Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For The Quarterly Period Ended September 30, 2008

OR

 

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

Commission File Number: 814-00702

 

 

HERCULES TECHNOLOGY GROWTH

CAPITAL, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Maryland   743113410

(State or Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification No.)

 

400 Hamilton Ave., Suite 310 Palo Alto, California 94301   94301
(Address of Principal Executive Offices)   (Zip Code)

(650) 289-3060

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods as 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 is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

On November 7, 2008, there were 32,862,554 shares outstanding of the Registrant’s common stock, $0.001 par value.

 

 

 


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

FORM 10-Q TABLE OF CONTENTS

 

PART I.     FINANCIAL INFORMATION     3
    Item 1.   Consolidated Financial Statements    3
  Consolidated Statement of Assets and Liabilities as of September 30, 2008 (unaudited) and December 31, 2007    3
  Consolidated Schedule of Investments as of September 30, 2008 (unaudited)    4
  Consolidated Schedule of Investments as of December 31, 2007    18
  Consolidated Statement of Operations for the three and nine-month periods ended September 30, 2008 and 2007 (unaudited)    32
  Consolidated Statement of Changes in Net Assets for the nine-month periods ended September 30, 2008 and 2007 (unaudited)    33
  Consolidated Statement of Cash Flows for the nine-month periods ended September 30, 2008 and 2007 (unaudited)    34
  Notes to Consolidated Financial Statements (unaudited)    35
    Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    48
    Item 3.   Quantitative and Qualitative Disclosures About Market Risk    61
    Item 4.   Controls and Procedures    61
PART II.     OTHER INFORMATION    61
    Item 1.   Legal Proceedings    61
    Item 1A.   Risk Factors    61
    Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    66
    Item 3.   Defaults Upon Senior Securities    66
    Item 4.   Submission of Matters to a Vote of Security Holders    66
    Item 5.   Other Information    66
    Item 6.   Exhibits    67
SIGNATURES    68

 

2


Table of Contents

PART I: FINANCIAL INFORMATION

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

 

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES

(in thousands, except per share data)

 

     September 30,
2008
(unaudited)
    December 31,
2007
 

Assets

    

Investments:

    

Non-affiliate investments (cost of $621,675 and $513,106)

   $ 632,500     $ 525,725  

Affiliate investments (cost of $6,344 and $6,344)

     4,247       4,247  
                

Total investments, at value (cost of $628,019 and $519,450 respectively)

     636,747       529,972  

Deferred loan origination revenue

     (7,769 )     (6,593 )

Cash and cash equivalents

     20,489       7,856  

Interest receivable

     7,859       6,387  

Other assets

     17,677       4,321  
                

Total assets

     675,003       541,943  

Liabilities

    

Accounts payable and accrued liabilities

     7,213       6,956  

Short-term credit facility

     127,900       79,200  

Long-term credit facility

     10,000       —    

Long-term SBA debentures

     127,200       55,050  
                

Total liabilities

     272,313       141,206  
                

Net assets

   $ 402,690     $ 400,737  
                

Net assets consist of:

    

Common stock, par value

   $ 33     $ 33  

Capital in excess of par value

     397,990       393,530  

Deferred stock compensation

     (2,418 )     (78 )

Unrealized appreciation on investments

     8,105       10,129  

Accumulated realized gains on investments

     5,812       819  

Distributions in excess of investment income

     (6,832 )     (3,696 )
                

Total net assets

   $ 402,690     $ 400,737  
                

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

     32,863       32,541  
                

Net asset value per share

   $ 12.25     $ 12.31  
                

See notes to consolidated financial statements (unaudited).

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Acceleron Pharmaceuticals, Inc. (0.77%)*(4)

   Drug Discovery   

Senior Debt
Matures January 2010
Interest rate 10.25%

   $ 2,204    $ 2,202    $ 2,202
     

Preferred Stock Warrants

        69      731
     

Preferred Stock Warrants

        35      162

Acceleron Pharmaceuticals, Inc. (0.45%)

     

Preferred Stock

        1,243      1,805
                      

Total Acceleron Pharmaceuticals, Inc.

              3,549      4,900

Aveo Pharmaceuticals, Inc. (3.78%)(4)

   Drug Discovery   

Senior Debt
Matures November 2011
Interest rate 11.13%

   $ 15,000      14,913      14,890
     

Preferred Stock Warrants

        190      252
     

Preferred Stock Warrants

        104      68
     

Preferred Stock Warrants

        24      23
                      

Total Aveo Pharmaceuticals, Inc.

              15,231      15,233

Elixir Pharmaceuticals, Inc. (2.8%)(4)

   Drug Discovery   

Senior Debt
Matures December 2010
Interest rate Prime + 4.50%

   $ 11,000      11,000      11,000
     

Preferred Stock Warrants

        217      260
                      

Total Elixir Pharmaceuticals, Inc.

              11,217      11,260

EpiCept Corporation (0.91%)(4)

   Drug Discovery   

Senior Debt
Matures April 2009
Interest rate 15.00%

   $ 2,768      2,532      2,897
     

Common Stock Warrants

        —        —  
     

Common Stock Warrants

        161      610
     

Common Stock Warrants

        40      154
                      

Total EpiCept Corporation

              2,733      3,661

Horizon Therapeutics, Inc. (1.53%)(4)

   Drug Discovery   

Senior Debt
Matures May 2011
Interest rate Prime + 1.50%

   $ 6,000      5,880      5,880
     

Preferred Stock Warrants

        178      263
                      

Total Horizon Therapeutics, Inc.

              6,058      6,143

Inotek Pharmaceuticals Corp. (0.37%)

   Drug Discovery   

Preferred Stock

        1,500      1,500
                      

Total Inotek Pharmaceuticals Corp.

              1,500      1,500

Memory Pharmaceuticals Corp. (3.04%)(4)

   Drug Discovery   

Senior Debt
Matures December 2010
Interest rate 11.45%

   $ 13,245      12,221      12,221
     

Common Stock Warrants

        1,751      23
                      

Total Memory Pharmaceuticals Corp.

              13,972      12,244

Merrimack Pharmaceuticals, Inc. (0.25%)(4)

   Drug Discovery   

Convertible Senior Debt
Matures October 2008
Interest rate 11.15%

   $ 85      85      85
     

Preferred Stock Warrants

        156      914

Merrimack Pharmaceuticals, Inc. (0.69%)

     

Preferred Stock

        2,000      2,787
                      

Total Merrimack Pharmaceuticals, Inc.

              2,241      3,786

Neosil, Inc. (0.00%)

   Drug Discovery   

Preferred Stock Warrants

        83      —  
                      

Total Neosil, Inc.

              83      —  

Paratek Pharmaceuticals, Inc. (0.10%)(4)

   Drug Discovery   

Preferred Stock Warrants

        137      415

Paratek Pharmaceuticals, Inc. (0.25%)

     

Preferred Stock

        1,000      1,000
                      

Total Paratek Pharmaceuticals, Inc.

              1,137      1,415

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

   Industry   

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Portola Pharmaceuticals, Inc. (3.28%)(4)

   Drug Discovery   

Senior Debt
Matures September 2011
Interest rate Prime + 2.16%

   $ 12,917    12,840    12,840
     

Preferred Stock Warrants

      152    350
                  

Total Portola Pharmaceuticals, Inc.

            12,992    13,190

Recoly, N.V. (0.74%)(6)

   Drug Discovery   

Senior Debt
Matures May 2012
Interest rate Prime + 4.25%

   $ 3,000    3,000    3,000
                  

Total Recoly, N.V.

            3,000    3,000
                  

Total Drug Discovery (18.96%)

            73,713    76,332
                  

Affinity Videonet, Inc. (1.62%)(4)

   Communications &
Networking
  

Senior Debt
Matures June 2012
Interest rate Prime + 4.50%

   $ 4,000    3,935    3,935
     

Senior Debt
Matures June 2012
Interest rate Prime + 5.50%

   $ 2,000    2,000    2,000
     

Revolving Line of Credit
Matures June 2012
Interest rate Prime + 3.50%

   $ 500    500    500
     

Preferred Stock Warrants

      74    72
                  

Total Affinity Videonet, Inc.

            6,509    6,507

E-band Communications, Inc. (0.50%)(7)

   Communications &
Networking
  

Preferred Stock

      2,000    2,000
                  

Total E-Band Communications, Inc.

            2,000    2,000

IKANO Communications, Inc. (3.88%)(4)

   Communications &
Networking
  

Senior Debt
Matures April 2011
Interest rate 11.00%

   $ 15,196    15,196    15,196
     

Preferred Stock Warrants

      46    175
     

Preferred Stock Warrants

      72    266
                  

Total IKANO Communications, Inc.

            15,314    15,637

Kadoink, Inc. (0.5%)(4)

   Communications &
Networking
  

Senior Debt
Matures April 2011
Interest rate Prime + 2.00%

   $ 2,000    1,952    1,952
     

Preferred Stock Warrants

      73    72

Kadoink, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Kadoink, Inc.

            2,275    2,274

Neonova Holding Company (2.24%)

   Communications &
Networking
  

Senior Debt
Matures September 2012
Interest rate Prime + 3.25%

   $ 9,000    8,924    8,924
     

Preferred Stock Warrants

      94    80

Neonova Holding Company (0.06%)

     

Preferred Stock

      250    250
                  

Total Neonova Holding Company

            9,268    9,254

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Peerless Network, Inc. (0.37%)(5)

   Communications & Networking   

Senior Debt
Matures June 2011
Interest rate Prime + 3.25%

   $ 1,500    1,428    1,428
     

Preferred Stock Warrants

      95    75

Peerless Network, Inc. (0.25%)

     

Preferred Stock

      1,000    1,000
                  

Total Peerless Network, Inc.

            2,523    2,503

Ping Identity Corporation (0.21%)(4)

   Communications & Networking   

Senior Debt
Matures June 2009
Interest rate 11.50%

   $ 851    842    842
     

Preferred Stock Warrants

      51    2
                  

Total Ping Identity Corporation

            893    844

Purcell Systems, Inc. (2.47%)

   Communications & Networking   

Senior Debt
Matures June 2010
Interest rate Prime + 3.50%

   $ 1,807    1,739    1,739
     

Revolving Line of Credit
Matures July 2009
Interest rate Prime + 2.75%

   $ 6,000    6,000    6,000
     

Senior Debt
Matures July 2011
Interest rate Prime + 3.50%

   $ 1,600    1,600    1,600
     

Preferred Stock Warrants

      123    613
                  

Total Purcell Systems, Inc.

            9,462    9,952

Rivulet Communications, Inc. (0.57%)(5)

   Communications & Networking   

Senior Debt
Matures April 2010
Interest rate 10.50%

   $ 2,324    2,301    2,301
     

Preferred Stock Warrants

      51    —  

Rivulet Communications, Inc. (0.00%)

     

Preferred Stock

      250    4
                  

Total Rivulet Communications, Inc.

            2,602    2,305

Seven Networks, Inc. (2.57%)(4)

   Communications & Networking   

Senior Debt
Matures April 2010
Interest rate Prime + 6.00%

   $ 6,941    6,859    6,859
     

Revolving Line of Credit
Matures September 2009
Interest rate Prime + 5.00%

   $ 3,000    3,000    3,000
     

Preferred Stock Warrants

      174    500
                  

Total Seven Networks, Inc.

            10,033    10,359

Simpler Networks Corp. (0.98%)(8)

   Communications & Networking   

Senior Debt
Matures July 2010
Interest rate 18.25%

   $ 4,646    4,615    3,966
     

Preferred Stock Warrants

      160    —  

Simpler Networks Corp. (0.00%)

     

Preferred Stock

      500    —  
                  

Total Simpler Networks Corp.

            5,275    3,966

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Stoke, Inc. (0.77%)

   Communications & Networking   

Senior Debt
Matures August 2010
Interest rate 10.55%

   $ 3,028    2,995    2,995
     

Preferred Stock Warrants

      53    116
                  

Total Stoke, Inc.

            3,048    3,111

Tectura Corporation (6.32%)(4)

   Communications & Networking   

Senior Debt
Matures April 2012
Interest rate LIBOR + 6.90%

   $ 7,753    7,852    7,852
     

Revolving Line of Credit
Matures April 2009
Interest rate LIBOR + 6.35%

   $ 12,000    12,000    12,000
     

Revolving Line of Credit
Matures March 2009
Interest rate LIBOR + 7.50%

   $ 5,507    5,507    5,507
     

Preferred Stock Warrants

      51    90
                  

Total Tectura Corporation

            25,410    25,449

Teleflip, Inc. (0.16%)

   Communications & Networking   

Senior Debt
Matures June 2010
Interest rate Prime + 2.75%

   $ 906    907    651
     

Preferred Stock Warrants

      11    —  
                  

Total Teleflip, Inc.

            918    651

Wireless Channels, Inc. (3.01%)(4)

   Communications & Networking   

Senior Debt
Matures April 2010
Interest rate Prime + 4.25%

   $ 11,156    11,461    11,461
     

Preferred Stock Warrants

      155    641
                  

Total Wireless Channels, Inc.

            11,616    12,102

Zayo Bandwidth, Inc. (6.21%)

   Communications & Networking   

Senior Debt
Matures November 2013
Interest rate Libor + 5.25%

   $ 25,000    25,000    25,000
                  

Total Zayo Bandwith, Inc.

            25,000    25,000
                  

Total Communications & Networking (32.75%)

            132,146    131,914
                  

Atrenta, Inc. (2.30%)(5)

   Software   

Senior Debt
Matures January 2010
Interest rate 11.50%

   $ 2,961    2,898    2,898
     

Revolving Line of Credit
Matures October 2009
Interest rate Prime + 2.00%

   $ 6,000    6,000    6,000
     

Preferred Stock Warrants

      102    242
     

Preferred Stock Warrants

      34    79
     

Preferred Stock Warrants

      71    56

Atrenta, Inc. (0.06%)

     

Preferred Stock

      250    240
                  

Total Atrenta, Inc.

            9,355    9,515

Blurb, Inc. (1.67%)

   Software   

Senior Debt
Matures December 2009
Interest rate 9.55%

   $ 1,720    1,709    1,709
     

Senior Debt
Matures June 2011
Interest rate Prime + 3.50%

   $ 5,000    5,000    5,000
     

Preferred Stock Warrants

      25    33
                  

Total Blurb, Inc.

            6,734    6,742

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)
   Value(3)

Braxton Technologies, LLC. (2.5%)(5)

   Software   

Senior Debt
Matures July 2012
Interest rate Libor + 7.25%

   $ 10,000    9,863    9,863
     

Preferred Stock Warrants

      188    202
                  

Total Braxton Technologies, LLC.

            10,051    10,065

Bullhorn, Inc. (0.28%)

   Software   

Senior Debt
Matures November 2010
Interest rate Prime + 3.75%

   $ 877    851    851
     

Preferred Stock Warrants

      43    261
                  

Total Bullhorn, Inc.

            894    1,112

Cittio, Inc. (0.22%)

   Software   

Senior Debt
Matures May 2010
Interest rate 11.00%

   $ 849    832    832
     

Preferred Stock Warrants

      53    59
                  

Total Cittio, Inc.

            885    891

Clickfox, Inc. (0.62%)

   Software   

Senior Debt
Matures September 2011
Interest rate 10.25%

   $ 2,500    2,337    2,337
     

Preferred Stock Warrants

      163    161
                  

Total Clickfox, Inc.

            2,500    2,498

Forescout Technologies, Inc. (0.46%)(4)

   Software   

Senior Debt
Matures August 2009
Interest rate 11.15%

   $ 1,191    1,169    1,169
     

Revolving Line of Credit
Matures February 2009
Interest rate Prime + 2.25%

   $ 500    500    500
     

Preferred Stock Warrants

      99    162
                  

Total Forescout Technologies, Inc.

            1,768    1,831

GameLogic, Inc. (0.59%)(4)

   Software   

Senior Debt
Matures September 2010
Interest rate Prime + 4.125%

   $ 2,461    2,369    2,369
     

Preferred Stock Warrants

      93    —  
                  

Total GameLogic, Inc.

            2,462    2,369

Gomez, Inc. (0.13%)(4)

   Software   

Preferred Stock Warrants

      35    526
                  

Total Gomez, Inc.

            35    526

HighJump Acquisition, LLC. (2.98%)(4)

   Software   

Senior Debt
Matures May 2013
Interest rate Prime + 7.50%

   $ 12,000    12,000    12,000
                  

Total HighJump Acquisition, LLC.

            12,000    12,000

HighRoads, Inc. (0.01%)(4)

   Software   

Preferred Stock Warrants

      44    57
                  

Total HighRoads, Inc.

            44    57

Infologix, Inc. (5.21%)(4)

  

 

Software

  

 

Senior Debt
Matures April 2012
Interest rate Prime + 4.50%

   $ 12,000    12,000    12,000
     

Revolving Line of Credit
Matures August 2009
Interest rate Prime + 2.50%

   $ 9,000    9,000    9,000
                  

Total Infologix, Inc.

            21,000    21,000

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Intelliden, Inc. (0.43%)

   Software   

Senior Debt
Matures February 2010
Interest rate 13.20%

   $ 1,652    1,645    1,645
     

Preferred Stock Warrants

      18    72
                  

Total Intelliden, Inc.

            1,663    1,717

Oatsystems, Inc. (0.00%)(4)

   Software   

Preferred Stock Warrants

      67    —  
                  

Total Oatsystems, Inc.

            67    —  

Proficiency, Inc. (0.37%)(6)(7)

   Software   

Senior Debt
Matures August 2012
Interest rate 8.00%

   $ 1,500    1,497    1,497
     

Preferred Stock Warrants

      97    —  

Proficiency, Inc. (0.19%)

     

Preferred Stock

      2,750    750
                  

Total Proficiency, Inc.

            4,344    2,247

PSS Systems, Inc. (0.72%)(4)

   Software   

Senior Debt
Matures March 2010
Interest rate 10.74%

   $ 2,837    2,813    2,813
     

Preferred Stock Warrants

      51    93
                  

Total PSS Systems, Inc.

            2,864    2,906

Rockyou, Inc. (0.74%)(4)

   Software   

Senior Debt
Matures May 2011
Interest rate Prime + 2.50%

   $ 3,000    2,883    2,883
     

Preferred Stock Warrants

      117    99
                  

Total Rockyou, Inc.

            3,000    2,982

Savvion, Inc. (1.43%)(4)

   Software   

Senior Debt
Matures April 2009
Interest rate Prime + 3.45%

   $ 574    574    574
     

Revolving Line of Credit
Matures March 2009
Interest rate Prime + 4.45%

   $ 2,078    2,078    2,078
     

Revolving Line of Credit
Matures March 2009
Interest rate Prime + 3.00%

   $ 2,907    2,855    2,855
     

Preferred Stock Warrants

      52    264
                  

Total Savvion, Inc.

            5,559    5,771

Sportvision, Inc. (0.02%)

   Software   

Preferred Stock Warrants

      39    86
                  

Total Sportvision, Inc.

            39    86

WildTangent, Inc. (0.53%)

   Software   

Senior Debt
Matures March 2011
Interest rate 9.65%

   $ 2,000    1,845    1,845
     

Preferred Stock Warrants

      238    282
                  

Total WildTangent, Inc.

            2,083    2,127
                  

Total Software (21.46%)

            87,347    86,442
                  

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Luminus Devices, Inc. (3.07%)(4)

   Electronics & Computer
Hardware
  

Senior Debt
Matures November 2010
Interest rate 12.875%

   $ 7,861    11,474    11,474
     

Preferred Stock Warrants

      183    273
     

Preferred Stock Warrants

      84    142
     

Preferred Stock Warrants

      334    481
                  

Total Luminus Devices, Inc.

            12,075    12,370

Maxvision Holding, LLC. (2.7%)(4)

   Electronics & Computer
Hardware
  

Senior Debt
Matures October 2012
Interest rate Prime + 5.50%

   $ 5,000    5,089    5,089
     

Senior Debt
Matures April 2012
Interest rate Prime + 2.25%

   $ 5,292    5,292    5,292
     

Revolving Line of Credit
Matures April 2012
Interest rate Prime +2.25%

   $ 472    502    502

Maxvision Holding, LLC. (0.02%) (4)

     

Preferred Stock

      81    82
                  

Total Maxvision Holding, LLC

            10,964    10,965

NetEffect, Inc. (0.62%)

   Electronics & Computer Hardware   

Senior Debt
Matures May 2010
Interest rate 16.95%

   $ 2,552    2,515    2,515
     

Preferred Stock Warrants

      47    —  
                  

Total NetEffect, Inc.

            2,562    2,515

Shocking Technologies, Inc. (1.01%)

   Electronics & Computer
Hardware
  

Senior Debt
Matures December 2010
Interest rate 9.75%

   $ 4,000    3,959    3,959
     

Preferred Stock Warrants

      63    89
                  

Total Shocking Technologies, Inc.

            4,022    4,048

SiCortex, Inc. (2.08%)

   Electronics & Computer
Hardware
  

Senior Debt
Matures December 2010
Interest rate 10.95%

   $ 8,179    8,077    8,077
     

Preferred Stock Warrants

      164    293
                  

Total SiCortex, Inc.

            8,241    8,370

Spatial Photonics, Inc. (0.97%)(4)

  

 

Electronics & Computer
Hardware

  

 

Senior Debt
Matures April 2011
Interest rate 10.066%

   $ 3,410    3,326    3,326
     

Senior Debt
Mature April 2011
Interest rate 9.217%

   $ 341    341    341
     

Preferred Stock Warrants

      130    237

Spatial Photonics, Inc. (0.12%)

     

Preferred Stock

      500    500
                  

Total Spatial Photonics Inc.

            4,297    4,404

VeriWave, Inc. (0.96%)

   Electronics & Computer
Hardware
  

Senior Debt
Matures May 2010
Interest rate 10.75%

   $ 2,960    2,932    2,932
     

Revolving Line of Credit
Matures September 30
Interest rate Prime +1.00%

   $ 922    922    922
     

Preferred Stock Warrants

      55    5
                  

Total VeriWave, Inc.

            3,909    3,859

ViDeOnline Communications, Inc. (0.07%)(4)

   Electronics & Computer
Hardware
  

Preferred Stock Warrants

      298    287
                  

Total ViDeOnline Communications, Inc.

            298    287
                  

Total Electronics & Computer Hardware (11.62%)

            46,368    46,818
                  

See notes to consolidated financial statements (unaudited)

 

10


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Aegerion Pharmaceuticals, Inc. (1.96%)(5)

   Specialty Pharmaceuticals   

Senior Debt
Matures August 2011
Interest rate 8.00%

   $ 7,525    7,525    7,525
     

Covertible Senior Debt
Matures December 2009
Interest rate Prime + 2.50%

   $ 76    76    76
     

Preferred Stock Warrants

      70    307

Aegerion Pharmaceuticals, Inc. (0.25%)(4)

     

Preferred Stock

      1,000    1,000
                  

Total Aegerion Pharmaceuticals, Inc.

            8,671    8,908

Panacos Pharmaceuticals, Inc. (4.55%)(4)

   Specialty Pharmaceuticals   

Senior Debt
Matures January 2011
Interest rate 11.20%

   $ 18,839    18,296    18,296
     

Common Stock Warrants

      876    23

Panacos Pharmaceuticals, Inc. (0.02%)

     

Common Stock

      410    62
                  

Total Panacos Pharmaceuticals, Inc.

            19,582    18,381

Quatrx Pharmaceuticals Company (4.99%)(4)

   Specialty Pharmaceuticals   

Senior Debt
Matures October 2011
Interest rate Prime + 4.85%

   $ 20,000    19,728    19,728
     

Preferred Stock Warrants

      220    149
     

Preferred Stock Warrants

      307    219

Quatrx Pharmaceuticals Company (0.19%)

     

Preferred Stock

      750    750
                  

Total Quatrx Pharmaceuticals Company

            21,005    20,846
                  

Total Specialty Pharmaceuticals (11.96%)

            49,258    48,135
                  

Annie’s, Inc. (1.52%)

   Consumer & Business Products   

Senior Debt - Second Lien
Matures April 2011
Interest rate LIBOR + 6.20%

   $ 6,000    5,768    5,768
     

Preferred Stock Warrants

      321    335
                  

Total Annie’s, Inc.

            6,089    6,103

BabyUniverse, Inc. (0.01%)(4)

   Consumer & Business Products   

Common Stock

      267    37
                  

Total BabyUniverse, Inc.

            267    37

IPA Holdings, LLC. (4.16%)(4)

  

 

Consumer & Business

Products

  

 

Senior Debt
Matures November 2012
Interest rate Prime + 3.50%

   $ 10,000    10,000    10,000
     

Senior Debt
Matures May 2013
Interest rate Prime + 6.00%

   $ 6,500    6,549    6,549
     

Revolving Line of Credit
Matures November 2012
Interest rate Prime + 2.50%

   $ 200    200    200

IPA Holding, LLC.(0.12%)

     

Preferred Stock

      500    500
                  

Total IPA Holding, LLC.

            17,249    17,249

Market Force Information, Inc. (0.01%)(4)

  

 

Consumer & Business

Products

  

Preferred Stock Warrants

      24    52

Market Force Information, Inc. (0.07%)

     

Preferred Stock

      500    298
                  

Total Market Force Information, Inc.

            524    350

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

OnTech Operations, Inc. (1.76%)

   Consumer & Business Products   

Senior Debt
Matures June 2011
Interest rate Prime + 6.375%

   $ 6,000    5,426    5,426
     

Revolving Line of Credit
Matures June 2009
Interest rate Prime +5.625%

   $ 806    806    806
     

Preferred Stock Warrants

      452    556
     

Preferred Stock Warrants

      218    314

OnTech Operations, Inc. (0.25%)

     

Preferred Stock

      1,000    1,000
                  

Total OnTech Operations, Inc.

            7,902    8,102

Wageworks, Inc. (0.25%)(4)

   Consumer & Business Products   

Preferred Stock Warrants

      252    1,018

Wageworks, Inc. (0.07%)

     

Preferred Stock

      250    265
                  

Total Wageworks, Inc.

            502    1,283
                  

Total Consumer & Business Products (8.22%)

            32,533    33,124
                  

Custom One Design, Inc. (0.22%)

   Semiconductors   

Senior Debt
Matures September 2010
Interest rate 11.50%

   $ 874    862    862
     

Common Stock Warrants

      18    5
                  

Total Custom One Design, Inc.

            880    867

Enpirion, Inc. (1.87%)

   Semiconductors   

Senior Debt
Matures August 2011
Interest rate Prime + 4.00%

   $ 7,500    7,372    7,372
     

Preferred Stock Warrants

      157    161
                  

Total Enpirion, Inc.

            7,529    7,533

iWatt Inc. (1.07%)(4)

   Semiconductors   

Senior Debt
Matures September 2009
Interest rate Prime + 2.75%

   $ 859    857    857
     

Senior Debt
Matures September 2009
Interest rate 11.00%

   $ 1,762    1,762    1,762
     

Revolving Line of Credit
Matures December 2008
Interest rate Prime + 2.00%

   $ 1,000    1,000    1,000
     

Preferred Stock Warrants

      47    103
     

Preferred Stock Warrants

      51    56
     

Preferred Stock Warrants

      73    69
     

Preferred Stock Warrants

      458    458

iWatt Inc. (0.24%)

     

Preferred Stock

      490    949
                  

Total iWatt Inc.

            4,738    5,254

NEXX Systems, Inc. (2.06%)(4)

   Semiconductors   

Senior Debt
Matures February 2010
Interest rate Prime + 3.50

   $ 3,146    3,067    3,067
     

Revolving Line of Credit
Matures December 2009
Interest rate Prime + 3.00%

   $ 2,546    2,546    2,546
     

Revolving Line of Credit
Matures December 2009
Interest rate Prime + 5.00%

   $ 2,454    2,454    2,454
     

Preferred Stock Warrants

      165    232
                  

Total NEXX Systems, Inc.

            8,232    8,299

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Quartics, Inc. (0.93%)(4)

   Semiconductors   

Senior Debt
Matures August 2010
Interest rate 11.05%

   $ 252    220    220
     

Senior Debt
Matures August 2010
Interest rate 8.80%

   $ 3,513    3,513    3,513
     

Preferred Stock Warrants

      53    5
                  

Total Quartics, Inc.

            3,786    3,738

Solarflare Communications, Inc. (0.17%)(4)

   Semiconductors   

Senior Debt
Matures August 2010
Interest rate 11.75%

   $ 526    475    475
     

Preferred Stock Warrants

      83    224

Solarflare Communications, Inc. (0.16%)

     

Preferred Stock

      641    641
                  

Total Solarflare Communications, Inc.

            1,199    1,340
                  

Total Semiconductors (6.72%)

            26,364    27,031
                  

Labopharm USA, Inc. (3.77%)(4)(6)

   Drug Delivery   

Senior Debt
Matures December 2011
Interest rate 10.95%

   $ 15,000    14,670    14,670
     

Common Stock Warrants

      458    507
                  

Total Labopharm USA, Inc.

            15,128    15,177

Transcept Pharmaceuticals, Inc. (1.13%)(5)

   Drug Delivery   

Senior Debt
Matures October 2009
Interest rate 10.69%

   $ 4,301    4,274    4,274
     

Preferred Stock Warrants

      36    116
     

Preferred Stock Warrants

      51    168

Transcept Pharmaceuticals, Inc. (0.12%)

     

Preferred Stock

      500    465
                  

Total Transcept Pharmaceuticals, Inc.

            4,861    5,023
                  

Total Drug Delivery (5.02%)

            19,989    20,200
                  

BARRX Medical, Inc.(0.82%)(4)

   Therapeutic   

Senior Debt
Mature December 2011
Interest rate 11.00%

   $ 3,333    3,270    3,270
     

Preferred Stock Warrants

      63    49

BARRX Medical, Inc. (0.37%)

     

Preferred Stock

      1,500    1,500
                  

Total BARRX Medical, Inc.

            4,833    4,819

EKOS Corporation (1.33%)

   Therapeutic   

Senior Debt
Matures November 2010
Interest rate Prime + 2.00%

   $ 5,000    4,806    4,806
     

Preferred Stock Warrants

      175    347
     

Preferred Stock Warrants

      152    188
                  

Total EKOS Corporation

            5,133    5,341

Gelesis, Inc. (0.37%)

   Therapeutic   

Senior Debt
Matures May 2012
Interest rate Prime + 5.65%

   $ 1,500    1,474    1,474
     

Preferred Stock Warrants

      25    33
                  

Total Gelesis, Inc.

            1,499    1,507

Gynesonics, Inc. (0.03%)(4)

   Therapeutic   

Preferred Stock Warrants

      18    105

Gynesonics, Inc. (0.08%)

     

Preferred Stock

      250    322
                  

Total Gynesonics, Inc.

            268    427

Light Science Oncology, Inc. (0.03%)

   Therapeutic   

Preferred Stock Warrants

      99    124
                  

Total Light Science Oncology, Inc.

            99    124

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Novasys Medical, Inc. (1.12%)(4)

   Therapeutic   

Senior Debt
Matures January 2010
Interest rate 9.70%

   $ 4,640    4,351    4,351
     

Preferred Stock Warrants

      71    114
     

Preferred Stock Warrants

      54    40

Novasys Medical, Inc. (0.14%)

     

Preferred Stock

      556    556
                  

Total Novasys Medical, Inc.

            5,032    5,061

Power Medical Interventions, Inc. (0.00%)

   Therapeutic   

Common Stock Warrants

      21    14
                  

Total Power Medical Interventions, Inc.

            21    14
                  

Total Therapeutic (4.29%)

            16,885    17,293
                  

Cozi Group, Inc. (0.03%)

   Internet Consumer & Business Services   

Preferred Stock Warrants

      148    122

Cozi Group, Inc. (0.06%)

     

Preferred Stock

      177    251
                  

Total Cozi Group, Inc.

            325    373

Invoke Solutions, Inc. (0.35%)(4)

   Internet Consumer & Business Services   

Senior Debt
Matures November 2009
Interest rate Prime + 3.75%

   $ 1,298    1,296    1,296
     

Preferred Stock Warrants

      56    80
     

Preferred Stock Warrants

      26    26
                  

Total Invoke Solutions, Inc.

            1,378    1,402

Prism Education Group Inc. (0.44%)

   Internet Consumer & Business Services   

Senior Debt
Matures December 2010
Interest rate 11.25%

   $ 1,682    1,656    1,656
     

Preferred Stock Warrants

      42    102
                  

Total Prism Education Group Inc.

            1,698    1,758

RazorGator Interactive Group, Inc. (1.55%)(5)

   Internet Consumer & Business Services   

Revolving Line of Credit
Matures January 2009
Interest rate Prime + 1.80%

   $ 3,000    3,000    3,000
     

Preferred Stock Warrants

      14    2,886
     

Preferred Stock Warrants

      28    352

RazorGator Interactive Group, Inc. (1.19%)

     

Preferred Stock

      1,000    4,791
                  

Total RazorGator Interactive Group, Inc.

            4,042    11,029

Serious USA, Inc. (0.35%)

   Internet Consumer & Business Services   

Senior Debt
Matures February 2011
Interest rate Prime + 3.00%

   $ 2,308    2,247    748
     

Revolving Line of Credit
Interest rate Prime + 2.00%

   $ 654    654    654
     

Preferred Stock Warrants

      94    0
                  

Total Serious USA, Inc.

            2,995    1,402

Spa Chakra, Inc. (1.24%)

   Internet Consumer & Business Services   

Senior Debt
Matures June 2010
Interest rate 14.45%%

   $ 5,000    5,000    5,000
                  

Total Spa Chakra, Inc.

            5,000    5,000
                  

Total Internet Consumer & Business Services (5.21%)

            15,438    20,964
                  

See notes to consolidated financial statements (unaudited)

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Lilliputian Systems, Inc. (1.28%)(4)

   Energy   

Senior Debt
Matures March 2010
Interest rate 9.75%

   $ 5,068    5,051    5,051
     

Preferred Stock Warrants

      49    86
                  

Total Lilliputian Systems, Inc.

            5,100    5,137
                  

Total Energy (1.28%)

            5,100    5,137
                  

Active Response Group, Inc. (2.34%)(4)

   Information Services   

Senior Debt
Matures March 2012
Interest rate LIBOR + 6.55%

   $ 9,309    9,215    9,215
     

Preferred Stock Warrants

      92    115
     

Common Stock Warrants

      46    84
                  

Total Active Response Group, Inc.

            9,353    9,414

Box.net, Inc. (0.08%)

   Information Services   

Senior Debt
Matures June 2011
Interest rate Prime + 1.50%

   $ 322    262    262
     

Preferred Stock Warrants

      73    59
                  

Total Box.net, Inc.

            335    321

Buzznet, Inc. (0.00%)

   Information Services   

Preferred Stock Warrants

      9    14

Buzznet, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Buzznet, Inc.

            259    264

hi5 Networkss, Inc. (2.34%)

   Information Services   

Senior Debt
Matures December 2010
Interest rate Prime + 2.5%

   $ 3,000    3,000    3,000
     

Senior Debt
Matures June 2011
Interest rate Prime + 0.5%

   $ 6,155    6,155    6,155
     

Preferred Stock Warrants

      212    285
                  

Total hi5 Networks, Inc.

            9,367    9,440

Jab Wireless, Inc. (3.56%)(4)

   Information Services   

Senior Debt
Matures January 2012
Interest rate 10.75%

   $ 2,715    2,715    2,715
     

Senior Debt
Matures January 2012
Interest rate 10.00%

   $ 1,793    1,793    1,793
     

Senior Debt
Matures January 2012
Interest rate 9.50%

   $ 2,824    2,824    2,824
     

Senior Debt
Matures January 2012
Interest rate 8.50%

   $ 6,700    6,700    6,700
     

Preferred Stock Warrants

      264    323
                  

Total Jab Wireless, Inc.

            14,296    14,355

Solutionary, Inc. (1.78%)(4)

   Information Services   

Senior Debt
Matures June 2010
Interest rate LIBOR + 5.50%

   $ 5,305    5,416    5,416
     

Revolving Line of Credit
Matures June 2010
Interest rate LIBOR + 5.00%

   $ 1,500    1,540    1,540
     

Preferred Stock Warrants

      94    209
     

Preferred Stock Warrants

      2    6

Solutionary, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Solutionary, Inc.

            7,302    7,421

See notes to consolidated financial statements (unaudited)

 

15


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

The Generation Networks, Inc. (1.47%)(4)

   Information Services   

Senior Debt
Matures March 2012
Interest rate Prime + 4.50%

   $ 6,185    6,012    5,904

The Generation Networks, Inc. (0.13%)

     

Preferred Stock

      500    500
                  

Total The Generation Networks, Inc.

            6,512    6,404

Wallop Technologies, Inc. (0.04%)

   Information Services   

Senior Debt
Matures March 2010
Interest rate 10.00%

   $ 157    153    153
     

Preferred Stock Warrants

      8    —  
                  

Total Wallop Technologies, Inc.

            161    153

Zeta Interactive Corporation (3.62%) (4)

   Information Services   

Senior Debt
Matures November 2011
Interest rate Prime +2.00%

   $ 6,530    6,385    6,385
     

Senior Debt
Matures November 2011
Interest rate Prime +3.00%

   $ 8,000    8,000    8,000
     

Preferred Stock Warrants

      172    208

Zeta Interactive Corporation (0.13%)

     

Preferred Stock

      500    500
                  

Total Zeta Interactive Corporation

            15,057    15,093
                  

Total Information Services (15.61%)

            62,642    62,865
                  

Novadaq Technologies, Inc. (0.12%)

   Diagnostic   

Common Stock

      1,626    477
                  

Total Novadaq Technologies, Inc.

            1,626    477

Optiscan Biomedical, Corp. (2.41%)(4)

   Diagnostic   

Senior Debt
Matures June 2011
Interest rate 10.25%

   $ 10,000    9,437    9,437
     

Preferred Stock Warrants

      760    250

Optiscan Biomedical, Corp. (0.74%)

     

Preferred Stock

      3,000    3,000
                  

Total Optiscan Biomedical, Corp.

            13,197    12,687
                  

Total Diagnostic (3.27%)

            14,823    13,164
                  

Guava Technologies, Inc. (1.08%)(4)

   Biotechnology Tools   

Senior Debt
Matures July 2009
Interest rate Prime + 3.25%

   $ 2,219    2,182    2,182
     

Convertible Debt

      250    250
     

Revolving Line of Credit
Matures December 2007
Interest rate Prime + 2.00%

   $ 1,875    1,575    1,575
     

Preferred Stock Warrants

      105    278
     

Preferred Stock Warrants

      68    44
                  

Total Guava Technologies, Inc.

            4,180    4,329

Kamada, LTD. (3.69%)(6)

   Biotechnology Tools   

Senior Debt
Matures November 2011
Interest rate 10.60%

   $ 15,000    14,575    14,575
     

Common Stock Warrants

      531    286
                  

Total Kamada, LTD.

            15,106    14,861

NuGEN Technologies, Inc. (0.77%)

   Biotechnology Tools   

Senior Debt
Matures November 2010
Interest rate Prime + 3.45%

   $ 1,706    1,683    1,683
     

Senior Debt
Matures November 2010
Interest rate Prime + 1.70%

   $ 1,000    1,000    1,000
      Preferred Stock Warrants       45    360
      Preferred Stock Warrants       33    43

NuGEN Technologies, Inc. (0.12%)

     

Preferred Stock

      500    500
                  

Total NuGEN Technologies, Inc.

            3,261    3,586
                  

Total Biotechnology Tools (5.66%)

            22,547    22,776
                  

See notes to consolidated financial statements (unaudited)

 

16


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

September 30, 2008

(unaudited)

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Crux Biomedical, Inc. (0.34%)

   Surgical Devices   

Senior Debt
Matures October 2010
Interest rate Prime + 1.75%

   $ 1,395      1,376      1,376
     

Preferred Stock Warrants

        37      —  

Crux Biomedical, Inc. (0.06%)

     

Preferred Stock

        250      250
                      

Total Crux Biomedical, Inc.

              1,663      1,626
                      

Transmedics, Inc. (1.49%)(5)

   Surgical Devices   

Senior Debt
Matures December 2011
Interest rate Prime + 5.25%

   $ 6,000      5,884      5,884
     

Preferred Stock Warrants

        139      122
                      

Total Transmedics, Inc.

              6,023      6,006
                      

Total Surgical Devices (1.89%)

              7,686      7,632
                      

Glam Media, Inc. (1.55%)

   Media/Content/Info   

Revolving Line of Credit
Matures April 2009
Interest rate Prime + 1.25%

   $ 5,935      5,681      5,681
     

Preferred Stock Warrants

        482      552
                      

Total Glam Media, Inc.

              6,163      6,233

Waterfront Media Inc. (2.2%)(5)

   Media/Content/Info   

Senior Debt
Matures December 2010
Interest rate Prime + 3.00%

   $ 2,984      2,956      2,956
     

Revolving Line of Credit
Matures October 2009
Interest rate Prime + 1.25%

   $ 5,000      5,000      5,000
     

Preferred Stock Warrants

        61      903

Waterfront Media Inc. (0.45%)

     

Preferred Stock

        1,000      1,828
                      

Total Waterfront Media Inc.

              9,017      10,687
                      

Total Media/Content/Info (4.2%)

              15,180      16,920
                      

Total Investments (158.12%)

            $ 628,019    $ 636,747
                      

 

* Value as a percent of net assets
(1) Preferred and common stock, warrants, and equity interests are generally non-income producing. Certain floating rate loans may also have interest rate floors.
(2) Gross unrealized appreciation, gross unrealized depreciation, and net appreciation for federal income tax purposes totaled $17,275, $12,659 and $4,616, respectively. The tax cost of investments is $632,130.
(3) Except for warrants in seven publicly traded companies and common stock in three publicly traded companies, all investments are restricted at September 30, 2008 and were valued at fair value as determined in good faith by the Board of Directors. No unrestricted securities of the same issuer are outstanding. The Company uses the Standard Industrial Code for classifying the industry grouping of its portfolio companies.
(4) Debt and warrant investments of this portfolio company have been pledged as collateral under the Credit Facility. Citigroup has an equity participation right on loans collateralized under the Credit Facility. The value of their participation right on unrealized gains in the related equity investments was approximately $896,000 at September 30, 2008 and is included in accrued liabilities and reduces the unrealized gain recognized by the Company at September 30, 2008.
(5) Debt investments of this portfolio company have been pledged as collateral under the Wells Facility.
(6) Non-U.S. company or the company’s principal place of business is outside the United States.
(7) Affiliate investment that is defined under the Investment Company Act of 1940 as companies in which HTGC owns as least 5% but not more than 25% of the voting securities of the company. All other investments are less than 5% owned.
(8) Debt is on non-accrual status at September 30, 2008, and is therefore considered non-income producing.

See notes to consolidated financial statements (unaudited).

 

17


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Acceleron Pharmaceuticals, Inc. (0.94%)*(4)

   Drug Discovery   

Senior Debt
Matures June 2009
Interest rate 10.25%

   $ 3,237    $ 3,184    $ 3,184
     

Preferred Stock Warrants

        69      472
     

Preferred Stock Warrants

        35      109

Acceleron Pharmaceuticals, Inc. (0.45%)

     

Preferred Stock

        1,243      1,804
                      

Total Acceleron Pharmaceuticals, Inc.

              4,531      5,569

Aveo Pharmaceuticals, Inc. (3.06%)(4)

   Drug Discovery   

Senior Debt
Matures September 2009
Interest rate 10.75%

   $ 12,078      11,984      11,984
     

Preferred Stock Warrants

        144      204
     

Preferred Stock Warrants

        46      74
                      

Total Aveo Pharmaceuticals, Inc.

              12,174      12,262

Elixir Pharmaceuticals, Inc. (3.58%)(4)

   Drug Discovery   

Senior Debt
Matures June 2010
Interest rate Prime + 2.45%

   $ 13,997      13,836      13,836
     

Preferred Stock Warrants

        217      511
                      

Total Elixir Pharmaceuticals, Inc.

              14,053      14,347

EpiCept Corporation (1.77%)(4)

   Drug Discovery   

Senior Debt
Matures August 2009
Interest rate 11.70%

   $ 7,307      6,878      6,878
     

Common Stock Warrants

        423      214
                      

Total EpiCept Corporation

              7,301      7,092

Horizon Therapeutics, Inc. (0.30%)(4)

   Drug Discovery   

Senior Debt
Matures April 2011
Interest rate 8.75%

   $ 12,000      1,022      1,022
     

Preferred Stock Warrants

        179      179
                      

Total Horizon Therapeutics, Inc.

              1,201      1,201

Inotek Pharmaceuticals Corp. (0.37%)

   Drug Discovery   

Preferred Stock

        1,500      1,500
                      

Total Inotek Pharmaceuticals Corp.

              1,500      1,500

Memory Pharmaceticals Corp. (3.48%)(4)

   Drug Discovery   

Senior Debt
Matures February 2011
Interest rate 11.45%

   $ 15,000      13,608      13,608
     

Common Stock Warrants

        1,751      341
                      

Total Memory Pharmaceticals Corp.

              15,359      13,949

Merrimack Pharmaceuticals, Inc. (0.37%)(4)

   Drug Discovery   

Convertible Senior Debt
Matures October 2008
Interest rate 11.15%

   $ 1,024      994      994
     

Preferred Stock Warrants

        155      502

Merrimack Pharmaceuticals, Inc. (0.70%)

     

Preferred Stock

        2,000      2,787
                      

Total Merrimack Pharmaceuticals, Inc.

              3,149      4,283

Neosil, Inc. (1.53%)

   Drug Discovery   

Senior Debt
Matures May 2010
Interest rate 10.75%

   $ 6,000      5,936      5,936
     

Preferred Stock Warrants

        82      177
                      

Total Neosil, Inc.

              6,018      6,113

See notes to consolidated financial statements (unaudited).

 

18


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Paratek Pharmaceuticals, Inc. (0.64%)(4)

   Drug Discovery   

Senior Debt
Matures June 2008
Interest rate 11.10%

   $ 2,587    2,568    2,568
     

Preferred Stock Warrants

      137    —  

Paratek Pharmaceuticals, Inc. (0.14%)

     

Preferred Stock

      550    550
                  

Total Paratek Pharmaceuticals, Inc.

   3,255    3,118

Portola Pharmaceuticals, Inc. (3.80%)(4)

   Drug Discovery   

Senior Debt
Matures September 2010
Interest rate Prime + 1.75%

   $ 15,000    14,894    14,894
     

Preferred Stock Warrants

      152    350
                  

Total Portola Pharmaceuticals, Inc.

   15,046    15,244

Sirtris Pharmaceuticals, Inc. (2.46%)(4)

   Drug Discovery   

Senior Debt
Matures April 2011
Interest rate 10.60%

   $ 9,079    9,022    9,022
     

Common Stock Warrants

      89    818

Sirtris Pharmaceuticals, Inc. (0.19%)

     

Common Stock

      500    776
                  

Total Sirtris Pharmaceuticals, Inc.

   9,611    10,616
                  

Total Drug Discovery (23.78%)

   93,198    95,294
                  

E-band Communications, Inc. (0.50%)(6)

   Communications & Networking   

Preferred Stock

      2,000    2,000
                  

Total E-Band Communications, Inc.

   2,000    2,000

IKANO Communications, Inc. (5.09%)(4)

   Communications & Networking   

Senior Debt
Matures March 2011
Interest rate 11.00%

   $ 19,983    19,983    19,983
     

Preferred Stock Warrants

      45    163
     

Preferred Stock Warrants

      72    256
                  

Total IKANO Communications, Inc.

   20,100    20,402

Ping Identity Corporation (0.40%)(4)

   Communications & Networking   

Senior Debt
Matures June 2009
Interest rate 11.50%

   $ 1,630    1,608    1,608
     

Preferred Stock Warrants

      52    11
                  

Total Ping Identity Corporation

   1,660    1,619

Purcell Systems, Inc. (2.33%)

   Communications & Networking   

Senior Debt
Matures June 2009
Interest rate Prime + 3.50%

   $ 2,224    3,126    3,126
     

Revolving Line of Credit
Matures June 2008
Interest rate Prime + 2.00%

   $ 7,000    6,000    6,000
     

Preferred Stock Warrants

      122    198
                  

Total Purcell Systems, Inc.

   9,248    9,324

See notes to consolidated financial statements (unaudited).

 

19


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Rivulet Communications, Inc. (0.83%)(4)

   Communications & Networking   

Senior Debt
Matures September 2009
Interest rate 10.60%

   $ 3,500    3,272    3,272
     

Preferred Stock Warrants

      50    63

Rivulet Communications, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Rivulet Communications, Inc.

   3,572    3,585

Seven Networks, Inc. (2.89%)(4)

   Communications & Networking   

Senior Debt
Matures April 2010
Interest rate Prime + 3.75%

   $ 9,419    9,291    9,291
     

Revolving Line of Credit
Matures April 2008
Interest rate Prime + 3.00%

   $ 2,000    2,000    2,000
     

Preferred Stock Warrants

      174    295
                  

Total Seven Networks, Inc.

   11,465    11,586

Simpler Networks Corp. (1.01%)(4)

   Communications & Networking   

Senior Debt
Matures July 2009
Interest rate 11.75%

   $ 4,112    4,046    4,046
     

Preferred Stock Warrants

      160    —  

Simpler Networks Corp. (0.00%)

     

Preferred Stock

      500    —  
                  

Total Simpler Networks Corp.

   4,706    4,046

Stoke, Inc. (0.57%)

   Communications & Networking   

Senior Debt
Matures August 2010
Interest rate 10.55%

   $ 2,250    2,204    2,204
     

Preferred Stock Warrants

      53    79
                  

Total Stoke, Inc.

   2,257    2,283

Tectura Corporation (5.26%)(4)

   Communications & Networking   

Senior Debt
Matures March 2012
Interest rate LIBOR + 6.15%

   $ 9,051    9,007    9,007
     

Revolving Line of Credit
Matures March 2008
Interest rate LIBOR + 5.15%

   $ 12,000    12,000    12,000
     

Preferred Stock Warrants

      52    83
                  

Total Tectura Corporation

   21,059    21,090

Teleflip, Inc. (0.25%)

   Communications & Networking   

Senior Debt
Matures May 2010
Interest rate Prime + 2.75%

   $ 1,000    992    992
     

Preferred Stock Warrants

      10    9
                  

Total Teleflip, Inc.

   1,002    1,001

Wireless Channels, Inc. (3.02%)

   Communications & Networking   

Senior Debt -Second Lien
Matures April 2010
Interest rate 9.25%

   $ 11,949    1,719    1,719
     

Senior Debt -Second Lien
Matures April 2010
Interest rate Prime + 4.25%

   $ 10,118    10,118    10,118
     

Preferred Stock Warrants

      155    241
                  

Total Wireless Channels, Inc.

   11,992    12,078

See notes to consolidated financial statements (unaudited).

 

20


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Zayo Bandwith, Inc. (6.24%)(4)

  

Communications

& Networking

  

Senior Debt -Second Lien
Matures April 2013
Interest rate Prime + 3.50%

   $ 25,000    25,000    25,000
            —      —  
                  

Total Zayo Bandwith, Inc.

   25,000    25,000
                  

Total Communications & Networking (28.45%)

   114,061    114,014
                  

Atrenta, Inc. (0.98%)(4)

   Software   

Senior Debt
Matures June 2009
Interest rate 11.50%

   $ 3,680    3,638    3,638
     

Preferred Stock Warrants

      102    220
     

Preferred Stock Warrants

      34    73

Atrenta, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Atrenta, Inc.

   4,024    4,181

Blurb, Inc. (0.63%)

   Software   

Senior Debt
Matures December 2009
Interest rate 9.55%

   $ 2,500    2,482    2,482
     

Preferred Stock Warrants

      25    44
                  

Total Blurb, Inc.

   2,507    2,526

Bullhorn, Inc. (0.25%)(4)

   Software   

Senior Debt
Matures March 2010
Interest rate Prime + 3.75%

   $ 1,000    959    959
     

Preferred Stock Warrants

      43    41
                  

Total Bullhorn, Inc.

   1,002    1,000

Cittio, Inc. (0.25%)

   Software   

Senior Debt
Matures April 2010
Interest rate 11.00%

   $ 1,000    1,000    1,000
                  

Total Cittio, Inc.

   1,000    1,000

Compete, Inc. (0.63%)(4)

   Software   

Senior Debt
Matures March 2009
Interest rate Prime + 3.50%

   $ 2,409    2,384    2,384
     

Preferred Stock Warrants

      62    136
                  

Total Compete, Inc.

   2,446    2,520

Forescout Technologies, Inc. (0.64%)(4)

   Software   

Senior Debt
Matures August 2009
Interest rate 11.15%

   $ 1,998    1,970    1,970
     

Revolving Line of Credit
Matures August 2007
Interest rate Prime + 1.49%

   $ 500    500    500
     

Preferred Stock Warrants

      58    76
                  

Total Forescout Technologies, Inc.

   2,528    2,546

GameLogic, Inc. (0.74%)(4)

   Software   

Senior Debt
Matures December 2009
Interest rate Prime + 4.125%

   $ 3,000    2,887    2,887
     

Preferred Stock Warrants

      93    91
                  

Total GameLogic, Inc.

   2,980    2,978

See notes to consolidated financial statements (unaudited).

 

21


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Gomez, Inc. (0.15%)(4)

   Software   

Senior Debt
Matures December 2007
Interest rate 12.25%

   $ 98    98    98
     

Preferred Stock Warrants

      35    513
                  

Total Gomez, Inc.

   133    611

HighRoads, Inc. (0.01%)(4)

   Software   

Preferred Stock Warrants

      44    58
                  

Total HighRoads, Inc.

   44    58

Intelliden, Inc. (0.60%)

   Software   

Senior Debt
Matures February 2010
Interest rate 13.20%

   $ 2,360    2,349    2,349
     

Preferred Stock Warrants

      18    60
                  

Total Intelliden, Inc.

   2,367    2,409

Oatsystems, Inc. (1.08%)(4)

   Software   

Senior Debt
Matures September 2009
Interest rate 11.00%

   $ 4,374    4,336    4,336
     

Preferred Stock Warrants

      67    4
                  

Total Oatsystems, Inc.

   4,403    4,340

Proficiency, Inc. (0.38%)(4)(6)

   Software   

Senior Debt
Matures July 2008
Interest rate 12.00%

   $ 1,500    1,497    1,497
     

Preferred Stock Warrants

      96    —  

Proficiency, Inc. (0.19%)

     

Preferred Stock

      2,750    750
                  

Total Proficiency, Inc.

   4,343    2,247

PSS Systems, Inc. (0.89%)(4)

   Software   

Senior Debt
Matures March 2010
Interest rate 10.74%

   $ 3,500    3,463    3,463
     

Preferred Stock Warrants

      51    86
                  

Total PSS Systems, Inc.

   3,514    3,549

Savvion, Inc. (1.62%)(4)

   Software   

Senior Debt
Matures March 2009
Interest rate Prime + 3.45%

   $ 1,268    1,268    1,268
     

Revolving Line of Credit
Matures March 2008
Interest rate Prime + 2.00%

   $ 3,000    3,000    3,000
     

Revolving Line of Credit
Matures March 2008
Interest rate Prime + 3.45%

   $ 1,985    1,985    1,985
     

Preferred Stock Warrants

      52    243
                  

Total Savvion, Inc.

   6,305    6,496

Sportvision, Inc. (0.01%)

   Software   

Preferred Stock Warrants

      39    50
                  

Total Sportvision, Inc.

   39    50

See notes to consolidated financial statements (unaudited).

 

22


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Talisma Corp. (0.11%)(4)

   Software   

Preferred Stock Warrants

      49    448
                  

Total Talisma Corp.

   49    448

WildTangent, Inc. (0.50%)(4)

   Software   

Senior Debt
Matures March 2011
Interest rate 9.65%

   $ 2,000    1,766    1,766
     

Preferred Stock Warrants

      238    238
                  

Total WildTangent, Inc.

   2,004    2,004
                  

Total Software (9.72%)

   39,688    38,963
                  

Agami Systems, Inc. (1.30%)(4)

  

Electronics &

Computer

Hardware

  

Senior Debt
Matures August 2009
Interest rate 11.00%

   $ 5,103    5,056    5,056
     

Preferred Stock Warrants

      85    137
                  

Total Agami Systems, Inc.

   5,141    5,193

Luminus Devices, Inc. (2.95%)(4)

  

Electronics &

Computer

Hardware

  

Senior Debt
Matures August 2009
Interest rate 12.50%

   $ 15,115    11,318    11,318
     

Preferred Stock Warrants

      183    113
     

Preferred Stock Warrants

      84    61
     

Preferred Stock Warrants

      334    334
                  

Total Luminus Devices, Inc.

   11,919    11,826

Maxvision Holding, LLC. (2.87%)(4)

  

Electronics &

Computer

Hardware

  

Senior Debt
Matures May 2012
Interest rate Prime + 5.50%

   $ 5,012    5,012    5,012
     

Senior Debt
Matures May 2012
Interest rate Prime + 2.25%

   $ 5,500    5,000    5,000
     

Revolving Line of Credit
Matures September 2012
Interest rate Prime +2.25%

   $ 972    1,472    1,472
                  

Total Maxvision Holding, LLC

   11,484    11,484

NetEffect, Inc. (0.61%)

  

Electronics &

Computer

Hardware

  

Senior Debt
Matures May 2010
Interest rate 11.95%

   $ 2,431    2,396    2,396
     

Preferred Stock Warrants

      44    50
                  

Total NetEffect, Inc.

   2,440    2,446

Shocking Technologies, Inc. (0.02%)

  

Electronics &

Computer

Hardware

  

Preferred Stock Warrants

      63    63
                  

Total Shocking Technologies, Inc.

   63    63

See notes to consolidated financial statements (unaudited).

 

23


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

SiCortex, Inc. (2.52%)

  

Electronics &

Computer

Hardware

  

Senior Debt
Matures December 2010
Interest rate 10.95%

   $ 10,000    9,861    9,861
     

Preferred Stock Warrants

      164    230
                  

Total SiCortex, Inc.

            10,025    10,091

Spatial Photonics, Inc. (0.93%)(4)

  

Electronics &

Computer

Hardware

  

Senior Debt
Matures May 2011
Interest rate 10.75%

   $ 3,751    3,623    3,623
     

Preferred Stock Warrants

      130    126

Spatial Photonics, Inc. (0.12%)

     

Preferred Stock

      500    500
                  

Total Spatial Photonics Inc.

            4,253    4,249

VeriWave, Inc. (1.35%)

  

Electronics &

Computer

Hardware

  

Senior Debt
Matures May 2010
Interest rate 10.75%

   $ 4,250    5,340    5,340
     

Preferred Stock Warrants

      54    85
                  

Total VeriWave, Inc.

            5,394    5,425

ViDeOnline Communications, Inc. (0.04%)(4)

  

Electronics &

Computer

Hardware

  

Preferred Stock Warrants

      298    176
                  

Total ViDeOnline Communications, Inc.

            298    176
                  

Total Electronics & Computer Hardware (12.71%)

            51,017    50,953
                  

Aegerion Pharmaceuticals, Inc. (2.48%)(4)

  

Specialty

Pharmaceuticals

  

Senior Debt
Matures August 2010
Interest rate Prime + 2.50%

   $ 9,735    9,682    9,682
     

Preferred Stock Warrants

      70    243

Aegerion Pharmaceuticals, Inc. (0.25%)

     

Preferred Stock

      1,000    1,000
                  

Total Aegerion Pharmaceuticals, Inc.

            10,752    10,925

Panacos Pharmaceuticals, Inc. (4.84%)(4)

  

Specialty

Pharmaceuticals

  

Senior Debt
Matures January 2011
Interest rate 11.20%

   $ 20,000    19,270    19,270
     

Common Stock Warrants

      876    137

Panacos Pharmaceuticals, Inc. (0.04%)

     

Common Stock

      410    157
                  

Total Panacos Pharmaceuticals, Inc.

            20,556    19,564

Quatrx Pharmaceuticals Company (3.60%)(4)

  

Specialty

Pharmaceuticals

  

Senior Debt
Matures January 2010
Interest rate Prime + 3.00%

   $ 14,324    14,214    14,214
     

Preferred Stock

Warrants

      220    193

Quatrx Pharmaceuticals Company (0.19%)

     

Preferred Stock

      750    750
                  

Total Quatrx Pharmaceuticals Company

            15,184    15,157
                  

Total Specialty Pharmaceuticals (11.40%)

            46,492    45,646
                  

See notes to consolidated financial statements (unaudited).

 

24


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

BabyUniverse, Inc. (0.05%)(4)

  

Consumer &

Business

Products

  

Common Stock

      267    219
                  

Total BabyUniverse, Inc.

            267    219

Market Force Information, Inc. (0.34%)(4)

  

Consumer &

Business

Products

  

Senior Debt
Matures May 2009
Interest rate 10.45%

   $ 1,294    1,284    1,284
     

Preferred Stock Warrants

      23    92

Market Force Information, Inc. (0.12%)

     

Preferred Stock

      500    500
                  

Total Market Force Information, Inc.

            1,807    1,876

Wageworks, Inc. (0.12%)(4)

  

Consumer &

Business

Products

  

Preferred Stock Warrants

      252    513

Wageworks, Inc. (0.05%)

     

Preferred Stock

      250    209
                  

Total Wageworks, Inc.

            502    722
                  

Total Consumer & Business Products (0.70%)

            2,576    2,817
                  

Ageia Technologies, Inc. (1.25%)(4)

   Semiconductors   

Senior Debt
Matures August 2008
Interest rate 10.25%

   $ 5,047    4,904    4,904
     

Convertible Debt

      124    124
     

Preferred Stock Warrants

      99    —  

Ageia Technologies, Inc. (0.00%)

     

Preferred Stock

      500    —  
                  

Total Ageia Technologies

            5,627    5,028

Custom One Design, Inc. (0.26%)

   Semiconductors   

Senior Debt
Matures September 2010
Interest rate 11.50%

   $ 1,000    984    984
     

Common Stock Warrants

      18    43
                  

Total Custom One Design, Inc.

            1,002    1,027

iWatt Inc. (1.19%)(4)

   Semiconductors   

Senior Debt
Matures September 2009
Interest rate Prime + 2.75%

   $ 1,457    1,382    1,382
     

Revolving Line of Credit
Matures September 2007
Interest rate Prime + 1.75%

   $ 3,235    3,235    3,235
     

Preferred Stock Warrants

      46    101
     

Preferred Stock Warrants

      51    51
                  

Total iWatt Inc.

            4,714    4,769

See notes to consolidated financial statements (unaudited).

 

25


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

NEXX Systems, Inc. (3.26%)(4)

   Semiconductors   

Senior Debt
Matures February 2010
Interest rate Prime + 2.75%

   $ 4,557    4,438    4,438
     

Revolving Line of Credit
Matures December 2009
Interest rate Prime + 1.75%

   $ 5,000    5,000    5,000
     

Revolving Line of Credit
Matures December 2009
Interest rate Prime + 3.75%

   $ 3,000    3,000    3,000
     

Preferred Stock Warrants

      165    623
                  

Total NEXX Systems, Inc.

            12,603    13,061

Quartics, Inc. (0.09%)(4)

   Semiconductors   

Senior Debt
Matures August 2010
Interest rate 11.05%

   $ 300    254    254
     

Preferred Stock Warrants

      53    115
                  

Total Quartics, Inc.

            307    369

Solarflare Communications, Inc. (0.19%)

   Semiconductors   

Senior Debt
Matures August 2010
Interest rate 11.75%

   $ 625    553    553
     

Preferred Stock Warrants

      84    194

Solarflare Communications, Inc. (0.12%)

     

Preferred Stock

      500    500
                  

Total Solarflare Communications, Inc.

            1,137    1,247
                  

Total Semiconductors (6.36%)

            25,390    25,501
                  

Labopharm USA, Inc. (3.74%)(4)(5)

   Drug Delivery   

Senior Debt
Matures July 2008
Interest rate 11.95%

   $ 15,000    14,547    14,547
     

Preferred Stock Warrants

      459    454
                  

Total Labopharm USA, Inc.

            15,006    15,001

Transcept Pharmaceuticals, Inc. (1.80%)(4)

   Drug Delivery   

Senior Debt
Matures October 2009
Interest rate 10.69%

   $ 6,993    6,944    6,944
     

Preferred Stock Warrants

      36    107
     

Preferred Stock Warrants

      50    173

Transcept Pharmaceuticals, Inc. (0.13%)

     

Preferred Stock

      500    500
                  

Total Transcept Pharmaceuticals, Inc.

            7,530    7,724
                  

Total Drug Delivery (5.67%)

            22,536    22,725
                  

BARRX Medical, Inc. (0.19%)

   Therapeutic   

Preferred Stock

      1,500    758
                  

Total BARRX Medical, Inc.

            1,500    758

See notes to consolidated financial statements (unaudited).

 

26


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

EKOS Corporation (1.28%)

   Therapeutic   

Senior Debt
Matures November 2010
Interest rate Prime + 2.00%

   $ 5,000    4,707    4,707
     

Preferred Stock Warrants

      174    281
     

Preferred Stock Warrants

      153    150
                  

Total EKOS Corporation

            5,035    5,138

Gynesonics, Inc. (0.01%)(4)

   Therapeutic   

Preferred Stock Warrants

      18    40

Gynesonics, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Gynesonics, Inc.

            268    290

Novasys Medical, Inc. (1.65%)(4)

   Therapeutic   

Senior Debt
Matures January 2010
Interest rate 9.70%

   $ 6,609    6,609    6,609
                  

Total Novasys Medical, Inc.

            6,609    6,609

Power Medical Interventions, Inc. (0.02%)

   Therapeutic   

Common Stock Warrants

      21    58
                  

Total Power Medical Interventions, Inc.

            21    58
                  

Total Therapeutic (3.21%)

            13,432    12,853
                  

Invoke Solutions, Inc. (0.56%)(4)

  

Internet

Consumer

& Business

  

Senior Debt
Matures December 2008
Interest rate 11.25%

   $ 2,187    2,155    2,155
   Services   

Preferred Stock Warrants

      56    74
     

Preferred Stock Warrants

      11    10
                  

Total Invoke Solutions, Inc.

            2,222    2,239

Prism Education Group Inc. (0.51%)

  

Internet

Consumer

& Business

  

Senior Debt
Matures December 2010
Interest rate 11.25%

   $ 2,000    1,964    1,964
   Services   

Preferred Stock Warrants

      44    67
                  

Total Prism Education Group Inc.

            2,008    2,031

RazorGator Interactive Group, Inc. (1.17%)(4)

  

Internet

Consumer

& Business

  

Senior Debt
Matures January 2008
Interest rate 9.95%

   $ 1,134    1,119    1,119
   Services   

Preferred Stock Warrants

      13    3,203
     

Preferred Stock Warrants

      28    362

RazorGator Interactive Group, Inc. (1.23%)

     

Preferred Stock

      1,000    4,935
                  

Total RazorGator Interactive Group, Inc.

            2,160    9,619

See notes to consolidated financial statements (unaudited).

 

27


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Serious USA, Inc. (0.75%)

   Internet Consumer & Business Services   

Senior Debt
Matures February 2011
Interest rate Prime + 3.00%

   $ 2,450    2,370    2,370
     

Revolving Line of Credit
Matures July 2008
Interest rate Prime + 2.00%

   $ 654    654    654
     

Preferred Stock Warrants

      93    5
                  

Total Serious USA, Inc.

            3,117    3,029
                  

Total Internet Consumer & Business Services (4.22%)

            9,507    16,918
                  

Lilliputian Systems, Inc. (1.75%)(4)

   Energy   

Senior Debt
Matures March 2010
Interest rate 9.75%

   $ 6,956    6,931    6,931
     

Preferred Stock Warrants

      48    85
                  

Total Lilliputian Systems, Inc.

            6,979    7,016
                  

Total Energy (1.75%)

            6,979    7,016
                  

Active Response Group, Inc. (2.50%)

   Information Services   

Senior Debt
Matures March 2012
Interest rate LIBOR + 6.55%

   $ 10,000    9,885    9,885
     

Preferred Stock Warrants

      92    83
     

Common Stock Warrants

      46    60
                  

Total Active Response Group, Inc.

            10,023    10,028

Buzznet, Inc. (0.25%)

   Information Services   

Senior Debt
Matures March 2010
Interest rate 10.25%

   $ 914    908    908
     

Preferred Stock Warrants

      9    86

Buzznet, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Buzznet, Inc.

            1,167    1,244

hi5 Networks, Inc. (1.00%)

   Information Services   

Senior Debt
Matures March 2011
Interest rate Prime + 2.5%

   $ 3,000    2,789    2,789
     

Revolving Line of Credit
Matures June 2011
Interest rate 7.75%

      1,000    1,000
     

Preferred Stock Warrants

      213    214
                  

Total hi5 Networks, Inc.

            4,002    4,003

Jab Wireless, Inc. (0.78%)

   Information Services   

Senior Debt
Matures March 2012
Interest rate 10.75%

   $ 3,097    2,834    2,834
     

Preferred Stock Warrants

      264    265
                  

Total Jab Wireless, Inc.

            3,098    3,099

See notes to consolidated financial statements (unaudited).

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Solutionary, Inc. (1.78%)

   Information Services   

Senior Debt
Matures June 2010
Interest rate LIBOR + 5.50%

   $ 5,528    5,454    5,454
     

Revolving Line of Credit
Matures June 2010
Interest rate LIBOR + 5.00%

   $ 1,505    1,505    1,505
     

Preferred Stock Warrants

      94    150
     

Preferred Stock Warrants

      2    5

Solutionary, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Solutionary, Inc.

            7,305    7,364

The Generation Networks, Inc. (4.12%)

   Information Services   

Senior Debt
Matures March 2012
Interest rate Prime + 4.50%

   $ 16,500    16,500    16,500

The Generation Networks, Inc. (0.12%)

     

Preferred Stock

      500    500
                  

Total The Generation Networks, Inc.

            17,000    17,000

Wallop Technologies, Inc. (0.06%)

   Information Services   

Senior Debt
Matures March 2010
Interest rate 10.00%

   $ 223    218    218
     

Preferred Stock Warrants

      7    9
                  

Total Wallop Technologies, Inc.

            225    227

Zeta Interactive Corporation (3.74%)(4)

   Information Services   

Senior Debt
Matures November 2011
Interest rate Prime +2.00%

   $ 15,000    6,828    6,828
     

Senior Debt
Matures November 2011
Interest rate Prime +3.00%

      8,000    8,000
     

Preferred Stock Warrants

      172    171

Zeta Interactive Corporation (0.12%)

     

Preferred Stock

      500    500
                  

Total Zeta Interactive Corporation

            15,500    15,499
                  

Total Information Services (14.59%)

            58,320    58,464
                  

Novadaq Technologies, Inc. (0.32%)

   Diagnostic   

Common Stock

      1,626    1,284
                  

Total Novadaq Technologies, Inc.

            1,626    1,284

Optiscan Biomedical, Corp. (0.08%)(4)

   Diagnostic   

Senior Debt
Matures March 2008
Interest rate 15.00%

   $ 271    263    263
     

Preferred Stock Warrants

      80    47

Optiscan Biomedical, Corp. (0.18%)

     

Preferred Stock

      1,000    722
                  

Total Optiscan Biomedical, Corp.

            1,343    1,032
                  

Total Diagnostic (0.58%)

            2,969    2,316
                  

See notes to consolidated financial statements (unaudited).

 

29


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Guava Technologies, Inc. (1.77%)(4)

   Biotechnology Tools   

Senior Debt
Matures July 2009
Interest rate Prime + 3.25%

   $ 4,076    4,790    4,790
     

Convertible Debt

      250    250
     

Revolving Line of Credit
Matures December 2007
Interest rate Prime + 2.00%

   $ 2,598    1,778    1,778
     

Preferred Stock Warrants

      105    200
     

Preferred Stock Warrants

      69    93
                  

Total Guava Technologies, Inc.

            6,992    7,111

NuGEN Technologies, Inc. (0.53%)

   Biotechnology Tools   

Senior Debt
Matures March 2010
Interest rate 11.70%

   $ 1,884    1,819    1,819
     

Preferred Stock Warrants

      45    252
     

Preferred Stock Warrants

      32    32

NuGEN Technologies, Inc. (0.12%)

     

Preferred Stock

      500    500
                  

Total NuGEN Technologies, Inc.

            2,396    2,603
                  

Total Biotechnology Tools (2.42%)

            9,388    9,714
                  

Rubicon Technology Inc. (0.69%)(4)

   Advanced Specialty Materials & Chemicals   

Preferred Stock Warrants

      82    2,764
                  

Total Rubicon Technology Inc.

            82    2,764
                  

Total Advanced Specialty Materials & Chemicals (0.69%)

            82    2,764
                  

Crux Biomedical, Inc. (0.15%)

   Surgical Devices   

Senior Debt
Matures December 2010
Interest rate Prime + 3.375%

   $ 600    565    565
     

Preferred Stock Warrants

      37    36

Crux Biomedical, Inc. (0.06%)

     

Preferred Stock

      250    250
                  

Total Crux Biomedical, Inc.

            852    851

Diomed Holdings, Inc. (1.49%)(4)

   Surgical Devices   

Senior Debt
Matures July 2010
Interest rate Prime + 3.00%

   $ 6,000    5,962    5,962
     

Common Stock Warrants

      43    8
                  

Total Diomed Holdings, Inc.

            6,005    5,970

Light Science Oncology, Inc. (2.50%)

   Surgical Devices   

Senior Debt
Matures July 2011
Interest rate 11.20%

   $ 10,000    9,605    9,605
     

Preferred Stock Warrants

      395    395
                  

Total Light Science Oncology, Inc.

            10,000    10,000
                  

Total Surgical Devices (4.20%)

            16,857    16,821
                  

See notes to consolidated financial statements (unaudited).

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED SCHEDULE OF INVESTMENTS - (Continued)

December 31, 2007

(dollars in thousands)

 

Portfolio Company

  

Industry

  

Type of Investment(1)

   Principal
Amount
   Cost(2)    Value(3)

Waterfront Media Inc. (1.54%)(4)

  

Media/Content/

Info

  

Senior Debt
Matures December 2010
Interest rate Prime + 3.00%

   $ 3,941      3,898      3,898
     

Revolving Line of Credit
Matures March 2008
Interest rate Prime + 1.25%

   $ 2,000      2,000      2,000
     

Preferred Stock Warrants

        60      295

Waterfront Media Inc. (0.25%)

     

Preferred Stock

        1,000      1,000
                      

Total Waterfront Media Inc.

              6,958      7,193
                      

Total Media/Content/Info (1.79%)

              6,958      7,193
                      

Total Investments (132.24%)

            $ 519,450    $ 529,972
                      

 

* 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 appreciation for federal income tax purposes totaled $16,430, $9,009 and $7,421, respectively. The tax cost of investments is $522,551.
(3) Except for warrants in ten publicly traded companies and common stock in four publicly traded companies, all investments are restricted at December 31, 2007 and were valued at fair value as determined in good faith by the Board of Directors. No unrestricted securities of the same issuer are outstanding. The Company uses the Standard Industrial Code for classifying the industry grouping of its portfolio companies.
(4) Debt and warrant investments of this portfolio company have been pledged as collateral under the Credit Facility. Citigroup has an equity participation right on loans collateralized under the Credit Facility. The value of their participation right on unrealized gains in the related equity investments was approximately $690,000 at December 31, 2007 and is included in accrued liabilities and reduces the unrealized gain recognized by the Company at December 31, 2007.
(5) Non-U.S. company or the company’s principal place of business is outside the United States.
(6) Affiliate investment that is defined under the Investment Company Act of 1940 as companies in which HTGC owns as least 5% but not more than 25% of the voting securities of the company. All other investments are less than 5% owned.

See notes to consolidated financial statements (unaudited).

 

31


Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(unaudited)

(In thousands, except per share data)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2008    2007     2008     2007  

Investment income:

         

Interest

   $ 17,348    $ 13,569     $ 47,669     $ 34,396  

Fees

     1,900      1,572       6,202       3,698  
                               

Total investment income

     19,248      15,141       53,871       38,094  

Operating expenses:

         

Interest

     3,929      553       8,694       3,003  

Loan fees

     618      419       1,564       935  

General and administrative

     1,937      1,420       5,307       4,442  

Employee Compensation:

         

Compensation and benefits

     2,544      2,404       8,198       6,358  

Stock-based compensation

     228      300       1,144       847  
                               

Total employee compensation

     2,772      2,704       9,342       7,205  
                               

Total operating expenses

     9,256      5,096       24,907       15,585  

Net investment income

     9,992      10,044       28,964       22,509  

Net realized gain on investments

     126      49       4,993       3  

Net increase (decrease) in unrealized appreciation on investments

     2,420      (2,915 )     (2,024 )     (733 )
                               

Net realized and unrealized gain (loss)

     2,546      (2,866 )     2,969       (730 )
                               

Net increase in net assets resulting from operations

   $ 12,538    $ 7,178     $ 31,933     $ 21,779  
                               

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

         

Basic

   $ 0.31    $ 0.31     $ 0.89     $ 0.84  
                               

Diluted

   $ 0.31    $ 0.31     $ 0.89     $ 0.83  
                               

Change in net assets per common share:

         

Basic

   $ 0.38    $ 0.22     $ 0.98     $ 0.81  
                               

Diluted

   $ 0.38    $ 0.22     $ 0.98     $ 0.81  
                               

Weighted average shares outstanding

         

Basic

     32,634      32,427       32,600       26,864  
                               

Diluted

     32,634      32,526       32,600       26,992  
                               

See notes to consolidated financial statements (unaudited).

 

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Table of Contents

HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

(unaudited)

(in thousands)

 

   

Common
Stock

   Capital in excess
of par value
   Deferred
Stock
Compensation
    Unrealized
Appreciation
on Investments
    Accumulated
Realized Gains
(Losses) on
Investments
    Distributions in
Excess of
Investment Income
    Provision for
Income Taxes
on Investment
Gains
    Net
Assets
 
   

Shares

   Par
Value
               

Balance at December 31, 2006

  21,927    $ 22    $ 257,235    $ —       $ 2,861     ($ 1,972 )   ($ 2,733 )   $ —       $ 255,413  

Net increase net assets resulting from operations

  —        —        —        —         (733 )     3       22,509       —         21,779  

Issuance of common stock

  25      —        349      —         —         —         —         —         349  

Issuance of common stock in public offering overallotment exercise

  10,040      10      128,405      —         —         —         —         —         128,415  

Issuance of common stock from warrant exercises

  291      —        3,071      —         —         —         —         —         3,071  

Issuance of common stock under dividend reinvestment plan

  250      —        3,304      —         —         —         —         —         3,304  

Issuance of common stock under restricted stock plan

  7      —        90      (90 )     —         —         —         —         —    

Dividends declared

  —        —        —        —         —         —         (23,551 )     —         (23,551 )

Stock-based compensation

  —        —        842      5       —         —         —         —         847  
                                                                  

Balance at September 30, 2007

  32,540    $ 32    $ 393,296    ($ 85 )   $ 2,128     ($ 1,969 )   ($ 3,775 )   $ —       $ 389,627  
                                                                  

 

Balance at December 31, 2007

  32,541    $ 33    $ 393,530    ($ 78 )   $ 10,129     $ 819     ($ 3,557 )   ($ 139 )   $ 400,737  

Net increase in net assets resulting from operations

  —        —        —        —         (2,024 )     4,993       28,964       —         31,933  

Issuance of common stock

  6      —        43      —         —         —         —         —         43  

Issuance of common stock from exercise of warrants

  88      —        933      —         —         —         —         —         933  

Issuance of common stock under restricted stock plan

  228      —        2,743      (2,743 )     —         —         —         —         —    

Dividends declared

  —        —        —        —         —         —         (32,100 )     —         (32,100 )

Stock-based compensation

  —        —        741      403       —         —         —         —         1,144  
                                                                  

Balance at September 30, 2008

  32,863    $ 33    $ 397,990    ($ 2,418 )   $ 8,105     $ 5,812     ($ 6,693 )   ($ 139 )   $ 402,690  
                                                                  

See notes to consolidated financial statements (unaudited).

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

(in thousands)

 

     Nine Months Ended September 30,  
     2008     2007  

Cash flows from operating activities:

    

Net increase in net assets resulting from operations

   $ 31,933     $ 21,779  

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

    

Purchase of investments

     (290,550 )     (219,307 )

Principal payments received on investments

     184,780       86,617  

Proceeds from sale of investments

     7,313       1,646  

Net unrealized appreciation (depreciation) on investments

     2,024       520  

Net unrealized appreciation on investments due to lender

     (247 )     214  

Net realized gain on investments

     (4,993 )     (3 )

Warrant values for loans not funded

     —         —    

Accretion of paid-in-kind principal

     (664 )     —    

Accretion of loan discounts

     (4,353 )     (1,744 )

Accretion of loan exit fees

     (1,149 )     (1,127 )

Depreciation

     218       152  

Stock-based compensation

     741       842  

Amortization of restricted stock

     403       —    

Common stock issued in lieu of Director compensation

     54       349  

Amortization of deferred loan origination revenue

     (3,758 )     (2,139 )

Change in operating assets and liabilities:

    

Interest receivable

     (338 )     (1,578 )

Prepaid expenses and other assets

     (8,718 )     1,769  

Income tax receivable

     —         29  

Accounts payable

     598       (249 )

Income tax payable

     (105 )     —    

Accrued liabilities

     (534 )     (274 )

Deferred loan origination revenue

     4,934       3,761  
                

Net cash (used in) operating activities

     (82,411 )     (108,744 )

Cash flows from investing activities:

    

Purchases of capital equipment

     (576 )     (146 )

Other long-term assets

     (8 )     (1,378 )
                

Net cash provided by (used in) investing activities

     (584 )     (1,544 )

Cash flows from financing activities:

    

Proceeds from issuance of common stock, net

     933       131,492  

Dividends paid

     (32,100 )     (20,246 )

Borrowings of credit facilities

     234,850       148,250  

Repayments of credit facilities

     (104,000 )     (137,300 )

Fees paid for credit facilities and debentures

     (4,055 )     (2,126 )
                

Net cash provided by financing activities

     95,628       120,070  
                

Net increase in cash

     12,633       9,782  

Cash and cash equivalents at beginning of period

     7,856       16,404  
                

Cash and cash equivalents at end of period

   $ 20,489     $ 26,186  
                

See notes to consolidated financial statements (unaudited).

 

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HERCULES TECHNOLOGY GROWTH CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

Hercules Technology Growth Capital, Inc. (the “Company”) is a specialty finance company that provides debt and equity growth capital to technology-related and life-science companies at all stages of development from seed and emerging growth to expansion and established stages of development, including expanding into select publicly listed companies and lower middle market companies. The Company sources its investments through its principal office located in Silicon Valley, as well as through its additional offices in the Boston, Massachusetts, Boulder, Colorado, Chicago, Illinois and San Diego, California areas. The Company was incorporated under the General Corporation Law of the State of Maryland in December 2003. The Company commenced operations on February 2, 2004 and commenced investment activities in September 2004.

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 4).

The Company formed Hercules Technology II, L.P. (“HT II”), which was licensed on September 27, 2006, to operate as a Small Business Investment Company (“SBIC”) under the authority of the Small Business Administration (“SBA”). As an SBIC, HT II is subject to a variety of regulations concerning, among other things, the size and nature of the companies in which it may invest and the structure of those investments. The Company also formed Hercules Technology SBIC Management, LLC (“HTM”), a limited liability company. HTM is a wholly-owned subsidiary of the Company. The Company is the sole limited partner of HT II and HTM is the general partner (see Note 3).

In December 2006, the Company established Hydra Management LLC and Hydra Management Co. Inc., a general partner and investment management group, respectively, should it determine in the future to pursue a relationship with an externally managed fund. These entities are currently inactive.

The consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. The accompanying consolidated interim financial statements are presented in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information, and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X under the Securities Act of 1933 and the Securities Exchange Act of 1934. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with U.S. GAAP are omitted. In the opinion of management, all adjustments consisting solely of normal recurring accruals considered necessary for the fair presentation of consolidated financial statements for the interim period 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, 2007. 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. Valuation of Investments

In September 2006, the FASB issued FAS No. 157, Fair Value Measurements (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value, outlines a fair value hierarchy based on inputs used to measure fair value and enhances disclosure requirements for fair value measurements. FAS 157 does not change existing guidance as to whether or not an instrument is carried at fair value. The Company adopted FAS 157 effective January 1, 2008. FAS 157 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.

          Consistent with FAS 157, the Company determines fair value to be the amount for which an investment could be exchanged in a current sale, which assumes an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. The Company’s valuation policy considers the fact that no ready market exists for substantially all of the securities in which it invests. In accordance with FAS 157, the Company has considered the principal market, or the market in which it exits its portfolio investments with the greatest volume and level of activity. FAS 157 requires that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. The Company believes that the market participants for its investments are primarily other technology and life science companies. Such participants acquire the company’s investments in order to gain access to the underlying assets of the portfolio company. As such, the Company believes the estimated value of the collateral of the portfolio company, up to the cost value of the investment, represents the fair value of the investment.

 

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Determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment, although the Company’s valuation policy is intended to provide a constant basis for determining the fair value of portfolio investments. Unlike banks, the Company is not permitted to provide a general reserve for anticipated loan losses. Instead, the Company must determine the fair value of each individual investment on a quarterly basis. The Company records unrealized depreciation on investments when it believes that an investment has decreased in value, including where collection of a loan or realization of an equity security is doubtful. 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.

As a business development company, the Company invests primarily in illiquid securities including debt and equity-related securities of private companies. The Company’s investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type of investments that the Company makes and the nature of its business, its valuation process requires an analysis of various factors. The Company’s valuation methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation.

At September 30, 2008, approximately 94% of the Company’s total assets represented investments in portfolio companies of which greater than 99% 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. Since there is typically no readily available market value for the investments in the Company’s portfolio, it 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 FAS 157 and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments determined in good faith by its Board may differ significantly from the value that would have been used had a ready market existed for such investments, and the differences could be material.

When originating a debt instrument, the Company generally receives warrants or other equity-related securities from the borrower. The Company determines the cost basis of the warrants or other equity-related securities received based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and warrants or other equity-related securities received. Any resulting discount on the loan from recordation of the warrant or other equity instruments is accreted into interest income over the life of the loan.

At each reporting date, privately held debt and equity 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 that could impact the valuation. 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 debt and equity 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. The Company may consider, but is not limited to, industry valuation methods such as price to enterprise value or price to equity ratios, discounted cash flow, valuation comparisons to comparable public companies or other industry benchmarks in its evaluation of the fair value of its investment.

An unrealized loss is recorded when an investment has decreased in value, including: where collection of a loan is doubtful, there is an adverse change in the underlying collateral or operational performance, there is a change in the borrower’s ability to pay, or there are other factors that lead to a determination of a lower valuation for the debt or equity security. Conversely, unrealized appreciation is recorded when the investment has appreciated in value. 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 Board of Directors estimates the fair value of warrants and other equity-related securities in good faith using a Black-Scholes pricing model and consideration of the issuer’s earnings, sales to third parties of similar securities, the comparison to publicly traded securities, and other factors.

The Company has categorized all investments recorded at fair value in accordance with FAS 157 based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by FAS 157 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.

 

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Investments measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations:

 

          Fair Value Measurements at Reporting Date Using

(in thousands)

Description

   9/30/2008    Quoted Prices In
Active Markets For
Identifiable Assets
(Level 1)
   Significant Other
Observable Inputs
(Level 2)
   Significant
Unobservable Inputs
(Level 3)

Senior secured debt

   $ 572,517    $ —      $ —      $ 572,517

Senior debt-second lien

     5,768      —        —        5,768

Preferred stock

     32,532      —        —        32,532

Common stock

     576      576      —        —  

Warrants

     25,354      —        1,618      23,736
                           
   $ 636,747    $ 576    $ 1,618    $ 634,553
                           

The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3) for the three months ended September 30, 2008:

 

Fair Value Measurements Using Significant Unobservable Inputs

   Three Months Ended
September 30, 2008
 
($ in thousands)       

Balance at June 30, 2008

   $ 599,498  

Total gains or losses

  

Net realized gains/(losses)(1)

     (300 )

Net change in unrealized appreciation or depreciation(2)

     4,214  

Purchases, repayments, and exits, net

     31,141  

Transfer in and/or out of level 3

     —    
        

Balance at September 30, 2008

   $ 634,553  
        

Net unrealized appreciation (depreciation) during the period relating to assets still held at the reporting date(3)

   $ 4,214  

 

(1)

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

(2)

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

(3)

Net change in unrealized appreciation or depreciation includes net unrealized appreciation (depreciation) resulting from changes in portfolio investment values during the reporting period and the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

The table below presents a reconciliation for all 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, 2008:

 

Fair Value Measurements Using Significant Unobservable Inputs

   Nine Months Ended
September 30, 2008
 
($ in thousands)       

Balance at December 31, 2007

   $ 522,740  

Total gains or losses

  

Net realized gains/(losses)(1)

     (516 )

Net change in unrealized appreciation or depreciation(2)

     4,590  

Purchases, repayments, and exits, net

     107,739  

Transfer in and/or out of level 3

     —    
        

Balance at September 30, 2008

   $ 634,553  
        

Net unrealized appreciation (depreciation) during the period relating to assets still held at the reporting date(3)

   $ 4,590  

 

(1)

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

(2)

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

(3)

Net change in unrealized appreciation or depreciation includes net unrealized appreciation (depreciation) resulting from changes in portfolio investment values during the reporting period and the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

 

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As required by the 1940 Act, the Company classifies its investments by level of control. “Control Investments” are defined in the 1940 Act as investments in those companies that the Company is deemed to “Control”. Generally, under 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 those investments that are neither Control Investments nor Affiliate Investments.

At September 30, 2008 and December 31, 2007, the Company had investments in two portfolio companies deemed to be Affiliates. One investment is a non-income producing equity investment and one is an investment in a portfolio company that became an Affiliate on December 17, 2007 upon a restructure of the company. Income derived from these investments was less than $98,000 since these investments became Affiliates.

Security transactions are recorded on the trade-date basis.

A summary of the Company’s investment portfolio by asset class as of September 30, 2008 and December 31, 2007 at fair value is shown as follows:

 

     September 30, 2008     December 31, 2007  
(in thousands)    Investments at Fair
Value
   Percentage of Total
Portfolio
    Investments at Fair
Value
   Percentage of Total
Portfolio
 

Senior debt with warrants

   $ 490,363    77.0 %   $ 441,838    83.4 %

Senior debt

     107,173    16.8 %     61,483    11.6 %

Preferred stock

     32,532    5.1 %     23,265    4.4 %

Senior debt-second lien with warrants

     6,103    1.0 %     —      —    

Common Stock

     576    0.1 %     2,938    0.5 %

Subordinated debt with warrants

     —      —         448    0.1 %
                          
   $ 636,747    100.0 %   $ 529,972    100.0 %
                          

A Summary of the Company’s investment portfolio at fair value, by geographic location as of September 30, 2008 and December 31, 2007 is as follows:

 

     September 30, 2008     December 31, 2007  
(in thousands)    Investments at Fair
Value
   Percentage of Total
Portfolio
    Investments at Fair
Value
   Percentage of Total
Portfolio
 

United States

   $ 601,462    94.4 %   $ 512,724    96.8 %

Canada

     15,177    2.4 %     15,001    2.8 %

Israel

     17,108    2.7 %     2,247    0.4 %

Netherlands

     3,000    0.5 %     —      —    
                          
   $ 636,747    100.0 %   $ 529,972    100.0 %
                          

 

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The following table shows the fair value of the Company’s portfolio by industry sector at September 30, 2008 and December 31, 2007 (excluding unearned income):

 

     September 30, 2008     December 31, 2007  
(in thousands)    Investments at Fair
Value
   Percentage of Total
Portfolio
    Investments at Fair
Value
   Percentage of Total
Portfolio
 

Communications & networking

   $ 131,914    20.7 %   $ 114,014    21.5 %

Information services

     62,865    9.9 %     58,464    11.0 %

Drug discovery

     76,332    12.0 %     95,294    18.0 %

Software

     86,442    13.6 %     38,963    7.4 %

Specialty pharmaceuticals

     48,135    7.6 %     45,646    8.6 %

Electronics & computer hardware

     46,818    7.4 %     50,953    9.6 %

Semiconductors

     27,031    4.2 %     25,501    4.8 %

Consumer & business products

     33,124    5.2 %     2,817    0.5 %

Drug delivery

     20,200    3.2 %     22,725    4.3 %

Internet consumer & business services

     20,964    3.3 %     16,918    3.2 %

Biotechnology tools

     22,776    3.5 %     9,714    1.8 %

Therapeutic

     17,293    2.7 %     12,853    2.4 %

Diagnostic

     13,164    2.0 %     2,316    0.5 %

Media/Content/Info

     16,920    2.7 %     7,193    1.4 %

Surgical Devices

     7,632    1.2 %     16,821    3.2 %

Energy

     5,137    0.8 %     7,016    1.3 %

Advanced Specialty Materials & Chemicals

     —      —         2,764    0.5 %
                          
   $ 636,747    100.0 %   $ 529,972    100.0 %
                          

During the three and nine-month periods ended September 30, 2008, the Company made investments in debt securities totaling $99.7 million and $303.4 million, respectively. The Company didn’t make any equity investment during the three month periods ended September 30, 2008. The Company made investments in equity securities of approximately $7.1 million in the nine-month periods ended September 30, 2008.

During the three month period ended September 30, 2008, the Company recognized net realized gains of approximately $126,000 due to realized gains totaling approximately $430,000 from the exercise of warrants and sale of common stock on one biopharmaceutical offset by the realized loss of approximately $304,000 from the companies in which we held and one portfolio loan.

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 fee income over the contractual life of the loan. These fees are reflected as adjustments to the loan yield in accordance with Statement of Financial Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring loans and Initial Direct Costs of Leases (“FAS 91”). The Company had approximately $7.8 million and $6.6 million of unamortized fees at September 30, 2008 and December 31, 2007, respectively, and approximately $3.1 million and $2.0 million in exit fees receivable at September 30, 2008 and December 31, 2007, respectively.

While not significant to the total debt investment portfolio, the Company has loans in its portfolio that contain a payment-in-kind (“PIK”) provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is added to the principal balance of the loan and recorded as interest income. To maintain the Company’s status as a RIC, this non-cash source of income must be paid out to stockholders in the form of dividends even though the Company has not yet collected the cash. Amounts necessary to pay these dividends may come from available cash or the liquidation of certain investments. For the three and nine-month periods ended September 30, 2008, approximately $283,000 and $698,000 in PIK income was recorded, respectively. For the three and nine month periods ended September 30, 2007, approximately $134,000 and $209,000 in PIK income was recorded.

 

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In some cases, the Company collateralizes its investments by obtaining a first priority security interest in a portfolio company’s assets, which may include their intellectual property. In other cases, the Company may obtain a negative pledge covering a portfolio company’s intellectual property. At September 30, 2008, approximately 44 portfolio company loans were secured by a first priority security in all of the assets of the portfolio company, 42 portfolio company loans were prohibited from pledging or encumbering their intellectual property and one portfolio company investment was secured by a second lien position on its assets. See “Part II—Item 1A—Risk Factors.”

3. Borrowings

The Company, through Hercules Funding Trust I, an affiliated statutory trust, has a securitized credit facility (the “Credit Facility”) with Citigroup Global Markets Realty Corp. and Deutsche Bank Securities Inc. The initial Credit Facility was a one year facility with an interest rate of LIBOR plus a spread of 1.20% and a borrowing capacity of $250.0 million.

On May 7, 2008, the Company amended and renewed its Credit Facility with Citigroup and Deutsche Bank providing for a borrowing capacity of $134.9 million and extending the expiration date to October 31, 2008. Under the terms of the amended agreement, the Company paid a renewal fee of approximately $1.3 million, interest on all borrowings was set at LIBOR plus a spread of 5.0%, and a fee of 2.50% is charged on any unused portion of the facility. The Credit Facility is collateralized by loans from the Company’s investment in portfolio companies, and includes an advance rate of approximately 45% of eligible loans. The Credit Facility contains covenants that, among other things, require the Company to maintain a minimum net worth and to restrict the loans securing the Credit Facility to certain dollar amounts, to concentrations in certain geographic regions and industries, to certain loan grade classifications, to certain security interests, and to certain interest payment terms. At September 30, 2008, the Company had $127.9 million outstanding under the Credit Facility, and was in compliance with all covenants. Unless extended, the Credit Facility terminates on October 31, 2008 and all subsequent payments secured from the portfolio companies whose debt is included in the collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding interest and principal are due and payable.

Citigroup has an equity participation right through a warrant participation agreement on the pool of loans and warrants collateralized under the 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 are 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 equals $3,750,000 (the “Maximum Participation Limit”). The obligations under the warrant participation agreement continue even after the Credit Facility is terminated until the Maximum Participation Limit has been reached. During the nine months ended September 30, 2008, the Company recorded an derivative additional liability related to this obligation and reduced its unrealized gains by approximately $300,000 for Citigroup’s participation in unrealized gains in the warrant portfolio. The value of their participation right on unrealized gains in the related equity investments since inception of the agreement was approximately $896,000 at September 30, 2008 and is included in accrued liabilities and reduces the unrealized gain recognized by the Company at September 30, 2008. Based on the Company’s average borrowings for the year ended December 31, 2007 and the quarter ended September 30, 2008 and the amount of expense it recorded for its realized and unrealized gains for the related periods, the additional cost of borrowings as a result of the warrant participation agreement could increase by approximately 0.55% and 1.03%, respectively. 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 $927,000 under the warrant participation agreement thereby reducing its realized gains by this amount.

As of September 30, 2008, the Company, through its special purpose entity (SPE), had transferred pools of loans and warrants with a fair value of approximately $323.0 million to Hercules Funding Trust I and had drawn $127.9 million under the Credit Facility. Transfers of loans have not met the requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, for sales treatment and are, therefore, treated as secured borrowings, with the transferred loans remaining in investments and the related liability recorded in borrowings. The average debt outstanding under the Credit Facility for the three and nine-month periods ended September 30, 2008 was approximately $118.2 and $97.8 million and the average interest rate was approximately 7.68% and 6.25%, excluding facility fees, respectively.

          In January 2005, the Company formed HT II and HTM. HT II is licensed as a SBIC. HT II borrows funds from the SBA against eligible investments and additional deposits to regulatory capital. Under the Small Business Investment Act and current SBA policy applicable to SBICs, an SBIC can have outstanding at any time SBA guaranteed debentures up to twice the amount of its regulatory capital. As of September 30, 2008, the maximum statutory limit on the dollar amount of outstanding SBA guaranteed debentures issued by a single SBIC is $130.6 million, subject to periodic adjustments by the SBA. The Company has submitted a leverage request to borrow to the maximum statutory limit and received the approval in November. With $65.3 million of regulatory capital as of September 30, 2008, HT II has the current capacity to issue up to a total of $130.6 million of SBA guaranteed debentures, subject to the payment of a 1% commitment fee to the SBA on the amount of the commitment. Currently, HT II has paid commitment fees of approximately $1.3 million and has a commitment from the SBA to issue a total of $127.2 million of SBA guaranteed debentures, of which approximately $127.2 million was outstanding as of September 30, 2008. There is no assurance that HT II will be able to draw up to the maximum limit available under the SBIC program.

 

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SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $18 million and have average annual fully taxed net income not exceeding $6.0 million for the two most recent fiscal years. In addition, SBICs must devote 20.0% of its investment activity to “smaller” concerns as defined by the SBA. A smaller concern is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services. Through its wholly-owned subsidiary HTII, the Company plans to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.

HTII is periodically examined and audited by the Small Business Administration’s staff to determine its compliance with small business investment company regulations. As of September 30, 2008, HTII could draw up to $127.2 million of leverage from the SBA as noted above. Borrowings under the program are charged interest based on ten year treasury rates plus a spread and the rates are generally set for a pool of debentures issued by the SBA in six month periods. The rate for the $12 million of borrowings originated from March 13, 2007 to September 10, 2007 was set by the SBA on September 26, 2007 at 5.528%. The rate for the $58.1 million borrowings made after September 10, 2007 through March 13, 2008 was set by the SBA on March 26, 2008 at 5.471%. The rate for the $38.8 million borrowings made after March 13, 2008 through September 10, 2008 was set by the SBA on September 24, 2008 at 5.725%. 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 2008 and 2007 annual fee has been set at 0.906%. Interest payments are payable semi-annually and there are no principal payments required on these issues prior to maturity. Debentures under the SBA generally mature ten years after being borrowed.

On August 25, 2008, the Company, through a special purpose wholly-owned subsidiary of the Company, Hercules Funding II, LLC, entered into a two-year revolving senior secured credit facility with an optional one-year extension with total commitments of $50 million, with Wells Fargo Foothill as a lender and as an arranger and administrative agent (the “Wells Facility”). The Wells Facility has the capacity to increase to $300 million if additional lenders are added to the syndicate. The Wells Facility expires on August 25, 2010, unless the option to extend the facility is exercised by the parties to the agreement.

Borrowings under the Wells Facility will generally bear interest at a rate per annum equal to Libor plus 325 basis points or PRIME plus 200 basis points. The Wells Facility requires the payment of a non-use fee of 50 basis points annually, which reduces to 30 basis points on the one year anniversary of the credit facility. The Wells Facility is collateralized by debt investments in our portfolio companies, and includes an advance rate equal to 50% of eligible loans placed in the collateral pool. The Wells Facility generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity, which includes the extension if exercised. We paid a one time $750,000 structuring fee in connection with the Wells Facility which is being amortized over a 2 year period. The average debt outstanding under the Wells Facility for the three-month period ended September 30, 2008 was approximately $1.8 million and the average interest rate was approximately 7.0%.

The Wells Facility requires various financial and operating covenants. These covenants require us to maintain certain financial ratios and a minimum net worth. 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 Wells Facility also required a minimum draw down of $10.0 million no later than September 30, 2008.

At September 30, 2008 and December 31, 2007, the Company had the following borrowing capacity and outstandings:

 

     September 30, 2008    December 31, 2007
(in thousands)    Facility Amount    Amount
Outstanding
   Facility Amount    Amount
Outstanding

Credit Facility

   $ 134,900    $ 127,900    $ 250,000    $ 79,200

Wells Facility

     50,000      10,000      —        —  

SBA Debenture

     127,200      127,200      127,200      55,050
                           

Total

   $ 312,100    $ 265,100    $ 377,200    $ 134,250
                           

4. Income taxes

The Company intends to continue to operate so as to qualify to be taxed as a RIC under the Code and, as such, the Company is not subject to federal income tax on the portion of its taxable income and gains distributed to stockholders. To qualify as a RIC, the Company is required, among other requirements, to distribute at least 90% of its annual 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

 

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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 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. Taxable income includes non-cash income and such as changes in accrued and reinvested interest which includes contractual payment-in-kind interest, and the amortization of discounts and fees. Cash collections of income resulting from contractual payment-in-kind interest or the amortization of discounts and fees generally occur upon the repayment of the loans or debt securities that include such items. Non-cash taxable income is reduced by non-cash expenses, such as realized losses and depreciation and amortization expense.

 

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For the quarter ended September 30, 2008, the Company declared a distribution of $0.34 per share. For 2008, the Company estimates that it will distribute $1.32 in dividends. A portion of the dividend is payable in all common stock through our Dividend Reinvestment Plan. The Company may distribute the dividend from its authorized stock as the Company shareholders approved the sell or distribution of up to 20% of its outstanding shares below NAV at its 2008 Annual Meeting of Stockholders. This estimate takes into account the Company’s expectations for the performance of its business for 2008, and its estimates of operating income, capital gains, net income and taxable income for 2008. The Company’s actual distributions for 2008 may differ from this estimate. 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, therefore a determination made on a quarterly basis may not be representative of the actual tax attributes of its distributions for a full year. If the Company had determined the tax attributes of its distributions year-to-date as of September 30, 2008, approximately $0.98 or 100.0% would be from ordinary income, however there can be no certainty to shareholders that this determination is representative of what the tax attributes of its 2008 distributions to shareholders will actually be.

If the Company does not distribute at least 98% of its annual taxable income in the year earned, the Company will generally be required to pay an excise tax equal to 4% of the amount by which 98% of the Company’s annual taxable income exceeds the distributions from such taxable income during the year earned. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, the Company accrues excise taxes on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income.

At December 31, 2007, we recorded a provision for exercise tax of approximately $139,000 on income and capital gains of approximately $4.2 million available for distribution to shareholders in 2008. Excess taxable income for 2007 represents ordinary income and capital gains. In accordance with regulated investment company distribution rules, the Company is required to declare current year dividends to be paid from carried over excess taxable income from 2007 before the Company files its 2007 tax return in September, 2008, and the Company must pay such dividends by December 31, 2008. The Company has complied with these requirements.

As of September 30, 2008 the Company has paid $32.1 million in dividends to shareholders during 2008. On October 21, 2008 the Company announced that its Board of Directors approved a dividend of $0.34 per share to shareholders of record as of November 14, 2008 and payable on December 15, 2008.

5. Shareholders’ Equity

The Company is authorized to issue 60,000,000 shares of common stock with a par value of $0.001. Each share of common stock entitles the holder to one vote.

In January 2005, the Company notified its shareholders of its intent to elect to be regulated as a BDC. In conjunction with the Company’s decision to elect to be regulated as a BDC, approximately 55% of the 5 Year Warrants were subject to mandatory cancellation under the terms of the Warrant Agreement with the warrant holder receiving one share of common stock for every two warrants cancelled and the exercise price of all warrants was adjusted to the then current net asset value of the common stock, subject to certain adjustments described in the Warrant Agreement. In addition, the 1 Year Warrants became subject to expiration immediately prior to the Company’s election to become a BDC, unless exercised. Concurrent with the announcement of the BDC election, the Company reduced the exercise price of all remaining 1 and 5 Year Warrants from $15.00 to $10.57. On February 22, 2005, the Company cancelled 47% of all outstanding 5 Year Warrants and issued 298,598 shares of common stock to holders of warrants upon exercise. In addition, the majority of shareholders owning 1 Year Warrants exercised them, and purchased 1,175,963 of common shares at $10.57 per share, for total consideration to the Company of $12,429,920. All unexercised 1 Year Warrants were then cancelled. The outstanding 5 Year Warrants will expire in June 2009.

A summary of activity in the 5 Year Warrants initially attached to units issued for the nine months ended September 30, 2008 is as follows:

 

     Five-Year
Warrants
 

Outstanding at December 31, 2007

   371,937  

Warrants issued

   —    

Warrants cancelled

   —    

Warrants exercised

   (88,323 )
      

Outstanding at September 30, 2008

   283,614  
      

The Company received net proceeds of approximately $933,000 from the exercise of the 5-Year Warrants in the nine-month period ended September 30, 2008.

          On January 3, 2007, in connection with the December 12, 2006 common stock issuance, the underwriters exercised their over-allotment option and purchased an additional 840,000 shares of common stock for additional net proceeds of approximately $10.9 million.

On June 4, 2007, the Company raised approximately $102.2 million, net of issuance costs, in a public offering of 8.0 million shares of its common stock. On June 19, 2007, in connection with the same common stock issuance, the underwriters exercised their over-allotment option and purchased an additional 1.2 million shares of common stock for additional net proceeds of approximately $15.4 million.

 

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6. Equity Incentive Plan

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

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

On June 21, 2007, the shareholders approved amendments to the 2004 Plan and the 2006 Plan allowing for the grant of restricted stock. The amended Plans limit the combined maximum amount of restricted stock that may be issued under both Plans to 10% of the outstanding shares of the Company’s stock on the effective date of the Plans plus 10% of the number of shares of stock issued or delivered by the Company during the terms of the Plans. The proposed 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.

In conjunction with the amendment and in accordance with the exemptive order, on June 21, 2007 the Company made an automatic grant of shares of restricted stock to Messrs. Badavas, Chow and Woodward, its independent Board of Directors, in the amounts of 1,667, 1,667 and 3,334 shares, respectively. The shares were issued pursuant to the 2006 Plan on July 31, 2007 and vest 33% on an annual basis from the date of grant. Deferred compensation cost of approximately $91,000 will be recognized ratably over the three year vesting period. During the three and nine-month periods ended September 30, 2008 the Company recognized compensation expense related to restricted stock to the Board of Directors of approximately $7,500 and $22,600, respectively. Approximately $5,000 of compensation expense related to restricted stock was recognized during the three and nine-month periods ended September 30, 2007.

During the nine months ended September 30, 2008, the Company granted approximately 248,650 restricted shares, of which 228,150 shares remain unvested and outstanding at September 30, 2008, pursuant to the 2004 Plan that vest 25% on an annual basis from the date of grant. During the nine months ended September 30, 2008, the Company cancelled 20,500 shares of restricted stock. Deferred compensation cost of approximately $2.4 million will be recognized ratably over the four year vesting period. During the three and nine-month periods ended September 30, 2008 the Company recognized compensation expense related to restricted stock pursuant to the 2004 Plan of approximately $171,000 and $403,000 respectively. There was no compensation expense related to restricted stock pursuant to the 2004 Plan during the three and nine-month periods ended September 30, 2007.

In 2004, each employee stock option to purchase two shares of common stock was accompanied by a warrant to purchase one share of common stock within one year and a warrant to purchase one share of common stock within five years. Both options and warrants had an exercise price of $15.00 per share on date of grant. On January 14, 2005, the Company notified all shareholders of its intent to elect to be regulated as a BDC and reduced the exercise price of all remaining 1 and 5 Year Warrants from $15.00 to $10.57 but did not reduce the strike price of the options (see Note 5). The unexercised one-year warrants expired and 55% of the five-year warrants were cancelled immediately prior to the Company’s election to become a BDC.

 

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A summary of common stock options and warrant activity under the Company’s 2006 and 2004 Plans for the nine months ended September 30 is as follows:

 

     Common Stock
Options
    Five-Year
Warrants

Outstanding at December 31, 2007

     2,920,513       10,692

Granted

     1,286,086       —  

Exercised

     —         —  

Cancelled

     (260,792 )     —  
              

Outstanding at September 30, 2008

     3,945,807       10,692
              

Weighted-average exercise price at September 30, 2008

   $ 13.18     $ 10.57
              

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, 2008, options for approximately 2.1 million shares were exercisable at a weighted average exercise price of approximately $13.18 per share with an expected term of 4.5 years. The outstanding five year warrants have an expected life of 5 years.

The Company determined that the fair value of options and warrants granted under the 2006 and 2004 Plan during the nine month periods ended September 30, 2008 and 2007 was approximately $1.1 million and $1.4 million, respectively. During the nine month periods ended September 30, 2008 and 2007, approximately $741,000 and $842,000 of share-based cost was expensed, respectively. As of September 30, 2008, there was approximately $1.6 million of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a weighted average period of 2.6 years. The fair value of options granted is based upon a Black-Scholes option pricing model using the assumptions in the following table for each of the nine month periods ended September 30, 2008 and 2007:

 

     2008     2007  

Expected Volatility

   23 %   24 %

Expected Dividends

   8% - 10 %   8 %

Expected term (in years)

   4.5     4.5  

Risk-free rate

   2.27% - 3.18 %   4.47% - 4.92 %

7. Earnings per Share

Shares used in the computation of the Company’s basic and diluted earnings (loss) per share are as follows:

 

     Three months ended September 30,    Nine months ended September 30,
(in thousands, except per share data)    2008    2007    2008    2007

Net increase in net assets resulting from operations

   $ 12,538    $ 7,178    $ 31,933    $ 21,779

Weighted average common shares outstanding—basic

     32,634      32,427      32,600      26,864

Change in net assets per common share—basic

   $ 0.38    $ 0.22    $ 0.98    $ 0.81

Net increase (decrease) in net assets resulting from operations

   $ 12,538    $ 7,178    $ 31,933    $ 21,779

Weighted average common shares outstanding

     32,634      32,427      32,600      26,864

Dilutive effect of warrants and stock options

     —        99      —        128
                           

Weighted average common shares outstanding—diluted

     32,634      32,526      32,600      26,992

Change in net assets per common share—diluted

   $ 0.38    $ 0.22    $ 0.98    $ 0.81

The calculation of change in net assets per common share—assuming dilution, excludes all anti-dilutive shares. For the three months ended September 30, 2008 and 2007, 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 4.1 million and 2.1 million, respectively. For the nine months ended September 30, 2008 and 2007, 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 4.1 million and 1.1 million shares, respectively.

8. Related-Party Transactions

During February 2007, Farallon Capital Management, L.L.C and its related affiliates and Manuel Henriquez, the Company’s CEO, exercised warrants to purchase 132,480 and 75,075 shares of the Company’s common stock, respectively. The exercise price of the warrants was $10.57 per share resulting in net proceeds to the company of approximately $2.2 million.

In conjunction with the Company’s public offering completed on June 4, 2007 and the related over-allotment exercise, the Company agreed to pay JMP Securities LLC a fee of approximately $1.6 million as co-manager of the offering.

 

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In connection with the sale of public equity investments, the Company paid JMP Securities LLC approximately $26,000 in brokerage commissions during the nine month period ended September 30, 2008. The Company paid approximately $8,000 in brokerage commissions during the nine months ended September 30, 2007.

9. Financial Highlights

Following is a schedule of financial highlights for the nine months ended September 30, 2008 and 2007:

 

     Nine Months Ended September 30,  
(in thousands, except per share data)    2008     2007  

Per share data:

    

Net asset value at beginning of period

   $ 12.31     $ 11.65  

Net investment income

     0.89       0.84  

Net realized gain on investments

     0.15       —    

Net unrealized appreciation on investments

     (0.06 )     (0.03 )
                

Total from investment operations

     0.98       0.81  

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

     (0.09 )     0.38  

Distributions

     (0.98 )     (0.90 )

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

     0.03       0.03  
                

Net asset value at end of period

   $ 12.25     $ 11.97  
                

Ratios and supplemental data:

    

Per share market value at end of period

   $ 9.70     $ 13.27  

Total return

     -9.34 %(2)     0.56 %(2)

Shares outstanding at end of period

     32,863       32,539  

Weighted average number of common shares outstanding

     32,600 (3)     26,864  

Net assets at end of period

   $ 402,690     $ 389,628  

Ratio of operating expense to average net assets (annualized)

     8.20 %     6.69 %

Ratio of net investment income before investment gains and losses to average net assets (annualized)

     9.54 %     9.67 %

Average debt outstanding

   $ 180,457     $ 59,809  

Weighted average debt per common share

   $ 5.51     $ 2.23  

Portfolio turnover

     3.01 %     0.45 %

 

(1)

Stock-based compensation expense is a non-cash expense that has no effect on net asset value. Pursuant to Financial Accounting Standards No. 123R, net investment income includes the expense associated with the granting of stock options and restricted stock and other stock based compensation, which is offset by a corresponding increase in paid-in capital.

(2)

The total return equals the change in the ending market value over the beginning of period price per share plus dividends per share during the period, divided by the beginning price.

(3)

Weighted average number of common shares outstanding excludes unvested restricted stock.

10. Commitments and Contingencies

In the normal course of business, the Company is party to financial instruments with off-balance sheet risk. These instruments consist primarily of unused commitments to extend credit, in the form of loans, to the Company’s portfolio companies. The balance of unused commitments to extend credit at September 30, 2008 totaled approximately $141.8 million. Since this commitment may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements.

Certain premises are leased under agreements which expire at various dates through December 2013. Total rent expense amounted to approximately $714,500 and $551,700 during the nine-month periods ended September 30, 2008 and 2007, respectively.

 

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The following table shows our contractual obligations as of September 30, 2008:

 

     Payments due by period
(in thousands)

Contractual Obligations(1)

   Total    Less than 1 year (2)(3)    1-3 years (2)    3-5 years    After 5 years

Borrowings (4)

   $ 265,100    $ 127,900    $ 10,000    $ —      $ 127,200

Operating Lease Obligations

     4,891      981      1,965      1,878      67
                                  

Total

   $ 269,991    $ 128,881    $ 11,965    $ 1,878    $ 127,267
                                  

 

(1)

Excludes commitments to extend credit to the portfolio companies.

(2)

Borrowings under the Credit Facility are listed based on the contractual maturity of the facility. Actual repayments could differ significantly due to prepayments by our existing portfolio companies, modifications of the current agreements with existing portfolio companies and modification of the credit facility.

(3)

The Company also has a warrant participation agreement with Citigroup. See Note 3.

(4)

Includes borrowings under the Credit Facility, Wells Facility and the SBA debentures.

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

11. Recent Accounting Pronouncements

In September 2006, the FASB issued FAS 157. FAS 157 defines fair value, establishes a framework for measuring fair value, outlines a fair value hierarchy based on inputs used to measure fair value and enhances disclosure requirements for fair value measurements. SFAS 157 does not change existing guidance as to whether an instrument is carried at fair value.

FAS 157 also (i) nullifies the guidance in EITF 02-3 that precluded recognition of a trading profit at the inception of a derivative contract, unless the fair value of such derivative was obtained from a quoted market price or other valuation technique incorporating observable inputs; (ii) clarifies that an issuer’s credit standing should be considered when measuring liabilities at fair value; (iii) precludes the use of a liquidity or block discount when measuring instruments trading in an active market at fair value; and (iv) requires costs related to acquiring financial instruments carried at fair value to be included in earnings as incurred.

The Company adopted FAS 157 effective January 1, 2008. No material change to the Company’s financial statements resulted from its adoption of FAS 157. For additional information regarding the Company’s adoption of FAS 157, see Note 2, “Investments,” to the Consolidated Financial Statements.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value. This statement applies to all reporting entities, and contains financial statement presentation and disclosure requirements for assets and liabilities reported at fair value as a consequence of the election. This statement is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.

In October 2008, the FASB issued FSP 157-3 “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP 157-3). FSP 157-3 clarifies the application of SFAS No. 157 in a market that is not active, and addresses application issues such as the use of internal assumptions when relevant observable data does not exist, the use of observable market information when the market is not active, and the use of market quotes when assessing the relevance of observable and unobservable data. FSP 157-3 is effective for all periods presented in accordance with SFAS No. 157. The adoption of FSP 157-3 did not have a significant impact on our financial results or fair value determinations.

12. Subsequent Events

On October 21, 2008, the Board of Directors declared a dividend of $0.34 per share for the second quarter, payable on December 15, 2008 to shareholders of record as of November 14, 2008.

In October, Hercules paid down the Wells Fargo credit facility by $10.0 million, resulting in borrowing capacity of $50.0 million.

On October 31, 2008 the Company’s Credit Facility expired under the normal terms. All subsequent payments secured from the portfolio companies whose debt is included in the Credit Facility collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding interest and principal are due and payable. During the amortization period, the Company no longer pays a non-use fee on the Credit Facility, although borrowings under the Credit Facility bear interest at a rate per annum equal to Libor plus 650 basis points during the amortization period.

In October, Hercules received full repayment of $2.5 million from NetEffect representing principal and interest outstanding. Intel, Inc. acquired the assets of the company in bankruptcy.

In October, Hercules received a repayment of approximately $700,000 in common stock from an undisclosed buyer for the assets of Teleflip.

 

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

Forward-Looking Statements

The information set forth in this report includes “forward-looking statements.” Such statements may include, but are not limited to: projections of revenues, income or loss, capital expenditures, plans for product development and cooperative arrangements, future operations, financing needs, or plans of Hercules, as well as assumptions relating to the foregoing. The terms “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negatives of these terms, or other similar expressions generally identify forward-looking statements.

The forward-looking statements made in this Form 10-Q speak only to events as of the date on which the statements are made. You should not place undue reliance on such forward-looking statements, as substantial risks and uncertainties could cause actual results to differ materially from those projected in or implied by these forward-looking statements due to a number of risks and uncertainties affecting its business. The forward-looking statements contained in this Form 10-Q are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements for subsequent events.

Overview

We are a specialty finance company that provides debt and equity growth capital to technology-related and life-science companies at all stages of development from seed and emerging growth to expansion and established stages of development. We primarily finance privately-held companies backed by leading venture capital and private equity firms, and may also finance select publicly listed companies and lower middle market companies. Our principal office is located in the Silicon Valley and we have additional offices in the Boston, Boulder, Chicago, Columbus and San Diego areas. Our goal is to be the leading structured mezzanine capital provider of choice for venture capital and private equity backed technology-related companies requiring sophisticated and customized financing solutions. Our strategy is to evaluate and invest in a broad range of companies active in the technology and life science industries and to offer a full suite of growth capital products up and down the capital structure. We invest primarily in structured mezzanine debt and, to a lesser extent, in senior debt and equity investments. We use the term “structured mezzanine debt investment” 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 mezzanine debt investments will typically be secured by some or all of the assets of the portfolio company.

Our investment objective is to maximize our portfolio total return by generating current income from our debt investments and capital appreciation from our equity-related investments. We are an internally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company under the 1940 Act. As a business development company, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in “qualifying assets,” including securities of private U.S. companies, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature in one year or less.

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

Our portfolio is comprised of, and we anticipate that our portfolio will continue to be comprised of, investments primarily in technology-related companies at various stages of their development. Consistent with regulatory requirements, we invest primarily in United States based companies and to a lesser extent in foreign companies. During 2007 and the nine month period ended September 30, 2008, our investing emphasis has been primarily on private companies following or in connection with a subsequent institutional round of equity financing, which we refer to as expansion-stage companies and private companies in later rounds of financing and certain thinly traded public companies, which we refer to as established-stage companies. In the near-term we are shifting our investment focus to expansion- and established-stage companies as we believe these investments currently provide higher yield returns. We have also historically focused our investment activities in private companies following or in connection with the first institutional round of financing, which we refer to as emerging-growth companies.

Portfolio and Investment Activity

          The total value of our investment portfolio was $636.7 million at September 30, 2008 as compared to $530.0 million at December 31, 2007. During the three and nine-month periods ended September 30, 2008, we made debt commitments to 7 and 35 portfolio companies totaling $54.2 million and $348.8 million, respectively. We funded $99.7 million to 29 companies and $291.6 million to 59 companies during the three and nine-month periods ended September 30, 2008, respectively. No equity investment was made during the three-month period ended September 30, 2008. We made equity investments in 10 portfolio companies totaling $5.9 million in the nine-month period ended September 30, 2008, bringing total equity investments at fair value to approximately $33.1 million. The fair value of our warrant portfolio at September 30, 2008 and December 31, 2007 was approximately $25.4 million and $21.6 million respectively. At September 30, 2008, we had unfunded contractual commitments of $141.8 million to 34 portfolio companies. In addition, as of September 30, 2008, we executed non-binding term sheets with nine prospective portfolio companies, representing approximately $95.5 million. However, we have determined to reduce the number of non-binding term sheets that we will continue to perform diligence on to approximately $17 million. We will postpone the remainder of these non-binding term sheets until the overall economy and credit markets stabilize.

 

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We receive payments in our loan portfolio based on scheduled amortization of the outstanding balances. In addition, we receive repayments of some of our loans prior to their scheduled maturity date. The frequency or volume of these repayments may fluctuate significantly from period to period. During the nine month period ended September 30, 2008, we received normal principal repayments of $70.1 million, and early repayments and working line of credit paydowns totaling $114.8 million. Total portfolio investment activity (exclusive of unearned income) as of the nine month period ended September 30, 2008 is as follows:

 

(in millions)    September 30,
2008
 

Beginning Portfolio

   $ 530.0  

Purchase of debt investments

     283.5  

Purchase of equity investments

     7.0  

Sale of equity investments

     5.2  

Principal payments received on investments

     (70.1 )

Early pay-offs and recoveries

     (114.8 )

Accretion of loan discounts and paid-in-kind principal

     5.0  

Net realized and unrealized change in investments

     (9.1 )
        

Ending Portfolio

   $ 636.7  
        

The following table shows the fair value of our portfolio of investments by asset class as of September 30, 2008 and December 31, 2007 (excluding unearned income):

 

     September 30, 2008     December 31, 2007  
(in thousands)    Investments at Fair
Value
   Percentage of Total
Portfolio
    Investments at Fair
Value
   Percentage of Total
Portfolio
 

Senior debt with warrants

   $ 490,363    77.0 %   $ 441,838    83.4 %

Senior debt

     107,173    16.8 %     61,483    11.6 %

Preferred stock

     32,532    5.1 %     23,265    4.4 %

Senior debt-second lien with warrants

     6,103    1.0 %     —      —    

Common Stock

     576    0.1 %     2,938    0.5 %

Subordinated debt with warrants

     —      —         448    0.1 %
                          
   $ 636,747    100.0 %   $ 529,972    100.0 %
                          

A summary of our investment portfolio at value by geographic location as of September 30, 2008 and December 31, 2007 is as follows.

 

     September 30, 2008     December 31, 2007  
     Investments at Fair
Value
   Percentage of Total
Portfolio
    Investments at Fair
Value
   Percentage of Total
Portfolio
 
(in thousands)           

United States

   $ 601,462    94.4 %   $ 512,724    96.8 %

Canada

     15,177    2.4 %     15,001    2.8 %

Israel

     17,108    2.7 %     2,247    0.4 %

Netherlands

     3,000    0.5 %     
                          
   $ 636,747    100.0 %   $ 529,972    100.0 %
                          

Our portfolio companies are primarily privately held expansion-and established-stage companies in the biopharmaceutical, communications and networking, consumer and business products, electronics and computers, energy, information services, internet consumer and business services, medical devices, semiconductor and software industry sectors. These sectors are characterized by high margins, high growth rates, consolidation and product and market extension opportunities. Value is often vested in intangible assets and intellectual property.

At September 30, 2008, we had investments in two portfolio companies deemed to be Affiliates. One investment is a non income producing equity investment and one portfolio company became an Affiliate on December 17, 2007 upon a restructure of the company. Income derived from these investments was less than $98,000 since these investments became Affiliates. No realized gains or losses related to Affiliates were recognized during the three and nine-month periods ended September 30, 2008.

 

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The following table shows the fair value of our portfolio by industry sector at September 30, 2008 and December 31, 2007 (excluding unearned income):

 

     September 30, 2008     December 31, 2007  
(in thousands)    Investments at Fair
Value
   Percentage of Total
Portfolio
    Investments at Fair
Value
   Percentage of Total
Portfolio
 

Communications & networking

   $ 131,914    20.7 %   $ 114,014    21.5 %

Information services

     62,865    9.9 %     58,464    11.0 %

Drug discovery

     76,332    12.0 %     95,294    18.0 %

Software

     86,442    13.6 %     38,963    7.4 %

Specialty pharmaceuticals

     48,135    7.6 %     45,646    8.6 %

Electronics & computer hardware

     46,818    7.4 %     50,953    9.6 %

Semiconductors

     27,031    4.2 %     25,501    4.8 %

Consumer & business products

     33,124    5.2 %     2,817    0.5 %

Drug delivery

     20,200    3.2 %     22,725    4.3 %

Internet consumer & business services

     20,964    3.3 %     16,918    3.2 %

Biotechnology tools

     22,776    3.5 %     9,714    1.8 %

Therapeutic

     17,293    2.7 %     12,853    2.4 %

Diagnostic

     13,164    2.0 %     2,316    0.5 %

Media/Content/Info

     16,920    2.7 %     7,193    1.4 %

Surgical Devices

     7,632    1.2 %     16,821    3.2 %

Energy

     5,137    0.8 %     7,016    1.3 %

Advanced Specialty Materials & Chemicals

     —      —         2,764    0.5 %
                          
   $ 636,747    100.0 %   $ 529,972    100.0 %
                          

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, 2008 and December 31, 2007:

 

     September 30, 2008     December 31, 2007  
(in thousands)    Investments at Fair
Value
   Percentage of Total
Portfolio
    Investments at Fair
Value
   Percentage of Total
Portfolio
 

Investment Grading

          

1

   $ 20,840    3.6 %   $ 27,678    5.7 %

2

     401,523    69.4       341,598    70.9  

3

     149,041    25.8       103,380    21.4  

4

     2,264    0.4       9,467    2.0  

5

     4,617    0.8       —      —    
                          
   $ 578,285    100.00 %   $ 482,123    100.00 %
                          

As of September 30, 2008, our investments had a weighted average investment grading of 2.25 as compared to 2.20 at December 31, 2007. Our policy is to downgrade the grading on our portfolio companies as they approach the point in time when they will require additional equity capital. Additionally, we may downgrade our portfolio companies if they are not meeting our financing criteria and their respective business plans. Various companies in our portfolio will require additional funding in the near term or have not met their business plans and have therefore been downgraded until the funding is complete or their operations improve. At September 30, 2008, twenty one portfolio companies were graded 3, two portfolio companies were graded 4 and two portfolio companies were graded 5, as compared to fifteen, three and zero portfolio companies, respectively, at December 31, 2007. At September 30, 2008, there was one portfolio company on non-accrual status. In general, interest is not accrued on loans and debt securities if we have doubt about interest collection or where the enterprise value of the portfolio company may not support further accrual. To the extent interest payments are received on a loan that is not accruing interest, we may use such payments to reduce our cost basis in the investment in lieu of recognizing interest income. No loans or debt securities were on non-accrual at December 31, 2007.

          The effective yield on our debt investments during the quarter was 13.1% which was lower than the effective yield of 14.3% in the preceding quarter due to the acceleration of fee income recognition from early loan repayments in the second quarter. The overall weighted average yield to maturity of our loan obligations was approximately 12.67% at September 30, 2008 as compared to 12.70% at December 31, 2007, attributed to increased investments to both expansion- and established-stage companies and asset based financing offered to more mature companies seeking revolver type financing solutions. The weighted average yield to maturity is computed using the interest rates in effect at the inception of each of the loans, and includes amortization of the loan facility fees, commitment fees and market premiums or discounts over the expected life of the debt investments, weighted by their respective costs when averaged and based on the assumption that all contractual loan commitments have been fully funded and held to maturity.

We generate revenue in the form of interest income, primarily from our investments in debt securities, and commitment and facility fees. Fees generated in connection with our debt investments are recognized over the life of the loan or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related

 

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securities that we acquire from our portfolio companies. Our investments generally range from $1.0 million to $30.0 million, with an average initial principal balance of between $1.0 million and $15.0 million. Our debt investments have a term of between two and seven years and typically bear interest at rates ranging from Prime rate to 14.0% (based on current interest rate conditions). In addition to the cash yields received on our loans, in some instances, our loans may also include any of the following: end-of-term payments, exit fees, balloon payment fees, PIK provisions, prepayment fees, and diligence fees, which may be required to be included in income prior to receipt. In most cases, we collateralize our investments by obtaining security interests in our portfolio companies’ assets, which may include their intellectual property. In other cases, we may obtain a negative pledge covering a company’s intellectual property. At September 30, 2008, approximately 44 portfolio company loans were secured by a first priority security in all of the assets of the portfolio company, 42 portfolio company loans were prohibited from pledging or encumbering their intellectual property and one portfolio company was secured with a second lien position. Interest on debt securities is generally payable monthly, with amortization of principal typically occurring over the term of the security for emerging-growth, expansion-stage and established-stage companies. In addition, certain loans may include an interest-only period ranging from three to eighteen months for emerging-growth and expansion-stage companies and longer for established-stage companies. In limited instances in which we choose to defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest become due at the maturity date.

Our senior debt investments also generally 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. As of September 30, 2008, we have received warrants in connection with the majority of our debt investments in each portfolio company, and have realized gains on 13 warrant positions since inception. During the three-month period ended September 30, 2008, we recognized realized gains of approximately $430,000 primarily from our warrant exercise and sale of common stock on one biopharmaceutical company. We recognized realized losses during the three-month period ended September 30, 2008 of approximately $304,000 from the sale of a debt investment to a syndication partner and the write off of warrants in two companies.

Our warrant coverage generally ranges from 3% to 20% of the principal amount invested in a portfolio company, with a strike price equal to the most recent equity financing round. We currently hold warrants in 95 portfolio companies, with a fair value of approximately $25.4 million which is included in the investment portfolio of $636.7 million. The fair value of the warrant portfolio has increased by $12.2 million or 92.4% as compared to the fair value of $13.2 million at September 30, 2007. These warrant holdings would allow us to invest approximately $59 million if such warrants are exercised. However, these warrants may not appreciate in value and, in fact, may decline in value. Accordingly, we may not be able to realize gains from our warrant interests.

 

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Results of Operations

Comparison of the Three and Nine-Month Periods Ended September 30, 2008 and 2007

Operating Income

Interest income totaled approximately $17.3 and $47.7 million for the three and nine-month periods ended September 30, 2008, respectively, compared with $13.6 and $34.4 for the three and nine-month periods ended September 30, 2007. These increases were primarily due to higher outstanding investment balances and accelerated interest income from early repayments. Income from commitment, facility and loan related fees totaled approximately $1.9 and $6.2 million for the three and nine-month periods ended September 30, 2008, respectively, as compared with approximately $1.6 and $3.7 million for the three and nine-month periods ended September 30, 2007. The increases in investment income and income from commitment, facility and loan related fees for both periods presented are the result of higher average loan balances outstanding due to origination activity and yield from the related investments and additional fees collected during the quarter from loan amendments and prepayments . At September 30, 2008, we had approximately $7.8 million of deferred revenue related to commitment and facility fees, as compared to approximately $5.1 million as of September 30, 2007.

Operating Expenses

Operating expenses totaled approximately $9.3 million and $24.9 million during the three and nine-month periods ended September 30, 2008, respectively, compared with $5.1 million and $15.6 million during the three and nine-month periods ended September 30, 2007, respectively. Operating expenses for the three and nine-month periods ended September 30, 2008 included interest expense, loan fees and unused commitment fees of approximately $4.5 million and $10.3 million, respectively, compared with $972,000 and $3.9 million for the three and nine-month periods ended September 30, 2007, respectively. The 363% increase in these expenses was due to the higher average outstanding debt balance of approximately $221.4 million during the three months ended September 30, 2008 as compared to $33.2 million during the three months ended September 30, 2007, higher cost of debt under our Credit Facility and higher fees for our SBA debenture. The expense was higher for the nine month period of 2008 compared to 2007 by 164% due to a higher average debt balance of $180.5 million compared to $59.8 million.

Employee compensation and benefits were approximately $2.5 million and $8.2 million during the three and nine-month periods ended September 30, 2008, respectively, compared with $2.4 million and $6.4 million during the three and nine-month periods ended September 30, 2007, respectively. The increase in compensation expense was primarily related to an increase in our headcount from 39 employees at September 30, 2007 to 46 employees at September 30, 2008 with increases for salaries. General and administrative expenses which include legal and accounting fees, insurance premiums, rent and various other expenses increased to $1.9 million and $5.3 million for the three and nine-month periods ended September 30, 2008, up from $1.4 million and $4.4 million during the three and nine-month periods ended September 30, 2007, primarily due to increases in recruiting expense and rent expenses. In addition, we incurred approximately $0.2 million and $1.1 million of stock-based compensation expense during the three and nine-month periods ended September 30, 2008, as compared to $0.3 million and $0.8 million in 2007, respectively.

Net Investment Income Before Income Tax Expense and Investment Gains and Losses

Net investment income before provision for income tax expense for the three and nine-month periods ended September 30, 2008 totaled $10.0 and $29.0 million, respectively, as compared with net investment income before provision for income tax expense of approximately $10.0 and $22.5 million for the three and nine-month periods ended September 30, 2007. The changes are made up of the items described above under “Operating Income” and “Operating Expenses.”

Net Investment Gains/Losses

Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of the investment without regard to unrealized appreciation or depreciation previously recognized, and include investments charged off during the period, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

 

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During the three-month period ended September 30, 2008, we generated realized gains totaling approximately $430,000 mainly from the exercise of warrants and sale of common stock on one biopharmaceutical Company. We recognized realized losses in the third quarter of 2008 of approximately $304,000 due to the write off of the of two company warrants and sale of one loan portfolio. This brings the total net realized gains to approximately $126,000 for the three month period ended September 30, 2008. A summary of realized and unrealized gains and losses for the three and nine-month periods ended September 30, 2008 and 2007 is as follows:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
(in thousands)    2008     2007     2008     2007  

Realized gains

     430       433       5,912       722  

Realized losses

     (304 )     (384 )     (919 )     (719 )
                                

Net realized gains

   $ 126     $ 49     $ 4,993     $ 3  
                                

During the three month period ended September 30, 2008, net unrealized investment appreciation totaled $2.4 million. During the nine month period ended September 30, 2008 net unrealized investment depreciation totaled approximately $2.0 million. Net unrealized depreciation was approximately $2.9 million and $733,000 for the three and nine-month periods ended September 30, 2007. The net unrealized appreciation and depreciation of investments is based on portfolio asset valuations determined in good faith by our Board of Directors. As of September 30, 2008, the net unrealized investment appreciation recognized by the Company was reduced by approximately $896,000 for a warrant participation agreement with Citigroup. For a more detailed discussion, see the discussion set forth under Note 3 to the consolidated financial statements. The following table itemizes the change in net unrealized appreciation (depreciation) of investments for the three and nine-month periods ended September 30, 2008:

 

     Three months ended
September 30, 2008
    Nine Months Ended
September 30, 2008
 
     Companies    Amount     Companies    Amount  
($ in thousands)                       

Gross unrealized appreciation on portfolio investments

   47    $ 5,681     47    $ 13,662  

Gross unrealized depreciation on portfolio investments

   41      (3,370 )   41      (12,304 )

Reversal of prior period net unrealized appreciation upon a realization

        221          (3,023 )

Citigroup Warrant Participation

        (112 )        (359 )
                      

Net unrealized appreciation/(depreciation) on portfolio investments

      $ 2,420        $ (2,024 )
                      

We previously announced that we anticipated achieving eight to 10 exit events during 2008. As of September 30, 2008, thirteen of our portfolio companies have achieved exit events.

Income Taxes and Excise Taxes

We account for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for 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 elected to be treated as a RIC under Subchapter M of the Code with the filing of our 2006 federal income tax return. Such election and qualification to be treated as a RIC requires that we comply with certain requirements contained in Subchapter M of the Code. Provided we continue to qualify as a RIC, our income generally will not be subject to federal income or excise taxes to the extent we make the requisite distributions to stockholders.

If we do not distribute at least 98% of our annual taxable income in the year earned, we will generally be required to pay an excise tax equal to 4% of the amount by which 98% of our annual taxable income exceeds the distributions from such taxable income during the year earned. To the extent that we determine that our estimated current year annual taxable income will be in excess of estimated current year dividend distributions from such taxable income, we accrue excise taxes on estimated excess taxable income as taxable income is earned using an annual effective excise tax rate. The annual effective excise tax rate is determined by dividing the estimated annual excise tax by the estimated annual taxable income.

At December 31, 2007, we had excess taxable income of $4.2 million available for distribution to shareholders in 2008. Excess taxable income for 2007 represents ordinary income and capital gains.

As of September 30, 2008 we have paid $32.1 million in dividends to shareholders during 2008. On October 21, 2008, we announced that our Board of Directors approved a dividend of $0.34 per share to shareholders of record as of November 14, 2008 and payable on December 15, 2008. For 2008, we estimate that we will distribute $1.32 in dividends. This estimate takes into account the Company’s expectations for the performance of its business for 2008, and its estimates of operating income, capital gains, net income and taxable income for 2008. The Company’s actual distributions for 2008 may differ from this estimate.

 

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In accordance with regulated investment company distribution rules, we declared current year dividends to be paid from carried over excess taxable income from 2007 before we file our 2007 tax return in September, 2008, and we paid such dividends as of September 30, 2008.

Net Increase in Net Assets Resulting from Operations and Earnings Per Share

For the three and nine-month periods ended September 30, 2008, net income totaled approximately $12.5 million and $31.9 million, respectively, compared to net income of approximately $7.2 million and $21.8 million for the three and nine-month periods ended September 30, 2007. These changes are made up of the items previously described.

Basic and fully diluted net income per share for the three and nine-month periods ended September 30, 2008 was $0.38 and $0.98, respectively, as compared to a basic and fully diluted net income per share of $0.22 and $0.81 for the three and nine-month periods ended September 30, 2007, respectively.

Financial Condition, Liquidity, and Capital Resources

At September 30, 2008, we had approximately $20.5 million in cash and cash equivalents and available borrowing capacity of approximately $7.0 million under our Credit Facility and approximately $40.0 million available under the Wells Facility. We primarily invest cash on hand in interest bearing deposit accounts. We have determined to de-leverage our balance sheet in the short term in order to support our liquidity position. In addition, our debt lending activities focus on providing portfolio companies short-term, 36-60 month amortizing credit facilities, which also continues to support our liquidity position.

For the nine months ended September 30, 2008, net cash used in operating activities totaled approximately $82.4 million as compared to $108.7 million for the nine months ended September 30, 2007. This decrease was due primarily due to $290.6 million used for investment in our portfolio companies offset by $185.0 million of principal payments during the nine months ended September 30, 2008 as compared $219.3 million used for investment in our portfolio companies offset by $86.6 million in principal repayments during the nine months ended September 30, 2007. Cash used in investing activities totaled approximately $584,300 for the nine months ended September 30, 2008 compared with net cash used in investing activities of $1.5 million for the nine months ended September 30, 2007. Net cash provided by financing activities totaled $95.6 million for the nine months ended September 30, 2008 compared to $120.1 million for the nine months ended September 30, 2007. This change is due to borrowings of $234.9 million on the credit facilities offset by repayment of $104.0 million and dividends paid of approximately $32.1 million in the nine months ended September 30, 2008.

As of September 30, 2008, net assets totaled $402.7 million, with a net asset value per share of $12.25. We intend to generate additional cash primarily from equity capital, future borrowings as well as cash flows from operations, including income earned from investments in our portfolio companies’ repayments, and, to a lesser extent, from the temporary investment of cash in U.S. government securities and other high-quality debt investments that mature in one year or less. Our primary use of funds will be investments in portfolio companies and cash distributions to holders of our common stock. After we have used our current capital resources, we expect to raise additional capital to support our future growth through future equity offerings, issuances of senior securities and/or future borrowings, to the extent permitted by the 1940 Act. As a result of the exemptive relief we received related to our SBA debt, we are not required to include SBA debt in the leverage ratio required by the 1940 Act. In order to fully leverage the Company, we would need to obtain additional credit. There can be no assurances that we will seek to, or be successful in, leveraging the Company further.

As required by the 1940 Act, our asset coverage must be at least 200% after each issuance of senior securities. Our asset coverage as of September 30, 2008 was approximately 484%, excluding SBA leverage.

We anticipate that we will continue to fund our investment activities through a combination of debt and additional equity capital over the next year. To the extent we determine to raise additional equity through an offering of our common stock at a price below net asset value, which we have received shareholder approval to do, existing investors will experience dilution.

As of September 30, 2008, we had $127.9 million outstanding under the Credit Facility, $10.0 million outstanding under the Wells Facility and approximately $127.2 million under the SBA program. As of September 30, 2008, there were $375.8 million of loans in the collateral pools and, based on eligible loans in the pools and existing advance rates, we have access to approximately $7 million of borrowing capacity available under our $134.9 million securitized credit facility and $40 million of borrowings under our Wells Facility. Our Credit Facility terminated on October 31, 2008 and unless we obtain an extension, all subsequent payments received from the portfolio companies whose debt is included in the collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding interest and principal are due and payable.

In addition, Citigroup has an equity participation right of 10% of the realized gains on warrants collateralized under the Credit Facility. However, no additional warrants are included in collateral subsequent to the facility amendment on May 2, 2007. See Note 3 to the consolidated financial statements for discussion of the participation right.

 

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At September 30, 2008 and December 31, 2007, we had the following borrowing capacity and outstandings:

 

     September 30, 2008    December 31, 2007
(in thousands)    Facility Amount    Amount
Outstanding
   Facility Amount    Amount
Outstanding

Credit Facility

   $ 134,900    $ 127,900    $ 250,000    $ 79,200

Wells Facility

     50,000      10,000      —        —  

SBA Debenture

     127,200      127,200      127,200      55,050
                           

Total

   $ 312,100    $ 265,100    $ 377,200    $ 134,250
                           

On September 27, 2006, HT II received a license to operate as a Small Business Investment Company under the SBIC program and is able to borrow funds from the SBA against eligible previously approved investments and additional contributions to regulatory capital. We have a commitment from the SBA permitting us to draw up to $127.2 million from the SBA, subject to certain regulatory requirements. At September 30, 2008, we had a net investment of $63.6 million in HT II, and there are investments in 47 companies with a fair value of approximately $197.1 million. The Company is the sole limited partner of HT II and HTM is the general partner. HTM is a wholly-owned subsidiary of the Company.

At our Annual Meeting of Stockholders on May 29, 2008, stockholders approved a proposal authorizing us to sell up to 20% of our common stock at a price below our net asset value per share, subject to Board approval of the offering. If we determine to conduct an offering to raise equity capital at a price below our net asset value, stockholders will experience immediate dilution following the offering. See Item 1A — Risk Factors.

Current Market Conditions

The debt and equity capital markets in the United States have been negatively impacted by significant write-offs in the financial services sector relating to subprime mortgages, the re-pricing of credit risk in the broadly syndicated market, and the current financial turmoil affecting the banking system and financial market. These events have led to worsening general economic conditions, which have resulted in a tightening in the broader financial and credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency and equity markets. The effects of the current financial turmoil have significantly reduced the availability of debt and equity capital for the market as a whole and financial firms in particular. We and other commercial finance companies have previously utilized the securitization market to finance some investment activities. Due to the current dislocation of the securitization market, which we believe may continue for an extended period of time, we and other companies in the commercial finance sector may have to access alternative debt markets in order to grow. The debt capital that will be available may be at a higher cost, if at all, and terms and conditions may be less favorable which could negatively affect our financial performance and results.

Off Balance Sheet Arrangements

In the normal course of business, we are party to financial instruments with off-balance sheet risk. These consist primarily of unfunded commitments to extend credit, in the form of loans, to our portfolio companies. Unfunded commitments to provide funds to portfolio companies are not be reflected on our balance sheet. Our unfunded commitments may be significant from time to time. As of September 30, 2008, we had unfunded commitments of approximately $141.8 million. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that we hold. Since these commitments may expire without being drawn upon and may be withdrawn under certain circumstances. Accordingly, the total commitment amount does not necessarily represent future cash requirements.

Contractual Obligations

The following table shows our contractual obligations as of September 30, 2008:

 

     Payments due by period
(in thousands)
Contractual Obligations(1)    Total    Less than 1 year (2)(3)    1-3 years    3-5 years    After 5 years

Borrowings (4)

   $ 265,100    $ 137,900    $ —      $ —      $ 127,200

Operating Lease Obligations

     4,891      981      1,965      1,878      67
                                  

Total

   $ 269,991    $ 138,881    $ 1,965    $ 1,878    $ 127,267
                                  

 

(1)

Excludes commitments to extend credit to our portfolio companies.

 

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(2)

Borrowings under the Credit Facility are listed based on the contractual maturity of the facility. Actual repayments could differ significantly due to prepayments by our existing portfolio companies, modifications of the current agreements with existing portfolio companies and modification of the credit facility.

(3)

We also have a warrant participation agreement with Citigroup. See Note 3.

(4)

Includes borrowings under our Credit Facility, Wells Facility and the SBA debentures.

Borrowings

We, through Hercules Funding Trust I, an affiliated statutory trust, have a securitized credit facility (the “Credit Facility”) with Citigroup Global Markets Realty Corp. and Deutsche Bank Securities Inc. The initial Credit Facility was a one year facility with an interest rate of LIBOR plus a spread of 1.20% and a borrowing capacity of $250 million.

On May 7, 2008, we amended and renewed our Credit Facility with Citigroup and Deutsche Bank providing for a borrowing capacity of $134.9 million and extending the expiration date to October 31, 2008. Under the terms of the agreement, the we paid a renewal fee of approximately $1.3 million, interest on all borrowings was set at LIBOR plus a spread of 5.0%, and a fee of 2.50% that is charged on any unused portion of the facility. The Credit Facility is collateralized by debt investment in our portfolio companies, and includes an advance rate of approximately 45% of eligible loans. The Credit Facility contains covenants that, among other things, require us to maintain a minimum net worth and to restrict the loans securing the Credit Facility to certain dollar amounts, to concentrations in certain geographic regions and industries, to certain loan grade classifications, to certain security interests, and to certain interest payment terms. At September 30, 2008, we had $127.9 million outstanding under the Credit Facility and were in compliance with all covenants. The Credit Facility terminated on October 31, 2008 and unless we obtain an extension all subsequent payments secured from the portfolio companies whose debt is included in the collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding principal and interest are due and payable.

Citigroup has an equity participation right through a warrant participation agreement on the pool of loans and warrants collateralized under the 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 are 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 equals $3,750,000 (the “Maximum Participation Limit”). The Obligations under the warrant participation agreement continue even after the Credit Facility is terminated until the Maximum Participation Limit has been reached. During the nine months ended September 30, 2008, we recorded an additional liability and reduced our unrealized and realized gains by approximately $300,000 for Citigroup’s participation in the warrant portfolio. The value of their participation right on unrealized gains in the related equity investments since inception of the agreement was approximately $896,000 at September 30, 2008 and is included in accrued liabilities. Since inception of the agreement, we have paid Citigroup approximately $927,000 under the warrant participation agreement thereby reducing its realized gains. There was approximately $91,000 realized gain unpaid and recorded as liability at September 30, 2008.

As of September 30, 2008, we, through our special purpose entity (SPE), had transferred pools of loans and warrants with a fair value of approximately $324.3 million to Hercules Funding Trust I and had drawn $127.9 million under the Credit Facility. Transfers of loans have not met the requirements of Statement of Financial Accounting Standards (“SFAS”) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, for sales treatment and are, therefore, treated as secured borrowings, with the transferred loans remaining in investments and the related liability recorded in borrowings. The average debt outstanding under the Credit Facility for the three and nine-month periods ended September 30, 2008 was approximately $118.2 and $97.8 million and the average interest rate was approximately 7.68% and 6.25%, excluding facility fees, respectively.

In January 2005, we formed HT II and HTM. HT II is licensed as a SBIC. HT II borrows funds from the SBA against eligible investments and additional deposits to regulatory capital. Under the Small Business Investment Act and current SBA policy applicable to SBICs, an SBIC can have outstanding at any time SBA guaranteed debentures up to twice the amount of its regulatory capital. As of September 30, 2008, the maximum statutory limit on the dollar amount of outstanding SBA guaranteed debentures issued by a single SBIC is $130.6 million, subject to periodic adjustments by the SBA. We have submitted a leverage request to increase our borrowing capacity to the full $130.6 million and received the approval in November. With $65.3 million of regulatory capital as of September 30, 2008, HT II would have the current capacity to issue up to a total of $130.6 million of SBA guaranteed debentures, subject to the payment of a 1% commitment fee to the SBA on the amount of the commitment. Currently, HT II has paid commitment fees of approximately $1.3 million and has a commitment from the SBA to issue a total of $127.2 million of SBA guaranteed debentures, of which approximately $127.2 million was outstanding as of September 30, 2008. There is no assurance that HT II will be able to draw up to the maximum limit available under the SBIC program.

As of September 30, 2008, assets held by HT II represented approximately 31.3% of the total assets of the Company.

 

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SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $18 million and have average annual fully taxed net income not exceeding $6.0 million for the two most recent fiscal years. In addition, SBICs must devote 20.0% of its investment activity to “smaller” concerns as defined by the SBA. A smaller concern is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services. Through our wholly-owned subsidiary HTII, we plan to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.

HTII is periodically examined and audited by the Small Business Administration’s staff to determine its compliance with small business investment company regulations. As of September 30, 2008, HTII could draw up to $127.2 million of leverage from the SBA as noted above. Borrowings under the program are charged interest based on ten year treasury rates plus a spread and the rates are generally set for a pool of debentures issued by the SBA in six month periods. The rate for the $12 million of borrowings originated from March 13, 2007 to September 10, 2007 was set by the SBA on September 26, 2007 at 5.528%. The rate for the $58.1 million borrowings made after September 10, 2007 through March 13, 2008 was set by the SBA on March 26, 2008 at 5.471%. The rate for the $38.8 million borrowings made after March 13, 2008 through September 10, 2008 was set by the SBA on September 24, 2008 at 5.725%. In addition, the SBA charges an annual 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 2008 and 2007 annual fee has been set at 0.906%. Interest payments are payable semi-annually and there are no principal payments required on these issues prior to maturity. Debentures under the SBA generally mature ten years after being borrowed.

On August 25, 2008, we, through a special purpose wholly-owned subsidiary of the Company, Hercules Funding II, LLC, entered into a two-year revolving senior secured credit facility with an optional one-year extension with total commitments of $50 million, with Wells Fargo Foothill, as a lender and as a arranger and administrative agent (the “Wells Facility”). The Wells Facility has the capacity to increase to $300 million if additional lenders are added to the syndicate. The Wells Facility expires on August 25, 2010, unless the option to extend is exercised by the parties to the agreement.

Borrowings under the Wells Facility will generally bear interest at a rate per annum equal to Libor plus 325 basis points or PRIME plus 200 basis points. The Wells Facility requires the payment of a non-use fee of 50 basis points annually, which reduces to 30 basis points on the one year anniversary of the credit facility. The Wells Facility is collateralized by debt investment in our portfolio companies, and includes an advance rate equal to 50% of eligible loans placed in the collateral pool. The Wells Facility generally requires payment of interest on a monthly basis. All outstanding principal is due upon maturity, which includes the extension if exercised. We paid a one- time $750,000 structuring fee in connection with the Wells Facility. The weighted average debt outstanding under the Wells Facility for the three-months period ended September 30, 2008 was approximately $1.8 million and the average interest rate was approximately 7.0%.

The Wells Facility requires various financial and operating covenants. These covenants require us to maintain certain financial ratios and a minimum net worth. 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 Wells Facility also required a minimum draw down of $10.0 million no later than September 30, 2008.

 

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Dividends

The following table summarizes our dividends declared and paid on all shares, including restricted stock, to date:

 

Date Declared

   Record Date    Payment Date    Amount Per Share

October 27, 2005

   November 1, 2005    November 17, 2005    $ 0.025

December 9, 2005

   January 6, 2006    January 27, 2006      0.300

April 3, 2006

   April 10, 2006    May 5, 2006      0.300

July 19, 2006

   July 31, 2006    August 28, 2006      0.300

October 16, 2006

   November 6, 2006    December 1, 2006      0.300

February 7, 2007

   February 19, 2007    March 19, 2007      0.300

May 3, 2007

   May 16, 2007    June 18, 2007      0.300

August 2, 2007

   August 16, 2007    September 17, 2007      0.300

November 1, 2007

   November 16, 2007    December 17, 2007      0.300

February 7, 2008

   February 15, 2008    March 17, 2008      0.300

May 8, 2008

   May 16, 2008    June 16, 2008      0.340

August 7, 2008

   August 15, 2008    September 15, 2008      0.340
            
         $ 3.405
            

On October 21, 2008, we announced that our Board of Directors approved a dividend of $0.34 per share to shareholders of record as of November 14, 2008 and payable on December 15, 2008.

Distributions in excess of our current and accumulated earnings and profits would 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 its taxable income for the full year and distributions paid for the full year, therefore a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. If we determined the tax attributes of its distributions year-to-date as of September 30, 2008, $0.98 or 100.0% would be from ordinary income and spill-over earnings from 2007, however there can be no certainty to stockholders that this determination is representative of what the tax attributes of its 2007 distributions to stockholders will actually be.

Recent Developments

In October, Hercules paid down the Wells Fargo credit facility by $10.0 million, resulting in borrowing capacity of $50.0 million.

On October 31, 2008 the Company’s Credit Facility expired under the normal terms. All subsequent payments secured from the portfolio companies whose debt is included in the Credit Facility collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding interest and principal are due and payable. During the amortization period, the Company no longer pays a non-use fee on the Credit Facility, although borrowings under the Credit Facility bear interest at a rate per annum equal to Libor plus 650 basis points during the amortization period.

In October, Hercules received full repayment of $2.5 million from NetEffect representing principal and interest outstanding. Intel, Inc. acquired the assets of the company in bankruptcy.

In October, Hercules received a repayment of approximately $700,000 in common stock from an investor for the assets of Teleflip.

Critical Accounting Policies

The preparation of consolidated financial statements in conformity with U.S. 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, 2008, approximately 94% of our total assets represented investments in portfolio companies of which greater than 99% 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. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our investments at fair value as determined in good faith by our board pursuant to a valuation policy and a consistent valuation process in accordance with the provisions of FAS No. 157, Fair Value Measurement (“FAS 157”) and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by our board may differ significantly from the value that would have been used had a ready market existed for such investments, and the differences could be material.

 

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In September 2006, the FASB issued FAS No. 157, Fair Value Measurements (“FAS 157”). FAS 157, which defines fair value, establishes a framework for measuring fair value, outlines a fair value hierarchy based on inputs used to measure fair value and enhances disclosure requirements for fair value measurements. FAS 157 does not change existing guidance as to whether or not an instrument is carried at fair value. We adopted FAS 157 effective January 1, 2008. FAS 157 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.

Consistent with FAS 157, we determine fair value to be the amount for which an investment could be exchanged in a current sale, which assumes an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. Our valuation policy considers the fact that no ready market exists for substantially all of the securities in which it invests. In accordance with FAS 157, we have considered the principal market, or the market in which we exit our portfolio investments with the greatest volume and level of activity. FAS 157 requires that the portfolio investment is assumed to be sold in the principal market to market participants, or in the absence of a principal market, the most advantageous market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. The Company believes that the market participants for its investments are primarily other technology and life science companies. Such participants acquire the company’s investments in order to gain access to the underlying assets of the portfolio company. As such, the Company believes the estimated value of the collateral of the portfolio company, up to the cost value of the investment, represents the fair value of the investment.

Determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment, although our valuation policy is intended to provide a constant basis for determining the fair value of portfolio investments. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we must determine the fair value of each individual investment on a quarterly basis. The Company records unrealized depreciation on investments when we believe that an investment has decreased in value, including where collection of a loan or realization of an equity security is doubtful. Conversely, where appropriate, the Company records unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, that our investment has also appreciated in value.

As a business development company, we invest primarily in illiquid securities including debt and equity-related securities of private companies. Our investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our valuation methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation.

When originating a debt instrument, we generally receive warrants or other equity-related securities from the borrower. We determine the cost basis of the warrants or other equity-related securities received based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and warrants or other equity-related securities received. Any resulting discount on the loan from recordation of the warrant or other equity instruments is accreted into interest income over the life of the loan.

At each reporting date, privately held debt and equity 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 that could impact the valuation. 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 debt and equity 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. We may consider, but are not limited to, industry valuation methods such as price to enterprise value or price to equity ratios, discounted cash flow, valuation comparisons to comparable public companies or other industry benchmarks in its evaluation of the fair value of its investment.

An unrealized loss is recorded when an investment has decreased in value, including: where collection of a loan is doubtful, there is an adverse change in the underlying collateral or operational performance, there is a change in the borrower’s ability to pay, or there are other factors that lead to a determination of a lower valuation for the debt or equity security. Conversely, unrealized appreciation is recorded when the investment has appreciated in value. 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 Board of Directors estimates the fair value of warrants and other equity-related securities in good faith using a Black-Scholes pricing model and consideration of the issuer’s earnings, sales to third parties of similar securities, the comparison to publicly traded securities, and other factors.

All investments recorded at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by FAS 157 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.

 

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Income Recognition. Interest income is recorded on the accrual basis and is recognized 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, the Company will, as a general matter, place the loan on non-accrual status and cease recognizing interest income on that loan until all principal has been paid. However, Hercules may make exceptions to this policy if the investment has sufficient collateral value and is in the process of collection. As of September 30, 2008 we had two loans on non-accrual status. There was one loan on non-accrual status as of September 30, 2007.

Paid-In-Kind and End of Term Income. Contractual paid-in-kind (“PIK”) interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We will generally cease accruing PIK interest if there is insufficient value to support the accrual or we do not expect the portfolio company to be able to pay all principal and interest due. In addition, we may also be entitled to an end-of-term payment that we amortize into income over the life of the loan. To maintain our status as a RIC, PIK and end-of-term income must be paid out to stockholders in the form of dividends even though we have not yet collected the cash. Amounts necessary to pay these dividends may come from available cash or the liquidation of certain investments. For the three and nine-months period ended September 30, 2008, approximately $1.7 million and $3.8 million in PIK and end-of-term income was recorded. There was approximately $682,000 and $1.5 million in PIK and end-of-term income recorded during the three and nine-month periods ended September 30, 2007.

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.

Stock-Based Compensation. We have issued and may, from time to time, issue additional stock options to employees under our 2004 Equity Incentive Plan. We follow SFAS No. 123 (revised 2004), Share-Based Payments (“FAS 123R”), to account for stock options granted. Under FAS 123R, compensation expense associated with stock-based compensation is measured at the grant date based on the fair value of the award and is recognized.

Federal Income Taxes. We intend to operate so as to qualify to be taxed as a RIC under Subchapter M of the Code and, as such, will not be subject to federal income tax on the portion of our taxable income and gains distributed to stockholders. To qualify as a RIC, we are required to distribute at least 90% of our investment company taxable income, as defined by the Code. We are subject to a non-deductible federal excise tax if we do not distribute at least 98% of our ordinary taxable income each calendar year and 98% of our net capital gain net income for the 1 year period ending on October 31.

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.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to financial market risks, including changes in interest rates. As of September 30, 2008, approximately 55% of our portfolio loans were at fixed rates and 45% of our loans were at variable rates. Over time additional investments may be at variable rates. We may, in the future, hedge against interest rate fluctuations by using standard hedging instruments such as futures, options, and forward contracts. While hedging activities may insulate us against changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates with respect to our borrowed funds and higher interest rates with respect to our portfolio of investments. Interest rates on our borrowings are based primarily on LIBOR. Borrowings under our SBA program are fixed at the ten-year treasury every March and September for borrowings of the preceding six months. At September 30, 2008, the borrowing rate under the Credit Facility was LIBOR plus a spread of 5.0%. The borrowing rate under the SBA facility for approximately $12.0 million of fixed rate borrowings was approximately 5.5% and the rate for the $58.1 million borrowings made after September 10, 2007 through March 13, 2008 was set by the SBA as announced on March 26, 2008 at 5.471%. The rate for the $38.8 million borrowings made after March 13, 2008 through September 10, 2008 was set by the SBA as announced on September 24, 2008 at 5.725%. In addition, the SBA charges an annual fee of 0.906%. Borrowings under the Wells Facility will generally bear interest at a rate per annum equal to LIBOR plus 325 basis points or PRIME plus 200 basis points. The Wells Facility requires the payment of a non-use fee of 50 basis points annually, which reduces to 30 basis points on the one year anniversary of the credit facility.

 

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 it files or submits under the Exchange Act 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 it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its 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, that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

At September 30, 2008, we were not a party to any legal proceedings. However, from time to time, we may be party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect upon our financial condition or results of operations.

 

ITEM 1A. RISK FACTORS

In addition to the risks discussed below, important risk factors that could cause results or events to differ from current expectations are described in Part I, Item 1A “Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

There can be no assurance that recently enacted legislation authorizing the U.S. government to purchase large amounts of illiquid mortgages and mortgage-backed securities from financial institutions will help stabilize the U.S. financial system.

On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”). The legislation was the result of a proposal by Treasury Secretary Henry Paulson to the U.S. Congress on September 20, 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. Pursuant to the EESA, the U.S. Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. There can be no assurance, however, as to the actual impact that the EESA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.

 

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We are currently in a period of capital markets disruption and recession and we do not expect these conditions to improve in the near future.

The U.S. capital markets have been experiencing extreme volatility and disruption for more than 12 months and we believe that the U.S. capital markets appear to have entered into a period of recession. Disruptions in the capital markets have increased the spread between the yields realized on risk-free and higher risk securities, resulting in illiquidity in parts of the debt capital markets. We believe these conditions may continue for a prolonged period of time or worsen in the future. A prolonged period of market illiquidity may cause us to reduce the value of loans we originate and/or fund, which could have an adverse effect on our business, financial condition, and results of operations. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing our investment originations and negatively impact our operating results.

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

At our Annual Meeting of Stockholders on May 29, 2008, stockholders approved a proposal authorizing us to sell up to 20% of our common stock at a price below the Company’s net asset value per share, subject to Board approval of the offering. If we were to issue shares at a price below net asset value, such sales would result in an immediate dilution to existing common stockholders, which would include a reduction in the net asset value per share as a result of the issuance. This dilution would also include a proportionately greater decrease in a stockholder’s interest in our earnings and assets and voting interest in us than the increase in our assets resulting from such issuance.

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

Because the number of shares of common stock that could be so issued and the timing of any issuance is not currently known, the actual dilutive effect of an offering cannot be predicted.

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 of 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 made smaller investments in more companies. The following table shows the fair value of investments held at September 30,2008 that are greater than 5% of net assets:

 

          September 30, 2008  
(in thousands)    Industry    Fair Value    Percentage of Net
Assets
 

Tectura Corporation

   Communications & Networking    $ 25,449    6.3 %

Zayo Bandwidth, Inc.

   Communications & Networking      25,000    6.2 %

Infologix, Inc.

   Software      21,000    5.2 %

Zayo Bandwidth Corporation provides bandwidth services to carriers, web-centric companies, public institutions and enterprises. Zayo’s mission is to be a highly reliable and responsive bandwidth provider in those geographies where it has fiber networks.

Tectura Corporation provides business value and competitive advantage to more than 4,000 clients worldwide through its Microsoft integrated business solutions. With successful implementations in over 50 countries, Tectura is a leading global provider of integrated business solutions to mid-market companies and large enterprise divisions.

InfoLogix, Inc., a public traded company, provides enterprise mobility and radio frequency identification (RFID) solutions in North America. It offers consulting, business software applications, managed services, mobile workstations and devices, and wireless infrastructure services for healthcare, distribution, manufacturing, retail, and transportation and field services sectors.

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

Current market conditions have materially and adversely impacted debt and equity capital markets in the United States.

The debt and equity capital markets in the United States have been negatively impacted by significant write-offs in the financial services sector relating to subprime mortgages and the re-pricing of credit risk in the broadly syndicated market, among other things. These events, along with the deterioration of the housing market, the failure of major financial institution and the resulting United States Federal government actions have led to worsening general economic conditions, which have materially and adversely impacted the broader financial and credit markets and have reduced the availability of debt and equity capital for the market as a whole and

 

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financial firms in particular. We and other commercial finance companies have previously utilized the securitization market to finance some investment activities. Due to the current dislocation of the securitization market, which we believe may continue for an extended period of time, we and other companies in the commercial finance sector may have to access alternative debt markets in order to grow. The debt capital that will be available may be at a higher cost, and terms and conditions may be less favorable which could negatively affect our financial performance and results. In addition, the prolonged continuation of further deterioration of current market conditions could adversely impact our business.

Any unrealized losses we experience on our investment portfolio may be an indication of future realized losses, which could reduce our income available for distribution.

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

To the extent venture capital or private equity firms decrease or discontinue funding to their portfolio companies, our portfolio companies may not be able to meet their obligations under the debt securities that we hold.

Most of our portfolio companies rely heavily on future rounds of funding from venture capital or private equity firms in order to continue operating their businesses and repaying their obligations to us under the debt securities that we hold. Venture capital and private equity firms in turn rely on their limited partners to pay in capital over time in order to fund their ongoing and future investment activities.

To the extent that venture capital and private equity firms’ limited partners are unable to fulfill their ongoing funding obligations, the venture capital or private equity firms may be unable to continue financially supporting the ongoing operations of our portfolio companies. As a result, our portfolio companies may be unable to repay their obligations under the debt securities that we hold, which would harm our financial condition and results of operations.

Further economic recessions or downturns could impair the ability of our portfolio companies to repay loans, which, in turn, could increase our non-performing assets, decrease the value of our portfolio, reduce our volume of new loans and harm our operating results, which might have an adverse effect on our results of operations.

Many of our portfolio companies are and may be susceptible to economic slowdowns or recessions and may be unable to repay our loans during such periods. Therefore, our non-performing assets are likely to increase and the value of our portfolio is likely to decrease during such periods. Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments.

Further economic recessions or downturns could impair the value of the collateral for our loans to our portfolio companies.

In particular, intellectual property owned or controlled by our portfolio companies constitutes an important portion of the value of the collateral of our loans to a portfolio companies. Adverse economic conditions may decrease the demand for our portfolio companies’ intellectual property and consequently its value in the event of a bankruptcy or required sale through a foreclosure proceeding. As a result, our ability to fully recover the amounts owed to us under the terms of the loans may be impaired by such events.

Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us.

A portfolio company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of the portfolio company’s loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize the portfolio company’s ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting portfolio company. In addition, if a portfolio company goes bankrupt, even though we may have structured our investment as senior debt or secured debt, depending on the facts and circumstances, including the extent to which we actually provided significant “managerial assistance,” if any, to that portfolio company, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to that of other creditors. These events could harm our financial condition and operating results.

We do not control our portfolio companies. These portfolio companies may face intense competition, including competition from companies with greater financial resources, more extensive research and development, manufacturing, marketing and service capabilities and greater number of qualified and experienced managerial and technical personnel. They may need additional financing which they are unable to secure and which we are unable or unwilling to provide, or they may be subject to adverse developments unrelated to the technologies they acquire.

Fluctuations in interest rates may adversely affect our profitability.

A portion of our income will depend upon the difference between the rate at which we borrow funds and the interest rate on the debt securities in which we invest. Because we will borrow 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 these funds. Typically, we anticipate that our interest-earning investments will accrue and pay interest at fixed rates, and that our interest-bearing liabilities will accrue interest at variable rates. As a result, 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. We anticipate using a combination of equity and long-term and short-term borrowings to finance our investment activities.

A significant increase in market interest rates could harm our ability to attract new portfolio companies and originate new loans and investments. We expect that most of our initial investments in debt securities will be at floating rates. However, in the event that we make investments in debt securities at variable rates, a significant increase in market interest rates could also result in an increase

 

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in our non-performing assets and a decrease in the value of our portfolio because our floating-rate loan portfolio companies may be unable to meet higher payment obligations. In periods of rising interest rates, our cost of funds would increase, resulting in a decrease in our net investment income. In addition, a decrease in interest rates may reduce net income, because new investments may be made at lower rates despite the increased demand for our capital that the decrease in interest rates may produce. We may, but will not be required to, hedge against the risk of adverse movement in interest rates in our short-term and long-term borrowings relative to our portfolio of assets. If we engage in hedging activities, it may limit our ability to participate in the benefits of lower interest rates with respect to the hedged portfolio. Adverse developments resulting from changes in interest rates or hedging transactions could have a material adverse effect on our business, financial condition, and results of operations.

Our common stock price has been and continues to be volatile and may decrease substantially.

The capital and credit market have been experiencing extreme volatility and disruption for more than 12 months. In recent weeks the volatility and disruption have reached unprecedented levels, and we have experienced greater than usual stock price volatility.

In addition, the trading price of our common stock following an offering may fluctuate substantially. The price of the common stock that will prevail in the market after an offering may be higher or lower than the price you paid and the liquidity of our common stock may be limited, in each case depending on many factors, some of which are beyond our control and may not be directly related to our operating performance. These factors include, but are not limited to, the following:

 

   

price and volume fluctuations in the overall stock market from time to time;

 

   

significant volatility in the market price and trading volume of securities of RICs, business development companies or other financial services companies;

 

   

any inability to deploy or invest our capital;

 

   

fluctuations in interest rates;

 

   

any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;

 

   

the financial performance of specific industries in which we invest in on a recurring basis; announcement of strategic developments, acquisitions, and other material events by us or our competitors, or operating performance of companies comparable to us;

 

   

changes in regulatory policies or tax guidelines with respect to RICs or business development companies;

 

   

losing RIC status;

 

   

actual or anticipated changes in our earnings or fluctuations in our operating results, or changes in the expectations of securities analysts;

 

   

changes in the value of our portfolio of investments;

 

   

realized losses in investments in our portfolio companies;

 

   

general economic conditions and trends;

 

   

loss of a major funded source; or

 

   

departures of key personnel.

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Due to the potential volatility of our stock price, we may be the target of securities litigation in the future. Securities litigation could result in substantial costs and could divert management’s attention and resources from our business.

Results may fluctuate and may not be indicative of future performance.

Our operating results may fluctuate and, therefore, you should not rely on current or historical period results to be indicative of our performance in future reporting periods. Factors that could cause operating results to fluctuate include, but are not limited to, variations in the investment origination volume and fee income earned, changes in the accrual status of our debt investments, variations in timing of prepayments, variations in and the timing of the recognition of net realized gains or losses and changes in unrealized appreciation or depreciation, the level of our expenses, the degree to which we encounter competition in our markets, and general economic conditions.

 

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

On August 25, 2008, we entered into the Wells Facility, a two-year revolving senior secured credit facility with an optional one-year extension with initial commitments of $50 million at closing. The Wells Facility has the capacity to increase to $300 million if additional lenders are added to the lending syndicate. See Note 3 to our consolidated financial statements. As of October 31, 2008, we didn’t have outstanding balance under the Wells Facility.

We expect to add additional lenders under the Wells Facility in the future and under the terms of the facility have a borrowing capacity of up to $300 million. Due to current credit conditions as a result of the overall downturn in the market, our cost of borrowing may increase with the addition of additional lenders under the Wells Facility. The current lenders have, and any future lender or lenders will have fixed dollar claims on our assets that are senior to the claims of our stockholders and, thus, will have a preference over our stockholders with respect to our assets. In addition, we may grant a security interest in our assets in connection with any such borrowing. We expect such a facility to contain customary default provisions such as a minimum net worth amount, a profitability test, and a restriction on changing our business and loan quality standards. An event of default under any credit facility would likely result, among other things, in termination of the availability of further funds under that facility and an accelerated maturity date for all amounts outstanding under the facility, which would likely disrupt our business and, potentially, the business of the portfolio companies whose loans that we financed through the facility. This could reduce our revenues and, by delaying any cash payment allowed to us under our facility until the lender has been paid in full, reduce our liquidity and cash flow and impair our ability to grow our business and maintain our status as a RIC.

On May 7, 2008, the Company renewed its Credit Facility with Citigroup and Deutsche Bank providing for a borrowing capacity of $135 million and extending the expiration date to October 31, 2008. See Note 12 to our consolidated financial statements. Unless extended, our Credit Facility terminates on October 31, 2008, and all subsequent payments received from the portfolio companies whose debt is included in the collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding interest and principal are due and payable.

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

The current economic and capital markets conditions in the U.S. have severely reduced capital availability. Reflecting concern about the stability of the financial markets, many lenders and institutional investors have reduced or ceased providing funding to borrowers. This market turmoil and tightening of credit have led to increased market volatility and widespread reduction of business activity generally.

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

As of September 30, 2008, we had $10 million in outstanding borrowings under the Wells Facility and $127.2 million under SBA debenture and $50.0 million available borrowing capacity under these facilities. Our Credit Facility terminated on October 31, 2008 and unless we obtain an extension all subsequent payments received from the portfolio companies whose debt is included in the collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding interest and principal are due and payable. As of September 30, 2008 we had $127.9 million outstanding under the Credit Facility.

If we are not able to extend our Credit Facility and are unable to secure additional lenders under our Wells Facility, the amount of borrowing capacity available to us will be significantly reduced upon the termination of the Credit Facility. There can be no assurance that we will be successful in obtaining any additional debt capital on terms acceptable to us or at all. If we are unable to obtain debt capital, then our equity investors will not benefit from the potential for increased returns on equity resulting from leverage to the extent that our investment strategy is successful and we may be limited in our ability to make new commitments or fundings to our portfolio companies.

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

On May 7, 2008, the Company renewed its Credit Facility with Citigroup and Deutsche Bank providing for a borrowing capacity of $135 million and extending the expiration date to October 31, 2008. Our Credit Facility terminated on October 31, 2008 and unless we obtain an extension all subsequent payments received from the portfolio companies whose debt is included in the collateral pool will be applied against interest and principal outstanding under the Credit Facility until April 30, 2009, when all outstanding interest and principal are due and payable.

 

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

 

   

be forced to reduce or discontinue our operations;

 

   

not be able to expand or acquire complementary businesses; and

 

   

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

 

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

During the three months ended September 30, 2008, one of our Directors elected to take part of their compensation in the form of common stock in lieu of cash. We issued a total of 1,667 shares of common stock to the Director with an aggregate price for the shares of common stock of approximately $14,866.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

 

ITEM 5. OTHER INFORMATION

Not applicable.

 

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ITEM 6. EXHIBITS

 

Exhibit
Number

  

Description

31.1

   Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

   Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

   Chief Executive Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

   Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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SIGNATURES

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

 

    HERCULES TECHNOLOGY GROWTH CAPITAL, INC. (Registrant)
Dated: November 10, 2008     /s/ MANUEL A. HENRIQUEZ
    Manuel A. Henriquez
        Chairman, President, and Chief Executive Officer
Dated: November 10, 2008     /s/ DAVID M. LUND
   

David M. Lund

Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit
Number

  

Description

31.1

   Chief Executive Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

   Chief Financial Officer Certification Pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

   Chief Executive Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

   Chief Financial Officer Certification pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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