HTGC

Business Context and Reporting Period

Company: Hercules Technology Growth Capital, Inc. (HTGC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: HTGC is a specialty finance company and Business Development Company (BDC) regulated under the Investment Company Act of 1940. It provides debt and equity growth capital to technology-related companies, primarily focusing on structured debt with warrants for venture capital and private equity-backed firms. The company operates as a Regulated Investment Company (RIC) for tax purposes.

Key Financial Metrics

Material Changes vs. Prior Period

• Portfolio Valuation: The company recorded a net unrealized depreciation of $21.4 million in 2008, compared to appreciation of $7.3 million in 2007. This decline was primarily driven by the collapse in financial markets and the impact of FAS 157 on portfolio valuations.
• Net Worth Reduction: Net worth decreased by approximately $18.6 million in the second half of 2008 due to unrealized depreciation.
• Debt Structure: The primary Credit Facility with Citigroup and Deutsche Bank expired on October 31, 2008, entering an amortization period with full repayment due by April 30, 2009. Outstanding balance was $89.6 million at year-end.
• Operating Expenses: Total operating expenses increased to $35.9 million from $21.4 million in 2007. This 68% increase was largely due to higher interest expense (average debt balance rose from $66.3 million to $196.9 million) and increased employee compensation.
• Investment Strategy Shift: Management shifted focus from emerging-growth companies to expansion and established-stage companies to manage credit performance and maintain liquidity in a challenging credit environment.

Guidance, Outlook, and Risks

• Liquidity and Dividends: To preserve cash, the Board declared that 90% of the first quarter 2009 dividend would be paid in newly issued common stock, with no more than 10% in cash. This aligns with IRS Revenue Procedure 2009-15.
• Debt Repayment: The company intends to repay the $89.6 million Credit Facility balance by April 30, 2009, using proceeds from loan repayments, the Wells Facility, and refinancing. There is no assurance of success given market conditions.
• SBIC Leverage: The company's SBIC subsidiary (HT II) has $127.2 million in outstanding SBA debentures. The American Recovery and Reinvestment Act of 2009 increased the borrowing limit to $150.0 million, with potential for further expansion to $225.0 million via a second license.
• Key Risks:
  • Market Conditions: Extreme volatility and lack of liquidity in debt capital markets may restrict access to funding and increase borrowing costs.
  • Valuation Uncertainty: Approximately 96% of assets are investments valued at fair value by the Board, creating inherent uncertainty in NAV.
  • Covenant Compliance: The Wells Facility requires a minimum tangible net worth of $360 million. As of Dec 31, 2008, net worth was $382 million, leaving a narrow margin.
  • Portfolio Concentration: Significant exposure to technology and life sciences sectors, with 57.2% of the portfolio concentrated in four industries.

Investor Verification Checklist

• Credit Facility Repayment: Verify the company's ability to repay the $89.6 million Citigroup/Deutsche Bank facility by April 30, 2009, given the frozen securitization market.
• Wells Facility Utilization: Monitor the ability to draw on the Wells Facility (currently $0 outstanding) to replace the expiring Credit Facility.
• Portfolio Downgrades: Review the increase in portfolio loans graded 3, 4, and 5 (indicating higher risk) from 2007 to 2008.
• Dividend Sustainability: Assess the impact of paying 90% of dividends in stock on shareholder dilution and cash flow requirements.
• NAV vs. Market Price: Note the significant discount of the stock price ($7.47 average in Q4 2008) to the NAV per share ($11.56).