Nov 2, 2012
Executives
Manuel A. Henriquez - Chairman, President and CEO Jessica T.
Baron - CFO, VP, Finance and PAO Linda Wells - Market Street Partners
Analysts
Troy Ward - Stifel, Nicolaus & Co., Inc. John Hecht - Stephens Inc., Research Division.
John Stilmar - JMP securities Robert Bordett - Raymond James Financial Services, Inc. Jason Arnold – RBC Capital Markets Aaron James Deer – Sandler O'Neill & Partners L.P.
Jonathan Bock - Wells Fargo J.T. Rogers – Janney Capital Markets
Operator
Good day, ladies and gentlemen and welcome to the Hercules Technology Growth Capital’s Q3 2012 Earnings Conference Call. At this time, all participants will be in a listen-only mode.
Later we will conduct a question-and-session, which instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded.
And now I’d like to introduce your host for today, Linda Wells, Investor Relations for Hercules.
Linda Wells
Thank you, operator and good afternoon everyone. On the call today are Manuel Henriquez, Hercules Co-founder, Chairman and CEO; and Jessica Baron, Vice President, Finance and Chief Financial Officer.
Hercules third quarter 2012 financial results were released just after today’s market close. They can be accessed from the Company’s website at www.herculestech.com.
We’ve arranged for a replay of the call at Hercules’ web page or by using the telephone number and pass code provided in today’s earnings release. I’d also like to call your attention to the Safe Harbor disclosure in our earnings release regarding forward-looking information.
Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results. In addition, the statements contained in this release that are not purely historical are forward-looking statements.
These forward-looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements including, without limitation, the risks, and uncertainties, including the uncertainties surrounding the current market turbulence, and other factors we identified from time-to-time in our filings with the Securities and Exchange Commission. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, any of those assumptions can prove to be inaccurate and as a result, the forward-looking statements based on those assumptions also can be incorrect.
You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events.
To obtain copies of related SEC filings, please visit sec.gov or visit the website www.herculestech.com. I’d now like to turn the call over to Manuel Henriquez, Hercules Co-founder, Chairman and CEO.
Manuel A. Henriquez
Thank you, Linda and good afternoon everybody. Before I start today, I want to say that I hope to god that everyone in this call on the East coast has not suffered damages and are doing okay after the horrific storms that we experienced.
Recently, so our hopes and prayers are with you on the East coast for a speedy recovery. And I think its important that we all recognize and help as much we can on that, in that effort for East coast.
Thank you, Linda and thank you everybody for joining us on the call today. We’ve changed a little bit of our format in our call to make the call little more efficient as well as in our press release I will call attention to slight change in format in our press releases as we try to get more expedited in our disclosures and better disclosures for our shareholders, investors out there.
With that said, let me turn to the agenda. I plan to having four ballpoints that I usually talk about, which is a summary of the operations, observations of the current environment both the direct investment environment and the venture capital landscape, our remaining outlook for 2012 and some perspective on the early part of 2013 and then of course to turn the call over to our CFO Jessica Baron to go through the financial presentation and then of course to wrap it up with our standard Q&A session with our investors – and analysts, excuse me.
So, now turning to the third quarter. Once again, we delivered a very strong quarter, very proud of what we did and what this Company has accomplished and continues to achieve as an organization.
We delivered a 28% increase year-over-year, in total investment income for $23.9 million. We also achieved a record and strong performance on net investment income at 33% increase year-over-year, $11.4 million or $0.23 a share for net investment income.
We also had a – experienced a 32% increase year-over-year on the DNOI of approximately $12.5 million representing $0.26 a share. Very, very strong operating performance, a very indicative of how we believe and how the market is going as we continue deploy assets.
We all saw a significant increase in the assets on our investor portfolio, an increase of 34% of the investment portfolio assets with $734 million in invested portfolio assets. Again, very strong quarter and I will talk more about that activity here shortly.
Portfolio growth. Origination activities remained very strong and very robust in Q3, much more than we had anticipated and much stronger than the earlier guidance that we gave at the beginning of – in our Q2 earnings call.
We continue to purse however a slow and steady strategy. Although we were experiencing a significant demand for capital in the investment opportunities, we remain steadfast however in ensuring that we work with the right companies, we achieve the yield successfully we want and the credit quality of the underwriting companies that we’re looking at.
That said, we’re also turning down a higher percentage of companies that we’ve had historically for multiple reasons out there and we will continue to do so as we roll through in Q4. We remain and will continue to be highly selective on the assets that we’re looking to invest in both by industry sectors and stage.
As we turn our attention, we finished the quarter with approximately $134 million of new commitments in the quarter that we closed, bringing a total year-to-date of closed commitments to $450 million. We are on track to hit or exceed the activities in 2011 with what we’ve so far in-house and I will actually provide more color to that as I go through this presentation.
As I wanted to update the guidance that we gave in Q2, for origination activities in fiscal 2012, I’m once again now increasing that outlook of total commitments to $550 million to $650 million of new commitments for 2012. This is up by approximately $50 million to $75 million from the previous guidance that we’ve given and a fact on the robust pipeline that we’re seeing after today.
On a net portfolio growth for Q3, we experience approximately $49 million net up portfolio growth in our assets. We had indicated a $20 million to $30 million net up in the portfolio, so above the expectations that we had originally expected to see during the period of time.
The vast majority of the assets came in line at the end of the quarter. We are continuing to experience a phenomenon that at this point I’m going to call the new norm.
And that is transaction of closing late in the quarter and our funding late in the quarter. So although the new commitment activity remains strong, the impact of earnings will be felt in a proceeding quarter because of the transaction of all closing way too late in the quarter and having little impact on earnings during that period of time when they close.
Something that I thought at this point would go away it is now the new norm. As I turn to our portfolio growth for Q4, in Q4 we’re looking at a net up in portfolio assets of approximately $50 million to $70 million in the quarter.
Again, we expect to see net investment assets of new investments on our books to go up by $50 million to $70 million as of Q4 with the origination activities. Moving to credit quality.
Credit quality remains strong. We continue to focus on credit and we remain very diligent and very active on credit.
However, we’re conceding a elongated process where most of our companies who are expected to close rounds of financings are taking suddenly longer than anticipated and thereby increasing our discern with some of the credits that we have. That does not mean that we expect to experience principal losses, but we’re seeing a longer process of closing rounds of financings and we’re remaining very cautious in monitoring that.
We have a handful of companies, specifically within the life sciences sectors that are experiencing longer capital raising processes mostly tied to elongated or extended out clinical trial processes that are taking longer than anticipated and thereby causing a delay and then closing rounds of financing until they get greater visibility in the products or services that they’re offering within the FDA clinical trial process. We also reevaluated and continuously monitor our European exposure.
The European exposure remains to minimus and very, very immaterial. I believe the long-term [relative] to the analysis we have less than $20 million of direct exposure to any kind of European exposure that we have.
However, some of our portfolio companies do have European exposures and we are monitoring that and nothing at this point that we believe there further disclosures and further evaluation. As I turn my attention to first – other aspects of the portfolio.
We are continuously managing through and cycling out of certain industries in our portfolio. What that means is that we’re deemphasizing certain sectors and stages of our portfolio, an increase in our exposure and interest and other areas of the portfolio.
This is a purposely done mechanism on how we mitigate risk and increase yields in a portfolio and cycle through different areas of venture capital activities what we think appropriate and we think that are overvalued and other sectors were undervalued and underrepresented in our investor portfolio that we will turn our attention too. Very important part of the process.
In supplementing our origination activities, we also increased our headcount during the quarter. We’ve now issued a press release giving guidance or giving disclosures that we now hired six investor professionals to the organization, one of which is in a legal department replacing our former Chief Legal Officer in terms of the day to day activities from a general counsel’s one of you and we’ve now moved our interim counsel, Nick Martitsch to actually work in Scott Harvey’s old position.
As we kind of look to increase our origination activities and legal activities. As part of the new hiring, two of those new hirers were Managing Directors in our Technology Group.
Those disclosures and those backgrounds you will see in the press release we issued recently. We are also taking a more cautious approach as we evaluate our life sciences investment.
We are concerned about the outlook and the election on certain life science investment activities and we also remain concerned with the elongated protracted approval process that we’re seeing within the FDA causing anxiety within the venture industry on continued fund companies that are taking longer than they should to get approved from the FDA process. We remain steadfast on credit as I said earlier and at this point our credit book looks strong.
Moving to yield, as we disclosed and discussed during Q2, what we expected did in fact occur. We did [Plato] the yield compressions in Q2 and we saw an increase in yields of 60 basis points in Q3.
That was achieved as we indicated during Q2 within change in mix in assets away from certain later stage deals more towards mid stage deals and also cycling through and cycling out later stage investments that we had, that are paid off or recycled out or restructured on those investments increasing yields. Yields increase is a component of more two different variables all of which we’re focused on to continue enhance our yields.
In Q3, we had an effective yield of 13.9% as I said earlier a 16 – 60 basis points increased in sequential quarter-over-quarter yield.
We expect that all that capital deployed and invested, if our projections hold through. We are working diligently to constantly spend our source of funding and liquidity.
We also locked in new SBA financing from the SBA at extremely attractive rate, which Jessica will talk about in her section. We ended the quarter with over $260 million of liquidity, $130 million of that is located in bank facilities, the rest of it in cash that we have available.
So far we’ve closed in fiscal 2012, two bond offerings, for total capital raise of $120 million with those bond offering is closing in July and September. We are very grateful and thankful to our investors who quickly absorb those bond offerings and we experience a higher and [anticipated] demand for those bond offerings.
As I turn to NII. NII for sure impact was $85 billion related to the bond offering.
We expect to see a drag on earnings in Q4 as we convert that additional liquidity from the baby bond offering of $85 million in Q4. As I said moments ago, we expect to convert all that excess liquidity into earning assets.
In Q4, however until such time that has completed, we expect to see a $0.01 to $0.03 earning impact until that capital is converted into earning assets during the quarter. We also completed a small equity offering subsequent to the quarter for approximately $33 million which also have a small drag in earnings in Q4 as we convert that additional liquidity into earning assets of anywhere to $0.01 to $0.02 as well.
We were actively and I can assure you engaged in converting this new liquidity into earning assets during the quarter and as I said earlier I expect to see that conversion of excess liquidity occur during Q4 and the earlier parts of Q1, fully absorbing all that new liquidity into earning assets. Turning my attention to liquidity events and equity events in our portfolio.
We had yet another IPO event in our portfolio during the quarter. We now have achieved eight – we now achieved 11 liquidity events year-to-date in our portfolio, four of which are completed M&A events, one which is announced recently Nextwave Pharmaceuticals and of course the one complete IPO truly during the quarter, making it for four M&A events and seven IPO events completed so far this year on pace exceed over previous quarters and years within the history of Hercules.
So very robust liquidity. That said, we currently have four companies in IPO registration.
We have Glori Energy, iWatt, Paratek, and one company of ours that filed for an IPO under the Jobs Act today. Our one portfolio remains very strong and extremely well positioned to continue to harvest capital gains in the future both of M&A and IPO activities.
We ended up the quarter with approximately 117 warrant position, 37 equity positions with a GAAP value of $33 million for the warrant position and a GAAP fair value of approximately $48 million for the equity position. As a reminder, our warrant portfolio has historically monetized with exit multiples 1x and as high as 10x.
We do not think nor should you forecast modeling at 1x or 10x. Our current average on realized excess in our portfolio on the warrant realization is hovering around 3.4 times as an average exit.
Also as a reminder, we do not expect and as we indicated throughout all our earnings calls, we do not expect 50% of our warrants to ever monetize. They will expire worthless and we constantly encourage our investors to use such numbers in your modeling as well.
Now turning my attention to the venture industry. The venture industry is experiencing some interesting changes.
Investment activities in Q3 and all the stage that I will quote is from Dow Jones Venture Source. Investment activities with the venture capitals in Q3 saw a $6.9 billion invested to 820 transactions.
It is unfortunately a 30% drop in year-over-year for the quarter. However, on a year-to-date basis the venture industry invested $22.8 billion to over 2,500 companies and only representing a 15% decline year-over-year.
Clearly Q3 was very soft. I do not expect however that 2012 venture capital investment activity to exceed 2011.
In fact, I believe that 2011 – excuse me, 2012 will be about a $28 billion to $29 billion investment activities by the VC's were down approximately 10% to 12% from the prior-year, 2011. By stage and Hercules core area focus, the venture capitals remain very robust and extremely active in investing in later stage deals where Hercules main focus remains over 61% of the capital invested by the venture capital community was invested later stage deals.
As a reminder, Hercules are leasing its investment activities which is definitely more the focus of banks is less than 3% or 5% of our total assets that we invest as a corporation. Bisector, an indicative of our investment activities and our recent hiring activities.
Information technology remained very strong and very robust. As evidenced by own new hiring and our standard team, the venture capitalist invested the most dollars in information technology for approximately $2.3 billion into 290 companies during the third quarter representing merely a 2% decrease year-over-year and accounted for 33% of the capital invested in Q3 went to information technology companies.
The second strongest category was life science and healthcare. Life science and healthcare companies experience a $1.6 billion in investment activities by the VC's to 171 transactions.
Although it declined 15% we view the decline as expected and how we’ve been forecasting, a slight adjustment in investment activities until such time as the political outlook is resolved in both the FDA and the new presidential candidates on the impact on healthcare services system. The third category, saving strong dollars.
It is the consumer services or more commonly known as social networking or web based services. Although this category experience a significant drop of 38% year-over-year that drop is been expected.
The category received $1.2 billion to 158 transactions during the quarter. Financial services and business services received the next largest tranche of capital at $1.2 billion to 126 companies, also representing a decline of approximately 35% on a year-over-year basis.
Now there were some interesting news and some interest developments in the quarter. The venture capital fund raise activities was a surprise.
Through the first three months of the quarter, 120 venture funds raised a whopping $17.5 billion or a 38% increase year-over-year. Even I was taken back by the robust capital raising activities by select venture capitalist.
My extrapolation of this data is the stronger – getting stronger and the weak are dying. Yes, the venture its consolidating, but those who have strong track records and strong investment activities continue to execute in capital raising.
For early stage companies, early stage funds, so a fairly dramatic pick up in investment activities with approximately 71 funds raising, brought the $4.5 billion of activities during the quarter. Assets – although assets remain somewhat aloof.
IPO and M&A activities all be were down in the quarter were still quite strong and quite good for Hercules. As I said earlier, we experience one IPO and one very strong M&A activity during the quarter, still leaving us with four companies and IPO registrations.
During the quarter [trying to] venture that companies completed IPO offerings one of which of course was Hercules Company truly up. That is compared to simply 11 companies during the same period of 2011, another indication of Hercules positioning and picking the right companies.
There are currently 36 venture backed IPO companies in registration currently today. Four of those are Hercules companies.
In excess the 10% representation of venture backed IPOs at IPO registration are Hercules companies, once again, strengthening that our team is picking the right companies. On the M&A activities nine companies witnessed exits of M&A raising significant money, $13 billion during the quarter.
Although it is a drop on a year-over-year basis, it’s a jump of 32%. Now turning my attention to other activities during the quarter that we talked about.
In the quarter we saw a continued growth in our pipeline. We have over $1 billion of transactions in our pipeline today.
We face the quarter with over $70 million of unfunded commitments. This represents a new asset to convert and become interesting assets in the quarters to come.
However, and as a reminder, not all (indiscernible) become earning assets. We finished the quarter with over a $160 million of signed term sheets.
We expect 80% of those term sheets to covert to earning assets during the quarter, in Q4 and beyond. I’m very confident with what I note today, our Q4 activities are sectored to be quite strong with over 50% to $70 million of net assets filed during the quarter.
Our team has done a phenomenal job and continues to do a fantastic job of monitoring our credit in our portfolio and continue to harvest new investment opportunities in the marketplace. There is no question that our size, and our market positioning continuously affords us strong dealer flow and due strong investment activities in the marketplace today.
As I turn my attention to the reminder of the year, we remained concerned on the outlook of the election and the outlook of the fiscal cliff. Both could have adversely impacted our portfolio and both were ready in case things turn in the wrong direction, if fiscal cliff is not addressed.
We will curtail investment activities, if the fiscal cliff problem returns that we saw a year-ago. We will convert to cash as much as we can and wait out for situation until better outlook of the U.S.
economy and where the U.S. economy is headed.
We are very optimistic what we’re seeing in the marketplace. However, we want to remain cautious.
We are well positioned for the reminder of 2012 and we are on track to win – to well attract to exceed our realizations of over $630 million that we saw in 2011 with the investment activities we’re seeing today in 2012. That will put the portfolio in great position for 2013, our earnings basis as we convert this main liquidity to earnings assets.
With that, I will turn the call over to Jessica.
Jessica T. Baron
Thank you, Manuel and thank you everyone for listening today. As you know we filed a 10-Q, I lost the earnings press release after the market close today.
And we’ve made some changes to the format of the press release to make it [much in size] and we appreciate any feedback you may on those changes. Here is brief recap of our financial results for the third quarter of 2012.
We delivered a quarterly record $23.9 million in total investment income of revenues, an increase of 27.8% when compared to the third quarter of 2011. This increase was due to a higher average balance and just earning investments outstanding.
We ended the quarter with interest earning debt investments of $694 million, an increase of over 35% year-over-year. The GAAP effective yield on our debt investments was 14.4% for the third quarter, excluding the income acceleration impact from early payouts and one-time event, the effective yield for the quarter was 13.9%, up 60 basis points sequentially.
Excluding early payoff, the normal run rate of our portfolio historically has been between 12.5% to 15.5%. I’d also like to note that our peak income has historically has been the case is immaterial to our financial statements.
Once again, take which is non-cash revenue, which must be paid out to our shareholders in the form of dividends, continue to represent a small component of less than 1.3% of our total investment income for the third quarter. Our cost of debt increased to $6.1 million for the third quarter of ’12 compared to $4.3 million in the third quarter of ’11.
This increase is primarily attributed to interest and fee expense related to approximately $85 million of senior unsecured notes which were offered in two tranches in April and the beginning of July. Also we had $425,000 of accelerated fee expense due to the pay down of 24.8 million of SG&A debentures during the quarter.
So its partially offset by a $280,000 decrease in interest expense related to a lower weighted average costs of SBA debentures relative to the third quarter of ’11. Operating expenses for the quarter totaled $6.5 million as compared to $5.8 million in the third quarter of ’11.
This increase is primarily due to an increase in accounting and legal expenses for the quarter. The third quarter total net investment income was $11.4 million compared to $8.6 million in the third quarter of ’11, representing an increase of approximately 32.6%.
Net investment income for quarter was $0.23 per share for the third quarter of ’12. Our net unrealized appreciation from loans, warrants, and equity investments were $2.6 million for the third quarter of which $3.2 million of appreciation was due to fair value, yield and market based adjustments.
$12 million due to depreciation was attributable to collateral based loan impairments on the portfolio and a $11.4 million of appreciation was related to the reversal of net unrealized appreciation to realized losses on loans, warrants and equity. Our recognized net realized losses were approximately $9.1 million primarily driven by a $8.7 million loss from liquidation of our investments in MaxVision.
Cumulative realized gains for the first nine months of 2012 was $2 million, which includes the realized gains on our warrant and equity sales outlined in previous quarters. Now moving on to the balance sheet, we’ve seen significant growth in our portfolio over the last year as a result of our debt investment origination activities.
As of September 30, 2012 net investment assets including warrants and equity was $774 million, an increase of 34% compared with September 30, ’11. We remain pleased with our loan portfolio of credit quality.
The weighted average loan rating of our portfolio was 2.12 compared to 2.08 in the prior quarter. We had one small debt investment on non-accrual at the end of the third quarter.
At September 30, ’12 our warrant positions in a 117 companies to provide us with the option to invest $77 million of additional capital. Our equity investments at fair value as of September 30 totaled approximately $48 million.
Now turning to our liquidity at September 30, we had approximately $261 million of availability comprised of $107.1 million of cash, $24.7 million of SBA borrowing capacity and $130 million of borrowing capacity under our credit facilities. With regard to SBA debentures, during the September [pulling] we locked in at an interest rate including annual fees of around 3% per annum for the $24.3 million of debentures that which we borrowed.
This reflects interest rate savings on each borrowing’s of approximately 350 basis points over the long-term. In July we closed a follow-on issuance of $43 million of 7% senior unsecured notes that we had originally issued on April 17, ’12 these are the April 2019 notes bringing the total amount of notes issued in a single series to approximately $84.5 million.
In late September we closed our second baby bond offering issuing $75 million of 7% senior unsecured notes due 2019 as well. Subsequent to quarter end the underwriters exercised the over allotment from additional $10.8 million of notes bringing the total size of the offering to $85.8 million.
As a result of adding this additional leverage at the end of the third quarter we anticipate an increase in our interest and fee expense by approximately $1.5 million per quarter or $0.03 to $0.04 in earnings until the capital was fully deployed as Manuel mentioned. Also subsequent to quarter end, we closed a public offering of $3.1 million common shares at a price of $10.85 per share resulting in proceeds of approximately $33.6 million including other offering related expenses.
The earning solution of this equity raise is $0.01 to $0.02 for the fourth quarter. This as Manuel also mentioned is expected to be offset by continued portfolio growth of about $50 million to $70 million in the fourth quarter which will have a net impact of approximately $0.02 to $0.03.
Our next asset value as of September 30 was 471.7 million or $9.47 per share compared to $9.54 on 49.7 million shares as of June 30, ’12. This decrease in the third quarter of ’12 was primarily attributed to unrealized depreciation on the investment portfolio.
Finally we declared a 29th consecutive dividend of $0.24 per share. So in closing the third quarter was another solid quarter and our diversified sources of funding and enhanced balance sheet puts us in position to grow our investment portfolio and deliver strong earnings and dividends for our shareholders.
Operator, we’re now ready to open the call for questions.
Operator
Okay. (Operator Instructions) So we’ll take our first question coming from Troy Ward from Stifel, Nicolaus.
Troy, please go ahead.
Troy Ward - Stifel, Nicolaus & Co., Inc.
Just Manuel, real quickly. I think from the industry data towards the end of your prepared comments, you highlighted several changes that are happening in the industry based on fund raising and details.
But I think earlier in the call, you said you were moving out of certain stages and into certain areas from a sector standpoint, I didn’t catch what you are referring to there. Are you making some changes in your focus?
Manuel A. Henriquez
We were advocating this now for a while. As we said, the answer to 2012 we remain very concerned about the political leanings towards certain industries have that under one administration maybe adverse versus another administration.
And because of political outlook the selection is now so tight, it’s almost difficult to say who’s going to win and what's going to happen. So two industries in particular we’re kind of taking a little more of a watch and wait attitude before increasing our investment activity especially in lieu of we’re now less than a week away from having a better perspective.
Those two categories that we’re concerned about remain to be life sciences as well as Cleantech. Both have risk in both reimbursement of Obamacare, they may be impacted depending on which party wins, were a adverse impact in those areas which is why we’re kind of being a bit slower in new investment activities in that area as well as harvesting certain investments in our portfolio today.
Troy Ward - Stifel, Nicolaus & Co., Inc.
Okay, great. Thanks for that clarification.
And then in the press release there’s a couple of things, you stated there was $12 million depreciation largely attributable to investments and I know that 10Q got filed right as the call started. But can you provide what those names were and give us some color behind those investments?
Manuel A. Henriquez
You know I will -- I generally don’t, but it’s in the queue, so I am happy to talk about them. Let me first calculate by saying that the reason why the impairments are there are lesser because we have an M&A credit risk and but mostly because that we are forced under the fair value accounting rules to take into that account.
So both these companies are life sciences companies. One of which is called Chroma and the other one which is called OfficeScan.
Both of those companies are in the midst of doing capital raise. Both of those companies are in the midst of either going through some form of clinical trials, and because of that we felt that it was prudent to take an impairment for the short-term, but we expect given what we're seeing coming together here that in the fourth quarter both of those investments should be probably reversed once they close the new round of capital.
Troy Ward - Stifel, Nicolaus & Co., Inc.
Okay. And then one more thing from the press release, you talk about Nexway being purchased by Pfizer.
Was that expected in your 930 valuations or should we expect a material change in the valuation of the warrants from the $370,000 at quarter end?
Manuel A. Henriquez
Well, a little bit of both.
Jessica T. Baron
Yeah. So fair value requires that you do your mark as of the measurement date.
So at that point in time we had some knowledge of positive events occurring for that company in the fourth quarter, but we definitely set the mark-to-market perspective, so there probably is now that the transaction has closed incremental additional appreciation for that investment, but you can look at the valuation and see the magnitude there.
Manuel A. Henriquez
And I’ll go further, as you’ll see in their own press release the company issued and Pfizer issued, there’s an earn-out function of it, and earn-outs are very hard to accrue for. So the company, let me make sure I don’t speak out of school, the company was bought for in the mid $200 million level.
Jessica T. Baron
In the $225 million.
Manuel A. Henriquez
Okay, thank you. (Indiscernible) was public or not public.
It was bought for a mid $200 million level and the earn-out is rough $700 million. So there could be another two to three X appreciation in value attributed to the performance of the company closed acquisition.
So more upside may actually exist there, but because it’s an earn-out, so we have some indication of traction, a target crew for that.
Troy Ward - Stifel, Nicolaus & Co., Inc.
All right. That’s good color.
I’ll hop back in the queue to ask my follow-ups. Thanks.
Manuel A. Henriquez
All right.
Operator
Okay, thank you. And we’ll take our next question from John Hecht from Stephens.
John Hecht, please go ahead with your question.
John Hecht - Stephens Inc., Research Division.
Good afternoon guys. Thanks for taking my questions.
Just a little bit more on credit. Number one is, did you provide the cost of the new non-accrual?
Jessica T. Baron
The cost basis of that investment is approximately $350,000.
John Hecht - Stephens Inc., Research Division.
Okay, so it’s the minimal, okay. And then you did provide some of the details with the depreciation related to some life science businesses and Manuel, you talked about sort of your broad fear on that in some of the selection basis support.
Can you give us just a conceptually maybe a figure or something about the total exposure to life sciences companies that are kind of in an eminent basis going through capital raising just so we have a sense for it?
Manuel A. Henriquez
Well okay, and I am happy you asked the question, but I got to be honest. Every one of our companies is at one point or another going through capital raise.
As I said on these calls many times is the expectations of all of our companies or I should say substantially all of our companies that will require subsequent amounts of equity capital in frequencies of 9 to 14 months. So this is nothing normal.
The only reason why on these particular deals we’ve taken some form of impairment is either because the process is taking a little longer than we would -- initially would have, have hoped for or we’re getting mix data from the FDA on either digging way too long to respond to these clinical trials and as a prudent thing to do we picture the impairments. But our life sciences portfolio, I don’t want anybody to extrapolate that for some reason life sciences in disproportion, not a risk, that’s not true whatsoever.
I mean our life sciences portfolio to answer your question, it’s probably somewhere neighborhood around 40% to 42% of overall portfolio exposure and I am perfectly comfortable with that exposure.
John Hecht - Stephens Inc., Research Division.
Okay. Thanks for the color.
And then turning to the yields you had a 60 basis point increase. You sounded like some of that was mix shift where some of your later stage investments paid off, you’ve been focused more on middle-stage which I guess has higher yields.
Within the middle-stage category or any particular category, what are you seeing with respect to competitive trends right now?
Manuel A. Henriquez
I look at, as indicative in our pipeline our investment activities in Q3 and the very strong Q4 that we’re looking at. I think the competitive landscape is changing quite dramatically.
We still have small little bites out there of competitors, but we’re not seeing a disproportionate ground slow of competitor out there, so they’re exchanging quite dramatically. Now the sub $2 million, $3 million deals which are traditional bank deals, those always remain very competitive and I think its silly pricing in that area, and we don’t really do well there and nor do we focus in that area.
Later stage stuff, things have a little bit of market type flavor to them. We’re seeing very, very tight yields in that area.
We're seeing higher leverage covenant light and we don’t think the yields are being priced there where it should be, which is why we’re very back to that middle-stage we like quite a bit which we think its out of favor and these are companies that are looking for exists from an IPO or M&A events that are three to four years out, and the larger deal sizes which means that banks at other places are not necessarily comfortable underwriting that risk and we are.
John Hecht - Stephens Inc., Research Division.
Okay, great. Thanks.
And then final question; the increase in headcount can you give me a sense for, maybe to annualize the increase in SG&A from that?
Manuel A. Henriquez
Sure. We’re expecting that the annualized increase in SG&A should be about $1.5 million to $1.75 million on a fully burdened basis on this new headcount.
And we expect that this new headcount would take about six to nine months from a cost basis to converting to accretive earning basis for us in terms of new asset originations.
John Hecht - Stephens Inc., Research Division.
Great. Thanks very much guys.
Operator
Okay, thank you. And we’ll take our next question from John Stilmar from JMP securities.
John, please go ahead with your question.
John Stilmar - JMP securities
Thank you, good evening. Really quickly, Manuel touching on John’s previous question, we talked about the competitive dynamic.
But obviously from a demand side, what's really changed? Look, you painted a clear picture that venture capital deal activity has started to decline through 2012 and it seems like almost coincidently of QE3 we have even though I am not sure if that’s the real driver, we’ve had an acceleration in your business or at least since last earnings call.
What is really the driver there, is this private equity starting to -- start to come into the venture capital world, so therefore there is a better visibility. What is kind of -- or is your -- with longer investment cycles are people now turning to debt a lot more veraciously.
What it is about your value proposition on the demand side it’s created this sort of acceleration of your business?
Manuel A. Henriquez
There’s a lot of variables that impact that. I think that you’ve touched a couple of them.
One is in fact the demand for debt actually is increasing for multiple reasons. One, people want to have insurance on their balance sheet and so rather than taking insurance out in the form of equity capital raises they’d rather bolster their liquidity positions as a private company using debt to either position themselves or M&A or IPO activity.
Number two, some of these underlying early stage investors are currently fund raising and they may not want to initially face the reality of going out and raising equity capital and from a new venture capital fund and see the valuations get materially clipped down or adjusted downward because of the venture capitals have more demand now -- have more buying power towards companies themselves. And three, our entrepreneurs who are in a midst of cross the chasm of a major milestone and they don’t want to initially go on fund raise right now, because within next 30 to 60 days on or about they could be achieving a major milestone which could be a huge valuation inflection point for themselves.
So there’s a lot of activities going on, on uncertainty and posturing for milestones and ongoing momentum out there that people want to have debt. We’re also seeing the supply side that a lot of our competitors who are out there are unable to raise new capital or new funds, because remember the venture industry, the top tier guys are raising capital but the second and third tier, fourth tier venture capital firms are struggling to raise capital.
Some of these venture debt providers were private and rely upon the LP community are going to struggle to raise money which means that all that supply, all that demand starts coming to us from deal flow and that’s exactly we’re seeing in the market place today. We’re seeing a very strong robust market out there.
John Stilmar - JMP securities
Okay, great. And then, really quickly just to maybe beat a dead horse here, on the two write down in the life sciences, is the message that we’re hearing from you is that really the longer lead time at least in terms of the FDA and alternative rounds of financing taking a little bit longer and so you’re taking a prudent approach in conservative fair value just by virtue of fact that you would expect a certain kind of exit or activity to de-risk the investment and because that hasn’t happened you started to put a risk premium on it?
Manuel A. Henriquez
Absolutely. I mean our job is this.
We invest in companies that are highly disruptive. We invest in companies that have a high cash burn rate.
We invest in companies that in the life sciences category are embarking on or engage in FDA clinical trial processes that are blind to us, blind to the company and company management that only the FDA knows how they’re going. And until those trials are un-blinded and the results are made aware it’s very difficult for some of these companies to raise capital with the expectation that things may be good or may be bad and because in some cases we don’t know either.
We think it’s prudent that until such time as either strong acclamation with an equity investment is consummated in these companies or you have clear indication on how the FDA trials came out that we think it is the absolute prudent thing to do to impair that asset until such time as that information is made available to us.
John Stilmar - JMP securities
Great. Thank you very much for your time.
Operator
Thank you. And we’ll take our next question from Robert Bordett from Raymond James.
Robert, please go ahead with your question.
Robert Bordett - Raymond James Financial Services, Inc.
Hi everybody. Jessica, just two quick ones.
I think you’ve covered a lot of the details there. On the expense side obviously you mentioned your $425,000 in the interest expense or was it kind of related fees, was there any expenses in other areas like you mentioned accounting, legal et cetera was higher in the quarter and so higher G&A.
Does any of that, for lack of a better term non-recurring or abnormal maybe tied to some of the capital raising that you did during the quarter or is that a new normal run rate going forward?
Jessica T. Baron
Yeah, I don’t foresee that as being a normal run rate. I mean the main driver of that was more of seasonality where we’re continuously cleaning up some of the hangover expenses related to the annual filings for 2011.
But that’s certainly not on the accounting and legal side a normal run rate.
Robert Bordett - Raymond James Financial Services, Inc.
Okay, got it. Thank you.
You just go back to kind of the big question of the wild card of the election and your expectations for Q4, I mean you’ve said net up $50 million to $70 million in the fourth quarter. I mean, is that a range that encompasses the full range of potential and kind of binary outlook for how the election turns out, or is that a range that’s contingent on one particular candidate you’re coming at ahead at this point?
Manuel A. Henriquez
No its actually the mean, a standard deviation would be -- it could be a standard deviation on the positive side could be up to $80 million to $90 million and a standard deviation on negative side could be $40 million to $50 million. But that’s what we think is the mean, the $50 million to $70 million is what we think is agnostic into what candidate wins, but a certain candidate you could have spring effect on increasing activities, that is correct.
But that you should forecast the $50 million to $70 million is kind of the mean case.
Robert Bordett - Raymond James Financial Services, Inc.
Okay, got it. I appreciate it.
Thanks.
Operator
Thank you sir. And we’ll take our next question from Jason Arnold from RBC Capital Markets.
Jason, please go ahead.
Jason Arnold – RBC Capital Markets
Good afternoon. Just a follow-up on the pricing side.
I was just curious if you could comment on what rates you’re seeing on new investments, is it up, down, sideways versus the prior quarter?
Manuel A. Henriquez
Well it’s certainly not sideways, because the yield is going up by 60 basis points. It’s up -- it’s up quite a bit.
And I would think that on a conservative it’s up by 75 to 125 basis points. And I think that that activity will temper out a little bit.
I think that in Q4 you may see it go up by another 10 to 15 basis points, but not dramatic. I think that you could see increases going on in Q1 of next year but right now for Q4 I think up another 10 or 15 basis points is probably the right number, because we’re holding back on certain asset mixes where you can see a disproportion of higher yield, but it’s a silly trade to go in for higher yields when the industry may be distressed if the wrong person or the wrong candidate makes it to office or not.
So we want to be, for one week away we’d rather be on the conservative side and hold on to some liquidity and we’re personally happy with the 60 basis point yield increase.
Jason Arnold – RBC Capital Markets
Okay, and so just to be clear and that the 10 to 15 basis points additional that would be on the average portfolio versus just new investments?
Manuel A. Henriquez
Yes.
Jason Arnold – RBC Capital Markets
Okay, very good. Okay, thank you for that.
And then I guess just one another quick follow-up, I was just curious if you’d comment on kind of where you’re out of the various sub-segments of venture tech that you participate in, where you expect to see the most lending growth really coming over the next two to three quarters (indiscernible)?
Manuel A. Henriquez
Well again it depends on the election. I mean, I got to tell you that life science is just still a very attractive ready to invest, but the venture capitalist and ourselves are still waiting to get some indication which way things are to go.
Cleantech, I think is probably suffered the most of all the categories because its destiny or its future is totally unknown at this point. So that outlook is solidified you’re going to see a drag there a little bit.
But I think technology is extremely attractive where we invest again. Networking and communications are extremely attractive to invest again; a contrarian view is semiconductor.
There’s a lot of interesting semi’s and as geometries gets smaller with new smartphones there’s a whole wave of technological revolution that has to happen there. So, we like that area quite a bit, networking and com, semiconductors, software analytics remains a very interesting area that we’re focusing on.
So, we like a lot of areas of technology quite strongly.
Jason Arnold – RBC Capital Markets
Okay. Thanks for the color.
Operator
Thank you. And we’ll take our next question from Aaron Deer from Sandler O'Neill.
Please go ahead Aaron.
Aaron James Deer – Sandler O'Neill & Partners L.P.
Hi good afternoon everyone.
Manuel A. Henriquez
Hi, Aaron.
Aaron James Deer – Sandler O'Neill & Partners L.P.
Looking at your leverage, I guess adjusted for the SBIC that your leverage ratio was right above the 50% mark, and then I guess with the recent (indiscernible) brings it down some, but I am just -- I am wondering if you can talk a little bit about the what are your thoughts on what are the appropriate adjusted leverage ratio should be or where you look for it to be going forward?
Manuel A. Henriquez
I think already we said on various calls, our Board of Directors along with myself feel that on a GAAP basis that leverage should hover around probably 0.7% to 0.75% and really its (indiscernible) upon the capital markets activities that are out there. If the capital markets are robust and sustained you may let it creep up to 0.85% but really the sweet spot is 0.07 to 0.75 which equates to approximately on a – that it just be – speak that on a GAAP versus non.
On a regulatory leverage basis it’s that 0.75% on a GAAP basis it’s about the 1.2 level. So the difference is for the callers on the phone, if you excluded $225 million of SBA capital, that’s what gives you the higher increase.
So, on a regulatory basis which exclude SBA its 0.7 to 0.75. On a pure GAAP basis including SBA it’s about the 1.2 range and I probably just confused the heck out of everybody.
I apologize.
Aaron James Deer – Sandler O'Neill & Partners L.P.
All right. And then going back to the question’s right on your staffing levels.
It’s great to see you guys continuing to do some new hires on the business development front. Just curious what the -- when you look at your entire business development staff in terms of the number of personal, where does that stand today relative to where it was at December 31?
Manuel A. Henriquez
Well, December 31, which fiscal year?
Aaron James Deer – Sandler O'Neill & Partners L.P.
This past year, 2011.
Manuel A. Henriquez
You may recall that we consciously made a decision to vacate a little bit of market initiative. We felt that the yield spreads were not what we are accustomed to or what we like plus the cost of capital.
We didn’t think was -- we weren’t getting the right spread that we believe on a cost of capital. So we actually divested ourselves from a most of our lower middle market team we kept three lower middle market folks that are most special situation folks on our staff.
So, on a headcount apples-to-apples if you will, ignoring industry allocations we’re probably at parity, even.
Aaron James Deer – Sandler O'Neill & Partners L.P.
Okay. And then, I guess I think all my other questions were answered.
Thank you.
Jessica T. Baron
Thank you.
Operator
Okay, thank you. And we’ll take our next question coming from Jonathan Bock from Wells Fargo.
Jonathan, please go ahead.
Jonathan Bock - Wells Fargo
Good afternoon and thank you for taking my questions. A lot of them have been answered already, but maybe looking at a philosophical point.
So with the recent debt issuance that you have had obviously that’s been a trend across the entirety that BDC space. I mean well could you give us maybe your thoughts on the need to push out your liabilities obviously a positive versus the need to deliver maybe steady or even stronger kind of earnings in consistent dividend growth because obviously that’s offset by really high coupons that you put on and not drawing on your revolver.
So maybe to talk about the cost benefit there and more importantly like kind of how you look at earnings longer term relative to the solidity of your balance sheet?
Manuel A. Henriquez
Yeah you can do the math as well as I can. This is not going to be rocket science; we can do this math real quick.
If you look at where we finished the quarter we finished about $700 million of interest earnings assets, the number was $695 million. If you look at our projections that we’re indicating here, $50 million to $70 million net up you’ll quickly see the absorption of all that entire interest expense from the baby bond offerings in essence into earnings assets and as I said a small spill over going to Q1.
So suddenly you’re looking at our portfolio that you convert all that earnings assets in essence if you will close to almost $800 million of earning assets, a couple rate at 12.5% -- sorry 12.5% to 13.5% if you will to be conservative you can extrapolate what that does to earnings. So you’ll start seeing a significant earnings increase going into 2013 and then to your point what we’re planning on doing is which is perfectly done is that in Q4, in early parts of Q1 2013 we will be reducing our credit line which and the current yield spread that we’re seeing we’re going to give you probably 700 basis point net spread over cost of capital at that point, so its highly accretive and that’s our debt.
Jonathan Bock - Wells Fargo
Okay, great, thanks. And maybe one comment, just as it relates to warrant coverage, I know you mentioned last quarter obviously you were looking a high quality transactions willing to lower warrant coverage or give up on warrant coverage rather in order to receive some higher cash coupons and also stay in some high quality credit.
What's the view of warrant coverage today where you’re investing? Is that an item that in working with VC they’re more than willing to bard it on or maybe less willing given the kind of environment?
Manuel A. Henriquez
No, I think that it’s a bit of that yield, to the specific of your question, some of these 60 basis point yield increases during the quarter is in fact directly attributed to trading off some of the lower warrant coverage’s for higher cash yields. We have less appetite to take on higher warrant coverage’s at potentially overvalue companies and I’d rather trade off lower warrant coverage to better coupon rates or fixed cash back in than taking warrants itself if I think they’re overvalued.
So that’s exactly some of the things that we’ve done right now, but that’s the condition that hasn’t flows quite dramatically from quarter-to-quarter, so we did engage with that in Q3, we expect to continue to engage in that in Q4 which sells us into strong message to the competitive environment out there that our flexibility on structuring deals was certainly -- certainly they can't do as well as we can and will do that.
Jonathan Bock - Wells Fargo
Okay, great. And then maybe one last competitive comment as it relates to the commercial banks or the venture banks rather, I know in smaller deals you mentioned they have been extremely competitive.
Can you talk about maybe their willingness to perhaps move into your market and get aggressive given the need to deploy capital and earn a decent return in the phase of declining then?
Manuel A. Henriquez
Yeah, I think your question is incredibly insightful. We're seeing banks beginning to do silly things, and its only a matter of time where the venture into waters they probably should be in and start experiencing loses.
I'll not get into specific which deals I am referring to, but we’re seeing recently where some institutions have ventured into spaces where they’re now experiencing very difficult credit situations and in some cases credit loses where they’re reaching for asset growth and yields to help compress the NIM compression that is going through and now they’re getting to trouble. And we’re kind of just, in essence when a deal gets over you can competitive, we’ll just sit back and say take it.
We will not compromise underwriting just for yields and some of these institutions are still yield hungry that we think are doing silly deals I think it’s going to be interesting to watch what venture 2012 does some incredible performance in some of these companies. But the starvation for asset growth and the need for them to stop the NIM compression that they’re experiencing will trigger them to do riskier deals out there.
Jonathan Bock - Wells Fargo
And then I guess that kind of begs a question, so if there is a potential for venture banks or others to perhaps deploy capital and get a little aggressive in the credit spectrum, we’re also trying to counterbalance that with the fact that you’ve got substantial growth coming out of your portfolio, so what at point will we have to be asking you the same question?
Manuel A. Henriquez
I think you should ask that question when its reflected in our credit performance. I think that after eight years of running this organization I think the credit discipline as I said more than once and I apologize if investors don’t like this, I'll not grow earnings just to grow earnings at the cost of giving up credit.
I just don’t believe in that and I think that if earnings growth is not there because of credit quality, I'll be happy to miss earnings because I know how difficult it is to deal with bad credits. And our credit history speaks for itself.
I think that you will see us be very opportunistic on the right opportunities and very conservative when it merits that issue. I think that an area that is extremely [frosty] and extremely aggressive is early stage investing is the finest transactions less than $3 million it is ridiculously competitive in terms of pricing in yield.
Jonathan Bock - Wells Fargo
We would agree with your credit performance, it does speak for itself so again thanks for the clarity and the color guys. I appreciate it.
Operator
Okay, thank you. And we’ll take our next question from J.T.
Rogers from Janney Capital Markets. Please go ahead J.T.
J.T. Rogers – Janney Capital Markets
Good afternoon everybody. Quick question, just as we shift to more middle stage companies, how that affects your realization of accelerated fees which have been sort of an important contributor to NII over the past couple of quarter, I mean will assets sit in your portfolio longer or will they be refinanced out by some other sources, capital?
Manuel A. Henriquez
You hit a spot on J.T. What happens is that, you’re trading off the velocity of generating prepaying penalties or acceleration of fees for longer (indiscernible) plus which is more than offset by that interest income or yield that we have.
So, it’s actually – it’s a wiser quality asset gain versus short-term earnings gain.
J.T. Rogers – Janney Capital Markets
Okay, great. And then just sort of where we're right now, and looking at your pipeline, what is sort of the minimum liquidity you all would feel comfortable with before you start looking for other sources of debt or equity capital.
Obviously you have a lot of liquidity right now.
Manuel A. Henriquez
Well you know J.T. if I answer that question am signaling capital raises.
The answer is that, I think our history we’ll kind of give you indication of that. It’s a combination, if you -- most people will notice that this is probably the lowest unfunded commitment pipeline we’ve had that’s purposely being done on driving that number down a little bit, purposely so.
I think that we still have under our regulatory ability we have the ability to tap in, another $200 million plus of leverage on our balance sheet, that is to optimize it. We will not go to the full extent.
So there’s no question as I said more than few earnings calls that our preference still is to continue to leverage the balance sheet. I feel that Jonathan Bock was correct in his perspective that we will be looking to use our bank lines in the coming quarters and continue to rely on leverage and just do equity capital raises to supplement equity and that’s just to do a whole big equity raise.
J.T. Rogers – Janney Capital Markets
That makes sense, but I guess to ask the question in a different way, what about sort of looking at your line of credit as being capital that you have in reserve so that you can go a little bit deeper in leverage and maybe pretend a little bit more on term debt and obviously you’ve been increasing your use of that, but I just wondered what your thoughts are?
Manuel A. Henriquez
I think you’re right, I mean, I view – I do view the bank lines as (indiscernible) emergency back stops. But I do view and that’s kind of flexible financing vehicles and if you go back to the genesis of BDCs back in 2004, 2005, 2006, historically the use of bank lines was that you borrowed the bank lines and then you turn around and term it out in some formal conduit or securitization.
I’m encouraged by what I’m seeing in the securitization markets. I said that we’re looking at; I expect that may be in 2013 that we will use some formal securitization, which allows us to use the bank lines, use them up and then put amount in a securitized vehicle.
So I think that’s exactly that you’re looking at the right way and your question is spot on.
J.T. Rogers – Janney Capital Markets
Great, Manuel. Thanks a lot.
Operator
Okay. Thank you.
It appears that we have run out of time for questions. So I’d like to turn the conference back to Manuel for any closing remarks.
Manuel A. Henriquez
Thank you, operator. Thank you everybody and thank you for being at our conference call today.
Again, our hopes and prayers are with everybody in East coast. Please continue to work diligently.
I know you’ve suffered a tremendous amount. And again we’re grateful and I’m glad everyone come out safe as much as you possible can be after that tragedy.
We will be arranging as we generally do, investor calls and meetings with our shareholders in the coming weeks and quarters. We did have some drift plans in New York, but I have to be honest, we are kind of waiting and see until to figure out what in the world we can and cannot do with hotels and logistics.
But we will be attending a few conferences on the East coast in the coming weeks and months here. So let us now [join] to meet with us and again thank you every part of the Hercules and thank you operator.
Operator
Okay. Thank you ladies and gentlemen.
This does conclude your conference. You may now disconnect and have a great day.