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 September 30, 2014
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
(Address of Principal Executive Offices)
94301
(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
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 November 3, 2014, there were 64,199,024 shares outstanding of the Registrant’s common stock, $0.001 par value.
HERCULES TECHNOLOGY GROWTH CAPITAL, INC.
FORM 10-Q TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
3
Item 1.
Consolidated Financial Statements
Consolidated Statement of Assets and Liabilities as of September 30, 2014 (unaudited) and December 31, 2013
Consolidated Statement of Operations for the three and nine month periods ended September 30, 2014 and 2013 (unaudited)
5
Consolidated Statement of Changes in Net Assets for the three and nine month periods ended September 30, 2014 and 2013 (unaudited)
6
Consolidated Statement of Cash Flows for the nine month periods ended September 30, 2014 and 2013 (unaudited)
7
Consolidated Schedule of Investments as of September 30, 2014 (unaudited)
8
Consolidated Schedule of Investments as of December 31, 2013
20
Notes to Consolidated Financial Statements (unaudited)
32
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
58
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
93
Item 4.
Controls and Procedures
94
PART II. OTHER INFORMATION
95
Legal Proceedings
Item 1A. Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
97
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
SIGNATURES
98
2
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
CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES
(unaudited)
(dollars in thousands, except per share data)
September 30, 2014
December 31, 2013
Assets
Investments:
Non-control/Non-affiliate investments (cost of $996,338 and $891,059, respectively)
$
990,068
899,314
Affiliate investments (cost of $15,959 and $15,238, respectively)
8,845
10,981
Total investments, at value (cost of $1,012,297 and $906,297, respectively)
998,913
910,295
Cash and cash equivalents
158,627
268,368
Restricted cash
2,096
6,271
Interest receivable
9,146
8,962
Other assets
30,556
27,819
Total assets
1,199,338
1,221,715
Liabilities
Accounts payable and accrued liabilities
11,613
14,268
Long-term Liabilities (Convertible Senior Notes)
40,012
72,519
Asset-Backed Notes
27,951
89,557
2019 Notes
170,364
2024 Notes
103,000
—
Long-term SBA Debentures
190,200
225,000
Total liabilities
543,140
571,708
Commitments and Contingencies (Note 10)
Net assets consist of:
Common stock, par value
65
62
Capital in excess of par value
670,711
656,594
Unrealized appreciation (depreciation) on investments
(14,706
)
3,598
Accumulated realized losses on investments
(2,233
(15,240
Undistributed net investment income
2,361
4,993
Total net assets
656,198
650,007
Total liabilities and net assets
Shares of common stock outstanding ($0.001 par value, 100,000,000 authorized)
64,182
61,837
Net asset value per share
10.22
10.51
See notes to consolidated financial statements.
The following table presents the assets and liabilities of our consolidated securitization trust for asset-backed notes (see Note 4), which is a variable interest entity (“VIE”). The assets of our securitization VIE can only be used to settle obligations of our consolidated securitization VIE, these liabilities are only the obligations of our consolidated securitization VIE, and the creditors (or beneficial interest holders) do not have recourse to our general credit. These assets and liabilities are included in the Consolidated Statements of Assets and Liabilities above.
(Dollars in thousands)
ASSETS
Restricted Cash
Total investments, at value (cost of $87,405 and $166,513, respectively)
85,233
165,445
87,329
171,716
LIABILITIES
4
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended September 30,
Nine Months Ended September 30,
2014
2013
Investment income:
Interest income
Non-Control/Non-Affiliate investments
33,210
35,623
92,975
93,722
Affiliate investments
130
561
1,747
1,684
Total interest income
33,340
36,184
94,722
95,406
Fees
3,671
4,832
12,037
11,088
30
9
Total fees
3,679
4,837
12,067
11,097
Total investment income
37,019
41,021
106,789
106,503
Operating expenses:
Interest
6,495
7,587
20,177
22,788
Loan fees
1,364
1,072
4,531
3,341
General and administrative
2,397
2,176
6,984
6,831
Employee Compensation:
Compensation and benefits
3,922
7,030
11,375
14,992
Stock-based compensation
2,823
1,596
6,849
4,349
Total employee compensation
6,745
8,626
18,224
19,341
Total operating expenses
17,001
19,461
49,916
52,301
Loss on debt extinguishment (Long-term Liabilities - Convertible Senior Notes)
(1,023
Net investment income
18,995
21,560
55,850
54,202
Net realized gain on investments
5,664
7,125
13,007
11,309
Total net realized gain on investments
Net increase in unrealized appreciation (depreciation) on investments
(10,029
9,288
(15,447
10,506
547
(992
(2,857
(1,468
Total net unrealized appreciation (depreciation) on investments
(9,482
8,296
(18,304
9,038
Total net realized and unrealized gain (loss)
(3,818
15,421
(5,297
20,347
Net increase in net assets resulting from operations
15,177
36,981
50,553
74,549
Net investment income before investment gains and losses per common share:
Basic
0.30
0.35
0.89
0.91
Change in net assets per common share:
0.24
0.61
0.80
1.26
Diluted
0.23
0.59
0.78
1.23
Weighted average shares outstanding
62,356
60,522
61,444
58,206
63,779
60,750
63,554
58,396
Dividends declared per common share:
0.31
0.93
0.86
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
(dollars and shares in thousands)
Undistributed
net investment
income/
Unrealized
Accumulated
(Distributions
Provision for
Capital in
Appreciation
Realized
in excess of
Income Taxes
Common Stock
excess
(Depreciation)
Gains (Losses)
investment
on Investment
Net
Shares
Par Value
of par value
on Investments
income)
Gains
Balance at December 31, 2012
52,925
53
564,508
(7,947
(36,916
(3,388
(342
515,968
Net increase in net assets
resulting from operations
Issuance of common stock
1,337
1
16,542
16,543
Issuance of common stock under
restricted stock plan
472
(1
Issuance of common stock as
stock dividend
142
1,923
Retired shares from net issuance
(1,170
(18,259
(18,260
Public offering
8,050
95,529
95,537
Dividends declared
(47,292
4,408
Balance at September 30, 2013
61,756
664,650
1,091
(25,607
3,522
643,376
Balance at December 31, 2013
5,335
Net increase (decrease) in net assets
256
2,873
632
76
1,152
(193
(5,992
1,574
9,180
9,182
(58,482
6,905
Balance at September 30, 2014
2,703
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
Cash flows from operating activities:
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by
(used in) operating activities:
Purchase of investments
(415,399
(411,515
Principal payments received on investments
316,543
336,438
Proceeds from the sale of investments
17,977
29,459
Net unrealized depreciation (appreciation) on investments
18,304
(9,038
(13,007
(11,309
Accretion of paid-in-kind principal
(1,990
(2,269
Accretion of loan discounts
(7,690
(4,556
Accretion of loan discount on Convertible Senior Notes
738
812
Loss on conversion of Convertible Senior Notes
1,023
Accretion of loan exit fees
(754
(10,031
Change in deferred loan origination revenue
(616
2,540
Unearned fees related to unfunded commitments
(7,789
(364
Amortization of debt fees and issuance costs
4,131
2,918
Depreciation
161
162
Stock-based compensation and amortization of restricted stock grants
Change in operating assets and liabilities:
Interest and fees receivable
(184
(641
Prepaid expenses and other assets
59
570
Accounts payable
1,126
(63
Accrued liabilities
(4,203
2,588
Net cash provided by (used in) operating activities
(34,112
4,658
Cash flows from investing activities:
Purchases of capital equipment
(94
(240
Reduction of (investment in) restricted cash
4,175
(3,632
Other long-term assets
(30
Net cash provided by (used in) investing activities
4,081
(3,902
Cash flows from financing activities:
Proceeds from issuance (repurchase of employee shares due to restricted stock vesting) of
common stock, net
6,734
93,443
Dividends paid
(57,330
(45,368
Issuance of 2024 Notes, net
99,655
Repayments of Asset-Backed Notes
(61,606
(26,832
Repayments of Long-Term SBA Debentures
(34,800
Cash paid for redemption of Convertible Senior Notes
(31,577
Fees paid for credit facilities and debentures
(786
Net cash provided by (used in) financing activities
(79,710
21,243
Net decrease in cash and cash equivalents
(109,741
21,999
Cash and cash equivalents at beginning of period
182,994
Cash and cash equivalents at end of period
204,993
Supplemental non-cash investing and financing activities:
Dividends Reinvested
Paid-in-Kind Principal
1,990
2,269
CONSOLIDATED SCHEDULE OF INVESTMENTS
Portfolio Company
Sub-Industry
Type of
Investment(1)
Maturity Date
Interest Rate and Floor
Principal
Amount
Cost(2)
Value(3)
Debt Investments
Biotechnology Tools
1-5 Years Maturity
Labcyte, Inc. (11)(13)(14)
Senior Secured
June 2016
Interest rate PRIME + 6.70% or Floor rate of 9.95%
3,104
3,252
3,262
Subtotal: 1-5 Years Maturity
Subtotal: Biotechnology Tools (0.50%)*
Communications & Networking
OpenPeak, Inc. (11)(13)
April 2017
Interest rate PRIME + 8.75% or Floor rate of 12.00%
9,296
9,454
9,331
SkyCross, Inc. (13)(14)
January 2018
Interest rate PRIME + 9.70%
7,500
7,278
7,440
Interest rate PRIME + 7.70% or Floor rate of 10.95%
14,500
14,050
14,362
Total SkyCross, Inc.
22,000
21,328
21,802
Spring Mobile Solutions, Inc. (13)
November 2016
Interest rate PRIME + 8.00% or Floor rate of 11.25%
18,840
18,886
19,075
49,668
50,208
Subtotal: Communications & Networking (7.65%)*
Consumer & Business Products
Fluc, Inc. (9)
Convertible Senior Note
March 2017
Interest rate FIXED 4.00%
100
Pong Research Corporation (13)(14)
December 2017
Interest rate PRIME + 6.75% or Floor rate of 10.00%
5,000
4,872
The Neat Company (12)(13)(14)
September 2017
Interest rate PRIME + 7.75% or Floor rate of 11.00%, PIK Interest 1.00%
20,010
19,221
24,193
Subtotal: Consumer & Business Products (3.69%)*
Drug Delivery
AcelRx Pharmaceuticals, Inc. (3)(10)(13)(14)
October 2017
Interest rate PRIME + 3.85% or Floor rate of 9.10%
25,000
24,643
24,791
BIND Therapeutics, Inc. (3)(13)(14)
September 2016
Interest rate PRIME + 7.00% or Floor rate of 10.25%
3,694
3,736
3,638
Celator Pharmaceuticals, Inc. (3)(13)
Interest rate PRIME + 6.50% or Floor rate of 9.75%
10,000
9,865
Celsion Corporation (3)(13)
June 2017
9,763
9,966
Dance Biopharm, Inc. (13)(14)
November 2017
Interest rate PRIME + 7.40% or Floor rate of 10.65%
4,000
3,935
3,965
Edge Therapeutics, Inc. (13)
March 2018
Interest rate PRIME + 5.95% or Floor rate of 10.45%
3,000
2,846
Neos Therapeutics, Inc. (13)(14)
Interest rate PRIME + 7.25% or Floor rate of 10.50%
4,881
Interest rate PRIME + 5.75% or Floor rate of 9.00%
9,689
Total Neos Therapeutics, Inc.
15,000
14,881
14,570
Zosano Pharma, Inc. (13)
Interest rate PRIME + 6.80% or Floor rate of 12.05%
3,857
73,526
73,498
Under 1 Year Maturity
Revance Therapeutics, Inc. (3)(13)
March 2015
Interest rate PRIME + 6.60% or Floor rate of 9.85%
410
445
4,096
4,439
Total Revance Therapeutics, Inc.
4,506
4,884
Subtotal: Under 1 Year Maturity
Subtotal: Drug Delivery (11.94%)*
78,410
78,382
Drug Discovery & Development
ADMA Biologics, Inc. (3)(12)(13)
Interest rate PRIME + 3.00% or Floor rate of 8.75%, PIK Interest of 1.95%
10,103
9,961
10,026
Anacor Pharmaceuticals, Inc. (14)
July 2017
Interst rate PRIME + 6.40% or Floor rate of 11.65%
30,000
29,316
29,916
Aveo Pharmaceuticals, Inc. (3)(10)(11)(13)(14)
Interest rate PRIME + 11.90% or Floor rate of 11.90%
9,688
Celladon Corporation (3)(13)(14)
February 2018
Interest rate PRIME + 3.00% or Floor rate of 8.25%
9,939
Cempra, Inc. (3)(13)
April 2018
Interest rate PRIME + 6.30% or Floor rate of 9.55%
18,000
18,010
Cerecor Inc. (13)
August 2017
Interest rate PRIME + 4.70% or Floor rate of 7.95%
7,337
Cleveland BioLabs, Inc. (3)(13)(14)
January 2017
Interest rate PRIME + 6.20% or Floor rate of 10.45%
2,000
2,040
Concert Pharmaceuticals, Inc. (3)(4)
October 2015
Interest rate PRIME + 3.25% or Floor rate of 8.50%
9,218
9,162
9,254
CTI BioPharma Corp. (pka Cell Therapeutics, Inc.) (11)(13)
October 2016
Interest rate PRIME + 9.00% or Floor rate 12.25%
14,962
15,332
Insmed, Incorporated (11)(13)
January 2016
Interest rate PRIME + 4.75% or Floor rate of 9.25%
20,000
19,871
20,071
Neothetics, Inc. (pka Lithera, Inc) (13)(14)
3,909
Merrimack Pharmaceuticals, Inc. (3)(13)
Interest rate PRIME + 5.30% or Floor rate of 10.55%
40,000
40,516
40,599
Neuralstem, Inc. (9)(13)(14)
Interest rate PRIME + 7.75% or Floor rate of 11.00%
5,834
5,904
6,138
uniQure B.V. (3)(5)(10)(13)
June 2018
Interest rate PRIME + 5.00% or Floor rate of 10.25%
19,826
200,401
202,085
September 2015
Interest rate PRIME + 7.15% or Floor rate of 11.90%
11,611
Subtotal: Drug Discovery & Development (32.57%)*
212,012
213,696
Electronics & Computer Hardware
Plures Technologies, Inc. (8)(12)
Interest rate LIBOR + 8.75% or Floor rate of 12.00%, PIK Interest of 4.00%
267
180
Subtotal: Electronics & Computer Hardware (0.00%)*
Energy Technology
Agrivida, Inc. (14)
December 2016
5,468
5,518
2,992
American Superconductor Corporation (3)(11)(13)
Interest rate PRIME + 7.25% or Floor rate of 11.00%
8,667
8,763
8,741
Amyris, Inc. (10)(13)
February 2017
Interest rate PRIME + 6.25% or Floor rate of 9.5%
Interest rate PRIME + 5.25% or Floor rate of 8.50%
Total Amyris, Inc.
BioAmber, Inc. (5)(10)(13)
22,153
23,573
23,290
Enphase Energy, Inc. (13)
August 2016
Interest rate PRIME + 8.25% or Floor rate of 11.50%
5,861
5,956
6,001
Fluidic, Inc. (13)
March 2016
4,347
4,386
4,370
Polyera Corporation (13)(14)
4,214
4,346
4,369
TAS Energy, Inc. (13)
December 2015
8,506
8,674
8,608
91,216
88,371
December 2014
1,154
1,648
Glori Energy, Inc. (3)(11)(13)
June 2015
2,667
2,908
Scifiniti (pka Integrated Photovoltaics, Inc.) (14)
February 2015
Interest rate PRIME + 7.38% or Floor rate of 10.63%
549
546
Stion Corporation (4)(6)(13)
3,379
3,415
2,501
8,517
7,603
Subtotal: Energy Technology (14.63%)*
99,733
95,974
Healthcare Services, Other
Chromadex Corporation (3)(13)(14)
Interest rate PRIME + 6.10% or Floor rate of 9.35%
2,500
2,387
InstaMed Communications, LLC (13)(14)
2,736
2,805
2,825
MDEverywhere, Inc. (13)
Interest rate LIBOR + 9.50% or Floor rate of 10.75%
2,383
2,375
2,266
7,567
7,478
Subtotal: Healthcare Services, Other (1.14%)*
Information Services
InXpo, Inc. (13)(14)
July 2016
Interest rate PRIME + 7.50% or Floor rate of 10.75%
2,057
2,056
2,064
Womensforum.com (11)(12)
Interest rate LIBOR + 6.50% or Floor rate of 9.25%
6,200
6,128
5,739
Interest rate LIBOR + 7.50% or Floor rate of 10.25%, PIK Interest 2.00%
4,678
4,624
4,342
Total Womensforum.com
10,878
10,752
10,081
12,808
12,145
Eccentex Corporation (11)(13)
May 2015
322
334
April 2015
Interest rate LIBOR + 6.50% or Floor rate of 9.00%
1,250
1,241
1,162
1,575
1,323
Subtotal: Information Services (2.05%)*
14,383
13,468
10
Internet Consumer & Business Services
CashStar, Inc. (12)(14)
Interest rate PRIME + 6.25% or Floor rate 10.50%, PIK Interest 1.00%
7,120
7,008
7,074
Education Dynamics, LLC (12)(14)
Interest rate LIBOR + 12.5% or Floor rate 12.50%, PIK Interest 1.50%
20,513
20,493
20,593
Gazelle, Inc. (12)(14)
April 2016
Interest rate PRIME + 7.00% or Floor rate of 10.25%, PIK Interest 2.50%
13,625
13,410
Just Fabulous, Inc. (4)(13)
14,300
14,600
LightSpeed Retail, Inc. (5)(10)
May 2018
Interest rate PRIME + 3.25% or Floor rate of 6.50%
1,984
Reply! Inc. (11)(12)(13)
February 2016
Interest rate PRIME + 7.25% or Floor rate of 10.50%, PIK Interest 2.00%
2,939
2,883
Tapjoy, Inc. (13)
July 2018
Vaultlogix, LLC (12)(13)(14)
Interest rate LIBOR + 8.50% or Floor rate of 10.00%, PIK interest 2.50%
8,102
8,090
WaveMarket, Inc. (11)(13)
Interest rate PRIME + 5.75% or Floor rate of 9.50%
8,195
8,172
8,253
331
343
Total WaveMarket, Inc.
8,526
8,596
79,524
80,138
NetPlenish (8)(9)(14)
Interest rate FIXED 10.00%
92
381
373
Total NetPlenish
473
465
Interest rate PRIME + 6.88% or Floor rate of 10.13%, PIK Interest 2.00%
8,423
8,496
8,581
Interest rate PRIME + 7.25% or Floor rate of 11.00%, PIK Interest 2.00%
1,857
1,911
1,931
Total Reply! Inc.
10,280
10,407
10,512
Tectura Corporation (8)(12)
N/A
Interest rate LIBOR + 10.00% or Floor rate of 13.00%
6,468
Interest rate LIBOR + 8.00% or Floor rate of 11.00%, PIK Interest 1.00%
9,070
2,791
563
173
1,539
Total Tectura Corporation
21,101
6,493
Interest rate LIBOR + 7.00% or Floor rate of 8.50%
5,740
5,876
37,849
22,881
Subtotal: Internet Consumer & Business Services (15.70%)*
117,373
103,019
11
Media/Content/Info
Rhapsody International, Inc. (12)(14)
Interest rate PRIME + 5.25% or Floor rate of 9.00%, PIK interest of 1.50%
20,129
19,618
19,612
Zoom Media Group, Inc. (12)
Interest rate PRIME + 7.25% or Floor rate of 10.50%, PIK Interest 3.75%
2,979
2,911
2,925
22,529
22,537
4,500
4,474
Subtotal: Media/Content/Info (4.12%)*
27,003
27,011
Medical Devices & Equipment
Amedica Corporation (3)(9)(13)(14)
19,501
19,783
Avedro, Inc. (13)(14)
7,183
Baxano Surgical, Inc. (3)(13)
Interest rate PRIME + 7.75% or Floor rate of 12.50%
7,405
4,925
Gamma Medica, Inc. (13)
3,840
Home Dialysis Plus, Inc. (4)(13)
Interest rate PRIME + 4.35% or Floor rate of 9.60%
14,732
InspireMD, Inc. (3)(5)(10)(13)
Interest rate PRIME + 5.00% or Floor rate of 10.50%
9,710
9,694
9,653
Medrobotics Corporation (13)(14)
Interest rate PRIME + 7.85% or Floor rate of 11.10%
3,170
3,223
3,217
NetBio, Inc.
Interest rate PRIME + 5.00% or Floor rate of 11.00%
4,796
4,878
NinePoint Medical, Inc. (13)(14)
Interest rate PRIME + 5.85% or Floor rate of 9.10%
3,941
4,026
4,013
Quanterix Corporation (13)
Interest rate PRIME + 2.75% or Floor rate of 8.00%
4,895
SonaCare Medical, LLC (pka US HIFU, LLC) (11)(13)
4,167
4,402
4,315
SynergEyes, Inc. (13)(14)
4,982
United Orthopedic Group, Inc. (13)
Interest rate PRIME + 8.60% or Floor rate of 11.85%
24,288
24,334
24,577
ViewRay, Inc. (12)(14)
Interest rate PRIME + 7.00% or Floor rate of 10.25%, PIK Interest 1.50%
15,163
14,807
14,603
127,820
125,596
Interest rate FIXED 8.00%
500
Oraya Therapeutics, Inc. (11)(12)(13)
Interest rate PRIME + 5.50% or Floor rate of 10.25%, PIK Interest of 1.00%
6,159
6,120
4,443
6,620
4,943
Subtotal: Medical Devices & Equipment (19.89%)*
134,440
130,539
Semiconductors
Avnera Corporation (13)
4,963
4,991
Achronix Semiconductor Corporation
January 2015
Interest rate PRIME + 10.60% or Floor rate of 13.85%
341
Subtotal: Semiconductors (0.81%)*
5,304
5,332
12
Software
CareCloud Corporation (13)(14)
Interest rate PRIME + 5.50% or Floor rate of 8.75%
9,792
Clickfox, Inc. (13)(14)
6,000
5,981
Knowledge Adventure, Inc. (13)(14)
11,750
11,712
11,770
Mobile Posse, Inc. (13)(14)
3,274
3,241
Neos Geosolutions, Inc. (13)(14)
May 2016
Interest rate PRIME + 5.75% or Floor rate of 10.50%
2,707
2,811
2,829
Poplicus, Inc. (13)(14)
1,500
1,493
Soasta, Inc. (13)(14)
Interest rate PRIME + 4.75% or Floor rate of 8.00%
14,289
Interest rate PRIME + 2.25% or Floor rate of 5.50%
3,500
3,334
Total Soasta, Inc.
18,500
17,623
Sonian, Inc. (13)(14)
5,500
5,421
5,427
StartApp, Inc. (13)
2,981
3,046
3,038
Touchcommerce, Inc. (14)
Interest rate PRIME + 6.00% or Floor rate of 10.25%
4,692
4,742
65,812
65,969
July 2015
Interest rate PRIME + 9.25% or Floor rate of 12.50%
2,494
Total Clickfox, Inc.
4,494
Hillcrest Laboratories, Inc. (14)
1,460
1,452
1,467
Mobile Posse, Inc. (14)
Interest rate PRIME + 2.00% or Floor rate of 5.25%
489
Interest rate PRIME + 2.75% or Floor rate of 6.00%
200
Interest rate PRIME + 2.25% or Floor rate of 6.50%
3,811
3,804
3,802
10,439
10,452
Subtotal: Software (11.65%)*
76,251
76,421
Specialty Pharmaceuticals
Alimera Sciences, Inc. (3)
Interest rate PRIME + 7.65% or Floor rate of 10.90%
35,000
34,050
33,225
Cranford Pharmaceuticals, LLC (12)(13)(14)
Interest rate LIBOR + 9.55% or Floor rate of 10.80%, PIK Interest of 1.35%
17,137
17,007
16,922
Rockwell Medical, Inc. (13)(14)
19,436
19,840
70,897
69,987
August 2015
Interest rate LIBOR + 8.25% or Floor rate of 9.50%
2,467
2,470
Subtotal: Specialty Pharmaceuticals (11.04%)*
73,364
72,457
Surgical Devices
Transmedics, Inc. (11)(13)
November 2015
Interest rate FIXED 12.95%
6,583
6,483
Subtotal: Surgical Devices (0.99%)*
Total Debt Investments (138.36%)*
929,616
907,923
13
Type of Investment(1)
Series
Equity Investments
NuGEN Technologies, Inc. (14)
Equity
Preferred Series C
189,394
578
Subtotal: Biotechnology Tools (0.09%)*
GlowPoint, Inc. (3)
114,192
102
148
Peerless Network, Inc.
Preferred Series A
1,000,000
1,000
4,398
Stoke, Inc.
Preferred Series E
152,905
Subtotal: Communications & Networking (0.69%)*
1,602
4,546
Caivis Acquisition Corporation (14)
295,861
819
Market Force Information, Inc.
Preferred Series B
187,970
224
Subtotal: Consumer & Business Products (0.03%)*
1,319
Diagnostic
Singulex, Inc.
937,998
750
Subtotal: Diagnostic (0.11%)*
AcelRx Pharmaceuticals, Inc. (3)(10)(14)
54,240
108
298
Merrion Pharmaceuticals, Plc (3)(5)(10)
Neos Therapeutics, Inc. (14)
300,000
1,523
Transcept Pharmaceuticals, Inc. (3)(15)
41,570
84
Subtotal: Drug Delivery (0.29%)*
2,117
1,905
Acceleron Pharma, Inc. (3)(14)
147,001
1,025
4,401
Aveo Pharmaceuticals, Inc. (3)(10)(14)
167,864
842
186
Celladon Corporation (3)(14)
105,263
892
Cerecor Inc.
3,334,445
1,008
Dicerna Pharmaceuticals, Inc. (3)(14)
142,858
1,818
Inotek Pharmaceuticals Corporation
15,334
Merrimack Pharmaceuticals, Inc. (3)
848,591
3,213
7,523
Paratek Pharmaceuticals, Inc. (15)
2,881
167,468
156
Total Partek Pharmaceuticals, Inc.
170,349
1,131
158
Subtotal: Drug Discovery & Development (2.44%)*
10,711
15,986
Glori Energy, Inc. (3)
18,208
165
SCIEnergy, Inc.
Preferred Series 1
385,000
761
25
Subtotal: Energy Technology (0.03%)*
926
167
Good Technologies, Inc. (pka Visto Corporation)(14)
500,000
603
Subtotal: Information Services (0.07%)*
Blurb, Inc. (14)
220,653
175
377
Philotic, Inc.
8,121
Progress Financial
Preferred Series G
218,351
250
246
Taptera, Inc.
454,545
150
152
Subtotal: Internet Consumer & Business Services (0.12%)*
668
775
Everyday Health, Inc. (pka Waterfront Media, Inc.) (3)
97,060
1,356
Subtotal: Media/Content/Info (0.21%)*
14
Gelesis, Inc. (6)(14)
LLC Interest
2,024,092
925
314
Medrobotics Corporation (14)
136,798
271
Novasys Medical, Inc.
Preferred Series D-1
4,118,444
Optiscan Biomedical, Corp. (6)(14)
6,185,567
421
1,927,309
655
Preferred Series D
55,103,923
5,257
Total Optiscan Biomedical, Corp.
63,216,799
8,912
5,808
Oraya Therapeutics, Inc.
1,086,969
Subtotal: Medical Devices & Equipment (0.97%)*
11,587
6,393
Atrenta, Inc.
1,196,845
986
1,391
635,513
508
1,098
Total Atrenta, Inc.
1,832,358
1,494
2,489
Box, Inc. (14)
271,070
251
5,439
589,844
872
11,834
158,133
3,173
186,766
1,694
3,747
Preferred Series D-2
220,751
2,001
4,429
38,183
766
Total Box, Inc.
1,464,747
5,818
29,388
CapLinked, Inc.
Preferred Series A-3
53,614
51
90
ForeScout Technologies, Inc.
319,099
398
724
HighRoads, Inc.
190,170
307
146
Subtotal: Software (5.00%)*
8,068
32,837
QuatRx Pharmaceuticals Company
241,829
Preferred Series E-1
26,955
4,667,636
Total QuatRx Pharmaceuticals Company
4,936,420
Subtotal: Specialty Pharmaceuticals (0.00%)*
Gynesonics, Inc. (14)
219,298
83
656,538
282
138
1,991,157
712
Total Gynesonics, Inc.
2,866,993
1,244
1,221
Transmedics, Inc.
88,961
1,100
292
119,999
300
260,000
650
928
Total Transmedics, Inc.
468,960
2,050
1,378
Subtotal: Surgical Devices (0.40%)*
3,294
2,599
Total Equity Investments (10.45%)*
43,895
68,589
15
Warrant Investments
Labcyte, Inc. (14)
Warrant
1,127,624
323
54
Subtotal: Biotechnology Tools (0.01%)*
Intelepeer, Inc. (14)
117,958
31
OpenPeak, Inc.
108,982
149
121
PeerApp, Inc.
298,779
61
42
135,000
467
Ping Identity Corporation
1,136,277
52
SkyCross, Inc. (14)
Preferred Series F
9,762,777
393
417
Spring Mobile Solutions, Inc.
2,834,375
418
358
118,181
Subtotal: Communications & Networking (0.23%)*
1,335
1,538
Intelligent Beauty, Inc. (14)
190,234
230
365
99,286
24
Pong Research Corporation (14)
1,662,441
228
197
The Neat Company (14)
Preferred Series C-1
540,540
328
Subtotal: Consumer & Business Products (0.14%)*
847
Navidea Biopharmaceuticals, Inc. (pka Neoprobe) (3)(14)
333,333
244
Subtotal: Diagnostic (0.00%)*
176,730
786
330
Alexza Pharmaceuticals, Inc. (3)
37,639
645
BIND Therapeutics, Inc. (3)(14)
71,359
367
43
Celator Pharmaceuticals, Inc. (3)
158,006
107
Celsion Corporation (3)
194,986
428
Dance Biopharm, Inc. (14)
97,701
74
164
Edge Therapeutics, Inc.
129,870
390
392
Intelliject, Inc.
82,500
593
1,119
170,000
285
275
Revance Therapeutics, Inc. (3)
53,511
558
61,452
87
Zosano Pharma, Inc.
31,674
109
Subtotal: Drug Delivery (0.45%)*
4,484
2,960
ADMA Biologics, Inc. (3)
66,550
218
Anthera Pharmaceuticals, Inc. (3)(14)
40,178
984
608,696
194
184
Cempra, Inc. (3)
138,797
458
538
625,208
70
68
Chroma Therapeutics, Ltd. (5)(10)
325,261
490
Cleveland BioLabs, Inc. (3)(14)
156,250
105
Concert Pharmaceuticals, Inc. (3)
70,796
368
144
Coronado Biosciences, Inc. (3)
73,009
38
28
Epirus Biopharmaceuticals, Inc. (3)
64,194
276
Horizon Pharma, Inc. (3)
22,408
231
23
Neothetics, Inc. (pka Lithera, Inc)(14)
114,285
89
Nanotherapeutics, Inc. (14)
50,296
838
839
uniQure B.V. (3)(5)(10)
37,174
79
Subtotal: Drug Discovery & Development (0.39%)*
4,709
2,532
16
Clustrix, Inc.
50,000
Identiv, Inc. (3)
99,208
247
584
Subtotal: Electronics & Computer Hardware (0.09%)*
259
595
77,447
120
Alphabet Energy, Inc. (14)
86,329
81
145
American Superconductor Corporation (3)
512,820
391
86
Brightsource Energy, Inc. (14)
175,000
780
220
Calera, Inc. (14)
44,529
513
EcoMotors, Inc. (14)
437,500
308
Fluidic, Inc.
59,665
Fulcrum Bioenergy, Inc.
280,897
204
GreatPoint Energy, Inc. (14)
393,212
548
Polyera Corporation (14)
161,575
69
Propel Fuels (14)
3,200,000
211
530,811
181
145,811
50
Total SCIEnergy, Inc.
676,622
Preferred Series A-1
390,000
82
67
Solexel, Inc. (14)
1,171,625
614
Stion Corporation (6)
Preferred Series Seed
2,154
TAS Energy, Inc.
428,571
299
302
TPI Composites, Inc.
160
273
136
Trilliant, Inc. (14)
320,000
41
Subtotal: Energy Technology (0.37%)*
2,414
Chromadex Corporation (3)(14)
419,020
157
159
MDEverywhere, Inc.
129
29
Subtotal: Healthcare Services, Other (0.03%)*
188
Cha Cha Search, Inc. (14)
48,232
InXpo, Inc. (14)
648,400
740,832
Total InXpo, Inc.
1,389,232
Jab Wireless, Inc. (14)
266,567
265
934
RichRelevance, Inc. (14)
112,612
Subtotal: Information Services (0.15%)*
577
976
218,684
88
234,280
636
Total Blurb, Inc.
452,964
935
268
CashStar, Inc. (14)
Preferred Series C-2
727,272
57
Gazelle, Inc. (14)
991,288
Just Fabulous, Inc.
206,184
1,102
1,521
24,561
63
Prism Education Group, Inc. (14)
200,000
174,562
78
Reply! Inc.
137,225
320
ShareThis, Inc. (14)
493,502
133
Tapjoy, Inc.
430,485
263
Tectura Corporation
Preferred Series B-1
253,378
WaveMarket, Inc.
1,083,779
Subtotal: Internet Consumer & Business Services (0.36%)*
3,752
2,334
17
Everyday Health, Inc. (pka Waterfront Media,Inc.) (3)
73,345
60
499
Mode Media Corporation (14)
407,457
482
Rhapsody International, Inc. (14)
715,755
384
Zoom Media Group, Inc.
1,204
348
Subtotal: Media/Content/Info (0.15%)*
1,274
994
Amedica Corporation (3)(14)
516,129
459
Avedro, Inc. (14)
1,308,451
400
Baxano Surgical, Inc. (3)
882,353
439
Gamma Medica, Inc.
357,500
170
171
263,688
Home Dialysis Plus, Inc.
403
438
InspireMD, Inc. (3)(5)(10)
168,351
242
455,539
370
MELA Sciences, Inc. (3)
69,320
2,568
408
NinePoint Medical, Inc. (14)
587,840
169
109,449
526,840
125
53,607
Total Novasys Medical, Inc.
689,896
10,535,275
1,252
221
954
66
1,632,084
678
Total Oraya Therapeutics, Inc.
1,633,038
744
Quanterix Corporation
69,371
103
91
SonaCare Medical, LLC (pka US HIFU, LLC)
409,704
United Orthopedic Group, Inc.
423,076
608
ViewRay, Inc. (14)
312,500
333
280
Subtotal: Medical Devices & Equipment (0.34%)*
6,900
2,222
360,000
Avnera Corporation
102,958
21
SiTime Corporation (14)
195,683
Subtotal: Semiconductors (0.00%)*
22
392,670
350
Braxton Technologies, LLC
168,750
CareCloud Corporation (14)
413,433
258
423
Central Desktop, Inc. (14)
522,769
296
Clickfox, Inc. (14)
1,038,563
456
592,019
730
354
Preferred Series C-A
46,109
1,676,691
1,074
830
Daegis Inc. (pka Unify Corporation) (3)(14)
718,860
1,434
80,587
1,865,650
Knowledge Holdings, Inc. (14)
550,781
396,430
Neos Geosolutions, Inc. (14)
Preferred Series 3
221,150
Soasta, Inc. (14)
410,800
691
772
Sonian, Inc. (14)
185,949
106
SugarSync, Inc. (14)
Preferred Series CC
332,726
Preferred Series DD
107,526
33
Total SugarSync, Inc.
440,252
111
118
992,595
252
123
White Sky, Inc. (14)
Preferred Series B-2
124,295
WildTangent, Inc. (14)
100,000
238
46
Subtotal: Software (0.49%)*
4,896
3,245
18
285,016
728
670
155,324
Subtotal: Specialty Pharmaceuticals (0.10%)*
1,036
180,480
1,575,965
1,756,445
394
40,436
225
215,436
325
Subtotal: Surgical Devices (0.11%)*
719
740
Total Warrant Investments (3.41%)*
38,786
22,401
Total Investments (152.23%)*
1,012,297
*
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 $42.7 million, $59.7 million and $17.0 million respectively. The tax cost of investments is $1.0 billion.
(3)
Except for warrants in twenty-nine publicly traded companies and common stock in eleven publicly traded companies, all investments are restricted at September 30, 2014 and were valued at fair value as determined in good faith by the Audit Committee of 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 at 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 owns at least 25% of the voting securities of the company or has greater than 50% representation on its board. There were no control investments at September 30, 2014.
(8)
Debt is on non-accrual status at September 30, 2014, and is therefore considered non-income producing.
(9)
Denotes that all or a portion of the debt investment is convertible senior debt.
(10)
Indicates assets that the Company deems not “qualifying assets” under section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of the Company’s total assets at the time of acquisition of any additional non-qualifying assets.
(11)
Denotes that all or a portion of the debt investment secures the notes offered in the Debt Securitization (as defined in Note 4).
(12)
Denotes that all or a portion of the debt investment principal includes accumulated PIK, or paid-in-kind, interest and is net of repayments.
(13)
Denotes that all or a portion of the debt investment includes an exit fee receivable.
(14)
Denotes that all or a portion of the investment in this portfolio company is held by HT II or HT III, the Company’s wholly-owned SBIC subsidiaries.
(15)
Subsequent to September 30, 2014, this company completed a public merger. Note that the September 30, 2014 fair value does not reflect any potential impact of the conversion of our shares to the new entity.
19
Type ofInvestment(1)
MaturityDate
PrincipalAmount
Debt
Labcyte, Inc.(11)
4,270
4,323
4,289
Subtotal: Biotechnology Tools (0.66%)*
American Superconductor Corporation(3)(11)
4,615
Brightsource Energy, Inc.
January 2014
Interest rate Prime + 8.25% or Floor rate of 11.50%
15,886
Enphase Energy, Inc.(11)
June 2014
1,315
1,358
22,236
Agrivida, Inc.
5,887
5,770
9,801
APTwater, Inc
Interest rate PRIME + 6.75% or Floor rate of 10.00%, PIK Interest 2.75%
18,085
17,874
BioAmber, Inc.(5)(10)
25,298
25,798
7,400
7,422
7,314
4,922
Fulcrum Bioenergy, Inc.(11)
9,944
Glori Energy, Inc.(11)
5,333
5,457
5,414
Polyera Corporation
5,809
5,797
5,686
SCIEnergy, Inc.(4)
4,448
4,596
4,685
Scifiniti (pka Integrated Photovoltaics, Inc.)
1,463
1,443
1,429
Stion Corporation.(4)(6)
4,571
4,005
15,277
Interest rate PRIME + 6.25% or Floor rate of 9.50%
4,503
4,374
4,338
Total TAS Energy, Inc.
19,651
19,760
14,888
14,889
136,985
137,131
Subtotal: Energy Technology (24.52%)*(13)
159,221
159,367
OpenPeak, Inc.(11)
10,029
10,714
10,814
19,682
19,875
30,396
30,690
Subtotal: Communications & Networking (4.72%)*
AcelRx Pharmaceuticals, Inc.(3)(10)
14,556
15,006
BIND Therapeutics, Inc.(3)
Interest rate Prime + 7.00% or Floor rate of 10.25%
4,407
4,458
Celsion Corporation(3)
Interest rate Prime + 8.00% or Floor rate of 11.25%
4,897
Dance Biopharm, Inc.
Interest rate PRIME + 7.4% or Floor rate of 10.65%
974
Intelliject, Inc.(11)
Interest rate PRIME + 5.75% or Floor rate of 11.00%
15,150
15,450
NuPathe, Inc.(3)
Interest rate Prime - 3.25% or Floor rate of 9.85%
5,749
5,629
5,744
Revance Therapeutics, Inc.
9,798
10,032
9,943
980
1,011
11,043
10,937
56,655
57,466
Subtotal: Drug Delivery (8.84%)*
ADMA Biologics, Inc.(3)
Interest rate Prime + 2.75% or Floor rate of 8.50%
4,956
4,892
Anacor Pharmaceuticals, Inc.
29,083
29,810
Aveo Pharmaceuticals, Inc.(3)(10)(11)
19,396
19,590
Cell Therapeutics, Inc.(3)(11)
Interest rate Prime + 9.00% or Floor rate of 12.25%
14,750
15,200
Cempra, Inc.(3)(11)
14,795
14,550
Cleveland BioLabs, Inc.(3)
5,909
Concert Pharmaceuticals, Inc.(4)
15,091
14,933
14,649
Coronado Biosciences, Inc.(3)(11)
Interest rate PRIME + 6.00% or Floor rate of 9.25%
13,654
13,720
13,449
Dicerna Pharmaceuticals, Inc.
Interest rate PRIME + 4.40% or Floor rate of 10.15%
5,026
4,981
Insmed, Incorporated(11)
19,708
19,535
Merrimack Pharmaceuticals, Inc.(3)
40,314
39,455
Neuralstem, Inc.(3)
8,000
7,874
8,035
Paratek Pharmaceuticals, Inc.
Interest rate Fixed 10.00%
36
45
Total Paratek Pharmaceuticals, Inc.
uniQure B.V.(5)(10)(11)
9,695
9,818
200,232
199,872
Subtotal: Drug Discovery & Development (30.75%)*
524
526
Identive Group, Inc.(3)(11)
5,938
5,696
5,755
OCZ Technology Group, Inc.
Interest rate Prime + 8.75% or Floor rate of 12.50%, PIK Interest 3.00%
Plures Technologies, Inc.(3)
Interest rate Prime + 12.75% or Floor rate of 16.00%, PIK Interest 4.00%
2,046
1,958
1,458
9,400
8,959
Subtotal: Electronics & Computer Hardware (1.38%)*
InstaMed Communications, LLC
1,875
1,907
Orion Healthcorp, Inc.
Interest rate LIBOR + 10.50% or Floor rate of 12.00%, PIK Interest 3.00%
6,591
6,467
6,413
Interest rate LIBOR + 9.50% or Floor rate of 11.00%
9,000
8,838
8,445
461
Total Orion Healthcorp, Inc.
16,091
15,769
15,318
Pacific Child & Family Associates, LLC
Interest rate LIBOR + 9.00% or Floor rate of 11.50%
1,946
2,017
1,988
Interest rate LIBOR + 11.00% or Floor rate of 14.00%, PIK interest 3.75%
6,836
6,867
6,833
Total Pacific Child & Family Associates, LLC
8,782
8,884
8,822
29,508
29,025
Subtotal: Healthcare Services, Other (4.47%)*
Eccentex Corporation(11)
657
658
185
InXpo, Inc.
2,550
2,384
Jab Wireless, Inc.
Interest rate Libor + 6.75% or Floor rate of 8.00%
29,822
Interest rate Prime + 6.75% or Floor rate of 8.00%
1,996
Total Jab Wireless, Inc.
32,000
31,818
Womensforum.com(11)
4,607
4,536
4,127
6,793
6,470
1,227
1,156
12,757
12,556
11,754
47,521
46,140
Subtotal: Information Services (7.10%)*
Gazelle, Inc.
October 2014
2,137
2,115
Tectura Corporation(8)
May 2014
3,566
10,777
5,943
310
2,757
22,807
22,806
12,576
24,921
14,691
Blurb, Inc.
6,351
6,216
6,054
CashStar, Inc.
Interest rate Prime + 6.25% or Floor rate 10.50%, PIK Interest 1.00%
4,018
3,944
3,916
Education Dynamics, LLC
Interest rate Libor + 12.5% or Floor rate 12.50%, PIK Interest 1.5%
24,685
24,284
23,582
Interest rate Prime + 7.00% or Floor rate of 10.25%, PIK Interest 2.50%
12,365
12,283
12,128
4,842
NetPlenish(8)
383
375
480
Reply! Inc.(11)
3,031
3,051
3,034
Interest rate Prime + 6.88% or Floor rate of 10.13%, PIK Interest 2.00%
9,169
9,086
Interest rate Prime + 7.25% or Floor rate of 11.00%, PIK Interest 2.00%
2,020
2,044
2,070
14,220
14,181
14,273
ShareThis, Inc.
14,578
14,160
VaultLogix, LLC
7,897
7,927
7,525
7,949
7,898
7,397
Total VaultLogix, LLC
15,847
15,826
14,923
WaveMarket, Inc.(11)
Interest rate Prime + 5.75% or Floor rate of 9.50%
9,940
9,665
106,148
103,545
Subtotal: Internet Consumer & Business Services (18.19%)*
131,069
118,236
3,858
Interest rate PRIME + 7.25% and PIK + 3.75% or Floor rate of 10.50%
4,288
4,122
4,071
Subtotal: Media/Content/Info (1.22%)*
7,981
7,929
Oraya Therapeutics, Inc.(9)(11)
Interest rate Fixed 7.00%
Baxano Surgical, Inc.(3)
Interest rate PRIME + 7.75% or Floor rate of 12.5%
7,222
Interest rate PRIME + 6.35% or Floor rate of 9.60%
9,732
InspireMD, Inc.(3)(5)(10)
9,696
Medrobotics Corporation
4,561
4,489
4,454
4,788
NinePoint Medical, Inc.
5,946
5,911
5,794
Interest rate PRIME + 5.50% or Floor rate of 10.25%
7,064
6,980
7,162
SonaCare Medical, LLC (pka US HIFU, LLC)(11)
5,667
5,754
24,647
25,166
ViewRay, Inc.
14,489
93,707
94,320
Subtotal: Medical Devices & Equipment (14.59%)*
94,206
94,819
1,032
1,006
SiTime Corporation
3,473
4,495
4,479
Subtotal: Semiconductors (0.69%)*
Clickfox, Inc.
September 2014
1,979
StartApp, Inc.
191
Touchcommerce, Inc.
Interest rate Prime + 2.25% or Floor rate of 6.50%
3,111
3,071
2,970
5,241
5,140
5,842
5,530
Hillcrest Laboratories, Inc.
2,660
2,630
2,604
Mobile Posse, Inc.
3,876
3,879
Neos Geosolutions, Inc.
Interest rate Prime + 5.75% or Floor rate of 10.50%
3,771
3,808
3,705
Sonian, Inc.
2,507
2,498
Interest rate Prime + 6.00% or Floor rate of 10.25%
4,688
4,767
28,372
28,315
Subtotal: Software (5.15%)*
33,613
33,455
Rockwell Medical, Inc.
March
2017
20,055
Subtotal: Specialty Pharmaceuticals (3.09%)*
Transmedics, Inc.(11)
7,250
7,207
Subtotal: Surgical Devices (1.11%)*
Total Debt (126.46%)*
835,882
821,988
NuGEN Technologies, Inc.
687
Subtotal: Biotechnology Tools (0.11%)*
GlowPoint, Inc.(3)
Communications &Networking
3,621
Subtotal: Communications & Networking (0.62%)*
4,002
Caivis Acquisition Corporation
Consumer &Business Products
598
IPA Holdings, LLC
676
Subtotal: Consumer & Business Products (0.24%)*
1,819
1,559
Subtotal: Diagnostic (0.12%)*
89,243
178
1,009
Merrion Pharmaceuticals,Plc(3)(5)(10)
Transcept Pharmaceuticals, Inc.(3)
140
Subtotal: Drug Delivery (0.20%)*
833
1,313
Acceleron Pharma, Inc.(3)
Drug Discovery &Development
256,410
1,505
9,286
Aveo Pharmaceuticals, Inc.(3)(10)
Dicerna Pharmaceuticals, Inc.(12)
20,107
503
1,055
Total Dicerna Pharmaceuticals, Inc.
162,965
1,503
1,283
Inotek PharmaceuticalsCorporation
546,448
2,912
85,450
Preferred Series H
244,158
329,608
1,005
Subtotal: Drug Discovery & Development (2.12%)*
8,355
13,788
26
Buzznet, Inc.
263,158
Good Technologies, Inc. (pka Visto Corporation)
Subtotal: Information Services (0.00%)*
853
Internet Consumer &Business Services
444
Trulia, Inc.(3)
29,340
141
1,035
Subtotal: Internet Consumer & Business Services (0.27%)*
1,759
Everyday Health, Inc. (pka Waterfront Media, Inc.)
145,590
425
Subtotal: Media/Content/Info (0.07%)*
Gelesis, Inc.(6)
Medical Devices &Equipment
466
269
Optiscan Biomedical, Corp.(6)
411
135
41,352,489
3,945
4,006
49,465,365
7,600
4,552
Subtotal: Medical Devices & Equipment (0.81%)*
9,775
5,287
1,607
1,088
2,695
Box, Inc.
390,625
7,031
124,511
2,241
3,974
932,203
4,501
16,779
849
337
Subtotal: Software (3.19%)*
6,751
20,754
Gynesonics, Inc.
73
1,621,553
580
749
2,497,389
1,112
945
303
212
886
1,401
Subtotal: Surgical Devices (0.36%)*
3,162
2,346
Total Equity (8.10%)*
36,808
52,670
27
Labcyte, Inc.
234,659
234
Subtotal: Biotechnology Tools (0.05%)*
401
243
Alphabet Energy, Inc.
176
American Superconductor Corporation(3)
214
Calera, Inc.
EcoMotors, Inc.
475
210
Glori Energy, Inc.
145,932
GreatPoint Energy, Inc.
44
Propel Fuels
233
1,061,623
360
Solexel, Inc.
278
Stion Corporation(6)
1,627
756
172
376
Trilliant, Inc.
34
Subtotal: Energy Technology (0.78%)*(13)
7,179
5,099
Intelepeer, Inc.
112
Preferred Series 2
661
158,536
72,727
Total Stoke, Inc.
231,263
Subtotal: Communications & Networking (0.20%)*
1,287
Intelligent Beauty, Inc.
1,027
650,000
Subtotal: Consumer & Business Products (0.22%)*
529
1,436
Navidea Biopharmaceuticals, Inc. (pka Neoprode)(3)
Subtotal: Diagnostic (0.02%)*
961
Alexza Pharmaceuticals, Inc.(3)
294
97,493
227
249
154
594
1,115
106,631
139
Revance Therapeutics, Inc.(12)
Preferred Series E-5
802,675
557
Subtotal: Drug Delivery (0.50%)*
3,476
3,243
39
31,750
Anthera Pharmaceuticals, Inc.(3)
Cell Therapeutics, Inc.(3)
679,040
405
601
Cempra, Inc.(3)
Chroma Therapeutics, Ltd.(5)(10)
Cleveland BioLabs, Inc(3)
Concert Pharmaceuticals, Inc.(12)
400,000
Coronado Biosciences, Inc.(3)
21,000
237
26,400
48
47,600
575
Horizon Pharma, Inc.(3)
302,143
155
488
648,798
295
1,045
Portola Pharmaceuticals, Inc.(3)
68,702
153
683
uniQure B.V.(5)(10)(12)
185,873
313
Subtotal: Drug Discovery & Development (0.85%)*
4,746
5,509
Identive Group, Inc.(3)
992,084
552,467
124
Subtotal: Electronics & Computer Hardware (0.04%)*
55
Subtotal: Healthcare Services, Other (0.01%)*
19,962
Cha Cha Search, Inc.
582,015
49
40
1,230,415
147
85
RichRelevance, Inc.
576
248
47
151,827
Invoke Solutions, Inc.
53,084
137,456
589
1,057
Prism Education Group, Inc.
241
Subtotal: Internet Consumer & Business Services (0.32%)*
2,973
2,078
110,018
Glam Media, Inc.
Subtotal: Media/Content/Info (0.05%)*
890
344
245
297
424,008
34,199
Total Medrobotics Corporation
458,207
207
MELA Sciences, Inc.(3)
693,202
288
232
95,498
716,948
677
134
812,446
743
201
785
Subtotal: Medical Devices & Equipment (0.54%)*
5,610
3,508
Subtotal: Semiconductors (0.03%)*
206
72
4,701
199,219
117
3,331
62,255
625
532,544
8,657
187
Central Desktop, Inc.
495
363
1,630,582
1,060
858
Daegis Inc. (pka Unify Corporation)(3)
1,433
SugarSync, Inc.
Total Sugarsync, Inc.
64
White Sky, Inc.
WildTangent, Inc.
Subtotal: Software (1.69%)*
4,301
11,009
335
Subtotal: Surgical Devices (0.12%)*
754
Total Warrants (5.48%)*
33,606
35,637
Total Investments (140.04%)*
906,297
Gross unrealized appreciation, gross unrealized depreciation, and net depreciation for federal income tax purposes totaled $48.8 million, $44.5 million and $4.3 million respectively. The tax cost of investments is $906.2 million
Except for warrants in twenty-five publicly traded companies and common stock in nine publicly traded companies, all investments are restricted at December 31, 2013 and were valued at fair value as determined in good faith by the Valuation Committee of 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.
Control investment that is defined under the Investment Company Act of 1940 as companies in which HTGC owns at least 25% of the voting securities of the company or has greater than 50% representation on its board.
Debt is on non-accrual status at December 31, 2013, and is therefore considered non-income producing.
Convertible Senior Debt
Subsequent to December 31, 2013, this company completed an initial public offering. Note that the December 31, 2013 fair value does not reflect any potential impact of the conversion of our preferred shares to common shares which may include reverse split associated with the offering.
In our quarterly and annual reports filed with the Commission prior to the Annual Report on Form 10-K for the year ended December 31, 2013, we referred to this industry sector as “Clean Tech.”
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Basis of Presentation
Hercules Technology Growth Capital, Inc. (the “Company”) is a specialty finance company focused on providing senior secured loans to venture capital-backed companies in technology-related markets, including technology, biotechnology, life science, and energy and renewables technology industries at all stages of development. The Company sources its investments through its principal office located in Palo Alto, CA, as well as through its additional offices in Boston, MA, New York, NY and McLean, VA. 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 elected to be treated for tax purposes as a regulated investment company, or RIC, under the Code (see Note 5). As an investment company, the Company follows accounting and reporting guidance in Accounting Standards Codification (“ASC”) 946.
Hercules Technology II, L.P. (“HT II”), Hercules Technology III, L.P. (“HT III”), and Hercules Technology IV, L.P. (“HT IV”), are Delaware limited partnerships that were formed in January 2005, September 2009 and December 2010, respectively. HT II and HT III were licensed to operate as small business investment companies (“SBICs”) under the authority of the Small Business Administration (“SBA”) on September 27, 2006 and May 26, 2010, respectively. 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. HT IV was formed in anticipation of receiving an additional SBIC license; however, the Company has not yet applied for such license, and HT IV currently has no assets or liabilities. The Company also formed Hercules Technology SBIC Management, LLC, or (“HTM”), a limited liability company in November 2003. HTM is a wholly owned subsidiary of the Company and serves as the limited partner and general partner of HT II and HT III (see Note 4 to the Company’s consolidated financial statements).
HT II and HT III hold approximately $142.8 million and $305.0 million in assets, respectively, and they accounted for approximately 9.2% and 19.7% of our total assets, respectively, prior to consolidation at September 30, 2014.
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). By investing through these wholly owned subsidiaries, the Company is able to benefit from the tax treatment of these entities and create a tax structure that is more advantageous with respect to the Company’s RIC status.
The consolidated financial statements include the accounts of the Company, its subsidiaries and its consolidated securitization VIE. 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 statement 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, 2013. The year-end consolidated statement of assets and liabilities data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP. 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.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company and its subsidiaries and all VIEs of which the Company is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation.
A VIE is an entity that either (i) has insufficient equity to permit the entity to finance its activities without additional subordinated financial support or (ii) has equity investors who lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the party with both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE.
To assess whether the Company has the power to direct the activities of a VIE that most significantly impact its economic performance, the Company considers all the facts and circumstances including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes identifying the activities that most significantly impact the VIE’s economic performance and identifying which party, if any, has power over those activities. In general, the party that makes the most significant decisions affecting the VIE is determined to have the power to direct the activities of a VIE. To assess whether the Company has the obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE, the Company considers all of its economic interests, including debt and equity interests, servicing rights and fee arrangements, and any other variable interests in the VIE. If the Company determines that it is the party with the power to make the most significant decisions affecting the VIE, and the Company has a potentially significant interest in the VIE, then it consolidates the VIE.
The Company performs ongoing reassessments, usually quarterly, of whether it is the primary beneficiary of a VIE. The reassessment process considers whether the Company has acquired or divested the power to direct the activities of the VIE through changes in governing documents or other circumstances. The Company also reconsiders whether entities previously determined not to be VIEs have become VIEs, based on certain events, and therefore are subject to the VIE consolidation framework.
As of the date of this report, the only VIE consolidated by the Company is its securitization VIE formed in conjunction with the issuance of the Asset-Backed Notes (See Note 4).
Valuation of Investments
At September 30, 2014, 83.3% 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 investments are carried at fair value in accordance with the 1940 Act and Accounting Standards Codification topic 820 Fair Value Measurements and Disclosures (“ASC 820”). The Company’s debt securities are primarily invested in venture capital-backed companies in technology-related markets, including technology, biotechnology, life science and energy and renewables technology industries. Given the nature of lending to these types of businesses, substantially all of 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 of Directors 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.
The Company may from time to time engage an independent valuation firm to provide the Company with valuation assistance with respect to certain 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 being initially valued by the investment professionals responsible for the portfolio investment;
(2) preliminary valuation conclusions are then documented and business based assumptions are discussed with the Company’s investment committee;
(3) the Audit Committee of the Board of Directors reviews the preliminary valuation of the investments in the portfolio as provided by the investment committee, which incorporates the results of the independent valuation firm as appropriate;
(4) the Board of Directors, upon the recommendation of the Audit Committee, 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 investment committee.
ASC 820 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. ASC 820 also requires disclosure 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. 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.
In accordance with ASU 2011-04, the following tables provide quantitative information about the Company’s Level 3 fair value measurements of the Company’s investments as of September 30, 2014 (unaudited) and December 31, 2013. In addition to the techniques and inputs noted in the tables below, according to the Company’s valuation policy, the Company may also use other valuation techniques and methodologies when determining the Company’s fair value measurements. The table below is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to the Company’s fair value measurements.
Investment Type - Level Three
Fair Value at
(in thousands)
Valuation
Techniques/Methodologies
Unobservable Input (a)
Range
Weighted
Average (b)
Pharmaceuticals
82,606
Originated Within 6 Months
Origination Yield
9.79% - 17.50%
12.58%
224,002
Market Comparable Companies
Hypothetical Market Yield
7.45% - 16.07%
13.07%
Premium/(Discount)
(1.00%) - 0.50%
Medical Devices
46,070
8.20% - 16.56%
13.90%
74,172
11.72% - 23.60%
14.88%
(1.00%) - 1.50%
9,367
Liquidation(c)
Probability weighting of alternative outcomes
25.00% - 75.00%
Technology
79,778
6.86% - 43.33%
14.39%
104,927
3.48% - 19.44%
14.09%
(0.50%) - 0.50%
50.00%
14.16%
58,209
12.25% - 17.53%
15.39%
(0.50%) - 1.00%
5,492
20.00% - 80.00%
Lower Middle Market
61,546
11.59% - 15.90%
13.80%
0.00% - 0.50%
17,737
10.00% - 75.00%
Debt Investments Where Fair Value Approximates Cost
91,917
Imminent Payoffs
21,939
Debt Investments Maturing in Less than One Year
Total Level Three Debt Investments
(a)
The significant unobservable inputs used in the fair value measurement of the Company’s debt securities are hypothetical market yields and premiums/(discounts). The hypothetical market yield is defined as the exit price of an investment in a hypothetical market to hypothetical market participants where buyers and sellers are willing participants. The premiums (discounts) relate to company specific characteristics such as underlying investment performance, security liens, and other characteristics of the investment. Significant increases (decreases) in the inputs in isolation would result in a significantly lower (higher) fair value measurement, depending on the materiality of the investment. Debt investments in the industries noted in the Company’s Consolidated Schedule of Investments are included in the industries note above as follows:
Pharmaceuticals, above, is comprised of debt investments in the Therapeutic, Specialty Pharmaceuticals, Drug Discovery and Development, Drug Delivery, and Diagnostics and Biotechnology industries in the Schedule of Investments.
Medical Devices, above, is comprised of debt investments in the Therapeutic, Surgical Devices, Medical Devices and Equipment and Biotechnology Tools industries in the Schedule of Investments.
Technology, above, is comprised of debt investments in the Software, Semiconductors, Internet Consumer and Business Services, Information Services, and Communications and Networking industries in the Schedule of Investments.
Lower Middle Market, above, is comprised of debt investments in the Communications and Networking, Electronics and Computer Hardware, Healthcare Services - Other, Information Services, Internet Consumer and Business Services, Media/Content/Info, and Specialty Pharmaceuticals industries in the Schedule of Investments.
Energy Technology, above, aligns with the Energy Technology Industry in the Schedule of Investments.
(b)
Weighted averages are calculated based on the fair market value of each investment.
(c)
The significant unobservable input s used in the fair value measurement of impaired debt securities is the probability weighting of alternative outcomes.
Investment Type – Level
Three Debt Investments
Average (c)
25,811
12.56% - 14.53%
13.36%
250,607
13.83% - 15.47%
14.13%
(1.00%) - 0.00%
46,900
13.54% - 17.37%
14.87%
34,723
14.32% - 17.37%
15.23%
(1.00%) - 1.00%
18,796
10.62% - 15.97%
14.26%
98,290
14.72% - 21.08%
15.48%
0.00% - 1.00%
1,643
Liquidation
30.00% - 70.00%
32,597
14.68% - 15.87%
15.17%
108,238
15.37%
(0.50%) - 1.50%
121,347
14.83% - 19.73%
16.12%
Broker Quote (b)
Price Quotes
99.50% - 100.25% of par
$2.0 - $22.5 million
Debt Investments Where Fair Value Approximates Amortized Cost
15,906
Convertible Debt at Par
The significant unobservable inputs used in the fair value measurement of the Company’s securities are hypothetical market yields and premiums/(discounts). The hypothetical market yield is defined as the exit price of an investment in a hypothetical market to hypothetical market participants where buyers and sellers are willing participants. The premiums (discounts) relate to company specific characteristics such as underlying investment performance, security liens, and other characteristics of the investment. Significant increases (decreases) in the inputs in isolation would result in a significantly lower (higher) fair value measurement, depending on the materiality of the investment. Debt investments in the industries noted in the Company’s Consolidated Schedule of Investments are included in the industries note above as follows:
Energy Technology, above, aligns with the Energy Technology Industry in the Schedule of Investments. In our quarterly and annual reports filed with the Commission prior to the 2013 Annual Report on Form 10-K, we referred to the Energy Technology Industry as “Clean Tech” and we referred to these investments as “Clean Tech” in the Schedule of Investments included in such reports.
A broker quote valuation technique was used to derive the fair value of debt investments which are part of a syndicated facility.
35
Equity and Warrant Investments
Valuation Techniques/
Methodologies
Weighted Average (e)
9,434
EBITDA Multiple (b)
4.6x - 22.8x
8.9x
Revenue Multiple (b)
0.8x - 3.7x
2.2x
Discount for Lack of Marketability (c)
9.24% - 35.82%
16.55%
Average Industry Volatility (d)
54.11% - 97.91%
61.99%
Risk-Free Interest Rate
0.10% - 0.89%
0.15%
Estimated Time to Exit (in months)
10 - 32
42,307
Market Adjusted OPM Backsolve
34.93% - 84.30%
55.96%
0.10% - 1.38%
0.21%
17 - 47
7,980
0.0x - 96.6x
17.1x
0.3x - 13.9x
3.7x
11.76% - 35.82%
21.98%
38.61% - 90.38%
62.85%
0.05% - 1.38%
0.71%
7 - 47
9,783
29.91% - 97.91%
67.12%
0.05% - 2.66%
0.82%
7 - 48
Total Level Three Warrant and Equity Investments
69,504
The significant unobservable inputs used in the fair value measurement of the Company’s warrant and equity-related securities are revenue and/or EBITDA multiples and discounts for lack of marketability. Additional inputs used in the Black Scholes option pricing model include industry volatility, risk free interest rate and estimated time to exit. Significant increases (decreases) in the inputs in isolation would result in a significantly higher (lower) fair value measurement, depending on the materiality of the investment. For some investments, additional consideration may be given to data from the last round of financing or merger/acquisition events near the measurement date.
Represents amounts used when the Company has determined that market participants would use such multiples when pricing the investments.
Represents amounts used when the Company has determined market participants would take into account these discounts when pricing the investments.
(d)
Represents the range of industry volatility used by market participants when pricing the investment.
(e)
10,244
8.6x - 17.7x
0.7x - 13.8x
9.1% - 23.6%
43.4% - 110.7%
0.1% - 0.4%
6 - 30
9,289
45.6% - 109.7%
0.1% - 0.9%
6 - 42
18,127
Other
44.0%
0.1%
10,200
5.0x - 51.4x
0.5x - 13.8x
6.4% - 36.0%
21.3% - 110.7%
0.1% - 1.0%
6 - 48
8,913
35.7% - 109.9%
0.1% - 2.7%
3 - 48
9,595
44.0% - 56.9%
12 - 48
66,368
Represents the range of average industry volatility used by market participants when pricing the investment.
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 venture capital-backed companies in technology- related markets, including technology, biotechnology, life science and energy and renewables technology industries. 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 debt instruments for these investment securities to be traded or exchanged.
In making a good faith determination of the value of our investments, the Company generally starts with the cost basis of the investment, which includes the value attributed to the OID, if any, and PIK interest or other receivables which have been accrued to principal as earned. The Company then applies the valuation methods as set forth below.
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. The Company determines the yield at inception for each debt investment. The Company then uses senior secured, leveraged loan yields provided by third party providers to determine the change in market yields between inception of the debt security and the measurement date. Industry specific indices are used to benchmark/assess market based movements. Under this process, the Company also evaluates the collateral for recoverability of the debt investments as well as applies all of its historical fair value analysis.
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 credit adjusted hypothetical yield for each investment as of the measurement date. The anticipated future cash flows from each investment are then discounted at the hypothetical yield to estimate each 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 financial condition and market changing events that impact valuation, estimated remaining life, current market yields and interest rate spreads of similar securities as of the measurement date. The Company values its syndicated debt investments using broker quotes and bond indices amongst other factors. 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 debt investment is doubtful or, if under the in-exchange premise, when the value of a debt security is less than the 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 is 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 investment and warrants or other equity-related securities received. Any resulting discount on the debt investment 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. The Company has a limited number of equity securities in public companies. In accordance with the 1940 Act, unrestricted publicly traded securities for which market quotations are readily available are valued at the closing market quote on the measurement date.
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 securities. 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.
37
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 September 30, 2014 (unaudited) and as of December 31, 2013. The Company transfers investments in and out of Level 1, 2 and 3 securities as of the beginning balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period. During the nine months ended September 30, 2014, there were no transfers between Levels 1 or 2.
Balance
September 30,
Quoted Prices In
Active Markets For
Identical Assets
Significant
Other Observable
Inputs
Unobservable
Description
(Level 1)
(Level 2)
(Level 3)
Senior secured debt
Preferred stock
50,476
Common stock
18,113
16,848
1,265
Warrants
4,638
17,763
977,427
December 31,
35,554
17,116
15,009
2,107
6,930
28,707
888,356
The table below presents 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 nine months ended September 30, 2014 (unaudited) and year ended December 31, 2013.
Balance,
January 1, 2014
Net Realized
(Losses) (1)
Net Change in
(Depreciation) (2)
Purchases
Sales
Repayments
Gross
Transfers
into
Level 3 (3)
out of
Senior Debt
(7,799
412,757
(317,536
(1,487
Preferred Stock
(250
10,358
5,028
(503
1,769
(1,480
689
(1,189
517
(13,998
6,168
(1,682
(1,949
956
(11,781
423,953
(3,374
(4,916
January 1, 2013
Gains (Losses) (1)
Level 3 (4)
827,540
(9,536
(8,208
484,367
(8
(469,780
769
(3,156
33,178
7,968
7,682
6,198
(18,572
776
(1,676
2,367
(1,103
22,140
6,173
6,524
(10,350
(1,037
885,225
3,689
4,544
497,839
(28,930
1,638
(5,869
Includes net realized gains (losses) recorded as realized gains or losses in the accompanying consolidated statements of operations.
Included in change in net unrealized appreciation (depreciation) in the accompanying consolidated statements of operations.
Transfers in/out of Level 3 during the nine months ended September 30, 2014 relate to the conversion of Paratek Pharmaceuticals, Inc., SCI Energy, Inc., Oraya Therapeutics, Inc., and Neuralstem, Inc. debt to equity, the exercise of warrants in Box, Inc. to equity, the conversion of warrants in Glori Energy, Inc. to equity in the company’s reverse public merger and the initial public offerings of Concert Pharmaceuticals, Inc., Dicerna Pharmaceuticals, Inc., Everyday Health, Inc., Revance Therapeutics, Inc., and UniQure BV.
Transfers in/out of Level 3 during the year ended December 31, 2013 relate to the conversion of Optiscan BioMedical, Inc., Gynesonics, Inc., Philotic, Inc., and Tethys BioScience, Inc. debt to equity, the conversion of OCZ Technology warrants to principal and the initial public offerings of Portola Pharmaceuticals, Inc., Acceleron Pharma, Inc., Bind, Inc., and ADMA Biologics, Inc.
For the nine months ended September 30, 2014, approximately $9.8 million in net unrealized appreciation and approximately $166,000 in net unrealized depreciation was recorded for preferred stock and common stock Level 3 investments, respectively, relating to assets still held at the reporting date. For the same period, approximately $6.3 million and $7.8 million in net unrealized depreciation was recorded for warrant and debt Level 3 investments, respectively, relating to assets still held at the reporting date.
For the year ended December 31, 2013, approximately $4.4 million and $4.1 million in net unrealized appreciation was recorded for preferred stock and warrant Level 3 investments, respectively, relating to assets still held at the reporting date. For the same period, approximately $8.2 million and $1.1 million in net unrealized depreciation was recorded for debt and common stock Level 3 investments, respectively, relating to assets still held at the reporting date.
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.
The following table summarizes our realized and unrealized gain and loss and changes in our unrealized appreciation and depreciation on affiliate investments for the three and nine months ended September 30, 2014 and 2013 (unaudited). The Company did not hold any Control investments at either September 30, 2014 or 2013.
Three Months Ended September 30, 2014
Nine Months Ended September 30, 2014
Type
Investment
Income
Unrealized (Depreciation)/
Reversal of
Gain/(Loss)
Gelesis, Inc.
Affiliate
316
(36
(156
Optiscan BioMedical, Corp.
6,029
(23
(67
Stion Corporation
606
1,777
(2,634
Three Months Ended September 30, 2013
Nine Months Ended September 30, 2013
September 30, 2013
523
(487
(1,143
12,374
566
(505
1,693
(325
12,897
During the year ended December 31, 2013, Stion Corporation became classified as an affiliate.
A summary of the composition of the Company’s investment portfolio as of September 30, 2014 (unaudited) and December 31, 2013 at fair value is shown as follows:
Investments at
Fair Value
Percentage of Total
Portfolio
Senior secured debt with warrants
648,298
64.9
%
634,820
69.7
282,026
28.2
222,805
24.5
5.1
3.9
1.8
1.9
100.0
The increase in senior secured debt is consistent with the overall increase in the investment portfolio at September 30, 2014 from December 31, 2013. The decrease in senior secured debt with warrants is primarily due to exercises of the Company’s outstanding warrants to equity in four portfolio companies, with a cumulative fair value of approximately $65.0 million, during the nine-months ended September 30, 2014. As a result, the existing debt investments that were included in senior secured debt with warrants at December 31, 2013 are included in senior secured debt at September 30, 2014.
A summary of the Company’s investment portfolio, at value, by geographic location as of September 30, 2014 (unaudited) and December 31, 2013 is shown as follows:
United States
943,918
94.5
864,003
94.9
Canada
25,336
2.5
2.8
Netherlands
19,905
2.0
10,131
1.1
Israel
9,754
1.0
9,863
England
0.1
The following table shows the fair value of the Company’s portfolio by industry sector at September 30, 2014 (unaudited) and December 31, 2013:
232,214
23.2
219,169
24.1
139,154
13.9
103,614
11.4
112,503
11.3
65,218
7.2
106,128
10.6
122,073
13.4
98,555
9.9
164,466
18.1
83,247
8.3
62,022
6.8
73,127
7.3
2.2
56,292
5.6
35,979
4.0
29,361
2.9
8,679
25,309
2,995
0.3
14,917
1.5
46,565
9,822
10,307
7,666
0.8
0.5
5,354
0.6
29,080
3.2
3,894
0.4
5,275
902
9,211
During the three and nine months ended September 30, 2014, the Company funded investments in debt securities totaling approximately $125.1 million and $408.3 million, respectively. During the three and nine months ended September 30, 2014, the Company funded equity investments totaling approximately $3.5 million and $5.1 million, respectively. During the three months ended September 30, 2014 the Company converted approximately $250,000 of debt to equity in one portfolio company and during the nine months ended September 30, 2014 the Company converted approximately $1.5 million of debt to equity in four portfolio companies.
During the three and nine months ended September 30, 2013, the Company funded investments in debt securities totaling approximately $67.5 million and $405.4 million, respectively. During the three and nine months ended September 30, 2013, the Company funded equity investments totaling approximately $1.5 million and $3.5 million, respectively. The Company did not convert any debt to equity in the three months ended September 30, 2013 and converted approximately $836,000 of debt to equity in three portfolio companies in the nine months ended September 30, 2013. The Company converted approximately $803,000 of warrants to debt in both the three and nine months ended September 30, 2013.
No single portfolio investment represents more than 10% of the fair value of the investments as of September 30, 2014 and December 31, 2013.
During the three and nine months ended September 30, 2014, the Company recognized net realized gains of approximately $5.7 million (or $0.09 per share) and $13.0 million (or $0.21 per share) on the portfolio, respectively. During the three months ended September 30, 2014, the Company recorded gross realized gains of approximately $5.9 million primarily from the sale of investments in two portfolio companies, including Acceleron Pharma ($3.1 million) and IPA Holdings ($1.5 million). These gains were partially offset by gross realized losses of approximately $218,000 from the liquidation of the Company’s investments in two portfolio companies. During the nine months ended September 30, 2014, the Company recorded gross realized gains of approximately $13.8 million primarily from the sale of investments in six portfolio companies, including Acceleron Pharma ($4.0 million), Neuralstem ($1.7 million), IPA Holdings ($1.5 million), Cell Therapeutics ($1.3 million), Trulia ($1.0 million), and Portola Pharmaceuticals ($700,000).These gains were partially offset by gross realized losses of approximately $748,000 from the liquidation of the Company’s investments in eight portfolio companies.
During the three and nine months ended September 30, 2013, the Company recognized net realized gains of approximately $7.1 million and $11.3 million on the portfolio, respectively. During the three months ended September 30, 2013, the Company recorded gross realized gains of approximately $7.8 million primarily from the sale of investments in three portfolio companies, including iWatt, Inc. ($4.7 million), AcelRx, Inc. ($1.1 million) and Facebook, Inc. ($728,000). These gains were partially offset by gross realized losses of $460,000 from the liquidation of the Company’s investments in six portfolio companies. During the nine months ended September 30, 2013, the Company recorded gross realized gains of approximately $17.5 million primarily from the sale of investments in eight portfolio companies. These gains were partially offset by approximately $6.2 million in gross realized losses from the liquidation of the Company’s investments in nineteen portfolio companies.
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. 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 $3.9 million and $4.0 million of unamortized fees at September 30, 2014 and December 31, 2013, respectively, and approximately $21.4 million and $14.4 million in exit fees receivable at September 30, 2014 and December 31, 2013, respectively.
The Company has debt investments 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 $851,000 and $889,000 in PIK income during the three months ended September 30, 2014 and 2013, respectively. The Company recorded approximately $2.6 million and $2.7 million in PIK income during the nine months ended September 30, 2014 and 2013, 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 three and nine months ended September 30, 2014 and 2013.
In the majority of cases, the Company collateralizes its investments by obtaining a first priority security interest in a portfolio company’s assets, which may include its intellectual property. In other cases, the Company may obtain a negative pledge covering a company’s intellectual property. At September 30, 2014, approximately 59.4% of the Company’s portfolio company debt investments were secured by a first priority security in all of the assets of the portfolio company, including their intellectual property, and 40.6% of the debt investments were to portfolio companies that were prohibited from pledging or encumbering their intellectual property. At September 30, 2014 the Company had no equipment only liens on any of our portfolio companies.
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 Convertible Senior Notes, 2019 Notes payable (the “April 2019 Notes” and the “September 2019 Notes”, together the “2019 Notes”), the 2024 Notes, the Asset-Backed Notes and the SBA debentures as sources of liquidity remain a strategic advantage due to their flexible structure, long-term duration, and low fixed interest rates. At September 30, 2014, the April 2019 Notes were trading on the New York Stock Exchange for $1.020 per dollar at par value, the September 2019 Notes were trading on the New York Stock Exchange for $1.015 per dollar at par value and the 2024 Notes were trading on the New York Stock Exchange for $0.988 per dollar at par value. Based on market quotations on September 30, 2014, the Convertible Senior Notes were trading for $1.258 per dollar at par value and the Asset-Backed Notes were trading for $1.003 per dollar at par value. 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 the SBA debentures would be approximately $195.8 million, compared to the carrying amount of $190.2 million as of September 30, 2014.
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 2.
The liabilities of the Company below are recorded at amortized cost and not at fair value on the Consolidated Statement of Assets and Liabilities. The following table provides additional information about the level in the fair value hierarchy of the Company’s liabilities at September 30, 2014 (unaudited) and December 31, 2013:
Observable Inputs
Convertible Senior Notes
51,461
Asset Backed Notes
28,021
April 2019 Notes
86,180
September 2019 Notes
87,145
101,805
SBA Debentures
195,841
105,206
89,893
86,281
87,248
222,742
4. Borrowings Long Term
Outstanding Borrowings
At September 30, 2014 (unaudited) and December 31, 2013, the Company had the following available borrowings and outstanding borrowings:
Total Available
Carrying Value (1)
SBA Debentures (2)
Convertible Senior Notes (3)
40,923
75,000
Wells Facility
Union Bank Facility
682,438
531,527
664,921
557,440
Except for the Convertible Senior Notes, all carrying values are the same as the principal amount outstanding.
In March 2014, the Company repaid $34.8 million of SBA debentures under HT II, priced at approximately 6.38%, including annual fees. At September 30, 2014, the total available borrowings under the SBA debentures were $190.2 million, of which $41.2 million was available in HT II and $149.0 million was available in HT III. At December 31, 2013, the total available borrowings under the SBA debentures were $225.0 million, of which $76.0 million was available in HT II and $149.0 million was available in HT III.
During the three months ended September 30, 2014, holders of approximately $34.1 million of the Company’s Convertible Senior Notes exercised their conversion rights. The balance at September 30, 2014 represents the remaining aggregate principal amount outstanding of the Convertible Senior Notes less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes. The total unaccreted discount for the Convertible Senior Notes was approximately $911,000 at September 30, 2014 and $2.5 million at December 31, 2013.
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. With the Company’s net investment of $38.0 million in HT II as of September 30, 2014, HT II has the capacity to issue a total of $41.2 million of SBA guaranteed debentures, subject to SBA approval, of which $41.2 million was available at September 30, 2014. As of September 30, 2014, HT II has paid the SBA commitment fees and facility fees of approximately $1.5
million and $3.6 million, respectively. As of September 30, 2014 the Company held investments in HT II in 42 companies with a fair value of approximately $110.9 million, accounting for approximately 11.1% of the Company’s total portfolio at September 30, 2014.
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 $74.5 million in HT III as of September 30, 2014, HT III has the capacity to issue a total of $149.0 million of SBA guaranteed debentures, of which $149.0 million was outstanding as of September 30, 2014. As of September 30, 2014, HT III has paid commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of September 30, 2014, the Company held investments in HT III in 42 companies with a fair value of approximately $255.5 million accounting for approximately 25.6% of the Company’s total portfolio at September 30, 2014.
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 $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years. In addition, SBICs must devote 25.0% of its investment activity to “smaller” enterprises as defined by the SBA. A smaller enterprise 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 HT 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 September 30, 2014 as a result of having sufficient capital as defined under the SBA regulations.
The rates of borrowings under various draws from the SBA beginning in March 2009 are set semiannually in March and September and range from 2.25% to 4.62%. Interest payments on SBA debentures are payable semiannually. 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 March 2009, the initial maturity of SBA debentures will occur in March 2019. In addition, the SBA charges a fee that is set annually, depending on the Federal fiscal year the leverage commitment was delegated by the SBA, regardless of the date that the leverage was drawn by the SBIC. The annual fees related to HT II debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year in which the underlying commitment was closed. The annual fees on other debentures have been set at 0.906%. The annual fees related to HT III debentures that pooled on March 27, 2013 were 0.804%. The annual fees on other debentures have been set at 0.515%. The average amount of debentures outstanding for the three months ended September 30, 2014 for HT II was approximately $41.2 million with an average interest rate of approximately 4.56%. The average amount of debentures outstanding for the three months ended September 30, 2014 for HT III was approximately $149.0 million with an average interest rate of approximately 3.46%. The average amount of debentures outstanding for the nine months ended September 30, 2014 for HT II was approximately $48.6 million with an average interest rate of approximately 4.80%. The average amount of debentures outstanding for the nine months ended September 30, 2014 for HT III was approximately $149.0 million with an average interest rate of approximately 3.42%.
As of September 30, 2014, 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. In aggregate, at September 30, 2014, with the Company’s net investment of $112.5 million, HT II and HT III have the capacity to issue a total of $190.2 million of SBA-guaranteed debentures, subject to SBA approval. In March 2014, the Company repaid $34.8 million of SBA debentures under HT II, priced at approximately 6.38%, including annual fees. At September 30, 2014, the Company has issued $190.2 million in SBA-guaranteed debentures in the Company’s SBIC subsidiaries.
The Company reported the following SBA debentures outstanding as of September 30, 2014 (unaudited) and December 31, 2013:
Issuance/Pooling Date
Interest Rate (1)
SBA Debentures:
March 26, 2008
March 1, 2018
6.38%
34,800
March 25, 2009
March 1, 2019
5.53%
18,400
September 23, 2009
September 1, 2019
4.64%
3,400
September 22, 2010
September 1, 2020
3.62%
6,500
3.50%
22,900
March 29, 2011
March 1, 2021
4.37%
28,750
September 21, 2011
September 1, 2021
3.16%
March 21, 2012
March 1, 2022
3.28%
3.05%
11,250
September 19, 2012
September 1, 2022
24,250
March 27, 2013
March 1, 2023
24,750
Total SBA Debentures
Interest rate includes annual charge
On March 6, 2012, the Company and U.S. Bank National Association (the “Trustee”) entered into an indenture (the “Base Indenture”). On April 17, 2012, the Company and the Trustee entered into the First Supplemental Indenture to the Base Indenture (the “First Supplemental Indenture”), dated April 17, 2012, relating to the Company’s issuance, offer and sale of $43.0 million aggregate principal amount of 7.00% senior notes due 2019 (the “April 2019 Notes”). The sale of the April 2019 Notes generated net proceeds, before expenses, of approximately $41.7 million.
In July 2012, the Company reopened the Company’s April 2019 Notes and issued an additional $41.5 million in aggregate principal amount of April 2019 Notes, which includes exercise of an over-allotment option, bringing the total amount of the April 2019 Notes issued to approximately $84.5 million in aggregate principal amount.
On September 24, 2012, the Company and the Trustee, entered into the Second Supplemental Indenture to the Base Indenture (the “Second Supplemental Indenture”), dated as of September 24, 2012, relating to the Company’s issuance, offer and sale of $75.0 million aggregate principal amount of 7.00% senior notes due 2019 (the “September 2019 Notes” and, together with the April 2019 Notes, the “2019 Notes”). The sale of the September 2019 Notes generated net proceeds, before expenses, of approximately $72.75 million.
In October 2012, the underwriters exercised their over-allotment option for an additional $10.9 million of the September 2019 Notes, bringing the total amount of the September 2019 Notes issued to approximately $85.9 million in aggregate principal amount.
As of September 30, 2014 (unaudited) and December 31, 2013, the 2019 Notes payable is comprised of:
84,490
85,874
Carrying Value of 2019 Notes
The April 2019 Notes will mature on April 30, 2019 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after April 30, 2015, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The April 2019 Notes bear interest at a rate of 7.00% per year payable quarterly on January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2012, and trade on the New York Stock Exchange under the trading symbol “HTGZ.”
The April 2019 Notes are the Company’s direct unsecured obligations and rank: (i) pari passu with the Company’s other outstanding and future senior unsecured indebtedness, including without limitation, the $40.9 million in aggregate principal amount of the Convertible Senior Notes; (ii) senior to any of the Company’s future indebtedness that expressly provides it is subordinated to the April 2019 Notes; (iii) effectively subordinated to all the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which the Company subsequently grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under the Company’s Credit Facilities; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries, including without limitation, the indebtedness of Hercules Technology II, L.P. and Hercules Technology III, L.P. and borrowings under the Company’s revolving senior secured credit facility with Wells Fargo Capital Finance, LLC.
The Base Indenture, as supplemented by the First Supplemental Indenture, contains certain covenants including covenants requiring the Company’s compliance with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act to comply with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act and to provide financial information to the holders of the April 2019 Notes and the Trustee if the Company should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the First Supplemental Indenture. The Base Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding April 2019 Notes in a series may declare such April 2019 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period.
The April 2019 Notes were sold pursuant to an underwriting agreement dated April 11, 2012 among the Company and Stifel, Nicolaus & Company, Incorporated, as representative of the several underwriters named in the underwriting agreement.
The September 2019 Notes will mature on September 30, 2019 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after September 30, 2015, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The September 2019 Notes bear interest at a rate of 7.00% per year payable quarterly on March 30, June 30, September 30 and December 30 of each year, commencing on December 30, 2012, and trade on the New York Stock Exchange under the trading symbol “HTGY.”
The September 2019 Notes are the Company’s direct unsecured obligations and rank: (i) pari passu with the Company’s other outstanding and future senior unsecured indebtedness, including without limitation, the $40.9 million in aggregate principal amount of the Convertible Senior Notes; (ii) senior to any of the Company’s future indebtedness that expressly provides it is subordinated to the September 2019 Notes; (iii) effectively subordinated to all the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which the Company subsequently grants security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under the Company’s credit facilities; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries, including without limitation, the indebtedness of Hercules Technology II, L.P. and Hercules Technology III, L.P. and borrowings under the Company’s revolving senior secured credit facility with Wells Fargo Capital Finance.
The Base Indenture, as supplemented by the Second Supplemental Indenture, contains certain covenants including covenants requiring the Company to comply with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18 (a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act to comply with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act and to provide financial information to the holders of the September 2019 Notes and the Trustee if the Company should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the Second Supplemental Indenture. The Base Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding September 2019 Notes in a series may declare such September 2019 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period.
The September 2019 Notes were sold pursuant to an underwriting agreement dated September 19, 2012 among the Company and Stifel, Nicolaus & Company, Incorporated, as representative of the several underwriters named in the underwriting agreement.
For the three and nine months ended September 30, 2014 and 2013 (unaudited), the components of interest expense and related fees and cash paid for interest expense for the April 2019 Notes and September 2019 Notes are as follows:
Stated interest expense
8,944
Amortization of debt issuance cost
725
Total interest expense and fees
3,224
9,669
Cash paid for interest expense and fees
As of September 30, 2014, the Company was in compliance with the terms of the Base Indenture, and respective supplemental indentures thereto, governing the April 2019 Notes and September 2019 Notes.
On July 14, 2014, the Company and U.S. Bank, N.A. (the “Trustee”), entered into the Third Supplemental Indenture (the “Third Supplemental Indenture”) to the Base Indenture between the Company and the Trustee, dated July 14, 2014, relating to the Company’s issuance, offer and sale of $100.0 million aggregate principal amount of 2024 Notes. On August 6, 2014, the underwriters issued notification to exercise their over-allotment option for an additional $3.0 million in aggregate principal amount of the 2024 Notes. The sale of the 2024 Notes generated net proceeds of approximately $99.9 million.
The 2024 Notes will mature on July 30, 2024 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after July 30, 2017, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The 2024 Notes bear interest at a rate of 6.25% per year payable quarterly on January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2014, and trade on the New York Stock Exchange under the trading symbol “HTGX.”
The 2024 Notes will be the Company’s direct unsecured obligations and will rank: (i) pari passu with the Company’s other outstanding and future senior unsecured indebtedness, including without limitation, the approximately $84.5 million 7.00% Senior Notes due April 30, 2019 (the “April 2019 Notes”); the approximately $85.9 million 7.00% Senior Notes due September 30, 2019 (the “September 2019 Notes” and together with the April 2019 Notes, the “2019 Notes”), the $40.9 million 6.00% Convertible Senior Notes due 2016 (the “Convertible Senior Notes”) and the approximately $28.0 million fixed-rate asset-backed notes (the “Asset-Backed Notes”); (ii) senior to any of the Company’s future indebtedness that expressly provides it is subordinated to the 2024 Notes; (iii) effectively subordinated to all the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which the Company subsequently grants security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under the Company’s credit facilities; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries, including without limitation, the indebtedness of HT II and HT III and any borrowings under the Company’s revolving senior secured credit facility with Wells Fargo Capital Finance.
The Base Indenture, as supplemented by the Third Supplemental Indenture, contains certain covenants including covenants requiring the Company to comply with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act and to comply with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the Third Supplemental Indenture. The Base Indenture, as supplemented by the Third Supplemental Indenture, also contains certain reporting requirements, including a requirement that the Company provide financial information to the holders of the 2024 Notes and the Trustee if the Company should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. The Base Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding 2024 Notes in a series may declare such 2024 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period. As of September 30, 2014, the Company was in compliance with the terms of the Base Indenture as supplemented by the Third Supplemental Indenture.
At September 30, 2014, the 2024 Notes had an outstanding principal balance of $103.0 million.
For the three and nine months ended September 30, 2014 (unaudited), the components of interest expense and related fees and cash paid for interest expense for the 2024 Notes are as follows:
1,068
1,137
On December 19, 2012, the Company completed a $230.7 million term debt securitization in connection with which an affiliate of the Company’s made an offer of $129.3 million in aggregate principal amount of fixed-rate asset-backed notes (the “Asset-Backed Notes”), which Asset-Backed Notes were rated A2(sf) by Moody’s Investors Service, Inc. The Asset-Backed Notes were issued by Hercules Capital Funding Trust 2012-1 pursuant to a note purchase agreement, dated as of December 12, 2012, by and among the Company, Hercules Capital Funding 2012-1 LLC, as Trust Depositor (the “Trust Depositor”), Hercules Capital Funding Trust 2012- 1, as Issuer (the “Issuer”), and Guggenheim Securities, LLC, as Initial Purchaser, and are backed by a pool of senior loans made to certain of the Company’s portfolio companies and secured by certain assets of those portfolio companies and are to be serviced by the Company. Interest on the Asset-Backed Notes will be paid, to the extent of funds available, at a fixed rate of 3.32% per annum. The Asset-Backed Notes have a stated maturity of December 16, 2017.
As part of this transaction, the Company entered into a sale and contribution agreement with the Trust Depositor under which the Company has agreed to sell or have contributed to the Trust Depositor certain senior loans made to certain of the Company’s portfolio companies (the “Loans”). The Company has made customary representations, warranties and covenants in the sale and contribution agreement with respect to the Loans as of the date of their transfer to the Trust Depositor.
In connection with the issuance and sale of the Asset-Backed Notes, the Company has made customary representations, warranties and covenants in the note purchase agreement. The Asset-Backed Notes are secured obligations of the Issuer and are non-recourse to the Company. The Issuer also entered into an indenture governing the Asset-Backed Notes, which includes customary representations, warranties and covenants. The Asset-Backed Notes were sold without being registered under the Securities Act of 1933, as amended (the “Securities Act”), to “qualified institutional buyers” in compliance with the exemption from registration provided by Rule 144A under the Securities Act and to institutional “accredited investors” (as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act) who in each case, are “qualified purchasers” for purposes of Section 3(c)(7) under the 1940 Act. In addition, the Trust Depositor entered into an amended and restated trust agreement, which includes customary representation, warranties and covenants.
The Loans are serviced by the Company pursuant to a sale and servicing agreement, which contains customary representations, warranties and covenants. The Company performs certain servicing and administrative functions with respect to the Loans. The Company is entitled to receive a monthly fee from the Issuer for servicing the Loans. This servicing fee is equal to the product of one-twelfth (or in the case of the first payment date, a fraction equal to the number of days from and including December 5, 2012 through and including January 15, 2013 over 360) of 2.00% and the aggregate outstanding principal balance of the Loans, excluding all defaulted Loans and all purchased Loans, as of the first day of the related collection period (the period from the 5th day of the immediately preceding calendar month through the 4th day of the calendar month in which a payment date occurs, and for the first payment date, the period from and including December 5, 2012, to the close of business on January 4, 2013).
The Company also serves as administrator to the Issuer under an administration agreement, which includes customary representations, warranties and covenants.
At September 30, 2014 and December 31, 2013, the Asset Backed Notes had an outstanding principal balance of $28.0 million and $89.6 million, respectively.
Under the terms of the Asset Backed Notes, the Company is required to maintain a reserve cash balance, funded through interest and principal collections from the underlying securitized debt portfolio, which may be used to pay monthly interest and principal payments on the Asset-Backed Notes. The Company has segregated these funds and classified them as Restricted Cash. There was approximately $2.1 million and $6.3 million of Restricted Cash as of September 30, 2014 and December 31, 2013, respectively, funded through interest collections.
In April 2011, the Company issued $75.0 million in aggregate principal amount of 6.00% convertible senior notes (the “Convertible Senior Notes”) due 2016. During the three months ended September 30, 2014, holders of approximately $34.1 million of the Company’s Convertible Senior Notes exercised their conversion rights. As of September 30, 2014, the carrying value of the Convertible Senior Notes, comprised of the aggregate principal amount outstanding less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes, is approximately $40.0 million.
The Convertible Senior Notes mature on April 15, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Senior Notes bear interest at a rate of 6.00% per year payable semiannually in arrears on April 15 and October 15 of each year, commencing on October 15, 2011. The Convertible Senior Notes are 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 secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by 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 the Company’s election, cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s 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. As of September 30, 2014, the conversion rate was 87.5583 shares of common stock per $1,000 principal amount of Convertible Senior Notes (equivalent to an adjusted conversion price of approximately $11.42 per share of common stock).
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, holders of the 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.
The Convertible Senior Notes are accounted for in accordance with ASC 470-20 (previously FASB Staff Position No. APB 14- 1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”). In accounting for the Convertible Senior Notes, the Company estimated at the time of issuance that the values of the debt and the embedded conversion feature of the Convertible Senior Notes were approximately 92.8% and 7.2%, respectively. The original issue discount of 7.2% attributable to the conversion feature of the Convertible Senior Notes was recorded in “capital in excess of par value” in the consolidated statement of assets and liabilities. As a result, the Company recorded 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 8.1%.
Upon meeting the stock trading price conversion requirement as set forth in the Indenture, dated April 15, 2011, between the Company and U.S. Bank National Association, during the three months ended June 30, 2014, the Convertible Senior Notes became convertible on July 1, 2014 and continued to be convertible through September 30, 2014. As of September 30, 2014, approximately $34.1 million of the Convertible Senior Notes were converted and were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 924,000 shares of the Company’s common stock. Upon meeting the stock trading price conversion requirement during the three months ended September 30, 2014, the Convertible Senior Notes continue to be convertible through December 30, 2014. See “Subsequent Events.”
The Company recorded a loss on extinguishment of debt for the proportionate amount of unamortized debt issuance costs and original issue discount. The loss was partially offset by a gain in the amount of the difference between the outstanding principal balance of the converted notes and the fair value of the debt instrument. The net loss on extinguishment of debt the Company recorded for the three and nine months ended September 30, 2014 was approximately $1.0 million and was classified as a component of net investment income in the Company’s Consolidated Statements of Operations.
As of September 30, 2014 (unaudited) and December 31, 2013, the components of the carrying value of the Convertible Senior Notes were as follows:
Principal amount of debt
Original issue discount, net of accretion
(911
(2,481
Carrying value of Convertible Senior Notes
For the three and nine months ended September 30, 2014 and 2013 (unaudited), the components of interest expense, fees and cash paid for interest expense for the Convertible Senior Notes were as follows:
1,125
2,434
3,375
Accretion of original issue discount
433
Total interest expense
486
1,540
4,620
Cash paid for interest expense
2,250
The estimated effective interest rate of the debt component of the Convertible Senior Notes, equal to the stated interest of 6.0% plus the accretion of the original issue discount, was approximately 8.1% for the three and nine months ended September 30, 2014 and 2013. Interest expense decreased by approximately $950,000 during both the three and nine months ended September 30, 2014 from the comparative periods in 2013, due to Convertible Senior Notes settled prior to the interest payment date. As of September 30, 2014, the Company is in compliance with the terms of the indentures governing the Convertible Senior Notes.
In August 2008, the Company entered into a $50.0 million two-year revolving senior secured credit facility with Wells Fargo Capital Finance (the “Wells Facility”). On June 20, 2011, the Company renewed the Wells Facility, and the Wells Facility was further amended on August 1, 2012, December 17, 2012 and August 8, 2014. Under this senior secured facility, Wells Fargo Capital Finance has made commitments of $75.0 million. The facility contains an accordion feature, in which the Company can increase the credit line up to an aggregate of $300.0 million, funded by additional lenders and with the agreement of Wells Fargo Capital Finance and subject to other customary conditions. The Company expects to continue discussions with various other potential lenders to join the new facility; however, there can be no assurances that additional lenders will join the Wells Facility.
On August 1, 2012, the Company entered into an amendment to the Wells Facility that reduced the interest rate floor by 75 basis points to 4.25% and extended the maturity date by one year to August 2015. Additionally, the August 2012 amendment added an amortization period that commences on the day immediately following the end of the revolving credit availability period and ends one year thereafter on the maturity date. The August 2012 amendment also reduced the unused line fee, as further discussed below. On August 8, 2014, the Company entered into a further amendment to the Wells Facility to set the interest rate floor at 4.00% and to extend the revolving credit availability period to August 2017.
As amended, borrowings under the Wells Facility will generally bear interest at a rate per annum equal to LIBOR plus 3.50%, with a floor of 4.00% and an advance rate of 50% against eligible debt investments. The Wells Facility is secured by debt investments in the borrowing base. The Wells Facility requires payment of a non-use fee on a scale of 0.0% to 0.50% of the average monthly outstanding balance. The monthly payment of a non-use fee thereafter shall depend on the average balance that was outstanding on a scale between 0.0% and 0.50%. For the three and nine months ended September 30, 2014 and 2013, this non-use fee was approximately $96,000 and $284,000, respectively. On June 20, 2011 the Company paid an additional $1.1 million in structuring fees in connection with the Wells Facility which are being amortized through the end of the term of the Wells Facility. In connection with the August 2014 amendments, the Company paid an additional $750,000 in structuring fees in connection with the Wells Facility which are being amortized through the end of the term of the Wells Facility.
The Wells Facility includes various financial and operating covenants applicable to the Company and the Company’s subsidiaries, in addition to those applicable to Hercules Funding II, LLC. As amended, these covenants require the Company to maintain certain financial ratios and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $500.0 million plus 90% of the cumulative amount of equity raised after June 30, 2014. 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 September 30, 2014. At September 30, 2014 there were no borrowings outstanding on this facility.
The Company has a $75.0 million revolving senior secured credit facility (the “Union Bank Facility”) with Union Bank (“Union Bank”). The Company originally entered into the Union Bank Facility on February 10, 2010 but, following several amendments, amended and restated the Union Bank Facility on August 14, 2014. The amendment and restatement extends the maturity date of the Union Bank Facility to August 1, 2017, increases the size of the Union Bank Facility to $75.0 million from $30.0 million, and adjusts the interest rate for LIBOR borrowings under the Union Bank Facility. LIBOR-based borrowings by the Company under the Union Bank Facility will bear interest at a rate per annum equal to LIBOR plus 2.25% with no floor, whereas previously the Company paid a per annum interest rate on such borrowings equal to LIBOR plus 2.50% with a floor of 4.00%. Other borrowings by the Company under the Union Bank Facility, which are based on a reference rate instead of LIBOR, will continue to bear interest at a rate per annum equal to the reference rate (which is the greater of the federal funds rate plus 1.00% and a periodically announced Union Bank index rate) plus the greater of (i) 4.00% minus the reference rate and (ii) 1.00%. The Company continues to have the option of determining which type of borrowing to request under the Union Bank Facility. Subject to certain conditions, the amendment also removes a previous ceiling on the amount of certain unsecured indebtedness that the Company may incur.
Union Bank has made commitments to lend up to $75.0 million in aggregate principal amount. The Union Bank Facility contains an accordion feature, pursuant to which the Company may increase the size of the Union Bank Facility to an aggregate principal amount of $300.0 million by bringing in additional lenders, subject to the approval of Union Bank and other customary conditions. There can be no assurances that additional lenders will join the Union Bank Facility to increase available borrowings.
The Union Bank Facility requires the payment of a non-use fee of 0.50% annually. For the three and nine months ended September 30, 2014, this non-use fee was approximately $50,000 and $100,000, respectively. For the three and nine months ended September 30, 2013, this non-use fee was approximately $38,000 and $114,000, respectively. The amount that the Company may borrow under the Union Bank Facility is determined by applying an advance rate to eligible loans. The Union Bank Facility generally requires payment of monthly interest on loans based on a reference rate and at the end of a one, two, or three-month period, as applicable, for loans based on LIBOR. All outstanding principal is due upon maturity.
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 debt investments placed in the collateral pool.
The Company has various financial and operating covenants required by the Union Bank Facility. These covenants require, among other things, that the Company maintain certain financial ratios, including liquidity, asset coverage, and debt service coverage, and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $550.0 million plus 90% of the amount of net cash proceeds received from the sale of common stock after June 30, 2014. The Union Bank 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 September 30, 2014.
At September 30, 2014 there were no borrowings outstanding on this facility.
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. which expired under normal terms. During the first quarter of 2009, the Company paid off all principal and interest owed under the Citibank Credit Facility. Citigroup has an equity participation right through a warrant participation agreement on the pool of debt investments 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 is terminated until the Maximum Participation Limit has been reached.
During the nine months ended September 30, 2014, the Company reduced the Company’s realized gain by approximately $270,000 for Citigroup’s participation in the gain on sale of equity securities which were obtained from exercising a portfolio company warrant which was included in the collateral pool. The Company recorded a decrease on participation liability and an increase on unrealized appreciation by a net amount of approximately $146,000 as a result of year to date depreciation of fair value on the pool of warrants collateralized under the warrant participation agreement. The value of their participation right on unrealized gains in the related equity investments was approximately $224,000 as of September 30, 2014 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, the Company has paid Citigroup approximately $1.9 million under the warrant participation agreement thereby reducing the Company’s 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. Warrants subject to the Citigroup participation agreement are set to expire between February 2016 and March 2017.
5. Income taxes
The Company has elected to be taxed as a RIC under Subchapter M of the Code and intends to continue 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.
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 arrangements 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.
During the three months ended September 30, 2014, the Company declared a distribution of $0.31 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 our distributions year-to-date as of September 30, 2014, approximately 100% would be from ordinary income and spillover earnings from 2013. However there can be no certainty to shareholders that this determination is representative of what the tax attributes of its 2014 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 its ordinary income for each calendar year, (2) 98.2% of its 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 the Company chooses to carry over taxable income into the next tax year, dividends declared and paid by the Company 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 nine months ended September 30, 2014 was approximately $44.0 million or $0.71 per share. Taxable net realized gains for the same period were $18.7 million or approximately $0.30 per share. Taxable income for the nine months ended September 30, 2013 was approximately $51.3 million or $0.87 per share. Taxable net realized gains for the same period were $16.7 million or approximately $0.28 per share.
The Company intends to distribute approximately $3.8 million of spillover earnings from the year ended December 31, 2013 to our shareholders in 2014.
6. Shareholders’ Equity
On August 16, 2013, the Company entered into an “At-The-Market” (“ATM”) equity distribution agreement with JMP Securities LLC (“JMP”). The equity distribution agreement provides that the Company may offer and sell up to 8.0 million shares of its common stock from time to time through JMP, as its sales agent. Sales of the Company’s common stock, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act of 1933, as amended, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices.
During the nine months ended September 30, 2014, the Company sold 650,000 shares of common stock for total accumulated net proceeds of approximately $9.5 million, all of which is accretive to net asset value. The Company expects to use the net proceeds from the offering to make investments, to repurchase or pay liabilities and for general corporate purposes. As of September 30, 2014, approximately 7.35 million shares remained available for issuance and sale under the equity distribution agreement.
The Company has issued stock options for common stock subject to future issuance, of which 686,988 and 833,923 were outstanding at September 30, 2014 and December 31, 2013, respectively.
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 7.0 million shares of common stock. On June 1, 2011, stockholders approved an amended and restated plan and provided an increase of 1.0 million shares, authorizing the Company to issue 8.0 million shares of common stock under the 2004 Plan.
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 1.0 million shares of common stock. 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 stockholders 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 the Company 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 the Company’s 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.
The following table summarizes the common stock options activities for the nine months ended September 30, 2014 and 2013 (unaudited):
Common
Stock
Options
Average
Exercise Price
Outstanding at December 31,
833,923
12.53
2,574,749
12.00
Granted
245,000
16.06
325,000
14.16
Exercised
(248,206
10.97
(1,321,941
12.17
Forfeited
(143,729
15.12
(115,338
10.38
Expired
(65,000
13.30
Outstanding at September 30,
686,988
13.80
1,397,470
12.41
Shares Expected to Vest at September 30,
487,686
499,959
The following table summarizes common stock options outstanding and exercisable at September 30, 2014 (unaudited):
(Dollars in thousands,
except exercise price)
Options outstanding
Options exercisable
Range of exercise prices
Number of
shares
average
remaining
contractual life
Aggregate
intrinsic
value
exercise
price
Number
of shares
$9.25 - $14.86
385,488
4.91
888,601
12.27
199,302
4.12
676,613
11.14
$15.31 - $16.34
301,500
6.80
15.77
$9.25 - $16.34
5.74
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 September 30, 2014, options for 199,302 shares were exercisable at a weighted average exercise price of approximately $11.14 per share with weighted average of remaining contractual term of 4.12 years.
The Company determined that the fair value of options granted under the 2006 and 2004 Plans during the nine months ended September 30, 2014 and 2013 was approximately $126,000 and $779,000. During the nine months ended September 30, 2014 and 2013, approximately $313,000 and $266,000 of share-based cost due to stock option grants was expensed, respectively. As of September 30, 2014, there was approximately $710,000 of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a weighted average period of 2.0 years.
The fair value of options granted is based upon a Black Scholes option pricing model using the assumptions in the following table for the nine months ended September 30, 2014 and 2013:
Expected Volatility
19.90%
46.90%
Expected Dividends
10%
Expected term (in years)
4.5
Risk-free rate
1.24% - 1.66%
0.56% - 1.63%
During the nine months ended September 30, 2014 and 2013 the Company granted 989,883 shares and 607,001 shares, respectively, of restricted stock pursuant to the Plans. The Company determined that the fair value of restricted stock granted under the 2006 and 2004 Plans during the nine months ended September 30, 2014 and 2013 was approximately $13.7 million and $7.7 million, respectively. During the nine months ended September 30, 2014 and 2013, the Company expensed approximately $6.6 million and $4.1 million of compensation expense related to restricted stock, respectively. As of September 30, 2014, there was approximately $15.2 million of total unrecognized compensation costs related to restricted stock. These costs are expected to be recognized over a weighted average period of 1.6 years.
The following table summarizes the activities for our unvested restricted stock for the nine months ended September 30, 2014 and 2013 (unaudited):
Restricted
Stock Units
Unvested at December 31,
1,035,897
11.94
899,789
10.73
989,883
13.82
607,001
12.72
Vested
(478,161
12.04
(364,844
10.56
(144,277
12.76
(10,739
11.37
Unvested at September 30,
1,403,342
13.14
1,131,207
11.85
The SEC, 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
Shares used in the computation of the Company’s basic and diluted earnings per share are as follows (unaudited):
Numerator
Less: Dividends declared-common and restricted shares
(19,927
(17,277
Undistributed earnings
(4,750
19,704
(7,929
27,257
Undistributed earnings-common shares
Add: Dividend declared-common shares
19,469
16,949
57,298
46,292
Numerator for basic and diluted change in net assets per common share
14,719
36,653
49,369
73,549
Denominator
Basic weighted average common shares outstanding
Common shares issuable
1,423
2,110
190
Weighted average common shares outstanding assuming dilution
Change in net assets per common share
For the purpose of calculating diluted earnings per share for three and nine months ended September 30, 2014 and 2013, the dilutive effect of the Convertible Senior Notes under the treasury stock method is included in this calculation because the Company’s share price was greater than the conversion price in effect ($11.42 as of September 30, 2014 and $11.69 as of September 30, 2013, respectively) for the Convertible Senior Notes for such period.
The calculation of change in net assets resulting from operations per common share—assuming dilution, excludes all anti- dilutive shares. For the three months ended September 30, 2014 and 2013, the number of anti-dilutive shares, as calculated based on the weighted average closing price of the Company’s common stock for the periods, was approximately 742,043 and 1,549,001, respectively. For the nine months ended September 30, 2014 and 2013, the number of anti-dilutive shares, as calculated based on the weighted average closing price of the Company’s common stock for the periods, was approximately 752,116 and 2,081,780 shares, respectively.
At September 30, 2014, the Company was authorized to issue 100,000,000 shares of common stock with a par value of $0.001. Each share of common stock entitles the holder to one vote.
9. Financial Highlights
Following is a schedule of financial highlights for the nine months ended September 30, 2014 and 2013:
Per share data(1):
Net asset value at beginning of period
9.75
0.21
0.19
Net unrealized appreciation (depreciation) on investments
(0.30
0.15
Total from investment operations
0.82
1.27
Net increase (decrease) in net assets from capital share transactions
(0.27
Distributions of net investment income
(0.95
(0.82
Stock-based compensation expense included in investment income(2)
0.11
0.07
Net asset value at end of period
10.42
Ratios and supplemental data:
Per share market value at end of period
14.46
15.25
Total return(3)
-6.28
47.94
Shares outstanding at end of period
Weighted average number of common shares outstanding
Net assets at end of period
645,198
Ratio of operating expense to average net assets(4)(5)
10.17
11.84
Ratio of net investment income before investment gains and losses to average net assets(4)
11.38
Average debt outstanding
519,025
585,070
Weighted average debt per common share
8.44
10.05
All per share activity is calculated based on the weighted average shares outstanding for the relevant period.
Stock option expense is a non-cash expense that has no effect on net asset value. Pursuant to ASC 718, net investment income includes the expense associated with the granting of stock options which is offset by a corresponding increase in paid-in capital.
The total return for the nine months ended September 30, 2014 and 2013 equals the change in the ending market value over the beginning of the period price per share plus dividends paid per share during the period, divided by the beginning price assuming the dividend is reinvested on the date of the distribution. As such, the total return is not annualized.
All ratios are calculated based on weighted average net assets for the relevant period and are annualized.
Operating expense as used in the ratio of operating expense to average net assets does not include loss on debt extinguishment (long-term liabilities - convertible senior notes). If loss on debt extinguishment (long-term liabilities - convertible senior notes) were included in total expense, the ratio for the nine months ended September 30, 2014 would be 10.38%. There was no loss on debt extinguishment (long-term liabilities - convertible senior notes) in the nine months ended September 30, 2013 so the ratio for that period would not change.
10. Commitments and Contingencies
The Company’s commitments and contingencies consist primarily of unused commitments to extend credit in the form of loans to the Company’s portfolio companies. The balance of unfunded contractual commitments to extend credit at September 30, 2014 totaled approximately $242.5 million. Approximately $138.5 million of these unfunded contractual commitments as of September 30, 2014 are dependent upon the portfolio company reaching certain milestones before the debt commitment becomes available. Since a portion of these commitments may expire without being drawn, unfunded contractual commitments do not necessarily represent future cash requirements. In addition, the Company had approximately $223.0 million of non-binding term sheets outstanding at September 30, 2014. Non-binding outstanding term sheets are subject to completion of the Company’s due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. These non-binding term sheets generally convert to contractual commitments in approximately 90 days from signing. Not all non-binding term sheets are expected to close and do not necessarily represent the Company’s future cash requirements.
Certain premises are leased under agreements which expire at various dates through March 2020. Total rent expense amounted to approximately $397,000 and $1.2 million during the three and nine months ended September 30, 2014. There was approximately $296,000 and $900,000 recorded in the same periods ended September 30, 2013, respectively. Future commitments under the credit facility and operating leases were as follows at September 30, 2014:
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) (4)
67,600
192,164
271,400
Operating Lease Obligations (5)
6,666
1,586
1,576
538,193
1,949
70,638
193,740
271,866
Excludes commitments to extend credit to our portfolio companies.
The Company also has a warrant participation agreement with Citigroup. See Note 4 to the Company’s consolidated financial statements.
Includes $190.2 million in borrowings under the SBA debentures, $170.4 million of the 2019 Notes, $103.0 million of the 2024 Notes, $28.0 million in aggregate principal amount of the Asset-Backed Notes and $40.0 million of the Convertible Senior Notes.
Except for the Convertible Senior Notes, all carrying values are the same as the principal amount outstanding. The aggregate principal amount outstanding of the Convertible Senior Notes is $40.9 million less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes. The total unaccreted discount for the Convertible Senior Notes was $0.9 million at September 30, 2014.
Long-term facility leases.
The Company may, from time to time, be involved in litigation arising out of its operations in the normal course of business or otherwise. Furthermore, third parties may try to seek to impose liability on the Company in connection with the activities of its portfolio companies. While the outcome of any current legal proceedings cannot at this time be predicted with certainty, the Company does not expect any current matters will materially affect the Company’s financial condition or results of operations; however, there can be no assurance whether any pending legal proceedings will have a material adverse effect on the Company’s financial condition or results of operations in any future reporting period.
11. Recent Accounting Pronouncements
In June 2013, the FASB issued ASU 2013-08, “Financial Services - Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements,” which amends the criteria that define an investment company and clarifies the measurement guidance and requires new disclosures for investment companies. Under ASU 2013-08, an entity already regulated under the 1940 Act is automatically an investment company under the new GAAP definition, so the Company has concluded that there is no impact from adopting this standard on the Company’s statement of assets and liabilities or results of operations. The Company has adopted this standard for its fiscal year ending December 31, 2014.
12. Subsequent Events
Dividend Declaration
On October 29, 2014 the Board of Directors declared a cash dividend of $0.31 per share to be paid on November 24, 2014 to shareholders of record as of November 17, 2014. This dividend represents the Company’s thirty-seventh consecutive dividend declaration since the Company’s initial public offering, bringing the total cumulative dividend declared to date to $9.99 per share.
In April 2011, the Company issued $75.0 million in aggregate principal amount of 6.00% convertible senior notes, or the Convertible Senior Notes, due 2016. As of September 30, 2014, the carrying value of the Convertible Senior Notes, comprised of the aggregate principal amount outstanding less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes, is approximately $40.0 million.
The Convertible Senior Notes are convertible into shares of the Company’s common stock beginning October 15, 2015, or, under certain circumstances, earlier. Upon conversion of the Convertible Notes, the Company has the choice to pay or deliver, as the case may be, at the Company’s election, cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock. The current conversion price of the Convertible Senior Notes is approximately $11.42 per share of common stock, in each case subject to adjustment in certain circumstances. Upon meeting the stock trading price conversion requirement during the three months ended September 30, 2014, the Convertible Senior Notes continue to be convertible through December 31, 2014.
56
Subsequent to September 30, 2014 and as of November 3, 2014, approximately $23.1 million of the Convertible Senior Notes were converted. Of the $23.1 million, approximately $416,000 of the Convertible Senior Notes were converted and were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 7,500 shares of the Company’s common stock in October 2014, and approximately $22.7 million of the Convertible Senior Notes converted and will be settled in November 2014. The Company expects to generate an expense of approximately $1.0 million in the fourth quarter of 2014 related to these conversions.
2021 Asset Backed Notes
On November 4, 2014, Hercules Capital Funding Trust 2014-1, a newly-formed wholly owned subsidiary of the Company, priced a $129.3 million of fixed-rate asset-backed notes (the “2021 Asset Backed Notes”). The 2021 Asset Backed Notes are anticipated to be rated A(sf) on the Closing Date by Kroll Bond Rating Agency, Inc. (“KBRA”). The securitization is expected to close on November 13, 2014 and is subject to customary closing conditions.
The 2021 Asset Backed Notes will be issued by Hercules Capital Funding Trust 2014-1, LLC, as Trust Depositor, Hercules Capital Funding Trust 2014-1, as Issuer, and Guggenheim Securities, LLC, as Initial Purchaser. The 2021 Asset Backed Notes will be backed by a revolving pool of senior loans made to certain portfolio companies of the Company and secured by certain assets of those portfolio companies. The underlying loans will continue to be serviced by the Company. The securitization has an 18-month reinvestment period during which time principal collections may be reinvested into additional eligible loans. The fixed interest rate on the 2021 Asset Backed Notes will be 3.524%. The 2021 Asset Backed Notes will have a stated maturity of April 16, 2021.
Portfolio Company Developments
As of September 30, 2014, the Company held warrants or equity positions in six companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings, including Box, Inc., Dance Biopharm, Inc., Good Technology, Inc., Zosano, Inc. and two companies which filed confidentially under the JOBS Act. Subsequent to September 30, 2014, Dance Biopharm, Inc. withdrew their Form S-1 Registration Statement. In October 2014, the Company’s portfolio company Neothetics, Inc. filed a Form S-1 Registration Statement and in November 2014, the Company’s portfolio company Inotek Pharmaceuticals Corporation filed a Form S-1 Registration Statement. In addition, subsequent to September 30, 2014 the following current and former portfolio companies announced or completed M&A transactions or initial public offerings:
1.
In October 2014, InterCloud Systems, Inc. completed its acquisition of the Company’s portfolio company VaultLogix, LLC. The transaction consists of $16 million in cash, $12.75 million in restricted common stock, $11.5 million of which was valued at $16.50 per share, with the balance valued at market price, and $15.5 million in three year convertible seller notes, convertible at a fixed price of $6.37 per share.
2.
In October 2014, AVG Technologies completed its acquisition of the Company’s portfolio company Location Labs. Under the terms of the agreement, AVG will pay approximately $140 million initially, plus up to an additional approximately $80 million in cash consideration over the next two years based on the achievement of certain performance metrics and milestones.
3.
In October 2014, Premiere Global Services, Inc. completed its acquisition of the Company’s portfolio company Central Desktop, Inc. Financial terms were not disclosed.
4.
In October 2014, Breg, Inc. and the Company’s portfolio company United Orthopedic Group, Inc. announced that they had merged. United Orthopedic Group, Inc. will operate as a wholly-owned subsidiary of Breg, Inc. and financial terms were not disclosed.
5.
In October 2014, the Company’s portfolio company SiTime Corporation reached a definitive agreement to be acquired by MegaChips Corporation in a transaction valued at approximately $200.0 million, subject to customary closing conditions.
6.
In October 2014, the Company’s portfolio company Transcept Pharmaceuticals, Inc. completed its merger with Hercules’ portfolio company Paratek Pharmaceuticals, Inc. in an all-stock transaction. Immediately prior to the merger, Paratek received gross proceeds of $93.0 million from a combination of current and new investors.
7.
In October 2014, the Company’s former portfolio company Zayo Group Holdings, Inc. completed its initial public offering of 24,079,002 shares of its common stock, consisting of 16,008,679 shares sold by the portfolio company and 8,070,323 shares sold by the selling stockholders (including shares sold by the selling stockholders pursuant to the exercise in full of the underwriters’ option to purchase additional shares), at a price to the public of $19.00 per share.
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The matters discussed in this report, as well as in future oral and written statements by management of Hercules Technology Growth Capital, Inc., that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward- looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. 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;
our informal relationships with third parties including in the venture capital industry;
the expected market for venture capital investments and our addressable market;
the dependence of our future success on the general economy and its impact on the industries in which we invest;
our ability to access debt markets and equity markets;
the ability of our portfolio companies to achieve their objectives;
our expected financings and investments;
our regulatory structure and tax status;
our ability to operate as a BDC, a SBIC and a RIC;
the adequacy of our cash resources and working capital;
the timing of cash flows, if any, from the operations of our portfolio companies;
the timing, form and amount of any dividend distributions;
the impact of fluctuations in interest rates on our business;
the valuation of any investments in portfolio companies, particularly those having no liquid trading market; and
our ability to recover unrealized losses.
The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this report. In addition to historical information, the following discussion and other parts of this report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Item 1A—“Risk Factors” of Part II of this quarterly report on Form 10-Q, Item 1A—“Risk Factors” of our annual report on Form 10-K filed with the SEC on February 27, 2014 and under “Forward-Looking Statements” of this Item 2.
Overview
We are a specialty finance company focused on providing senior secured loans to venture capital-backed companies in technology-related markets, including technology, biotechnology, life science, and energy and renewables technology industries at all stages of development. We source our investments through our principal office located in Palo Alto, CA, as well as through our additional offices in Boston, MA, New York, NY and McLean, VA.
Our goal is to be the leading structured debt financing provider of choice for venture capital-backed companies in technology- related markets requiring sophisticated and customized financing solutions. Our strategy is to evaluate and invest in a broad range of technology-related markets including technology, biotechnology, life science, and energy and renewables technology industries and to offer a full suite of growth capital products. We invest primarily in structured debt with warrants and, to a lesser extent, in senior debt and equity investments. We invest primarily in private companies but also have investments in public companies.
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 typically are 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-backed companies in technology-related markets with attractive current yields and the potential for equity appreciation and realized gains. Our equity ownership in our portfolio companies may exceed 25% of the voting securities of such companies, which represents a controlling interest under the 1940 Act. In some cases, we receive the right to make additional equity investments in our portfolio companies in connection with future equity financing rounds. Capital that we provide directly to venture capital-backed companies in technology-related markets is generally used for growth and general working capital purposes as well as in select cases for acquisitions or recapitalizations.
We and our affiliates have filed an exemptive application with the SEC to permit greater flexibility to negotiate the terms of potential co-investments with us and our affiliates in a manner consistent with our investment objective, positions, policies, strategies and restrictions as well as regulatory requirements and other pertinent factors. This exemptive application is still pending, and there can be no assurance that we will receive exemptive relief from the SEC to permit us to co-invest with our affiliates. Under the terms of such relief permitting us to co-invest with our affiliates, a “required majority” (as defined in Section 57(o) of the 1940 Act) of our independent directors must make certain conclusions in connection with a co-investment transaction, including that (1) the terms of the transaction, including the consideration to be paid, are reasonable and fair to us and our stockholders and do not involve overreaching of us or our stockholders on the part of any person concerned and (2) the transaction is consistent with the interests of our shareholders and is consistent with our investment objective and strategies.
We also make investments in qualifying small businesses through our two wholly-owned SBICs. Our SBIC subsidiaries, HT II and HT III, hold approximately $142.8 million and $305.0 million in assets, respectively, and accounted for approximately 9.2% and 19.7% of our total assets, respectively, prior to consolidation at September 30, 2014. As of September 30, 2014, 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. In aggregate, at September 30, 2014, with our net investment of $112.5 million, HT II and HT III have the capacity to issue a total of $190.2 million of SBA-guaranteed debentures, subject to SBA approval. In March 2014, we repaid $34.8 million of SBA debentures under HT II, priced at approximately 6.38%, including annual fees. At September 30, 2014, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries.
We have qualified as and have elected to be treated for tax purposes as a RIC under 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, our qualification and election to be treated as a RIC requires that we comply with provisions contained in the Code. For example, as a RIC we must receive 90% or more of our income from qualified earnings, typically referred to as “good income,” as well as satisfy asset diversification and income distribution requirements.
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,” which includes securities of private U.S. companies, cash, cash equivalents and high-quality debt investments that mature in one year or less.
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 requirements under the 1940 Act, we invest primarily in United-States based companies and to a lesser extent in foreign companies.
We regularly engage in discussions with third parties with respect to various potential transactions. We may acquire an investment or a portfolio of investments or an entire company or sell a portion of our portfolio on an opportunistic basis. We, our subsidiaries or our affiliates may also agree to manage certain other funds that invest in debt, equity or provide other financing or services to companies in a variety of industries for which we may earn management or other fees for our services. We may also invest in the equity of these funds, along with other third parties, from which we would seek to earn a return and/or future incentive allocations. Some of these transactions could be material to our business. Consummation of any such transaction will be subject to
completion of due diligence, finalization of key business and financial terms (including price) and negotiation of final definitive documentation as well as a number of other factors and conditions including, without limitation, the approval of our board of directors and required regulatory or third party consents and, in certain cases, the approval of our stockholders. Accordingly, there can be no assurance that any such transaction would be consummated. Any of these transactions or funds may require significant management resources either during the transaction phase or on an ongoing basis depending on the terms of the transaction.
Portfolio and Investment Activity
The total fair value of our investment portfolio was $998.9 million at September 30, 2014, as compared to $910.3 million at December 31, 2013.
The fair value of our debt investment portfolio at September 30, 2014 was approximately $907.9 million, compared to a fair value of approximately $822.0 million at December 31, 2013. The fair value of the equity portfolio at September 30, 2014 was approximately $68.6 million, compared to a fair value of approximately $52.7 million at December 31, 2013. The fair value of the warrant portfolio at September 30, 2014 was approximately $22.4 million, compared to a fair value of approximately $35.6 million at December 31, 2013.
Portfolio Activity
Our investments in portfolio companies take a variety of forms, including unfunded contractual commitments and funded investments. From time to time, unfunded contractual commitments depend upon a portfolio company reaching certain milestones before the debt commitment is available to the portfolio company, which is expected to affect our funding levels. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as the on-balance sheet financial instruments that we hold. Debt commitments generally fund over the two succeeding quarters from close. Not all debt commitments represent our future cash requirements. Similarly, unfunded contractual commitments may expire without being drawn and do not represent our future cash requirements.
Prior to entering into a contractual commitment, we generally issue a non-binding term sheet to a prospective portfolio company. Non-binding term sheets are subject to completion of our due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. These non-binding term sheets generally convert to contractual commitments in approximately 90 days from signing. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.
Our portfolio activity for the nine months ended September 30, 2014 (unaudited) and the year ended December 31, 2013 was comprised of the following:
(in millions)
Debt Commitments (1)
New portfolio company
486.9
535.0
Existing portfolio company
95.9
165.1
582.7
700.1
Funded Debt Investments
276.9
373.1
131.4
118.0
408.3
491.1
Funded Equity Investments
3.7
1.4
Unfunded Contractual Commitments (2)
242.5
151.0
Non-Binding Term Sheets
223.0
28.0
10.0
38.0
Includes restructured loans and renewals in addition to new commitments.
The amount for September 30, 2014 includes unfunded contractual commitments in 33 new and existing portfolio companies. Approximately $138.5 million of these unfunded contractual commitments as of September 30, 2014 are dependent upon the portfolio company reaching certain milestones before the debt commitment becomes available.
We receive payments in our debt investment portfolio based on scheduled amortization of the outstanding balances. In addition, we receive principal repayments for some of our loans prior to their scheduled maturity date. The frequency or volume of these early principal repayments may fluctuate significantly from period to period. During the nine months ended September 30, 2014, we received approximately $316.5 million in aggregate principal repayments. Of the approximately $316.5 million of aggregate principal repayments, approximately $104.9 million were scheduled principal payments, and approximately $211.6 million were early principal repayments related to 25 portfolio companies. Of the approximately $211.6 million early principal repayments, approximately $24.0 million were early repayments due to M&A transactions and initial public offerings related to four portfolio companies.
Total portfolio investment activity (inclusive of unearned income) for the nine months ended September 30, 2014 (unaudited) and for the year ended December 31, 2013 was as follows:
Beginning Portfolio
910.3
906.3
New fundings
376.5
473.6
Restructure fundings
36.9
23.6
Warrants or OID not related to current period fundings
0.7
3.5
(104.9
(176.2
Early payoffs
(211.6
(300.6
Restructure payoffs
(9.8
Accretion of loan discounts and paid-in-kind principal
18.6
31.9
Acceleration of loan discounts and loan fees due to
early payoff or restructure
(1.0
(0.7
New loan fees
(6.5
(14.3
Warrants converted to equity
0.2
Proceeds from sale of investments
(3.9
(22.5
Net realized (loss) on investments
(0.8
(16.7
Net change in unrealized appreciation (depreciation)
(17.4
12.0
Ending Portfolio
998.9
The following table shows the fair value of our portfolio of investments by asset class as of September 30, 2014 (unaudited) and December 31, 2013.
The increase in senior secured debt is consistent with the overall increase in the investment portfolio at September 30, 2014 from December 31, 2013. The decrease in senior secured debt with warrants is primarily due to exercises of the our outstanding warrants to equity in four portfolio companies, with a cumulative fair value of approximately $65.0 million, during the nine months ended September 30, 2014. As a result, the existing debt investments that were included in senior secured debt with warrants at December 31, 2013 are included in senior secured debt at September 30, 2014.
A summary of our investment portfolio at value by geographic location is as follows:
As of September 30, 2014, the Company held warrants or equity positions in six companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings, including Box, Inc., Dance Biopharm, Inc., Good Technology, Inc., Zosano, Inc. and two companies which filed confidentially under the JOBS Act. There can be no assurance that these companies will complete their initial public offerings in a timely manner or at all.
Changes in Portfolio
We generate revenue in the form of interest income, primarily from our investments in debt securities, and commitment and facility fees. Fees generated in connection with our debt investments are recognized over the life of the loan or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related securities that we acquire from our portfolio companies. Our investments generally range from $1.0 million to $40.0 million. As of September 30, 2014, our debt investments have a term of between two and seven years and typically bear interest at a rate ranging from the prevailing U.S. prime rate, or Prime or the London Interbank Offered Rate, or LIBOR, to approximately 15%. In addition to the cash yields received on our debt investments, in some instances, our debt investments may also include any of the following: end-of- term payments, exit fees, balloon payment fees, commitment fees, success fees, PIK provisions or prepayment fees which may be required to be included in income prior to receipt.
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 $3.9 million and $4.0 million of unamortized fees at September 30, 2014 and December 31, 2013, respectively, and approximately $21.4 million and $14.4 million in exit fees receivable at September 30, 2014 and December 31, 2013, respectively.
We have debt investments 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 $851,000 and $889,000 in PIK income during the three months ended September 30, 2014 and 2013, respectively. We recorded approximately $2.6 million and $2.7 million in PIK income during the nine months ended September 30, 2014 and 2013, respectively.
In the majority of cases, we collateralize our investments by obtaining a first priority security interest in a portfolio company’s assets, which may include its intellectual property. In other cases, we obtain a negative pledge covering a company’s intellectual property. At September 30, 2014, approximately 59.4% of our portfolio company debt investments were secured by a first priority security in all of the assets of the portfolio company, including their intellectual property, and 40.6% of the debt investments were to portfolio companies that were prohibited from pledging or encumbering their intellectual property. At September 30, 2014 we had no equipment only liens on any of our portfolio companies.
Interest on debt securities is generally payable monthly, with amortization of principal typically occurring over the term of the security. In addition, certain of our loans may include an interest-only period ranging from three to eighteen months or longer. In limited instances in which we choose to defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest become due at the maturity date.
The effective yield on our debt investments during the three months ended September 30, 2014 and 2013 was 16.7% and 17.7%, respectively. This decrease in effective yield between periods is primarily due to the one-time fee accelerations during the three months ended September 30, 2013 that did not occur in the three months ended September 30, 2014. The effective yield is derived by dividing total investment income by the weighted average earning investment portfolio assets outstanding during the quarter which exclude non-interest earning assets such as warrants and equity investments.
Portfolio Composition
Our portfolio companies are primarily privately held companies and public companies which are active in the drug discovery and development, medical device and equipment, software, internet consumer and business services, energy technology, drug delivery, specialty pharmaceuticals, communications and networking, media/content/info, consumer and business products, information services, surgical devices, healthcare services, semiconductors, biotechnology tools, diagnostic and electronics and computer hardware industry sectors. These sectors are characterized by high margins, high growth rates, consolidation and product and market extension opportunities. Value for companies in these sectors is often vested in intangible assets and intellectual property.
As of September 30, 2014, approximately 68.9% of the fair value of our portfolio was composed of investments in five industries: 23.2% was composed of investments in the drug discovery and development industry, 13.9% was composed of investments in the medical devices and equipment industry, 11.3% was composed of investments in the software industry, 10.6% was composed of investments in the internet consumer and business services industry and 9.9% was composed of investments in the energy technology industry.
The following table shows the fair value of our portfolio by industry sector at September 30, 2014 (unaudited) and December 31, 2013:
Industry and sector concentrations vary as new loans are recorded and loans pay off. Loan revenue, consisting of interest, fees, and recognition of gains on equity and equity-related interests, can fluctuate materially when a loan is paid off or a related warrant or equity interest is sold. Revenue recognition in any given year can be highly concentrated among several portfolio companies.
For the nine months ended September 30, 2014 and the year ended December 31, 2013, our ten largest portfolio companies represented approximately 28.9% and 29.3% of the total fair value of our investments in portfolio companies, respectively. At September 30, 2014 we had two investments that represent 5% or more of our net assets and at December 31, 2013, we had one investment that represented 5% or more of our net assets. At September 30, 2014, we had five equity investments representing approximately 75.1% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments. At December 31, 2013, we had six equity investments which represented approximately 75.7% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments.
As of September 30, 2014, 100.0% of our debt investments were in a senior secured first lien position, and approximately 98.1% of the debt investment portfolio was priced at floating interest rates or floating interest rates with a Prime-or LIBOR-based interest rate floor. As a result, we believe we are well positioned to benefit when market interest rates may rise in the near future.
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 generally equal to the most recent equity financing round. As of September 30, 2014, we held warrants in 125 portfolio companies, with a fair value of approximately $22.4 million. The fair value of our warrant portfolio decreased by approximately 37.1%, as compared to a fair value of $35.6 million at December 31, 2013 primarily related to the reversal of unrealized appreciation related to the exercise of our warrant positions in Box, Inc. ($8.3 million) and Neuralstem, Inc. ($751,000) to preferred stock and unrealized depreciation related to collateral based impairments of approximately $2.9 million on nine of our warrant positions due to poor company performance.
Our existing warrant holdings currently would require us to invest approximately $83.2 million to exercise such warrants as of September 30, 2014. Warrants may appreciate or depreciate in value depending largely upon the underlying portfolio company’s performance and overall market conditions. Of the warrants which we have monetized since inception, we have realized warrant gain
multiples in the range of approximately 1.01x to 14.91x based on the historical rate of return on our investments. However, our 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 portfolio.
As required by the 1940 Act, we classify our investments by level of control. “Control investments” are defined in the 1940 Act as investments in those companies that we are deemed to “control”, which, in general, includes a company in which we own 25% or more of the voting securities of such company or have greater than 50% representation on its board. “Affiliate investments” are investments in those companies that are “affiliated companies” of ours, as defined in the 1940 Act, which are not control investments. We are deemed to be an “affiliate” of a company in which we have invested if we own 5% or more, but less than 25%, of the voting securities of such company. “Non-control/non-affiliate investments” are investments that are neither control investments nor affiliate investments.
The following table summarizes our realized and unrealized gain and loss and changes in our unrealized appreciation and depreciation on affiliate investments for the three and nine months ended September 30, 2014 and 2013 (unaudited). We did not hold any Control investments at either September 30, 2014 or 2013.
During the year ended December 31, 2013 Stion Corporation became classified as an affiliate.
Portfolio Grading
We use an investment grading system, which grades each debt investment on a scale of 1 to 5 to characterize and monitor our expected level of risk on the debt investments in our portfolio with 1 being the highest quality. The following table shows the distribution of our outstanding debt investments on the 1 to 5 investment grading scale at fair value as of September 30, 2014 (unaudited) and December 31, 2013, respectively:
Investment Grading
Number of Companies
Debt Investments at Fair Value
Percentage of Total Portfolio
279,330
30.8
162,586
19.8
422,940
46.6
429,804
52.3
155,187
17.1
184,692
22.5
28,253
3.1
30,687
22,213
2.4
14,219
1.7
As of September 30, 2014, our debt investments had a weighted average investment grading of 2.07, as compared to 2.20 at December 31, 2013. 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 or are underperforming relative to 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 therefore have been downgraded until their funding is complete or their operations improve.
At September 30, 2014, we had three debt investments on non-accrual with a cumulative cost and fair value of approximately $21.7 million and $6.5 million, respectively. At December 31, 2013 we had two debt investments on non-accrual with a cumulative cost and fair value of approximately $23.3 million and $12.6 million, respectively.
Results of Operations
Comparison of the three and nine month periods ended September 30, 2014 and 2013
Investment Income
Total investment income for the three months ended September 30, 2014 was approximately $37.0 million as compared to approximately $41.0 million for the three months ended September 30, 2013. Total investment income for the nine months ended September 30, 2014 was approximately $106.8 million as compared to approximately $106.5 million for the nine months ended September 30, 2013.
Interest income for the three months ended September 30, 2014 totaled approximately $33.3 million as compared to approximately $36.2 million for the three months ended September 30, 2013. Interest income for the nine months ended September 30, 2014 totaled approximately $94.7 million as compared to approximately $95.4 million for the nine months ended September 30, 2013. The decrease in interest income for both the three and nine months ended September 30, 2014 as compared to the same periods ended September 30, 2013 is primarily attributable to a lower weighted average yielding loan portfolio balance outstanding and a decrease in default interest income, partially offset by an increase in acceleration of loan exit fees related to early payoffs and loan restructurings.
Income from commitment, facility and loan related fees for the three months ended September 30, 2014 totaled approximately $3.7 million as compared to approximately $4.8 million for the three months ended September 30, 2013. Income from commitment, facility and loan related fees for the nine months ended September 30, 2014 totaled approximately $12.1 million as compared to approximately $11.1 million for the nine months ended September 30, 2013. The decrease in fee income for the three months ended September 30, 2014 is primarily attributable to fewer one-time fees as well as a lower weighted average yielding loan portfolio balance outstanding compared to the three months ended September 30, 2013. The increase in fee income for the nine months ended September 30, 2014 as compared to September 30, 2013 is primarily attributable to an increase in acceleration of commitment and facility fees related to early payoffs and loan restructurings as well as an increase in prepayment penalties collected on early payoffs.
The following table shows the PIK-related activity for the nine months ended September 30, 2014 and 2013, at cost (unaudited):
Beginning PIK loan balance
3,309
PIK interest capitalized during the period
2,410
Payments received from PIK loans
(1,786
(824
Ending PIK loan balance
5,186
The increase in payments received from PIK loans during the nine months ended September 30, 2014 is due to the addition of seven PIK loans which have incurred PIK capitalizations during the period partially offset by the paydown of four PIK loans during the nine months ended September 30, 2014.
In certain investment transactions, we may earn income from advisory services; however, we had no income from advisory services in the three and nine months ended September 30, 2014 and 2013, respectively.
Operating Expenses
Our operating expenses are comprised of interest and fees on our borrowings, general and administrative expenses and employee compensation and benefits. Our operating expenses totaled approximately $17.0 million and $19.5 million during the three months ended September 30, 2014 and 2013, respectively. Operating expenses totaled approximately $49.9 million and $52.3 million during the nine months ended September 30, 2014 and 2013, respectively.
Interest and Fees on our Borrowings
Interest and fees on our borrowings totaled approximately $7.9 million and $8.7 million for the three months ended September 30, 2014 and 2013, respectively, and approximately $24.7 million and $26.1 million for the nine months ended September 30, 2014 and 2013, respectively. The decrease in both the three and nine months was primarily attributable to the lower weighted average balances outstanding on our SBA obligations, Convertible Senior Notes, and Asset Backed Notes due to the payoff of $34.8 million of SBA debentures in the first quarter of 2014, the settlement of $34.1 million of our Convertible Senior Notes during the third quarter of 2014, and the amortization of our Asset Backed Notes from a balance of $89.6 million as of December 31, 2013 to $28.0 million as of September 30, 2014. Interest expense decreased by approximately $950,000 related to Convertible Senior Notes settled prior to the interest payment date, offset by interest and fees on our 6.25% notes due 2024 (the “2024 Notes”) issued in the third quarter of 2014.
We had a weighted average cost of debt, comprised of interest and fees and loss on debt extinguishment (long-term liabilities – convertible senior notes), of approximately 6.6% and 6.0% for the three months ended September 30, 2014 and 2013, respectively, and a weighted average cost of debt of approximately 6.6% and 6.0% for the nine months ended September 30, 2014 and 2013, respectively. The increase in both periods was primarily driven by the acceleration of fees related to the early payoffs of SBA obligations and our Asset-Backed Notes as described above.
General and Administrative Expenses
General and administrative expenses include legal fees, consulting fees, accounting fees, printer fees, insurance premiums, rent, expenses associated with the workout of underperforming investments and various other expenses. Our general and administrative expenses increased to $2.4 million from $2.2 million for the three months ended September 30, 2014 and 2013, respectively. This increase was primarily due to increased rent expense and outside consulting fees offset by decreased legal fees. Expenses increased to $7.0 million from $6.8 million for the nine months ended September 30, 2014 and 2013, respectively. This increase was primarily due to increased rent expense and marketing expense offset by decreased accounting fees and legal fees.
Employee Compensation
Employee compensation and benefits totaled approximately $3.9 million for the three months ended September 30, 2014 as compared to approximately $7.0 million for the three months ended September 30, 2013 and approximately $11.4 million for the nine months ended September 30, 2014 as compared to approximately $15.0 million for the nine months ended September 30, 2013. The decrease for both comparative periods was primarily due to decreasing our 2014 variable compensation accrued for the three and nine months ended September 30, 2014 as compared to the variable compensation accrued for the three and nine months ended September 30, 2013.
Stock-based compensation totaled approximately $2.8 million for the three months ended September 30, 2014 as compared to approximately $1.6 million for the three months ended September 30, 2013 and approximately $6.8 million for the nine months ended September 30, 2014 as compared to approximately $4.3 million for the nine months ended September 30, 2013. The increase for both comparative periods was primarily due to the increase of restricted stock units granted in April 2014 (981,550 shares) as compared to restricted stock units granted in March 2013 (606,001 shares).
Loss on Extinguishment of Convertible Senior Notes
Upon meeting the stock trading price conversion requirement as set forth in the Indenture, dated April 15, 2011, between us and U.S. Bank National Association, during the three months ended June 30, 2014, the Convertible Senior Notes became convertible on July 1, 2014 and continued to be convertible through September 30, 2014. As of September 30, 2014, holders of approximately $34.1 million of our Convertible Senior Notes exercised their conversion rights and these Convertible Senior Notes were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 924,000 shares of the Company’s common stock.
We recorded a loss on extinguishment of debt for the proportionate amount of unamortized debt issuance costs and original issue discount. The loss was partially offset by a gain in the amount of the difference between the outstanding principal balance of the converted notes and the fair value of the debt instrument. The net loss on extinguishment of debt we recorded for the three and nine months ended September 30, 2014 was approximately $1.0 million and was classified as a component of net investment income in our Consolidated Statements of Operations.
Net Investment Realized Gains and Losses and Net 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 an investment without regard to unrealized appreciation or depreciation previously recognized, and includes investments written 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.
A summary of realized gains and losses for the three and nine months ended September 30, 2014 and 2013 is as follows:
Realized gains
5,882
7,827
13,755
17,476
Realized losses
(218
(702
(748
(6,167
Net realized gains
During the three months ended September 30, 2014 and 2013, we recognized net realized gains of approximately $5.7 million and $7.1 million, respectively. During the three months ended September 30, 2014, we recorded gross realized gains of approximately $5.9 million primarily from the sale of investments in two portfolio companies, including Acceleron Pharma ($3.1 million) and IPA Holdings ($1.5 million). These gains were partially offset by gross realized losses of approximately $218,000 from the liquidation of our investments in two portfolio companies.
During the three months ended September 30, 2013, we recorded gross realized gains of approximately $7.8 million primarily from the sale of investments in three portfolio companies, including iWatt, Inc. ($4.7 million), AcelRx, Inc. ($1.1 million) and Facebook, Inc. ($728,000). These gains were partially offset by gross realized losses of approximately $460,000 from the liquidation of our investments in six portfolio companies.
During the nine months ended September 30, 2014 and 2013, we recognized net realized gains of approximately $13.0 million and $11.3 million, respectively. During the nine months ended September 30, 2014, we recorded gross realized gains of approximately $13.8 million primarily from the sale of investments in six portfolio companies, including Acceleron Pharma ($4.0 million), Neuralstem ($1.7 million), IPA Holdings ($1.5 million), Cell Therapeutics ($1.3 million), Trulia ($1.0 million) and Portola Pharmaceuticals ($700,000). These gains were partially offset by gross realized losses of approximately $748,000 from the liquidation of our investments in eight portfolio companies.
During the nine months ended September 30, 2013, we recorded gross realized gains of approximately $17.5 million primarily from the sale of investments in eight portfolio companies. These gains were partially offset by gross realized losses of approximately $6.2 million from the liquidation of our investments in nineteen portfolio companies.
The net unrealized appreciation and depreciation of our investments is based on the fair value of each investment determined in good faith by our Board of Directors. The following table summarizes the change in net unrealized appreciation/depreciation of investments for the three and nine months ended September 30, 2014 and 2013:
Gross unrealized appreciation on portfolio investments
12,656
28,760
48,230
58,168
Gross unrealized depreciation on portfolio investments
(17,753
(15,626
(59,699
(44,117
Reversal of prior period net unrealized appreciation
upon a realization event
(4,273
(6,196
(6,761
(13,599
Reversal of prior period net unrealized depreciation
219
2,335
7,977
Net unrealized (depreciation) on taxes payable
(212
(604
Net unrealized appreciation (depreciation) on escrow receivables
(309
(923
(465
564
Citigroup warrant participation
(54
Net unrealized appreciation (depreciation) on portfolio investments
During the three months ended September 30, 2014, we recorded approximately $9.5 million of net unrealized depreciation, of which $9.1 million is net unrealized depreciation from our debt, equity and warrant investments. Approximately $1.1 million is attributed to net unrealized depreciation on our debt investments which primarily related to $2.1 million unrealized depreciation for collateral based impairments on nine portfolio companies. Approximately $4.2 million is attributed to net unrealized depreciation on our equity investments which primarily related to the $3.6 million reversal of prior period net unrealized appreciation upon being realized as a gain for our sale of shares of Acceleron Pharma. Additionally, approximately $3.8 million is attributed to net unrealized depreciation on our warrant investments which primarily related to $2.1 million of unrealized depreciation on our public portfolio
company investments and $1.0 million of unrealized depreciation on three private portfolio company investments due to declines in portfolio company performance.
Net unrealized depreciation increased by approximately $212,000 as a result of estimated taxes payable for the three months ended September 30, 2014.
Net unrealized depreciation further increased by approximately $309,000 as a result of reducing escrow receivables for the three months ended September 30, 2014 related to merger and acquisition transactions closed on former portfolio companies.
During the three months ended September 30, 2014, net unrealized depreciation was offset by approximately $190,000 as a result of net depreciation of fair value on the pool of warrants collateralized under the warrant participation agreement due to the sale of shares of Acceleron Pharma that were subject to the agreement.
During the three months ended September 30, 2013, we recorded approximately $8.3 million of net unrealized appreciation, of which $9.3 million is net unrealized appreciation from our debt, equity and warrant investments. Approximately $7.3 million is attributed to net unrealized appreciation on equity, which primarily resulted from appreciation of our investment in Virident Systems due to the announcement of the portfolio company’s acquisition by Western Digital, Inc. Approximately $2.1 million is attributed to net unrealized appreciation on our debt investments, which primarily resulted from fair value adjustments made as a result of a decrease in interest rates reflected in our current quarter effective yield offset by $3.4 million of unrealized depreciation for collateral based impairments. We recorded approximately $99,000 of net unrealized depreciation on our warrant investments.
During the three months ended September 30, 2013, net unrealized appreciation decreased by approximately $54,000 as a result of appreciation of fair value on the pool of warrants collateralized under the warrant participation agreement. Additionally during the three months ended September 30, 2013, net unrealized appreciation on escrow receivables decreased by approximately $923,000, primarily due to the reversal of prior period net unrealized appreciation upon being realized as a gain.
The following table summarizes the change in net unrealized appreciation/(depreciation) in the investment portfolio by category for the three months ended September 30, 2014 and 2013 (unaudited).
Collateral Based Impairments
(2.1
(0.1
(0.4
(2.6
Reversals of Prior Period Collateral based impairments
Reversals due to Debt Payoffs & Warrant/Equity sales
(0.3
(3.7
Fair Value Market/Yield Adjustments*
Level 1 & 2 Assets
(1.2
(3.3
Level 3 Assets
Total Fair Value Market/Yield Adjustments
(0.2
(3.1
(2.8
Total Unrealized Appreciation/(Depreciation)
(1.1
(4.2
(3.8
(9.1
(3.4
(3.5
(2.4
4.1
6.0
1.2
8.0
15.2
2.1
9.3
Level 1 assets are generally equities listed in active markets and level 2 assets are generally warrants held in a public company. Observable market prices are typically the primary input in valuing level 1 and 2 assets. Level 3 asset valuations require inputs that are both significant and unobservable. Generally, level 3 assets are debt investments and warrants and equities held in a private company. See Note 2 to the financial statements discussing ASC 820.
During the nine months ended September 30, 2014, we recorded approximately $18.3 million of net unrealized depreciation, of which $17.4 million is net unrealized depreciation from our debt, equity and warrant investments. Approximately $7.8 million is attributed to net unrealized depreciation on our debt investments which primarily related to $12.6 million of unrealized depreciation for collateral based impairments on nine portfolio companies. Approximately $18.3 million is attributed to net unrealized depreciation on our warrant investments which primarily related to $8.3 million of net unrealized depreciation due to the exercise of our warrants in Box, Inc. to equity and $1.9 million of net unrealized depreciation due to the reversal of prior period net unrealized appreciation upon
being realized as a gain. This unrealized depreciation was offset by approximately $8.7 million of net unrealized appreciation on our equity investments, including approximately $8.4 million of net unrealized appreciation due to the exercise of our warrants in Box, Inc. to equity.
Net unrealized depreciation increased by approximately $604,000 as a result of estimated taxes payable for the nine months ended September 30, 2014.
Net unrealized depreciation further increased by approximately $465,000 as a result of reducing escrow receivables for the nine months ended September 30, 2014 related to merger and acquisition transactions closed on former portfolio companies.
During the nine months ended September 30, 2014, net unrealized depreciation was offset by approximately $146,000 as a result of net depreciation of fair value on the pool of warrants collateralized under the warrant participation agreement due to the sale of shares of Acceleron Pharma that were subject to the agreement.
During the nine months ended September 30, 2013, we recorded approximately $9.0 million of net unrealized appreciation of which approximately $8.4 million is net unrealized appreciation from our debt, equity and warrant investments. Approximately $14.7 million is attributed to net unrealized appreciation on equity which primarily resulted from appreciation of our investment in Virident Systems due to the announcement of the portfolio company’s acquisition by Western Digital, Inc. of approximately $7.2 million and approximately $2.7 million due to the reversal of prior period net unrealized depreciation upon being realized as a loss. Approximately $3.9 million is attributed to net unrealized appreciation on our warrant investments, of which approximately $10.9 million is due to the reversal of prior period net unrealized appreciation upon being realized as a gain and $2.7 million is due to the reversal of prior period net unrealized depreciation upon being realized as a loss. We recorded approximately $10.2 million of net unrealized depreciation on our debt investments, which primarily related to $10.3 million of unrealized depreciation for collateral based impairments on with portfolio companies.
For the nine months ended September 30, 2013, net unrealized appreciation increased by approximately $45,000 as a result of depreciation during the nine months ended September 30, 2013 of fair value on the pool of warrants collateralized under the warrant participation agreement.
The following table summarizes the change in net unrealized appreciation/(depreciation) in the investment portfolio by category for the nine months ended September 30, 2014 and 2013 (unaudited).
(12.6
(2.9
(4.7
(9.7
(14.1
1.3
10.3
11.5
14.0
(5.7
12.8
(7.8
8.7
(18.3
(10.3
(10.4
1.6
2.7
(8.2
5.2
(1.5
9.0
17.5
12.2
22.7
(10.2
14.7
8.4
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. We intend to distribute approximately $3.8 million of spillover earnings from the year ended December 31, 2013 to our shareholders in 2014.
Net Increase in Net Assets Resulting from Operations and Earnings Per Share
For the three months ended September 30, 2014 and 2013, the net increase in net assets resulting from operations totaled approximately $15.2 million and approximately $37.0 million, respectively. For the nine months ended September 30, 2014 and 2013, the net increase in net assets resulting from operations totaled approximately $50.6 million and approximately $74.5 million, respectively. These changes are made up of the items previously described.
The basic and fully diluted net change in net assets per common share were $0.24 and $0.23, respectively, for the three months ended September 30, 2014, whereas the basic and fully diluted net change in net assets per common share for the three months ended September 30, 2013 was $0.61 and $0.59, respectively. The basic and fully diluted net change in net assets per common share was $0.80 and $0.78 for the nine months ended September 30, 2014, whereas the basic and fully diluted net change in net assets per common share for the nine months ended September 30, 2013 was $1.26 and $1.23, respectively.
For the purpose of calculating diluted earnings per share for three and nine months ended September 30, 2014 and 2013, the dilutive effect of the Convertible Senior Notes under the treasury stock method is included in this calculation as our share price was greater than the conversion price in effect ($11.42 as of September 30, 2014 and $11.69 as of September 30, 2013, respectively) for the Convertible Senior Notes for such periods.
Financial Condition, Liquidity, and Capital Resources
Our liquidity and capital resources are derived from our Wells Facility, Union Bank Facility (together the “Credit Facilities”), SBA debentures, Convertible Senior Notes, 2019 Notes, 2024 Notes, Asset-Backed Notes (as each is defined herein) and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and payments of fees and other operating expenses we incur. We have used, and expect to continue to use, our borrowings and the proceeds from the turnover of our portfolio and from public and private offerings of securities to finance our investment objectives. We may raise additional equity or debt capital through both registered offerings off a shelf registration, “At-The-Market”, or ATM, and private offerings of securities, by securitizing a portion of our investments or borrowing, including from the SBA through our SBIC subsidiaries.
On August 16, 2013, we entered into an ATM equity distribution agreement with JMP Securities LLC, or JMP. The equity distribution agreement provides that we may offer and sell up to 8.0 million shares of our common stock from time to time through JMP, as our sales agent. Sales of our common stock, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act of 1933, as amended, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices.
During the nine months ended September 30, 2014, we sold 650,000 shares of common stock for total accumulated net proceeds of approximately $9.5 million, all of which is accretive to net asset value. We expect to use the net proceeds from the offering to make investments, to repurchase or pay liabilities and for general corporate purposes. As of September 30, 2014, approximately 7.35 million shares remained available for issuance and sale under the equity distribution agreement.
As of September 30, 2014, approximately $34.1 million of our Convertible Senior Notes were converted and were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 924,000 of our common stock. Upon meeting the stock trading price conversion requirement during the three months ended September 30, 2014, the Convertible Senior Notes continue to be convertible through December 31, 2014. See “Subsequent Events”.
At September 30, 2014, we had $40.9 million of Convertible Senior Notes, $170.4 million of 2019 Notes, $103.0 million of 2024 Notes, $28.0 million of Asset-Backed Notes and $190.2 million of SBA debentures payable. We had no borrowings outstanding under either the Wells Facility or the Union Bank Facility.
At September 30, 2014, we had $308.6 million in available liquidity, including $158.6 million in cash and cash equivalents. We had available borrowing capacity of approximately $75.0 million under the Wells Facility and $75.0 million under the Union Bank Facility, subject to existing terms and advance rates and regulatory requirements. We primarily invest cash on hand in interest bearing deposit accounts.
At September 30, 2014, we had $112.5 million of cash in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC. With our net investments of $38.0 million and $74.5 million in HT II and HT III, respectively, we have the combined capacity to issue a total of $190.2 million of SBA guaranteed debentures, subject to SBA approval. At September 30, 2014, we have issued $190.2 million in SBA guaranteed debentures in our SBIC subsidiaries.
At September 30, 2014, we had approximately $2.1 million of restricted cash, which consists of collections of interest and principal payments on assets that are securitized. In accordance with the terms of the related securitized Asset-Backed Notes, based on current characteristics of the securitized debt investment portfolios, the restricted funds may be used to pay monthly interest and principal on the securitized debt and are not distributed to us or available for our general operations. During the nine months ended September 30, 2014, we principally funded our operations from (i) cash receipts from interest, dividend and fee income from our investment portfolio and (ii) cash proceeds from the realization of portfolio investments through the repayments of debt investments and the sale of debt and equity investments.
During the nine months ended September 30, 2014, our operating activities used $34.1 million of cash and cash equivalents, compared to $4.7 million provided during the nine months ended September 30, 2013. This $38.8 million decrease in cash provided by operating activities resulted primarily from the decrease in net assets resulting from operations of approximately $24.0 million, the decrease of proceeds received from investment payoffs of approximately $19.9 million and the decrease in sale of investments of approximately $11.5 million. These decreases were partially offset by increases in unrealized appreciation on investments of approximately $27.3 million.
During the nine months ended September 30, 2014, our investing activities provided $4.1 million of cash, compared to approximately $3.9 million used during the nine months ended September 30, 2013. This $8.0 million increase in cash provided by investing activities was primarily due to a reduction of approximately $7.8 million in cash, classified as restricted cash, on assets that are securitized.
During the nine months ended September 30, 2014, our financing activities used $79.7 million of cash, compared to $21.2 million provided during the nine months ended September 30, 2013. This $100.9 million increase in cash used by financing activities was primarily due to a decrease in proceeds from issuance of common stock of $86.7 million and an increase in repayments of Asset-Backed Notes and Long-Term SBA Debentures of $34.8 million and $34.8 million, respectively, during the nine months ended September 30, 2014. In addition, during the nine months ended September 30, 2014, we paid $34.1 million in cash to settle our Convertible Senior Notes, of which $31.6 million is included in cash flows from financing activities and $2.5 million is in included in cash flows from operating activities which represents the proportional interest paid of the original issue discount. These increases in cash used by financing activities were partially offset by cash provided by the net issuance of our 2024 Notes for $99.7 million.
As of September 30, 2014, net assets totaled $656.2 million, with a net asset value per share of $10.22. We intend to generate additional cash primarily from cash flows from operations, including income earned from investments in our portfolio companies and, to a lesser extent, from the temporary investment of cash in other high-quality debt investments that mature in one year or less as well as from future borrowings as required to meet our lending activities. Our primary use of funds will be investments in portfolio companies and cash distributions to holders of our common stock.
As required by the 1940 Act, our asset coverage must be at least 200% after each issuance of senior securities. As of September 30, 2014 our asset coverage ratio under our regulatory requirements as a business development company was 292.2%, excluding our SBA debentures as a result of our exemptive order from the SEC which allows us to exclude all SBA leverage from our asset coverage ratio. As a result of the SEC exemptive order, our ratio of total assets on a consolidated basis to outstanding indebtedness may be less than 200%, which while providing increased investment flexibility, also may increase our exposure to risks associated with leverage. Total leverage when including our SBA debentures was 223.4% at September 30, 2014.
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At September 30, 2014 (unaudited) and December 31, 2013, we had the following available borrowings and outstanding amounts:
In March 2014, we repaid $34.8 million of SBA debentures under HT II, priced at approximately 6.38%, including annual fees. At September 30, 2014, the total available borrowings under the SBA debentures were $190.2 million, of which $41.2 million was available in HT II and $149.0 million was available in HT III. At December 31, 2013, the total available borrowings under the SBA debentures were $225.0 million, of which $76.0 million was available in HT II and $149.0 million was available in HT III.
Our net asset value may decline as a result of economic conditions in the United States. Our continued compliance with the covenants under our Credit Facilities, Convertible Senior Notes, 2019 Notes, 2024 Notes, Asset-Backed Notes and SBA debentures depend on many factors, some of which are beyond our control. Material net asset devaluation could have a material adverse effect on our operations and could require us to reduce our borrowings in order to comply with certain covenants, including the ratio of total assets to total indebtedness. We believe that our current cash and cash equivalents, cash generated from operations, and funds available from our Credit Facilities will be sufficient to meet our working capital and capital expenditure commitments for at least the next 12 months.
Debt financing costs are fees and other direct incremental costs we incur in obtaining debt financing and are recognized as prepaid expenses and amortized into the consolidated statement of operations as loan fees over the term of the related debt instrument. Prepaid financing costs, net of accumulated amortization, as of September 30, 2014 (unaudited) and December 31, 2013 were as follows:
4,202
5,074
4,595
5,319
3,288
883
2,686
485
880
14,504
14,800
Commitments
In the normal course of business, we are party to financial instruments with off-balance sheet risk. These consist primarily of unfunded contractual commitments to extend credit, in the form of loans, to our portfolio companies. Unfunded contractual commitments to provide funds to portfolio companies are not reflected on our balance sheet. Our unfunded contractual commitments may be significant from time to time. As of September 30, 2014, we had unfunded contractual commitments of approximately $242.5 million. Approximately $138.5 million of these unfunded contractual commitments are dependent upon the portfolio company reaching certain milestones before the contractual commitment becomes available. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that we hold. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent our future cash requirements. We intend to use cash flow from normal and early principal repayments, and proceeds from borrowings and notes to
fund these commitments. However, there can be no assurance that we will have sufficient capital available to fund these commitments as they come due.
In addition, we had approximately $223.0 million of non-binding term sheets outstanding to nine new and existing companies, which generally convert to contractual commitments within approximately 90 days of signing. Non-binding outstanding term sheets are subject to completion of our due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.
Contractual Obligations
The following table shows our contractual obligations as of September 30, 2014 (unaudited):
We also have a warrant participation agreement with Citigroup. See Note 4 to our consolidated financial statements.
Certain premises are leased under agreements which expire at various dates through March 2020. Total rent expense amounted to approximately $397,000 and $1.2 million during the three and nine months ended September 30, 2014, respectively. There was approximately $296,000 and $900,000 recorded in the same periods ended September 30, 2013, respectively.
We and our executives and directors are covered by Directors and Officers Insurance, with the directors and officers being indemnified by us to the maximum extent permitted by Maryland law subject to the restrictions in the 1940 Act.
Borrowings
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. With our net investment of $38.0 million in HT II as of September 30, 2014, HT II has the capacity to issue a total of $41.2 million of SBA guaranteed debentures, subject to SBA approval, of which $41.2 million was available at September 30, 2014. As of September 30, 2014, HT II has paid the SBA commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of September 30, 2014 we held investments in HT II in 42 companies with a fair value of approximately $110.9 million, accounting for approximately 11.1% of our total portfolio at September 30, 2014.
On May 26, 2010, HT III received a license to operate as a SBIC under the SBIC program and is able to borrow funds from the SBA against eligible investments and additional contributions to regulatory capital. With our net investment of $74.5 million in HT III as of September 30, 2014, HT III has the capacity to issue a total of $149.0 million of SBA guaranteed debentures, of which $149.0 million was outstanding as of September 30, 2014. As of September 30, 2014, HT III has paid commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of September 30, 2014, we held investments in HT III in 42 companies with a fair value of approximately $255.5 million accounting for approximately 25.6% of our total portfolio at September 30, 2014.
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 $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years. In addition, SBICs must devote 25.0% of its investment activity to “smaller” enterprises as defined by the SBA. A smaller enterprise is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the
business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services. Through its wholly-owned subsidiaries HT II and HT III, we plan to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.
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 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 September 30, 2014 as a result of having sufficient capital as defined under the SBA regulations.
The rates of borrowings under various draws from the SBA beginning in March 2009 are set semiannually in March and September and range from 2.25% to 4.62%. Interest payments on SBA debentures are payable semiannually. 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 March 2009, the initial maturity of SBA debentures will occur in March 2019. In addition, the SBA charges a fee that is set annually, depending on the Federal fiscal year the leverage commitment was delegated by the SBA, regardless of the date that the leverage was drawn by the SBIC. The annual fees related to HT II debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year in which the underlying commitment was closed. The annual fees on other debentures have been set at 0.906%. The annual fees related to HT III debentures that pooled on March 27, 2013 were 0.804%. The annual fees on other debentures have been set at 0.515%.
The average amount of debentures outstanding for the three months ended September 30, 2014 for HT II was approximately $41.2 million with an average interest rate of approximately 4.56%. The average amount of debentures outstanding for the three months ended September 30, 2014 for HT III was approximately $149.0 million with an average interest rate of approximately 3.46%. The average amount of debentures outstanding for the nine months ended September 30, 2014 for HT II was approximately $48.6 million with an average interest rate of approximately 4.80%. The average amount of debentures outstanding for the nine months ended September 30, 2014 for HT III was approximately $149.0 million with an average interest rate of approximately 3.42%.
As of September 30, 2014, 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. In aggregate, at September 30, 2014, with our net investment of $112.5 million, HT II and HT III have the capacity to issue a total of $190.2 million of SBA-guaranteed debentures, subject to SBA approval. In March 2014, we repaid $34.8 million of SBA debentures under HT II, priced at approximately 6.38%, including annual fees. At September 30, 2014, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries.
We reported the following SBA debentures outstanding as of September 30, 2014 (unaudited) and December 31, 2013:
Interest Rate(1)
On March 6, 2012, we and U.S. Bank National Association (the “Trustee”) entered into an indenture (the “Base Indenture”). On April 17, 2012, we and the Trustee entered into the First Supplemental Indenture to the Base Indenture (the “First Supplemental
Indenture”), dated April 17, 2012, relating to our issuance, offer and sale of $43.0 million aggregate principal amount of 7.00% senior notes due 2019 (the “April 2019 Notes”). The sale of the April 2019 Notes generated net proceeds, before expenses, of approximately $41.7 million.
In July 2012, we reopened our April 2019 Notes and issued an additional $41.5 million in aggregate principal amount of April 2019 Notes, which includes exercise of an over-allotment option, bringing the total amount of the April 2019 Notes issued to approximately $84.5 million in aggregate principal amount.
On September 24, 2012, we and the Trustee, entered into the Second Supplemental Indenture to the Base Indenture (the “Second Supplemental Indenture”), dated as of September 24, 2012, relating to our issuance, offer and sale of $75.0 million aggregate principal amount of 7.00% senior notes due 2019 (the “September 2019 Notes” and, together with the April 2019 Notes, the “2019 Notes”). The sale of the September 2019 Notes generated net proceeds, before expenses, of approximately $72.75 million.
The April 2019 Notes will mature on April 30, 2019 and may be redeemed in whole or in part at our option at any time or from time to time on or after April 30, 2015, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The April 2019 Notes bear interest at a rate of 7.00% per year payable quarterly on January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2012, and trade on the New York Stock Exchange under the trading symbol “HTGZ.”
The April 2019 Notes are our direct unsecured obligations and rank: (i) pari passu with our other outstanding and future senior unsecured indebtedness, including without limitation, the $40.9 million in aggregate principal amount of the Convertible Senior Notes; (ii) senior to any of our future indebtedness that expressly provides it is subordinated to the April 2019 Notes; (iii) effectively subordinated to all our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under our Credit Facilities; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, including without limitation, the indebtedness of Hercules Technology II, L.P. and Hercules Technology III, L.P. and borrowings under our revolving senior secured credit facility with Wells Fargo Capital Finance, LLC.
The Base Indenture, as supplemented by the First Supplemental Indenture, contains certain covenants including covenants requiring our compliance with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act to comply with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act and to provide financial information to the holders of the April 2019 Notes and the Trustee if we should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the First Supplemental Indenture. The Base Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding April 2019 Notes in a series may declare such April 2019 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period.
The April 2019 Notes were sold pursuant to an underwriting agreement dated April 11, 2012 among us and Stifel, Nicolaus & Company, Incorporated, as representative of the several underwriters named in the underwriting agreement.
The September 2019 Notes will mature on September 30, 2019 and may be redeemed in whole or in part at our option at any time or from time to time on or after September 30, 2015, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued
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and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The September 2019 Notes bear interest at a rate of 7.00% per year payable quarterly on March 30, June 30, September 30 and December 30 of each year, commencing on December 30, 2012, and trade on the New York Stock Exchange under the trading symbol “HTGY.”
The September 2019 Notes are our direct unsecured obligations and rank: (i) pari passu with our other outstanding and future senior unsecured indebtedness, including without limitation, the $40.9 million in aggregate principal amount of the Convertible Senior Notes; (ii) senior to any of our future indebtedness that expressly provides it is subordinated to the September 2019 Notes; (iii) effectively subordinated to all our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under our credit facilities; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, including without limitation, the indebtedness of Hercules Technology II, L.P. and Hercules Technology III, L.P. and borrowings under our revolving senior secured credit facility with Wells Fargo Capital Finance.
The Base Indenture, as supplemented by the Second Supplemental Indenture, contains certain covenants including covenants requiring us to comply with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18 (a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act to comply with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act and to provide financial information to the holders of the September 2019 Notes and the Trustee if we should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the Second Supplemental Indenture. The Base Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding September 2019 Notes in a series may declare such September 2019 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period.
The September 2019 Notes were sold pursuant to an underwriting agreement dated September 19, 2012 among us and Stifel, Nicolaus & Company, Incorporated, as representative of the several underwriters named in the underwriting agreement.
As of September 30, 2014, we are in compliance with the terms of the Base Indenture, and respective supplemental indentures thereto, governing the April 2019 Notes and September 2019 Notes. See Note 4 to our consolidated financial statements for more detail on the 2019 Notes.
On July 14, 2014, we and U.S. Bank, N.A. (the “Trustee”), entered into the Third Supplemental Indenture (the “Third Supplemental Indenture”) to the Base Indenture between us and the Trustee, dated July 14, 2014, relating to our issuance, offer and sale of $100.0 million aggregate principal amount of 2024 Notes. On August 6, 2014, the underwriters issued notification to exercise their over-allotment option for an additional $3.0 million in aggregate principal amount of the 2024 Notes. The sale of the 2024 Notes generated net proceeds of approximately $99.9 million.
The 2024 Notes will mature on July 30, 2024 and may be redeemed in whole or in part at our option at any time or from time to time on or after July 30, 2017, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The 2024 Notes bear interest at a rate of 6.25% per year payable quarterly on January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2014, and trade on the New York Stock Exchange under the trading symbol “HTGX.”
The 2024 Notes will be our direct unsecured obligations and will rank: (i) pari passu with our other outstanding and future senior unsecured indebtedness, including without limitation, the approximately $84.5 million 7.00% Senior Notes due April 30, 2019 (the “April 2019 Notes”); the approximately $85.9 million 7.00% Senior Notes due September 30, 2019 (the “September 2019 Notes” and together with the April 2019 Notes, the “2019 Notes”), the $40.9 million 6.00% Convertible Senior Notes due 2016 (the “Convertible Senior Notes and the approximately $28.0 million fixed-rate asset-backed notes (the “Asset-Backed Notes”); (ii) senior to any of our future indebtedness that expressly provides it is subordinated to the 2024 Notes; (iii) effectively subordinated to all of our existing and future secured indebtedness (including indebtedness that is initially unsecured to which we subsequently grant security), to the extent of the value of the assets securing such indebtedness, including without limitation, borrowings under our credit facilities; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of our subsidiaries, including without limitation, the indebtedness of HT II and HT III and any borrowings under our revolving senior secured credit facility with Wells Fargo Capital Finance.
The Base Indenture, as supplemented by the Third Supplemental Indenture, contains certain covenants including covenants requiring us to comply with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18(a)(1)(A) as modified by Section 61(a)(1) of the 1940 Act and to comply with the restrictions on dividends, distributions and purchase of capital stock set forth in Section 18(a)(1)(B) as modified by Section 61(a)(1) of the 1940 Act. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the Third Supplemental Indenture. The Base Indenture, as supplemented by the Third Supplemental Indenture, also contains certain reporting requirements, including a requirement that we provide financial information to the holders of the 2024 Notes and the Trustee if we should no longer be subject to the reporting requirements under the Securities Exchange Act of 1934. The Base Indenture provides for customary events of default and further provides that the Trustee or the holders of 25% in aggregate principal amount of the outstanding 2024 Notes in a series may declare such 2024 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period. As of September 30, 2014, we were in compliance with the terms of the Base Indenture, as supplemented by the Third Supplemental Indenture.
On December 19, 2012, we completed a $230.7 million term debt securitization in connection with which an affiliate of ours made an offer of $129.3 million in aggregate principal amount of fixed-rate asset-backed notes (the “Asset-Backed Notes”), which Asset-Backed Notes were rated A2(sf) by Moody’s Investors Service, Inc. The Asset-Backed Notes were issued by Hercules Capital Funding Trust 2012-1 pursuant to a note purchase agreement, dated as of December 12, 2012, by and among us, Hercules Capital Funding 2012- 1 LLC, as Trust Depositor (the “Trust Depositor”), Hercules Capital Funding Trust 2012-1, as Issuer (the “Issuer”), and Guggenheim Securities, LLC, as Initial Purchaser, and are backed by a pool of senior loans made to certain of our portfolio companies and secured by certain assets of those portfolio companies and are to be serviced by us. Interest on the Asset-Backed Notes will be paid, to the extent of funds available, at a fixed rate of 3.32% per annum. The Asset-Backed Notes have a stated maturity of December 16, 2017.
As part of this transaction, we entered into a sale and contribution agreement with the Trust Depositor under which we have agreed to sell or have contributed to the Trust Depositor certain senior loans made to certain of our portfolio companies (the “Loans”). We have made customary representations, warranties and covenants in the sale and contribution agreement with respect to the Loans as of the date of their transfer to the Trust Depositor.
In connection with the issuance and sale of the Asset-Backed Notes, we have made customary representations, warranties and covenants in the note purchase agreement. The Asset-Backed Notes are secured obligations of the Issuer and are non-recourse to us. The Issuer also entered into an indenture governing the Asset-Backed Notes, which includes customary representations, warranties and covenants. The Asset-Backed Notes were sold without being registered under the Securities Act of 1933, as amended (the “Securities Act”), to “qualified institutional buyers” in compliance with the exemption from registration provided by Rule 144A under
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the Securities Act and to institutional “accredited investors” (as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act) who in each case, are “qualified purchasers” for purposes of Section 3(c)(7) under the 1940 Act. In addition, the Trust Depositor entered into an amended and restated trust agreement, which includes customary representation, warranties and covenants.
The Loans are serviced by us pursuant to a sale and servicing agreement, which contains customary representations, warranties and covenants. We perform certain servicing and administrative functions with respect to the Loans. We are entitled to receive a monthly fee from the Issuer for servicing the Loans. This servicing fee is equal to the product of one-twelfth (or in the case of the first payment date, a fraction equal to the number of days from and including December 5, 2012 through and including January 15, 2013 over 360) of 2.00% and the aggregate outstanding principal balance of the Loans, excluding all defaulted Loans and all purchased Loans, as of the first day of the related collection period (the period from the 5th day of the immediately preceding calendar month through the 4th day of the calendar month in which a payment date occurs, and for the first payment date, the period from and including December 5, 2012, to the close of business on January 4, 2013).
We also serve as administrator to the Issuer under an administration agreement, which includes customary representations, warranties and covenants.
At September 30 2014 and December 31, 2013, the Asset Backed Notes had an outstanding principal balance of $28.0 million and $89.6 million, respectively.
Under the terms of the Asset Backed Notes, we are required to maintain a reserve cash balance, funded through interest and principal collections from the underlying securitized debt portfolio, which may be used to pay monthly interest and principal payments on the Asset-Backed Notes. We have segregated these funds and classified them as Restricted Cash. There was approximately $2.1 million and $6.3 million of Restricted Cash as of September 30, 2014 and December 31, 2013, respectively, funded through interest collections.
In April 2011, we issued $75.0 million in aggregate principal amount of 6.00% convertible senior notes (the “Convertible Senior Notes”) due 2016. During the three months ended September 30, 2014, holders of approximately $34.1 million of our Convertible Senior Notes exercised their conversion rights. As of September 30, 2014, the carrying value of the Convertible Senior Notes, comprised of the aggregate principal amount outstanding less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes, is approximately $40.0 million
The Convertible Senior Notes mature on April 15, 2016 (the “Maturity Date”), unless previously converted or repurchased in accordance with their terms. The Convertible Senior Notes bear interest at a rate of 6.00% per year payable semiannually in arrears on April 15 and October 15 of each year, commencing on October 15, 2011. The Convertible Senior Notes are our senior unsecured obligations and rank senior in right of payment to our existing and future indebtedness that is expressly subordinated in right of payment to the Convertible Senior Notes; equal in right of payment to our existing and future unsecured indebtedness that is not so subordinated; effectively junior in right of payment to any of our secured indebtedness (including unsecured indebtedness that we later secure) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by our subsidiaries, financing vehicles or similar facilities.
Prior to the close of business on the business day immediately preceding October 15, 2015, holders may convert their Convertible Senior Notes only under certain circumstances set forth in the indenture. On or after October 15, 2015 until the close of business on the scheduled trading day immediately preceding the Maturity Date, holders may convert their Convertible Senior Notes at any time. Upon conversion, we will pay or deliver, as the case may be, at our election, cash, shares of our common stock or a combination of cash and shares of our common stock. The conversion rate will initially be 84.0972 shares of common stock per $1,000 principal amount of Convertible Senior Notes (equivalent to an initial conversion price of approximately $11.89 per share of common stock). The conversion rate will be subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the Maturity Date, the conversion rate will be increased for converting holders. As of September 30, 2014, the conversion rate was 87.5583 shares of common stock per $1,000 principal amount of Convertible Senior Notes (equivalent to an adjusted conversion price of approximately $11.42 per share of common stock).
We may not redeem the Convertible Senior Notes prior to maturity. No sinking fund is provided for the Convertible Senior Notes. In addition, if certain corporate events occur, holders of the Convertible Senior Notes may require us to repurchase for cash all or part of their Convertible Senior Notes at a repurchase price equal to 100% of the principal amount of the Convertible Senior Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.
The Convertible Senior Notes are accounted for in accordance with ASC 470-20 (previously FASB Staff Position No. APB 14- 1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”). In accounting for the Convertible Senior Notes, we estimated at the time of issuance that the values of the debt and the embedded conversion feature of the Convertible Senior Notes were approximately 92.8% and 7.2%, respectively. The original issue discount of 7.2% attributable to the conversion feature of the Convertible Senior Notes was recorded in “capital in excess of par value” in the consolidated statement of assets and liabilities. As a result, we record interest expense comprised of both stated interest expense as well as accretion of the original issue discount resulting in an estimated effective interest rate of approximately 8.1%.
Upon meeting the stock trading price conversion requirement during the three months ended June 30, 2014, the Convertible Senior Notes became convertible on July 1, 2014 and continued to be convertible through September 30, 2014. As of September 30, 2014, approximately $34.1 million of the Convertible Senior Notes were converted and were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 924,000 shares of our common stock. Upon meeting the stock trading price conversion requirement during the three months ended September 30, 2014, the Convertible Senior Notes continue to be convertible through December 30, 2014. See “Subsequent Events.”
The estimated effective interest rate of the debt component of the Convertible Senior Notes, equal to the stated interest of 6.0% plus the accretion of the original issue discount, was approximately 8.1% for the three and nine months ended September 30, 2014 and 2013. Interest expense decreased by approximately $950,000 during both the three and nine months ended September 30, 2014 from the comparative periods in 2013, due to Convertible Senior Notes settled prior to the interest payment date. As of September 30, 2014, we are in compliance with the terms of the indentures governing the Convertible Senior Notes.
In August 2008, we entered into a $50.0 million two-year revolving senior secured credit facility with Wells Fargo Capital Finance (the “Wells Facility”). On June 20, 2011, we renewed the Wells Facility, and the Wells Facility was further amended on August 1, 2012, December 17, 2012 and August 8, 2014. Under this senior secured facility, Wells Fargo Capital Finance has made commitments of $75.0 million. The facility contains an accordion feature, in which we can increase the credit line up to an aggregate of $300.0 million, funded by additional lenders and with the agreement of Wells Fargo Capital Finance and subject to other customary conditions. We expect to continue discussions with various other potential lenders to join the new facility; however, there can be no assurances that additional lenders will join the Wells Facility.
On August 1, 2012, we entered into an amendment to the Wells Facility that reduced the interest rate floor by 75 basis points to 4.25% and extended the maturity date by one year to August 2015. Additionally, the August 2012 amendment added an amortization
period that commences on the day immediately following the end of the revolving credit availability period and ends one year thereafter on the maturity date. The August 2012 amendment also reduced the unused line fee, as further discussed below. On August 8, 2014, the Company entered into a further amendment to the Wells Facility to set the interest rate floor at 4.00% and to extend the revolving credit availability period to August 2017.
As amended, borrowings under the Wells Facility will generally bear interest at a rate per annum equal to LIBOR plus 3.50%, with a floor of 4.00% and an advance rate of 50% against eligible debt investments. The Wells Facility is secured by debt investments in the borrowing base. The Wells Facility requires payment of a non-use fee on a scale of 0.0% to 0.50% of the average monthly outstanding balance. The monthly payment of a non-use fee thereafter shall depend on the average balance that was outstanding on a scale between 0.0% and 0.50%. For the three and nine months ended September 30, 2014 and 2013, this non-use fee was approximately $96,000 and $284,000, respectively. On June 20, 2011 we paid an additional $1.1 million in structuring fees in connection with the Wells Facility which are being amortized through the end of the term of the Wells Facility. In connection with the August 2014 amendments, the Company paid an additional $750,000 in structuring fees in connection with the Wells Facility which are being amortized through the end of the term of the Wells Facility.
The Wells Facility includes various financial and operating covenants applicable to us and our subsidiaries, in addition to those applicable to Hercules Funding II, LLC. As amended, these covenants require us to maintain certain financial ratios and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $500.0 million plus 90% of the cumulative amount of equity raised after June 30, 2014. The Wells Facility provides for customary events of default, including, but not limited to, payment defaults, breach of representations or covenants, bankruptcy events and change of control. We were in compliance with all covenants at September 30, 2014. See Note 4 to our consolidated financial statements for more detail on the Wells Facility.
We have a $75.0 million revolving senior secured credit facility (the “Union Bank Facility”) with Union Bank (“Union Bank”). We originally entered into the Union Bank Facility on February 10, 2010 but, following several amendments, amended and restated the Union Bank Facility on August 14, 2014. The amendment and restatement extends the maturity date of the Union Bank Facility to August 1, 2017, increases the size of the Union Bank Facility to $75.0 million from $30.0 million, and adjusts the interest rate for LIBOR borrowings under the Union Bank Facility. LIBOR-based borrowings under the Union Bank Facility will bear interest at a rate per annum equal to LIBOR plus 2.25% with no floor, whereas previously we paid a per annum interest rate on such borrowings equal to LIBOR plus 2.50% with a floor of 4.00%. Other borrowings under the Union Bank Facility, which are based on a reference rate instead of LIBOR, will continue to bear interest at a rate per annum equal to the reference rate (which is the greater of the federal funds rate plus 1.00% and a periodically announced Union Bank index rate) plus the greater of (i) 4.00% minus the reference rate and (ii) 1.00%. We continue to have the option of determining which type of borrowing to request under the Union Bank Facility. Subject to certain conditions, the amendment also removes a previous ceiling on the amount of certain unsecured indebtedness that we may incur.
Union Bank has made commitments to lend up to $75.0 million in aggregate principal amount. The Union Bank Facility contains an accordion feature, pursuant to which we may increase the size of the Union Bank Facility to an aggregate principal amount of $300.0 million by bringing in additional lenders, subject to the approval of Union Bank and other customary conditions. There can be no assurances that additional lenders will join the Union Bank Facility to increase available borrowings.
The Union Bank Facility requires the payment of a non-use fee of 0.50% annually. For the three and nine months ended September 30, 2014, this non-use fee was approximately $50,000 and $100,000, respectively. For the three and nine months ended September 30, 2013, this non-use fee was approximately $38,000 and $114,000, respectively. The amount that we may borrow under the Union Bank Facility is determined by applying an advance rate to eligible loans. The Union Bank Facility generally requires payment of monthly interest on loans based on a reference rate and at the end of a one, two, or three-month period, as applicable, for loans based on LIBOR. All outstanding principal is due upon maturity.
The Union Bank Facility is collateralized by debt investments in our portfolio companies, and includes an advance rate equal to 50.0% of eligible debt investments placed in the collateral pool.
We have various financial and operating covenants required by the Union Bank Facility. These covenants require, among other things, that we maintain certain financial ratios, including liquidity, asset coverage, and debt service coverage, and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $550.0 million plus 90% of the amount of net cash proceeds received from the sale of common stock after June 30, 2014. The Union Bank Facility provides for customary events of default, including, but not limited to, payment defaults, breach of representations or covenants, bankruptcy events and change of control. We were in compliance with all covenants at September 30, 2014.
80
We, through Hercules Funding Trust I, an affiliated statutory trust, had a securitized credit facility (the “Citibank Credit Facility”) with Citigroup Global Markets Realty Corp. which expired under normal terms. During the first quarter of 2009, we paid off all principal and interest owed under the Citibank Credit Facility. Citigroup has an equity participation right through a warrant participation agreement on the pool of debt investments 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.
During the nine months ended September 30, 2014, we reduced our realized gain by approximately $270,000 for Citigroup’s participation in the gain on sale of equity securities which were obtained from exercising a portfolio company warrant which was included in the collateral pool. We recorded a decrease on participation liability and an increase on unrealized appreciation by a net amount of approximately $146,000 as a result of year to date depreciation of fair value on the pool of warrants collateralized under the warrant participation agreement. The value of their participation right on unrealized gains in the related equity investments was approximately $224,000 as of September 30, 2014 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 $1.9 million under the warrant participation agreement thereby reducing our realized gains by this amount. We will continue to pay Citigroup under the warrant participation agreement until the Maximum Participation Limit is reached or the warrants expire. Warrants subject to the Citigroup participation agreement are set to expire between February 2016 and March 2017.
Dividends
The following table summarizes our dividends declared and paid, to be paid, or reinvested on all shares, including restricted stock, to date:
Date Declared
Record Date
Payment Date
Amount Per Share
October 27, 2005
November 1, 2005
November 17, 2005
0.03
December 9, 2005
January 6, 2006
January 27, 2006
April 3, 2006
April 10, 2006
May 5, 2006
July 19, 2006
July 31, 2006
August 28, 2006
October 16, 2006
November 6, 2006
December 1, 2006
February 7, 2007
February 19, 2007
March 19, 2007
May 3, 2007
May 16, 2007
June 18, 2007
August 2, 2007
August 16, 2007
September 17, 2007
November 1, 2007
November 16, 2007
December 17, 2007
February 7, 2008
February 15, 2008
March 17, 2008
May 8, 2008
May 16, 2008
June 16, 2008
0.34
August 7, 2008
August 15, 2008
September 19, 2008
November 6, 2008
November 14, 2008
December 15, 2008
February 12, 2009
February 23, 2009
March 30, 2009
0.32
May 7, 2009
May 15, 2009
June 15, 2009
August 6, 2009
August 14, 2009
September 14, 2009
October 15, 2009
October 20, 2009
November 23, 2009
December 16, 2009
December 24, 2009
December 30, 2009
0.04
February 11, 2010
February 19, 2010
March 19, 2010
0.20
May 3, 2010
May 12, 2010
June 18, 2010
August 2, 2010
August 12, 2010
September 17,2010
November 4, 2010
November 10, 2010
December 17, 2010
March 1, 2011
March 10, 2011
March 24, 2011
0.22
May 5, 2011
May 11, 2011
June 23, 2011
August 4, 2011
August 15, 2011
September 15, 2011
November 3, 2011
November 14, 2011
November 29, 2011
February 27, 2012
March 12, 2012
March 15, 2012
April 30, 2012
May 18, 2012
May 25, 2012
July 30, 2012
August 17, 2012
August 24, 2012
October 26, 2012
November 14, 2012
November 21, 2012
February 26, 2013
March 11, 2013
March 19, 2013
0.25
April 29, 2013
May 14, 2013
May 21, 2013
0.27
July 29, 2013
August 13, 2013
August 20, 2013
0.28
November 4, 2013
November 18, 2013
November 25, 2013
February 24, 2014
March 10, 2014
March 17, 2014
April 28, 2014
May 12, 2014
May 19, 2014
July 28, 2014
August 18, 2014
August 25, 2014
October 29, 2014
November 17, 2014
November 24, 2014
9.99
Dividend paid in cash and stock.
On October 29, 2014 the Board of Directors declared a cash dividend of $0.31 per share to be paid on November 24, 2014 to shareholders of record as of November 17, 2014. This dividend represents our thirty-seventh consecutive dividend declaration since our initial public offering, bringing the total cumulative dividend declared to date to $9.99 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, our Board of Directors may choose to pay an additional special dividend, or fifth dividend, so that we may distribute approximately all of our annual taxable income in the year it was earned, or may elect to maintain the option to spill over our excess taxable income into the coming year for future dividend payments.
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. Of the dividends declared during the years ended December 31, 2013 and 2012, 100% were distributions of ordinary income. There can be no certainty to stockholders that this determination is representative of what the tax attributes of our 2014 distributions to stockholders will actually be.
Each year a statement on Form 1099-DIV identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of paid-in-capital surplus which is a nontaxable distribution) is mailed to our stockholders. To the extent our taxable earnings fall below the total amount of our distributions for that fiscal year, a portion of those distributions may be deemed a tax return of capital to our stockholders.
We operate to qualify to be taxed as a RIC under the Code. Generally, a RIC is entitled to deduct dividends it pays to its shareholders from its income to determine “taxable income.” Taxable income includes our taxable interest, dividend and fee income, as well as taxable net capital gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash. Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual payment-in-kind interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual PIK interest arrangements 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.
As a RIC, we will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless we distribute 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”). 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). Depending on the level of taxable income earned in a tax year, we 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.
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. Our ability to make distributions will be limited by the asset coverage requirements under the 1940 Act.
We intend to distribute approximately $3.8 million of spillover earnings from the year ended December 31, 2013 to our shareholders in 2014.
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.
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.
At September 30, 2014, approximately 83.3% of our 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 investments are carried at fair value in accordance with the 1940 Act and Accounting Standards Codification topic 820 Fair Value Measurements and Disclosures (“ASC 820”). Our debt securities are primarily invested in venture capital-backed companies in technology-related markets, including technology, biotechnology, life science and energy and renewables technology industries. Given the nature of lending to these types of businesses, our investments in these portfolio companies are generally considered Level 3 assets under ASC 820 because there is no known or accessible market or market indexes for these investment securities to be traded or exchanged. As such, we value substantially all of our 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 of Directors 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.
We 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 being initially valued by the investment professionals responsible for the portfolio investment;
(2) preliminary valuation conclusions are then documented and business based assumptions are discussed with our investment committee;
(3) the Audit Committee of the Board of Directors reviews the preliminary valuation of the investments in the portfolio company as provided by the investment committee, which incorporates the results of the independent valuation firm as appropriate.
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:
In accordance with ASU 2011-04, the following table provides quantitative information about our Level 3 fair value measurements of our investments as of September 30, 2014. In addition to the techniques and inputs noted in the table below, according to our valuation policy, we may also use other valuation techniques and methodologies when determining our fair value measurements. The table below is not intended to be all-inclusive, but rather provides information on the significant Level 3 inputs as they relate to our fair value measurements.
The significant unobservable inputs used in the fair value measurement of our debt securities are hypothetical market yields and premiums/(discounts). The hypothetical market yield is defined as the exit price of an investment in a hypothetical market to hypothetical market participants where buyers and sellers are willing participants. The premiums (discounts) relate to company specific characteristics such as underlying investment performance, security liens, and other characteristics of the investment. Significant increases (decreases) in the inputs in isolation would result in a significantly lower (higher) fair value measurement, depending on the materiality of the investment. Debt investments in the industries noted in our Schedule of Investments are included in the industries note above as follows:
Pharmaceuticals, above, is comprised of debt investments in the Specialty Pharmaceuticals, Drug Discovery and Development, Drug Delivery, and Diagnostics and Biotechnology industries in the Schedule of Investments.
Technology, above, is comprised of debt investments in the Software, Semiconductors, Electronics and Computer Hardware, Internet Consumer and Business Services, Information Services, Media/Content/Info and Communications and Networking industries in the Schedule of Investments.
Lower Middle Market, above, is comprised of debt investments in the Communications and Networking, Software, Electronics and Computer Hardware, Information Services, Internet Consumer and Business Services, Media/Content/Info, and Specialty Pharmaceuticals industries in the Schedule of Investments. Energy Technology, above, aligns with the Energy Technology industry in the Schedule of Investments.
The significant unobservable input used in the fair value measurement of impaired debt securities is the probability weighting of alternative outcomes.
Investment Type - Level
Lower Middle Market, above, is comprised of debt investments in the Communications and Networking, Software, Electronics and Computer Hardware, Information Services, Internet Consumer and Business Services, Media/Content/Info, and Specialty Pharmaceuticals industries in the Schedule of Investments. Energy Technology, above, aligns with the Energy Technology industry in the Schedule of Investments. In our quarterly and annual reports filed with the Commission prior to the 2013 Annual Report on Form 10-K, we referred to the Energy Technology industry as “Clean Tech” and we referred to these investments as “Clean Tech” in the Schedule of Investments included in such reports.
The significant unobservable inputs used in the fair value measurement of our warrant and equity-related securities are revenue and/or EBITDA multiples and discounts for lack of marketability. Additional inputs used in the Black Scholes option pricing model include industry volatility, risk free interest rate and estimated time to exit. Significant increases (decreases) in the inputs in isolation would result in a significantly higher (lower) fair value measurement, depending on the materiality of the investment. For some investments, additional consideration may be given to data from the last round of financing or merger/acquisition events near the measurement date.
Represents amounts used when we have determined that market participants would use such multiples when pricing the investments.
Represents amounts used when we have determined market participants would take into account these discounts when pricing the 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 venture capital-backed companies in technology-related markets, including technology, biotechnology, life science and energy and renewables technology industries at all stages of development. Given the nature of lending to these types of businesses, our investments in these portfolio companies are considered Level 3 assets under ASC 820 because there is no known or accessible market or market indexes for debt instruments for these investment securities to be traded or exchanged.
In making a good faith determination of the value of our investments, we generally start with the cost basis of the investment, which includes the value attributed to the OID, if any, and PIK interest or other receivables which have been accrued to principal as earned. We then apply the valuation methods as set forth below.
We apply a procedure for debt investments that assumes a sale of investment in a hypothetical market to a hypothetical market participant where buyers and sellers are willing participants. The hypothetical market does not include scenarios where the underlying security was simply repaid or extinguished, but includes an exit concept. We determine the yield at inception for each debt investment. We then use senior secured, leveraged loan yields provided by third party providers to determine the change in market yields between inception of the debt security and the measurement date. Industry specific indices are used to benchmark/assess market based movements. Under this process, we also evaluate the collateral for recoverability of the debt investments as well as apply all of its historical fair value analysis.
We consider each portfolio company’s credit rating, security liens and other characteristics of the investment to adjust the baseline yield to derive a credit adjusted hypothetical yield for each investment as of the measurement date. The anticipated future cash flows from each investment are then discounted at the hypothetical yield to estimate each 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 yields and interest rate spreads of similar securities as of the measurement date. We value our syndicated debt investments using broker quotes and bond indices amongst other factors. If there is a significant deterioration of the credit quality of a debt investment, we may consider other factors than those a hypothetical market participant would use to estimate fair value, including the proceeds that would be received in a liquidation analysis.
We record unrealized depreciation on investments when we believe that an investment has decreased in value, including where collection of a debt investment is doubtful or, if under the in-exchange premise, when the value of a debt security is less than the 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 is greater than amortized cost.
When originating a debt instrument, we generally receive warrants or other equity-related securities from the borrower. We determine the cost basis of the warrants or other equity-related securities received based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and warrants or other equity-related securities received. Any resulting discount on the debt investment from recordation of the warrant or other equity instruments is accreted into interest income over the life of the loan.
Securities that are traded in the over-the-counter markets or on a stock exchange will be valued at the prevailing bid price at period end. We have a limited number of equity securities in public companies. In accordance with the 1940 Act, unrestricted publicly traded securities for which market quotations are readily available are valued at the closing market quote on the measurement date.
We estimate the fair value of warrants using a Black Scholes pricing model. At each reporting date, privately held warrant and equity related securities are valued based on an analysis of various factors including, but not limited to, the portfolio 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 securities. We periodically review the valuation of our portfolio companies that have not been involved in a qualifying external event to determine if the enterprise value of the portfolio company may have increased or decreased since the last valuation measurement date.
Income Recognition
We record interest income on the accrual basis and we recognize it as earned in accordance with the contractual terms of the loan agreement to the extent that such amounts are expected to be collected. Original Issue Discount (“OID”) initially represents the value of detachable equity warrants obtained in conjunction with the acquisition of debt securities and is accreted into interest income over the term of the loan as a yield enhancement. When a loan becomes 90 days or more past due, or if management otherwise does not expect the portfolio company to be able to service its debt and other obligations, we will generally place the loan on non-accrual status and cease recognizing interest income on that loan until all principal has been paid. Any uncollected interest related to prior periods is reversed from income in the period that collection of the interest receivable is determined to be doubtful. However, we may make exceptions to this policy if the investment has sufficient collateral value and is in the process of collection. At September 30, 2014, we had three debt investments on non-accrual with a cumulative cost and approximate fair value of $21.7 million and $6.5 million, respectively, compared to two debt investments on non-accrual at December 31, 2013 a cumulative cost and approximate fair market value of $23.3 million and $12.6 million, respectively.
Paid-In-Kind and End of Term Income
Contractual paid-in-kind (“PIK”) interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We will generally cease accruing PIK interest if there is insufficient value to support the accrual or we do not expect the portfolio company to be able to pay all principal and interest due. In addition, we may also be entitled to an end-of-term payment that we amortize into income over the life of the loan. To maintain our status as a RIC, PIK and end-of-term income must be paid out to stockholders in the form of dividends even though we have not yet collected the cash. Amounts necessary to pay these dividends may come from available cash or the liquidation of certain investments. We recorded approximately $851,000 and $889,000 in PIK income during the three months ended September 30, 2014 and 2013, respectively. We recorded approximately $2.6 million and $2.7 million in PIK income during the nine months ended September 30, 2014 and 2013, respectively.
Fee Income
Fee income, generally collected in advance, includes loan commitment and facility fees for due diligence and structuring, as well as fees for transaction services and management services rendered by us to portfolio companies and other third parties. Loan and commitment fees are amortized into income over the contractual life of the loan. Management fees are generally recognized as income when the services are rendered. Loan origination fees are capitalized and then amortized into interest income using the effective interest rate method. In certain loan arrangements, warrants or other equity interests are received from the borrower as additional origination fees.
We recognize nonrecurring fees amortized over the remaining term of the loan commencing in the quarter relating to specific loan modifications. Certain fees may still be recognized as one-time fees, including prepayment penalties, fees related to select covenant default waiver fees and acceleration of previously deferred loan fees and OID related to early loan pay-off or material modification of the specific debt outstanding.
Equity Offering Expenses
Our offering costs are charged against the proceeds from equity offerings when received.
Debt Issuance Costs
Debt issuance costs are fees and other direct incremental costs incurred by us in obtaining debt financing. Debt issuance costs are recognized as prepaid expenses and amortized over the life of the related debt instrument using the straight line method, which closely approximates the effective yield method.
Stock-Based Compensation
We have issued and may, from time to time, issue additional stock options and restricted stock to employees under our 2004 Equity Incentive Plan and Board members under our 2006 Equity Incentive Plan. We follow ASC 718, formally known as FAS 123R “Share-Based Payments” to account for stock options granted. Under ASC 718, compensation expense associated with stock-based compensation is measured at the grant date based on the fair value of the award and is recognized over the vesting period. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rate and expected option life.
We operate to qualify to be taxed as a RIC under the Code. Generally, a RIC is entitled to deduct dividends it pays to its shareholders from its income to determine “taxable income.” Taxable income includes our taxable interest, dividend and fee income, as well as taxable net capital gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as gains or losses are not included in taxable income until they are realized. In addition, gains realized for financial reporting purposes may differ from gains included in taxable income as a result of our election to recognize gains using installment sale treatment, which generally results in the deferment of gains for tax purposes until notes or other amounts, including amounts held in escrow, received as consideration from the sale of investments are collected in cash.
Taxable income includes non-cash income, such as changes in accrued and reinvested interest and dividends, which includes contractual PIK interest arrangements, and the amortization of discounts and fees. Cash collections of income resulting from contractual PIK interest arrangements 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.
As a RIC, we will be subject to a 4% nondeductible federal excise tax on certain undistributed income unless the we distribute 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”). 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).
Depending on the level of taxable income earned in a tax year, we 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.
At December 31, 2013 no excise tax was recorded. We intend to distribute approximately $3.8 million of spillover earnings from the year ended December 31, 2013 to our shareholders in 2014.
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 Pronouncements
In June 2013, the FASB issued ASU 2013-08, “Financial Services - Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements,” which amends the criteria that define an investment company and clarifies the measurement guidance and requires new disclosures for investment companies. Under ASU 2013-08, an entity already regulated under the 1940 Act is automatically an investment company under the new GAAP definition, so we have concluded that there is no impact from adopting this standard on our statement of assets and liabilities or results of operations. We have adopted this standard for our fiscal year ending December 31, 2014.
Subsequent Events
In April 2011, we issued $75.0 million in aggregate principal amount of 6.00% convertible senior notes, or the Convertible Senior Notes, due 2016. As of September 30, 2014, the carrying value of the Convertible Senior Notes, comprised of the aggregate principal amount outstanding less the unaccreted discount initially recorded upon issuance of the Convertible Senior Notes, is approximately $40.0 million.
The Convertible Senior Notes are convertible into shares of our common stock beginning October 15, 2015, or, under certain circumstances, earlier. Upon conversion of the Convertible Senior Notes, we have the choice to pay or deliver, as the case may be, at our election, cash, shares of our common stock or a combination of cash and shares of our common stock. The current conversion price of the Convertible Senior Notes is approximately $11.42 per share of common stock, in each case subject to adjustment in certain circumstances. Upon meeting the stock trading price conversion requirement during the three months ended September 30, 2014, the Convertible Senior Notes continue to be convertible through December 31, 2014.
Subsequent to September 30, 2014 and as of November 3, 2014, approximately $23.1 million of the Convertible Senior Notes were converted. Of the $23.1 million, approximately $416,000 of the Convertible Senior Notes were converted and were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 7,500 shares of the Company’s common stock in October 2014, and approximately $22.7 million of the Convertible Senior Notes converted and will be settled in November 2014. We expect to generate an expense of approximately $1.0 million in the fourth quarter of 2014 related to these conversions.
On November 4, 2014, Hercules Capital Funding Trust 2014-1, our newly-formed wholly owned subsidiary, priced a $129.3 million of fixed-rate asset-backed notes (the “2021 Asset Backed Notes”). The 2021 Asset Backed Notes are anticipated to be rated A(sf) on the Closing Date by Kroll Bond Rating Agency, Inc. (“KBRA”). The securitization is expected to close on November 13, 2014 and is subject to customary closing conditions.
The 2021 Asset Backed Notes will be issued by Hercules Capital Funding Trust 2014-1, LLC, as Trust Depositor, Hercules Capital Funding Trust 2014-1, as Issuer, and Guggenheim Securities, LLC, as Initial Purchaser. The 2021 Asset Backed Notes will be backed by a revolving pool of senior loans made to certain of our portfolio companies and secured by certain assets of those portfolio companies. The underlying loans will continue to be serviced by us. The securitization has an 18-month reinvestment period during which time principal collections may be reinvested into additional eligible loans. The fixed interest rate on the 2021 Asset Backed Notes will be 3.524%. The 2021 Asset Backed Notes will have a stated maturity of April 16, 2021.
Closed and Pending Commitments
As of November 3, 2014, Hercules has:
a.
Closed debt and equity commitments of approximately $83.7 million to new and existing portfolio companies.
b.
Pending commitments (signed non-binding term sheets) of approximately $211.3 million. The table below summarizes our year-to-date closed and pending commitments as follows:
Closed Commitments and Pending Commitments (in millions)
January 1 - September 30, 2014 Closed Commitments
587.7
Q4-14 Closed Commitments (as of November 3, 2014)
83.7
Total Year-to-date 2014 Closed Commitments (a)
671.4
Pending Commitments (as of November 3, 2014)(b)
211.3
Year to date 2014 Closed and Pending Commitments
882.7
Notes:
Closed Commitments may include renewals of existing credit facilities. Not all Closed Commitments result in future cash requirements. Commitments generally fund over the two succeeding quarters from close.
Not all pending commitments (signed non-binding term sheets) are expected to close and do not necessarily represent any future cash requirements.
As of September 30, 2014, we held warrants or equity positions in six companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings, including Box, Inc., Dance Biopharm, Inc., Good Technology, Inc., Zosano, Inc. and two companies which filed confidentially under the JOBS Act. Subsequent to September 30, 2014, Dance Biopharm, Inc. withdrew their Form S-1 Registration Statement. In October 2014, our portfolio company Neothetics, Inc. filed a Form S-1 Registration Statement and in November 2014, our portfolio company Inotek Pharmaceuticals Corporation filed a Form S-1 Registration Statement. In addition, subsequent to September 30, 2014 the following current and former portfolio companies announced or completed M&A transactions or initial public offerings:
In October 2014, InterCloud Systems, Inc. completed its acquisition of our portfolio company VaultLogix, LLC. The transaction consists of $16 million in cash, $12.75 million in restricted common stock, $11.5 million of which was valued at $16.50 per share, with the balance valued at market price, and $15.5 million in three year convertible seller notes, convertible at a fixed price of $6.37 per share.
In October 2014, AVG Technologies completed its acquisition of our portfolio company Location Labs. Under the terms of the agreement, AVG will pay approximately $140 million initially, plus up to an additional approximately $80 million in cash consideration over the next two years based on the achievement of certain performance metrics and milestones.
In October 2014, Premiere Global Services, Inc. completed its acquisition of Hercules portfolio company Central Desktop, Inc. Financial terms were not disclosed.
In October 2014, Breg, Inc. and our portfolio company United Orthopedic Group, Inc. announced that they had merged. United Orthopedic Group, Inc. will operate as a wholly-owned subsidiary of Breg, Inc. and financial terms were not disclosed.
In October 2014, our portfolio company SiTime Corporation reached a definitive agreement to be acquired by MegaChips Corporation in a transaction valued at approximately $200.0 million, subject to customary closing conditions.
In October 2014, our portfolio company Transcept Pharmaceuticals, Inc. completed its merger with our portfolio company Paratek Pharmaceuticals, Inc. in an all-stock transaction. Immediately prior to the merger, Paratek received gross proceeds of $93.0 million from a combination of current and new investors.
In October 2014, our former portfolio company Zayo Group Holdings, Inc. completed its initial public offering of 24,079,002 shares of its common stock, consisting of 16,008,679 shares sold by the portfolio company and 8,070,323 shares sold by the selling stockholders (including shares sold by the selling stockholders pursuant to the exercise in full of the underwriters’ option to purchase additional shares), at a price to the public of $19.00 per share.
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 interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle funds investments. Our investment income will be affected by changes in various interest rates, including LIBOR and Prime rates, to the extent our debt investments include variable interest rates. As of September 30, 2014, approximately 98.1% of the loans in our portfolio had variable rates based on floating Prime or LIBOR rates with a floor. 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.
Based on our Consolidated Statement of Assets and Liabilities as of September 30, 2014, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investments and borrowings.
Basis Point Change(1)
Expense
6,819
13,198
21,489
30,260
39,070
A decline in interest rates would not have a material impact on our Consolidated Financial Statements.
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. During the nine months ended September 30, 2014, we did not engage in interest rate hedging activities.
Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in the credit market, credit quality, size and composition of the assets in our portfolio. It also does not adjust for other business developments, including borrowings under our Credit Facilities, SBA debentures, Convertible Senior Notes, 2019 Notes, 2024 Notes and Asset-Backed Notes, that could affect the net increase in net assets resulting from operations, or net income. Accordingly, no assurances can be given that actual results would not differ materially from the statement above.
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.
For additional information regarding the interest rate associated with each of our Credit Facilities, SBA debentures, Convertible Senior Notes, 2019 Notes, 2024 Notes and Asset-Backed Notes, please refer to “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition, Liquidity and Capital Resources - Outstanding Borrowings” in this quarterly report on Form 10-Q.
ITEM 4.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our chief executive and chief financial officers, under the supervision and with the participation of our management, conducted an evaluation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of the end of the period covered by this quarterly report on Form 10-Q, our chief executive and chief financial officers have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our chief executive and chief financial officers, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financing reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended, that occurred during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
LEGAL PROCEEDINGS
We may, from time to time, be involved in litigation arising out of our operations in the normal course of business or otherwise. Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies. While the outcome of any current legal proceedings cannot at this time be predicted with certainty, we do not expect any current matters will materially affect our financial condition or results of operations; however, there can be no assurance whether any pending legal proceedings will have a material adverse effect on our financial condition or results of operations in any future reporting period.
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, 2013 filed with the Securities and Exchange Commission on February 27, 2014.
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 September 30, 2014 that represent greater than 5% of our net assets:
Percentage of Net Assets
Merrimack Pharmaceuticals, Inc.
48,121
Alimera Sciences, Inc.
33,895
Merrimack Pharmaceuticals, Inc. is a biopharmaceutical company discovering, developing and preparing to commercialize innovative medicines paired with companion diagnostics for the treatment of serious diseases, with an initial focus on cancer.
Alimera Sciences, Inc. is a biopharmaceutical company that specializes in the research, development and commercialization of prescription ophthalmic pharmaceuticals.
Our financial results could be materially adversely 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.
We face cyber-security risks.
Our business operations rely upon secure information technology systems for data processing, storage and reporting. Despite careful security and controls design, implementation and updating, our information technology systems could become subject to cyber-attacks. Network, system, application and data breaches could result in operational disruptions or information misappropriation, which could have a material adverse effect on our business, results of operations and financial condition.
We are dependent on information systems and systems failures could significantly disrupt our business, which may, in turn, negatively affect the market price of our common stock and our ability to pay dividends.
Our business is dependent on our and third parties’ communications and information systems. Any failure or interruption of those systems, including as a result of the termination of an agreement with any third-party service providers, could cause delays or other problems in our activities. Our financial, accounting, data processing, backup or other operating systems and facilities may fail to operate properly or become disabled or damaged as a result of a number of factors including events that are wholly or partially beyond our control and adversely affect our business. There could be:
sudden electrical or telecommunications outages;
natural disasters such as earthquakes, tornadoes and hurricanes;
disease pandemics;
events arising from local or larger scale political or social matters, including terrorist acts; and
cyber-attacks.
These events, in turn, could have a material adverse effect on our operating results and negatively affect the market price of our common stock and our ability to pay dividends to our stockholders.
96
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
During the nine month period ended September 30, 2014, we issued approximately 76,000 shares of common stock to shareholders in connection with the dividend reinvestment plan. These issuances were not subject to the registration requirements of the Securities Act of 1933, as amended. The aggregate value of the shares of our common stock issued under our dividend reinvestment plan was approximately $1.2 million.
DEFAULTS UPON SENIOR SECURITIES
Not Applicable
MINE SAFETY DISCLOSURES
ITEM 5.
OTHER INFORMATION
ITEM 6.
EXHIBITS
ExhibitNumber
10.1
Fifth Amendment to Loan and Security Agreement by and among Hercules Funding II LLC and Wells Fargo Capital Finance, LLC (f/k/a Wells Fargo Foothill, LLC), dated as of August 8, 2014.*
10.2
Second Amended and Restated Loan and Security Agreement between Hercules Technology Growth Capital, Inc. and Union Bank, N.A., dated as of August 14, 2014.(1)
31.1
Chief Executive Officer Certification Pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2
Chief Financial Officer Certification Pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1
Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
32.2
Chief Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
Filed herewith.
(1) Previously filed as part of the Current Report on Form 8-K of the Company, as filed on August 19, 2014.
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: November 6, 2014
/S/ MANUEL A. HENRIQUEZ
Manuel A. Henriquez
Chairman, President, and Chief Executive Officer
/S/ JESSICA BARON
Jessica Baron
Vice President, Finance and Chief Financial Officer
EXHIBIT INDEX
Exhibit
Chief Executive Officer Certification Pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
99