ACAS American Capital, Ltd.

Hercules Technology Growth Capital Inc.’s (HTGC) second-quarter 2012 distributable net operating income (DNOI) came in at 28 cents per share, outpacing the Zacks Consensus Estimate of 24 cents. This also compares favorably with the prior-year quarter’s DNOI of 26 cents.

Results in the quarter benefited from an impressive growth in total investment income and reduced operating expenses, partially offset by substantially higher interest expense and loan fees. Overall, Hercules ended the quarter on a spirited note with a stronger credit quality and a high level of liquidity.

Quarter in Detail

Hercules’ total investment income for the reported quarter came in at $23.9 million, up 14.6% from $20.8 million in the prior-year quarter. The surge resulted from higher average balance of interest earning investments and accelerated fees pertaining to early pay-offs. Moreover, total investment income was above the Zacks Consensus Estimate of $23.0 million.

Total operating expenses (excluding interest expense and loan fees) were $6.3 million, down 4.7% from $6.6 million in the year-ago quarter. The decline reflects absence of non-recurring executive severance costs that were present in the year-ago quarter.

On a year-over-year basis, interest expense and loan fees in the reported quarter jumped 36.4% to $5.2 million. The significant increase was mainly driven by interest and fee expense associated with senior unsecured convertible notes, which were issued in the second quarter of 2012 and augmented interest expenditure on higher SBA balance.

As of June 30, 2012, the weighted average cost of debt, comprising interest and fees, was 6.70% compared with 6.6% as of June 30, 2011.

Net investment income (before investment gains and losses) for the quarter came in at $12.3 million, up 18.8% from $10.4 million in the year-ago quarter. The increase was mainly attributable to a higher interest and fees earned from debt investments.

Business Highlights

The fair value of Hercules’ total investment portfolio was nearly $743.7 million as of June 30, 2012, up 6.9% from $695.4 million as of March 31, 2012. During the second quarter, the company provided approximately $139.0 million in debt and equity funding to new and existing portfolio companies.

As of June 30, 2012, Hercules’ net asset value was $9.54 per share compared with $9.76 as of March 31, 2012.

Dividend Update

Concurrent with the earning release, the Board of Directors at Hercules declared a quarterly cash dividend of 24 cents. The dividend is to be paid on August 24, 2012 to shareholders of record, as of August 17, 2012.

Share Repurchase Update

The company did not buyback shares of its common stock during the reported quarter. However, in July 2012, the Board of Directors approved the extension of the company’s share repurchase program through February 2013.

Peer Performance

On July 31, 2012, American Capital, Ltd. (ACAS) reported second quarter 2012 operating income of 58 cents per share, topping the Zacks Consensus Estimate of 21 cents. The results more than doubled from the year-ago earnings of 20 cents per share.

The favorable outcome was attributed to top-line growth and decreased operating expenses. Moreover, new investments and reduction of debt acted as the positives. An increase in non-accrual loans was a negative for the quarter.

Our Viewpoint

Hercules is well poised to expand its portfolio, given its strong liquidity position. Additionally, we believe that the company will continue to gain from the increased market demand for venture capital investments. Further, the company’s strong capital position enables it to enhance shareholder value.

In spite of these positives, the ongoing capital market disruption and sluggish economic recovery makes us apprehensive. We also remain wary of Hercules’ investment and credit management strategies. Moreover, the slow economic recovery may increase the cost of funding.

Currently, Hercules retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we maintain a long-term ‘Neutral’ recommendation on the shares.
 

 
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