank Facility at March 31, 2011.
(4) Long-term facility leases.

Hercules and its executives and directors are covered by Directors and Officers Insurance, with the directors and officers being indemnified by Hercules to the maximum extent permitted by Maryland law subject to the restrictions in the 1940 Act.

Borrowings

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 the normal terms. During the first quarter of 2009, we paid off all remaining 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 $444,000 as of March 31, 2011 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 its 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.

 

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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. As of March 31, 2011, 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. The Company’s net investment of $75.0 million in HT II as of March 31, 2011 fully funds the required regulatory capital for HT II. In January 2011, HT II repaid $25.0 million of debentures. HT II has a total of $125.0 million of SBA guaranteed debentures outstanding as of March 31, 2011 and has paid the SBA commitment fees of approximately $1.5 million. As of March 31, 2011, the Company held investments in HT II in 54 companies with a fair value of approximately $158.6 million, accounting for approximately 35.6% of the Company’s total portfolio.

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 the Company’s net investment of $37.5 million in HT III as of March 31, 2011, HT III has the capacity to issue a total of $75.0 million of SBA guaranteed debentures, subject to SBA approval, of which $38.75 million was outstanding as of March 31, 2011. As of March 31, 2011, HT III has paid commitment fees of approximately $750,000. 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. As of March 31, 2011, the Company held investments in HT III in 11 companies with a fair value of approximately $73.5 million, accounting for approximately 16.5% of the Company’s total portfolio.

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 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, the Company plans to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.

HT II and HT III are periodically examined and audited by the SBA’s 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 II’s or HT III’s 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 the Company if they do not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would, in turn, negatively affect the Company because HT II and III are the Company’s wholly owned subsidiaries. HT II and HT III were in compliance with the terms of the SBIC’s leverage as of March 31, 2011 as a result of having sufficient capital as defined under the SBA regulations. As of March 31, 2011, HT II and HT III could draw up to $25.0 million and $36.25 million, respectively, of additional leverage from SBA.

The rates of borrowings under various draws from the SBA beginning in April 2007 are set semiannually in March and September and range from 3.22% 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 fee related to HT III debentures that pooled on March 29, 2011 was 0.285%. The annual fees related to HT II debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year the underlying commitment was closed in. The annual fees on other debentures have been set at 0.906%. The average amount of debentures outstanding for the quarter ended March 31, 2011 for HT II was approximately $126.9 million with an average interest rate of approximately 5.0%. The average amount of debentures outstanding for the quarter ended March 31, 2011 for HT III was approximately $37.5 million with an average interest rate of approximately 4.08%.

During the quarter ended March 31, 2011, we repaid $25.0 million of SBA debentures under our first SBIC license. On April 27, 2011, we received approval from the SBA to borrow $25.0 million under a new capital commitment. See “—Subsequent Events.”

Wells Facility

On August 25, 2008, Hercules, through a special purpose wholly-owned subsidiary, Hercules Funding II, LLC, entered into a two-year revolving senior secured credit facility with an optional one-year extension with total commitments of $50 million, with Wells Fargo Capital Finance as a lender and as an arranger and administrative agent (the “Wells Facility”). The Wells Facility has the capacity to increase to $300 million if additional lenders are added to the syndicate. We continue to be in discussions with various other potential lenders to join the facility; however, there is no assurance that additional lenders may join the facility. The Wells Facility expires in August 2011.

 

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Borrowings under the Wells Facility will generally bear interest at a rate per annum equal to LIBOR plus 3.25% or PRIME plus 2.0%, but not less than 5.0%. The Wells Facility requires the payment of a non-use fee of 0.3% annually. The Wells Facility is collateralized by debt investments in our portfolio companies, and includes an advance rate equal to 50% of eligible loans placed in the collateral pool. The Wells Facility generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity. We have paid a total of $1.1 million in structuring fees in connection with the Wells Facility which is being amortized through August 2011. There was no outstanding debt under the Wells Facility at March 31, 2011.

The Wells Facility includes various financial and operating covenants applicable to the Company and its 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 of $250 million, contingent upon our total commitments under all lines of credit not exceeding $250 million. To the extent our total commitments exceeds $250 million, the minimum tangible net worth covenant will increase on a pro rata basis commensurate with our net worth on a dollar for dollar basis. In addition, the tangible net worth covenant will increase by 90 cents on the dollar for every dollar of equity capital subsequently raised by the Company. 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 March 31, 2011.

During March 2011, we received a commitment to renew the Wells Facility. Under this three-year senior secured facility, Wells Fargo Capital Finance and the Royal Bank of Canada (“RBC”) have made commitments of $75.0 million and $25.0 million, respectively. Borrowings under the facility are expected to be at an interest rate per annum equal to LIBOR plus 3.50%, with a floor of 5.00% and an advance rate of 50% against eligible loans. The facility will be secured by loans in the borrowing base. 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 RBC 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 new credit facility. This new arrangement will replace the existing $300 million Wells Facility under which Wells Fargo Capital Finance had committed $50 million in capital and is subject to customary closing conditions and completion of legal documentation. We expect the covenants and events of default to be consistent with our existing Wells Facility. No assurance can be given that Wells Fargo Capital Finance, RBC and Hercules will execute definitive documentation, that the definitive documentation will reflect the terms described herein or that the facility will be entered into at all.

Once the Wells Facility is renewed, we anticipate incurring a non-use fee expense of approximately $200,000 or $0.005 per share per quarter until we borrow under the facility. In total, we expect the expense from the Convertible Senior Notes and facility fees to negatively impact earnings in the near term by approximately $1.5 million or $0.04 per quarter until any of the capital is deployed. See “—Subsequent Events.”

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”). 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%, an advance rate of 50% against eligible loans, and secured by loans in the borrowing base. At March 31, 2011, there were no borrowings outstanding on this facility. The Union Bank Facility requires the payment of a nonuse fee of 0.25% annually. The Union Bank Facility is collateralized by debt investments in our portfolio companies, and includes an advance rate equal to 50% of eligible loans placed in the collateral pool. The Union Bank generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity. In February 2011, the maturity date of the facility was extended from May 1, 2011 to July 31, 2011. The Union Bank Facility includes various financial and operating covenants. These covenants require us to maintain certain financial ratios and a minimum tangible net worth. The Union Bank Facility provides for customary events of default, including, but not limited to, payment defaults, breech of representations or covenants, bankruptcy events and change of control.

Outstanding Borrowings

At March 31, 2011 and December 31, 2010, we had the following borrowing capacity and outstanding borrowings:

 

     March 31, 2011      December 31, 2010  
     Facility Amount      Amount
Outstanding
     Facility Amount      Amount
Outstanding
 

Union Bank Facility

   $ 20,000       $ —         $ 20,000       $ —     

Wells Facility

     50,000         —           50,000         —     

SBA Debenture(1)

     200,000         163,750         225,000         170,000   
                                   

Total

   $ 270,000       $ 163,750       $ 295,000       $ 170,000   
                                   

 

(1)

The Company has the ability to borrow $36.25 million subject to SBA approval and compliance with SBIC regulations. In April 2011, the SBA approved a $25.0 million commitment request. See “—Subsequent Events.”

 

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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    $ 0.025   
December 9, 2005    January 6, 2006    January 27, 2006      0.300   
April 3, 2006    April 10, 2006    May 5, 2006      0.300   
July 19, 2006    July 31, 2006    August 28, 2006      0.300   
October 16, 2006    November 6, 2006    December 1, 2006      0.300   
February 7, 2007    February 19, 2007    March 19, 2007      0.300   
May 3, 2007    May 16, 2007    June 18, 2007      0.300   
August 2, 2007    August 16, 2007    September 17, 2007      0.300   
November 1, 2007    November 16, 2007    December 17, 2007      0.300   
February 7, 2008    February 15, 2008    March 17, 2008      0.300   
May 8, 2008    May 16, 2008    June 16, 2008      0.340   
August 7, 2008    August 15, 2008    September 19, 2008      0.340   
November 6, 2008    November 14, 2008    December 15, 2008      0.340   
February 12, 2009    February 23, 2009    March 30, 2009      0.320
May 7, 2009    May 15, 2009    June 15, 2009      0.300   
August 6, 2009    August 14, 2009    September 14, 2009      0.300   
October 15, 2009    October 20, 2009    November 23, 2009      0.300   
December 16, 2009    December 24, 2009    December 30, 2009      0.040   
February 11, 2010    February 19, 2010    March 19, 2010      0.200   
May 3, 2010    May 12, 2010    June 18, 2010      0.200   
August 2, 2010    August 12, 2010    September 17,2010      0.200   
November 4, 2010    November 10, 2010    December 17, 2010      0.200   
March 1, 2011    March 10, 2011    March 24, 2011      0.220   
May 5, 2011    May 13, 2011    June 23, 2011      0.220   
              
         $ 6.245   
              

 

* Dividend paid in cash and stock.

On May 5, 2011, the Board of Directors announced a cash dividend of $0.22 per share to be paid on June 23, 2011 to shareholders of record as of May 13, 2011. This dividend is the Company’s twenty-third consecutive quarterly dividend declaration since its initial public offering, and will bring the total cumulative dividend declared to date to $6.25 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 stockholder’s 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 2011 distributions to stockholders. If we had determined the tax attributes of our distributions year-to-date as of March 31, 2011, approximately 91% would be from ordinary income and spillover earnings from 2010, and 9% would be a return of capital.

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.

 

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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.

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 March 31, 2011, approximately 77.5% of the Company’s 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 equity sponsored technology, life science and clean technology companies. 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 discussed with our investment committee;

(3) the valuation committee of the Board of Directors reviews the preliminary valuation of the investment committee and that of the independent valuation firm and responds to the valuation recommendation of the independent valuation firm to reflect any comments, if any, and

(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.

 

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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 1—Inputs 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 2—Inputs (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 instrument’s anticipated life. Fair valued assets that are generally included in this category are warrants held in a public company.

Level 3—Inputs reflect management’s 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.

Debt Investments

We follow the guidance set forth in ASC 820 which establishes a framework for measuring the fair value of 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. Our debt securities are primarily invested in equity sponsored technology, life science and clean technology companies. 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 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 excluding its interest rate sensitivity analysis, which was replaced by the hypothetical market participant method, as discussed above. 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 company’s credit rating, security liens and other characteristics of the investment to adjust the baseline yield to derive a hypothetical yield for each investment. The anticipated future cash flows from each investment are then discounted at the hypothetical yield to estimate each investment’s fair value as of the measurement date.

Our process includes, among other things, the underlying investment performance, the current portfolio company’s 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 it believes 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.

 

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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 valuation 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 company’s 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. 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 March 31, 2011, we had one portfolio company on non-accrual status with a fair value of zero. There were two loans on non-accrual status with a fair value of approximately $4.0 million as of December 31, 2010.

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. For the three-month periods ended March 31, 2011 and 2010, approximately $1.8 million and $1.7 million, respectively, in PIK and end of term income was recorded.

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.

 

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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.

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, 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.

Recent Accounting Pronouncement

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (“ASU 2010-06”), which amends ASC 820 and requires additional disclosure related to recurring and nonrecurring fair value measurements with respect to transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. The update also clarifies existing disclosure requirements related to the level of disaggregation and disclosure about inputs and valuation techniques. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009 except for disclosures related to activity in Level 3 fair value measurements which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted the requirements of ASU-2010-06 in the fourth quarter of 2009 and its adoption did not have a material effect on our consolidated financial statements.

Subsequent Events

Closed and Pending Commitments

As of May 5, 2011, we have closed commitments of approximately $51.5 million to new and existing portfolio companies, and funded approximately $39.0 million since the close of the first quarter. In addition, we have pending commitments (signed term sheets) of approximately $57.0 million.

The table below summarizes our year-to-date closed and pending commitments as follows:

 

2011 Closed Commitments and Pending Commitments (dollars in millions)

  

Closed Commitments, January 1, 2011 - March 31, 2011

   $ 98.0   

Closed Commitments, April 1, 2011 - May 5, 2011

     51.5   
        

Total 2011 Closed Commitments(a)

     149.5   

Pending Commitments (as of May 5, 2011)(b)

     57.0   
        

Total

   $ 206.5   
        

 

 

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.

SBA Facility

In April 2011, the Company received approval from the SBA to borrow $25.0 million under a new capital commitment under its second license held by HT III. This commitment allows the Company to borrow to the maximum of $225.0 million under two SBIC licenses, subject to SBA approval.

 

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Convertible Debt Offering

In April 2011, the Company issued and priced $75.0 million in aggregate principle amount of 6.00% convertible senior notes (the “Convertible Senior Notes”) due 2016.

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 the Company’s senior unsecured obligations and rank senior in right of payment to the Company’s existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Senior Notes; equal in right of payment to the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness (including unsecured indebtedness that the Company later secures) 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 the Company’s 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, the Company will pay or deliver, as the case may be, at its election, cash, shares of its common stock or a combination of cash and shares of its 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.

The Company 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 in respect of the Company, holders of Convertible Senior Notes may require the Company 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, the Company estimated that the values of the debt and equity components of the notes were approximately 92.8% and 7.2%, respectively. The original issue discount equal to the estimated equity component of 7.2% of the Convertible Senior Notes will initially be recorded in “capital in excess of par value” in the consolidated statement of assets and liabilities. As a result, the Company will 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%.

Portfolio Company Developments

In April 2011, two additional portfolio companies, BrightSource Energy, Inc. and Wageworks, Inc., filed their S-1 registration statements to complete their respective IPOs. The pricing range for these two companies is not currently available. In total, as of May 9, 2011, the Company holds investments in five companies in IPO registration. There can be no assurances that these companies will complete their IPOs in a timely manner or at all.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to financial market risks, including changes in interest rates. Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in the general level of interest rates can affect our net investment income, which is the difference between the interest income earned on interest earning assets and our interest expense incurred in connection with our interest bearing debt and liabilities. Changes in interest rates can also affect, among other things, our ability to acquire and originate loans and securities and the value of our investment portfolio.

As of March 31, 2011, approximately 88.2% of our portfolio loans were at variable rates or variable rates with a floor and 11.8% of our loans were at fixed rates. Over time additional investments may be at variable rates. We do not currently engage in any hedging activities. However , we may, in the future, hedge against interest rate fluctuations by using standard hedging instruments such as futures, options, and forward contracts. While hedging activities may insulate us against changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to our borrowed funds and higher interest rates with respect to our portfolio of investments. Interest rates on our borrowings are based primarily on LIBOR. Borrowings under our SBA program are fixed at the ten year treasury rate every March and September for borrowings of the preceding six months. Borrowings under the program are charged interest based on ten year treasury rates plus a spread and the rates are generally set for a pool of debentures issued by the SBA in three-month periods. The rates of borrowings under the various draws from the SBA beginning in April 2007 and set semiannually in March and September range from 3.22% to 5.73%. 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 fee related to HT III debentures that pooled on March 29, 2011 was 0.285%. The annual fees related to HT II debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year the underlying commitment was closed in. The annual fees on other debentures have been set at 0.906%. The average amount of debentures outstanding for the year ended December 31, 2010 for HT III was approximately $13.9 million with an average interest rate of approximately 3.215%. Interest is payable semiannually and there are no principal payments required on these issues prior to maturity. 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.

Interest is payable semi-annually and there are no principal payments required on these issues prior to maturity. 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.

 

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Borrowings under the Wells Facility will generally bear interest at a rate per annum equal to LIBOR plus 3.25% or PRIME plus 2.0%, but not less than 5.0%. The Wells Facility requires the payment of a non-use fee of 0.3% annually. The Wells Facility is collateralized by debt investment in our portfolio companies, and includes an advance rate equal to 50% of eligible loans placed in the collateral pool. The Wells Facility generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity. There were no borrowings outstanding under this facility at March 31, 2011. The facility expires in August 2011.

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%, an advance rate of 50% against eligible loans, and secured by loans in the borrowing base. The Union Bank Facility requires the payment of a unused fee of 0.25% annually. The Union Bank Facility is collateralized by debt investments in our portfolio companies, and includes an advance rate equal to 50% of eligible loans placed in the collateral pool. The Union Bank generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity. There were no outstanding borrowings under this facility at March 31, 2011. In February 2011, the maturity date under the credit facility was extended from May 1, 2011 to July 31, 2011, subject to the same terms and conditions.

Because we currently borrow, and plan to borrow in the future, money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income if there is not a corresponding increase in interest income generated by variable rate assets in our investment portfolio.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), of the effectiveness of the design and operation of these disclosure controls and procedures, as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of March 31, 2011. Based on this evaluation, the Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer) concluded that its disclosure controls and procedures were not effective as of as of March 31, 2011, the end of the period covered by this Quarterly Report on Form 10-Q, due to the material weakness described below involving investment portfolio holdings.

In light of this material weakness, the Company refined its procedures to ensure its financial statements were prepared in accordance with generally accepted accounting principles. The status of the remediation efforts, as discussed below, was regularly reviewed with management and the Company’s Audit Committee of the Board of Directors. The Audit Committee was advised of issues encountered and key decisions reached by management relating to the remediation efforts. Accordingly, management believes that the financial statements included in this Quarterly Report on Form 10-Q present fairly in all material respects the Company’s financial condition, results of operations and cash flows for the periods presented.

Changes in Internal Control Over Financial Reporting

As described in Item 9A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, management identified remedial steps that were implemented with respect to a disclosed material weakness. The Company refined its procedures to ensure its financial statements were prepared in accordance with generally accepted accounting principles. During the three month period ended December 31, 2010, and in connection with the year-end audit process, the Company corrected the valuation process to refine its application of ASC 820. The Company applied a new procedure that assumes a sale of an 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 the new process, the Company has continued to evaluate the collateral for recoverability of the debt investments as well as apply all of its historical fair value analysis excluding its interest rate sensitivity analysis, which was replaced by the hypothetical market participant method. The Company uses pricing on recently issued comparable debt securities to determine the baseline hypothetical market yields as of the measurement date. The Company considers each portfolio company’s credit rating, security liens and other characteristics of the investment to adjust the baseline yield to derive a hypothetical yield for each investment. The anticipated future cash flows from each investment are then discounted at the hypothetical yield to estimate each investment’s fair value as of the measurement date. The Company has completed its evaluation and testing of these additional processes.

As of March 31, 2011, management has evaluated the remedial action, assessed the operating effectiveness of the remediated controls and concluded that it has remediated the material weakness described above.

In connection with the preparation of the Company’s Consolidated Financial Statements for the three-month period ended March 31, 2011, the Company identified a material weakness in its internal control over financial reporting. A material weakness is a deficiency, or combination of control deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis. In particular, management became aware of matters where existing controls did not operate effectively to detect manual input errors in calculations used, to derive the fair value of some investment portfolio holdings as of the measurement date, thereby impacting reported amounts with respect to investments and net increase (decrease) in unrealized appreciation on investments. This control deficiency could result in misstatements of the aforementioned accounts and disclosures that would result in a material misstatement of the consolidated financial statements that would not be prevented or detected. Because of this material weakness, management concluded that the Company did not maintain effective control over financial reporting as of March 31, 2011. The Company has corrected the valuation process to refine its application of valuation procedures and believes that the Consolidated Financial Statements included in this Quarterly Report reflect the fair value of its portfolio investments in all material respects.

Remediation Efforts

The Company has designed its remediation efforts, as outlined below, to address the material weakness identified as of March 31, 2011 and to strengthen its internal control over financial reporting. Beginning in the second quarter of 2011 the Company has implemented the following remediation steps to address the material weakness as it relates to manual input errors in calculations used and to improve its internal control over financial reporting:

 

   

adding additional layers of review to ensure accuracy, existence and completeness of the number of equity security holdings as of the measurement date;

 

   

adding additional review steps, particularly surrounding any manually input data, in the calculations used to support the fair value of investments as of the measurement date; and

 

   

seeking to recruit additional experienced professionals to augment and upgrade its financial staff to address issues of timeliness and completeness in financial reporting.

The Company’s consolidated financial statements for the quarter ended March 31, 2011 reflect the debt, equity and warrant portfolio investment holdings’ fair value. In connection with the preparation of the Company’s Consolidated Financial Statements as of and for the three-month period ended March 31, 2011, the Company recorded additional unrealized depreciation on its investments subsequent to the preparation and review of management’s valuation materials. The Company subsequently evaluated and corrected the error in the affected period, March 31, 2011, in accordance with U.S. generally accepted accounting principles. Management believes that the remediation steps above will enhance the internal control procedures in order to effectively remediate such deficiency in the Company’s internal control processes related to such calculations. In addition, the Company conducted additional reviews of the portfolio investment listing and found no differences to balances previously reported.

 

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PART II: OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

At March 31, 2011, we were not a party to any legal proceedings. However, from time to time, we may be party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.

 

ITEM 1A. RISK FACTORS

In addition to the risks discussed below, important risk factors that could cause results or events to differ from current expectations are described in Part I, Item 1A “Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

We have identified a material weakness in our internal control over financial reporting, and our business and stock price may be adversely affected if we have not adequately addressed the weakness.

As a result of our evaluation of our internal control over financial reporting for the year ended December 31, 2010, management identified a material weakness related to our valuation process specifically involving debt investments. We have corrected the valuation process to refine our application of ASC 820 and believe that our audited consolidated financial statements for the year ended December 31, 2010 reflect the fair value of our debt investments in accordance with ASC 820 using the new valuation procedure. During the year ended December 31, 2010, we recognized additional unrealized depreciation of $803,000, which is not material to the 2010 consolidated financial statements. As of March 31, 2011, management has evaluated the remedial action, assessed the operating effectiveness of the remediated controls and concluded that it has remediated the material weakness described above.

In connection with the preparation of our Consolidated Financial Statements for the three-month period ended March 31, 2011, we identified a material weakness in our internal control over financial reporting related to manual input errors in calculations used to derive the fair value of some investment portfolio holdings as of the measurement date, thereby impacting reported amounts with respect to investments and net increase (decrease) in unrealized appreciation on investments. Our consolidated financial statements for the quarter ended March 31, 2011 reflect the fair value of our investments and we have taken remediation steps to enhance the internal control procedures in order to effectively remediate the deficiencies in our internal control processes related to such errors.

If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information, the market price of our stock and the Convertible Senior Notes could decline significantly, we may be unable to obtain additional financing to operate and expand our business, and our business and financial condition could be harmed. See Item 4—Controls and Procedures.

We have and may in the future choose to pay dividends in our own stock, in which case you may be required to pay tax in excess of the cash you receive.

Under a revenue procedure issued by the Internal Revenue Service, RICs are permitted to treat certain distributions made with respect to tax years ending prior to January 1, 2012, and payable in up to 90% in their stock, as taxable dividends that will satisfy their annual distribution obligations for federal income tax and excise tax purposes. In situations where this revenue procedure is not applicable, the Internal Revenue Service has also issued private letter rulings on cash/stock dividends paid by RICs and real estate investment trusts using a 20% cash standard (instead of the 10% cash standard of the revenue procedure) if certain requirements are satisfied. We previously determined to pay 90% of our first quarter 2009 dividend in shares of newly issued common stock, and we may in the future determine to distribute taxable dividends that are payable in part in our common stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income (or as long-term capital gain to the extent such distribution is properly designated as a capital gain dividend) to the extent of our current and accumulated earnings and profits for United States federal income tax purposes. As a result, a U.S. stockholder may be required to pay tax with respect to such dividends in excess of any cash received. If a U.S. stockholder sells the stock it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our stock in order to pay taxes owed on dividends, then such sales may put downward pressure on the trading price of our stock.

 

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We are dependent upon key management personnel for their time availability and our future success, particularly Manuel A. Henriquez, and if we are not able to hire and retain qualified personnel, or if we lose any member of our senior management team, our ability to implement our business strategy could be significantly harmed.

We depend upon the members of our senior management, particularly Mr. Henriquez, as well as other key personnel for the identification, final selection, structuring, closing and monitoring of our investments. These employees have critical industry experience and relationships on which we rely to implement our business plan. If we lose the services of Mr. Henriquez, or of any other senior management members, we may not be able to operate the business as we expect, and our ability to compete could be harmed, which could cause our operating results to suffer. Furthermore, we do not have an employment agreement with Mr. Henriquez and our senior management is not restricted from creating new investment vehicles subject to compliance with applicable law. We believe our future success will depend, in part, on our ability to identify, attract and retain sufficient numbers of highly skilled employees. If we do not succeed in identifying, attracting and retaining such personnel, we may not be able to operate our business as we expect.

Because we intend to distribute substantially all of our income to our stockholders in order to qualify as a RIC, we will continue to need additional capital to finance our growth. If additional funds are unavailable or not available on favorable terms, our ability to grow will be impaired.

In order to satisfy the tax requirements applicable to a RIC, to avoid payment of excise taxes and to minimize or avoid payment of income taxes, we intend to distribute to our stockholders substantially all of our ordinary income and realized net capital gains except for certain realized net long-term capital gains, which we may retain, pay applicable income taxes with respect thereto and elect to treat as deemed distributions to our stockholders. As a business development company, we generally are required to meet a coverage ratio of total assets to total borrowings and other senior securities, which includes all of our borrowings and any preferred stock that we may issue in the future, of at least 200%. This requirement limits the amount that we may borrow. This limitation may prevent us from incurring debt and require us to raise additional equity at a time when it may be disadvantageous to do so. We cannot assure you that debt and equity financing will be available to us on favorable terms, or at all, and debt financings may be restricted by the terms of any of our outstanding borrowings. If we are unable to incur additional debt, we may be required to raise additional equity at a time when it may be disadvantageous to do so. In addition, shares of closed-end investment companies have recently traded at discounts to their net asset values. This characteristic of closed-end investment companies is separate and distinct from the risk that our net asset value per share may decline. We cannot predict whether shares of our common stock will trade above, at or below our net asset value. If our common stock trades below its net asset value, we generally will not be able to issue additional shares of our common stock at its market price without first obtaining the approval for such issuance from our stockholders and our independent directors. If additional funds are not available to us, we could be forced to curtail or cease new lending and investment activities, and our net asset value could decline. In addition, our results of operations and financial condition could be adversely affected.

Because we borrow money, there could be increased risk in investing in our company.

Lenders have fixed dollar claims on our assets that are superior to the claims of stockholders, and we have granted, and may in the future grant, lenders a security interest in our assets in connection with borrowings. In the case of a liquidation event, those lenders would receive proceeds before our stockholders. In addition, borrowings, also known as leverage, magnify the potential for gain or loss on amounts invested and, therefore, increase the risks associated with investing in our securities. Leverage is generally considered a speculative investment technique. If the value of our assets increases, then leveraging would cause the net asset value attributable to our common stock to increase more than it otherwise would have had we not leveraged. Conversely, if the value of our assets decreases, leveraging would cause the net asset value attributable to our common stock to decline more than it otherwise would

 

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have had we not leveraged. Similarly, any increase in our revenue in excess of interest expense on our borrowed funds would cause our net income to increase more than it would without the leverage. Any decrease in our revenue would cause our net income to decline more than it would have had we not borrowed funds and could negatively affect our ability to make distributions on common stock. Our ability to service any debt that we incur will depend largely on our financial performance and will be subject to prevailing economic conditions and competitive pressures. We and, indirectly, our stockholders will bear the cost associated with our leverage activity. Our secured credit facilities with Wells Fargo Capital Finance LLC and Union Bank, N.A. and our Convertible Senior Notes contain financial and operating covenants that could restrict our business activities, including our ability to declare dividends if we default under certain provisions.

As of March 31, 2011, there were no amounts outstanding under our secured facilities with Wells Fargo and Union Bank and $163.75 million principal amount of indebtedness outstanding incurred by our SBIC subsidiaries.

There can be no assurance that we will be successful in obtaining any additional debt capital on terms acceptable to us or at all. If we are unable to obtain debt capital, then our equity investors will not benefit from the potential for increased returns on equity resulting from leverage to the extent that our investment strategy is successful and we may be limited in our ability to make new commitments or fundings to our portfolio companies.

As a business development company, generally we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have asset coverage of at least 200% after deducting the amount of such dividend, distribution, or purchase price. If this ratio declines below 200%, we may not be able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions. As of March 31, 2011 our asset coverage for senior indebtedness was 350.8% since we exclude SBA leverage from this ratio and we had no other borrowings outstanding.

There is a risk that you may not receive distributions or that our distributions may not grow over time.

We intend to make distributions on a quarterly basis to our stockholders. We cannot assure you that we will achieve investment results, or our business may not perform in a manner that will allow us to make a specified level of distributions or year-to-year increases in cash distributions. In addition, due to the asset coverage test applicable to us as a business development company, we may be limited in our ability to make distributions. Also, our credit facilities limit our ability to declare dividends if we default under certain provisions.

Our quarterly and annual operating results are subject to fluctuation as a result of the nature of our business, and if we fail to achieve our investment objective, the net asset value of our common stock may decline.

We could experience fluctuations in our quarterly and annual operating results due to a number of factors, some of which are beyond our control, including, but not limited to, the interest rate payable on the debt securities that we acquire, the default rate on such securities, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, changes in our portfolio

 

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composition, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.

In addition, any of these factors could negatively impact our ability to achieve our investment objectives, which may cause our net asset value of our common stock to decline.

It is likely that the terms of any long-term or revolving credit or warehouse facility we may enter into in the future could constrain our ability to grow our business.

On August 25, 2008, we, through a special purpose wholly-owned subsidiary, entered into a two-year revolving senior secured credit facility with an optional one-year extension with initial commitments of $50 million at closing with Wells Fargo Capital Finance (the “Wells Facility”). The Wells Facility has the capacity to increase to $300 million if additional lenders are added to the lending syndicate. As of March 31, 2011, we had zero outstanding borrowings under the Wells Facility.

During March 2011, we received a commitment to renew the Wells Facility. Under this three-year senior secured facility, Wells Fargo Capital Finance and RBC have made commitments of $75.0 million and $25.0 million, respectively. Borrowings under the facility are expected to be at an interest rate per annum equal to LIBOR plus 3.50%, with a floor of 5.00% and an advance rate of 50% against eligible loans. The facility will be secured by loans in the borrowing base. The facility contains an accordion feature, in which we can increase the credit line up to an aggregate of $300 million, funded by additional lenders and with the agreement of Wells Fargo Capital Finance and RBC 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 new credit facility. This new arrangement will replace the existing $300 million Wells Facility under which Wells Fargo Capital Finance had committed $50 million in capital and is subject to customary closing conditions and completion of legal documentation. We expect the covenants and events of default to be consistent with our existing Wells Facility. No assurance can be given that Wells Fargo Capital Finance, RBC and the Company will execute definitive documentation, that the definitive documentation will reflect the terms described herein or that the facility will be entered into at all.

On February 10, 2010, we entered a $20.0 million one-year revolving senior secured credit facility with Union Bank (the “Union Bank Facility”). 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%. At December 31, 2010, there were no borrowings outstanding on this facility. The Union Bank Facility requires the payment of a non-use fee of 0.25% annually. 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. In February 2011, we extended the termination date of this facility from May 1, 2011 to July 31, 2011.

The current lenders under the Wells Facility and the Union Bank Facility have, and any future lender or lenders will have, fixed dollar claims on our assets that are senior to the claims of our stockholders and, thus, will have a preference over our stockholders with respect to our assets in the collateral pool. In addition, we may grant a security interest in our assets in connection with any such borrowing. These facilities contain customary default provisions such as a minimum net worth amount, a profitability test, and a restriction on changing our business and loan quality standards. In addition, such facilities require or are expected to require the repayment of all outstanding debt on the maturity which may disrupt our business and potentially, the business our portfolio companies that are financed through the facilities. An event of default under these facilities would likely result, among other things, in

 

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termination of the availability of further funds under that facility and an accelerated maturity date for all amounts outstanding under the facility, which would likely disrupt our business and, potentially, the business of the portfolio companies whose loans we financed through the facility. This could reduce our revenues and, by delaying any cash payment allowed to us under our facility until the lender has been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain our status as a RIC.

The terms of future available financing may place limits on our financial and operating flexibility. If we are unable to obtain sufficient capital in the future, we may:

 

   

be forced to reduce or discontinue our operations;

 

   

not be able to expand or acquire complementary businesses; and

 

   

not be able to develop new services or otherwise respond to changing business conditions or competitive pressures.

In addition to regulatory restrictions that restrict our ability to raise capital, the Wells Facility, the Union Bank Facility and the Convertible Senior Notes contain various covenants which, if not complied with, could accelerate repayment under the facility, thereby materially and adversely affecting our liquidity, financial condition, results of operations and ability to pay dividends.

The credit agreements governing the Wells Facility and the Union Bank Facility and the Convertible Senior Notes require us to comply with certain financial and operational covenants. These covenants require us to, among other things, maintain certain financial ratios, including asset coverage, debt to equity and interest coverage. Our ability to continue to comply with these covenants in the future depends on many factors, some of which are beyond our control. There are no assurances that we will be able to comply with these covenants. Failure to comply with these covenants would result in a default which, if we were unable to obtain a waiver from the lenders under the Wells Facility and the Union Bank facility or the trustee or holders under the Convertible Senior Notes, could accelerate repayment under the facilities or the Convertible Senior Notes and thereby have a material adverse impact on our liquidity, financial condition, results of operations and ability to pay dividends. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition—Borrowings.”

If we cannot obtain additional capital because of either regulatory or market price constraints, we could be forced to curtail or cease our new lending and investment activities, our net asset value could decrease and our level of distributions and liquidity could be affected adversely.

Our ability to secure additional financing and satisfy our financial obligations under indebtedness outstanding from time to time will depend upon our future operating performance, which is subject to the prevailing general economic and credit market conditions, including interest rate levels and the availability of credit generally, and financial, business and other factors, many of which are beyond our control. The prolonged continuation or worsening of current economic and capital market conditions could have a material adverse effect on our ability to secure financing on favorable terms, if at all.

 

 

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If we are unable to obtain debt capital, then our equity investors will not benefit from the potential for increased returns on equity resulting from leverage to the extent that our investment strategy is successful and we may be limited in our ability to make new commitments or fundings to our portfolio companies.

As of March 31, 2011, we did not have any outstanding borrowings under either of our secured credit facilities with Wells Fargo or Union Bank and $163.75 million principal amount of indebtedness outstanding incurred by our SBIC subsidiaries. Available borrowing capacity under these facilities as of March 31, 2011 was $106.25 million and subject to terms, conditions and approvals of the SBA.

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.

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 additional contributions to regulatory capital. As of March 31, 2011, HT II had the potential to borrow up to $150.0 million of SBA-guaranteed debentures under the SBIC program. With our net investment of $75.0 million in HT II as of March 31, 2011, HT II has the capacity to issue a total of $150.0 million of SBA guaranteed debentures, subject to SBA approval, of which $125.0 million is outstanding as of March 31, 2011.

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. As of March 31, 2011, HT III had the potential to borrow up to $75.0 million of SBA-guaranteed debentures under the SBIC program. With our net investment of $37.5 million in HT III as of March 31, 2011, HT III has the capacity to issue a total of $75.0 million of SBA guaranteed debentures, subject to SBA approval, of which $38.75 million was outstanding as of March 31, 2011.

As of March 31, 2011, there was $163.75 million principal amount of indebtedness outstanding incurred by our SBIC subsidiaries. Access to the remaining leverage is subject to SBA approval and compliance with SBA regulations.

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.

Our wholly-owned SBIC subsidiaries may be unable to make distributions to us that will enable us to meet or maintain RIC status, which could result in the imposition of an entity-level tax.

In order for us to continue to qualify for RIC tax treatment and to minimize corporate-level taxes, we will be required to distribute substantially all of our net ordinary income and net capital gain income, including income from certain of our subsidiaries, which includes the income from our SBIC subsidiaries. We will be partially dependent on our SBIC subsidiaries for cash distributions to enable us to meet the RIC distribution requirements. Our SBIC subsidiaries may be limited by the Small Business Investment Act of 1958, and SBA regulations governing SBICs, from making certain distributions to us that may be necessary to maintain our status as a RIC. We may have to request a waiver of the SBA’s restrictions for our SBIC subsidiaries to make certain distributions to maintain our RIC status. We cannot assure you that

 

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the SBA will grant such waiver. If our SBIC subsidiaries are unable to obtain a waiver, compliance with the SBA regulations may result in loss of RIC tax treatment and a consequent imposition of an entity-level tax on us.

Price declines and illiquidity in the corporate debt markets could adversely affect the fair value of our portfolio investments, reducing our net asset value through increased net unrealized depreciation.

As a business development company, we are required to carry our investments at market value or, if no market value is ascertainable, at fair market value as determined in good faith by or under the direction of our board of directors. As part of the valuation process, we may take into account the following types of factors, if relevant, in determining the fair value of our investments: the enterprise value of a portfolio company (an estimate of the total fair value of the portfolio company’s debt and equity), the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, a comparison of the portfolio company’s securities to publicly traded securities, changes in the interest rate environment and the credit markets generally that may affect the price at which similar investments may be made in the future and other relevant factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, we use the pricing indicated by the external event to corroborate our valuation. Decreases in the market values or fair values of our investments are recorded as unrealized depreciation. If macro and micro market conditions should deteriorate, we could incur substantial realized losses and may suffer substantial unrealized depreciation in future periods, which could have a material adverse impact on our business, financial condition and results of operations.

Any unrealized losses we experience on our investment portfolio may be an indication of future realized losses, which could reduce our income available for distribution and could adversely affect our ability to service our outstanding borrowings.

As a business development company, we are required to carry our investments at market value or, if no market value is ascertainable, at fair value as determined in good faith by or under the direction of our Board of Directors. Decreases in the market values or fair values of our investments will be recorded as unrealized depreciation. Any unrealized losses in our investment portfolio could be an indication of a portfolio company’s inability to meet its repayment obligations to us with respect to the affected investments. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in future periods and could adversely affect our ability to service our outstanding borrowings.

An investment strategy focused primarily on privately-held companies presents certain challenges, including the lack of available information about these companies, a dependence on the talents and efforts of only a few key portfolio company personnel and a greater vulnerability to economic downturns.

We invest primarily in privately-held companies. Generally, very little public information exists about these companies, and we are required to rely on the ability of our management team to obtain adequate information to evaluate the potential returns from investing in these companies. If we are unable to uncover all material information about these companies, then we may not make a fully informed

 

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investment decision, and we may not receive the expected return on our investment or lose some or all of the money invested in these companies. Also, privately-held companies frequently have less diverse product lines and a smaller market presence than do larger competitors. Privately-held companies are, thus, generally more vulnerable to economic downturns and may experience more substantial variations in operating results than do larger competitors. These factors could affect our investment returns and our results of operations and financial condition.

In addition, our success depends, in large part, upon the abilities of the key management personnel of our portfolio companies, who are responsible for the day-to-day operations of our portfolio companies. Competition for qualified personnel is intense at any stage of a company’s development, and high turnover of personnel is common in technology-related companies. The loss of one or more key managers can hinder or delay a company’s implementation of its business plan and harm its financial condition. Our portfolio companies may not be able to attract and retain qualified managers and personnel. Any inability to do so may negatively impact our investment returns and our results of operations and financial condition.

Any unrealized depreciation that we experience on our loan portfolio may be an indication of future realized losses, which could reduce our income available for distribution and could adversely affect our ability to service our outstanding borrowings.

As a business development company, we are required to carry our investments at market value or, if no market value is ascertainable, at the fair value as determined in good faith by our Board of Directors in accordance with procedures approved by our Board of Directors. Decreases in the market values or fair values of our investments will be recorded as unrealized depreciation. Any unrealized depreciation in our loan portfolio could be an indication of a portfolio company’s inability to meet its repayment obligations to us with respect to the affected loans. This could result in realized losses in the future and ultimately in reductions of our income available for distribution in future periods and could adversely affect our ability to service our outstanding borrowings.

We may choose to waive or defer enforcement of covenants in the debt securities held in our portfolio, which may cause us to lose all or part of our investment in these companies.

We structure the debt investments in our portfolio companies to include business and financial covenants placing affirmative and negative obligations on the operation of the company’s business and its financial condition. However, from time to time we may elect to waive breaches of these covenants, including our right to payment, or waive or defer enforcement of remedies, such as acceleration of obligations or foreclosure on collateral, depending upon the financial condition and prospects of the particular portfolio company. These actions may reduce the likelihood of our receiving the full amount of future payments of interest or principal and be accompanied by a deterioration in the value of the underlying collateral as many of these companies may have limited financial resources, may be unable to meet future obligations and may go bankrupt. This could negatively impact our ability to pay dividends, could adversely affect our results of operation and financial condition and cause the loss of all or part of your investment.

If we conduct an offering of our common stock at a price below net asset value, investors are likely to incur immediate dilution upon the closing of the offering.

We are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, at a price below the current net asset value of the

 

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common stock, or sell warrants, options or rights to acquire such common stock, at a price below the current net asset value of the common stock if our board of directors determines that such sale is in the best interests of the Company and our stockholders have approved the practice of making such sales.

At our Annual Meeting of Stockholders on June 9, 2010, our stockholders approved a proposal authorizing us to sell up to 20% of our common stock at a price below the Company’s net asset value per share, subject to Board approval of the offering. If we were to issue shares at a price below net asset value, such sales would result in an immediate dilution to existing common stockholders, which would include a reduction in the net asset value per share as a result of the issuance. This dilution would also include a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance.

In addition, if we determined to conduct additional offerings in the future there may be even greater discounts if we determine to conduct such offerings at prices below net asset value. As a result, investors will experience further dilution and additional discounts to the price of our common stock.

Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect of an offering cannot be predicted. We did not sell any of our common stock at a price below our net asset value during the quarter ended March 31, 2011.

We may again obtain the approval of our stockholders to issue shares of our common stock at prices below the then current net asset value per share of our common stock. If we receive such approval from the stockholders, we may again issue shares of our common stock at a price below the then current net asset value per share of common stock. Any such issuance could materially dilute your interest in our common stock and reduce our net asset value per share.

We may again obtain the approval of our stockholders to issue shares of our common stock at prices below the then current net asset value per share of our common stock. Such approval has allowed and may again allow us to access the capital markets in a way that we typically are unable to do as a result of restrictions that, absent stockholder approval, apply to business development companies under the 1940 Act. Any decision to sell shares of our common stock below the then current net asset value per share of our common stock is subject to the determination by our board of directors that such issuance and sale is in our and our stockholders’ best interests.

Any sale or other issuance of shares of our common stock at a price below net asset value per share has resulted and will continue to result in an immediate dilution to your interest in our common stock and a reduction of our net asset value per share. This dilution would occur as a result of a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance. Because the number of future shares of common stock that may be issued below our net asset value per share and the price and timing of such issuances are not currently known, we cannot predict the actual dilutive effect of any such issuance. We also cannot determine the resulting reduction in our net asset value per share of any such issuance at this time. We caution you that such effects may be material, and we undertake to describe all the material risks and dilutive effects of any offering that we make at a price below our then current net asset value in the future in a prospectus supplement issued in connection with any such offering. We cannot predict whether shares of our common stock will trade above, at or below our net asset value.

Our shares may trade at discounts from net asset value or at premiums that are unsustainable over the long term.

Shares of business development companies may trade at a market price that is less than the net asset value that is attributable to those shares. Our shares have traded above and below our NAV. The possibility that our shares of common stock will trade at a discount from net asset value or at a premium

 

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that is unsustainable over the long term is separate and distinct from the risk that our net asset value will decrease. It is not possible to predict whether our shares will trade at, above or below net asset value in the future.

 

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Our financial results could be negatively affected if a significant portfolio investment fails to perform as expected.

Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. The following table shows the fair value of the totals of investments held in portfolio companies at March 31, 2011 that represent greater than 5% of net assets:

 

     March 31, 2011  
(in thousands)    Fair Value      Percentage of
Net  Assets
 

Aveo Pharmaceuticals, Inc.

   $ 28,614         7.1

Unify Corporation

     25,864         6.4

Pacira Pharmaceuticals

     25,481         6.3

Brightsource Energy, Inc.

     24,897         6.2

Anthera Pharmaceuticals

     24,824         6.2

Tectura Corporation

     24,232         6.0

Aveo Pharmaceuticals, Inc. is a biopharmaceutical company dedicated to the discovery and development of new, targeted cancer therapeutics.

Unify Corporation is a global provider of application development, data management and migration solutions.

Pacira Pharmaceuticals is an emerging specialty pharmaceutical company focused on the development, commercialization and manufacture of new pharmaceutical products.

Anthera Pharmaceuticals, Inc. is a biopharmaceutical company focused on developing and commercializing products to treat serious diseases, including cardiovascular and autoimmune diseases.

Brightsource Energy, Inc. designs, develops and sells solar thermal power systems that deliver reliable, clean energy to utilities and industrial companies.

Tectura Corporation is an IT services firm that specializes in Microsoft Business Solutions applications.

Our financial results could be negatively affected if these portfolio companies or any of our other significant portfolio companies encounter financial difficulty and fail to repay their obligations or to perform as expected.

 

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not Applicable

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

 

ITEM 4. RESERVED

 

ITEM 5. OTHER INFORMATION

Not applicable.

 

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ITEM 6. EXHIBITS

 

Exhibit
Number

  

Description

31.1    Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Chief Executive Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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SIGNATURES

Pursuant to the requirements of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

   

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

(Registrant)

Dated: May 10, 2011    

/s/    MANUEL A. HENRIQUEZ        

    Manuel A. Henriquez
    Chairman, President, and Chief Executive Officer
Dated: May 10, 2011    

/s/    DAVID M. LUND        

    David M. Lund
    Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit

Number

  

Description

31.1    Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Chief Executive Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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