Good day, everyone, and thank you for standing by. Welcome to Hercules Capital Second Quarter 2024 Financial Results and Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] And please be advised that today's conference is being recorded. I will hand the call over to the Managing Director of Investor Relations, Michael Hara. Please go ahead.

Thank you, Carmen. Good afternoon, everyone, and welcome to Hercules conference call for the second quarter 2024. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer; and Seth Meyer, CFO. Hercules' financial results were released just after today's market close, and can be accessed from Hercules' Investor Relations section at investor.htgc.com. An archived webcast replay will be available on the Investor Relations webpage for at least 30 days following the conference call. During this call, we may make forward-looking statements based on our own assumptions and current expectations. These forward-looking statements are not guarantees of future performance, and should not be relied upon in making any investment decision. Actual financial results may differ from the forward-looking statements made during this call for a number of reasons, including but not limited to the risks identified in our annual report on Form 10-K and other filings that are publicly available on the SEC's website. Any forward-looking statements made during this call are made only as of today's date, and Hercules assumes no obligation to update any such statements in the future. With that, I'll turn the call over to Scott.

Thank you, Michael. And thank you all for joining the Hercules Capital Q2 2024 earnings call. Following our record funding activity in Q1 2024, we followed-up with a record second quarter of total gross fundings of $461.5 million, which led to record total gross fundings of $1.07 billion for the first half of 2024. This is the first time in our 20 years history where we have delivered more than $1 billion of gross fundings in the first half of a calendar year. Our origination and funding performance in the first half continues to reflect the benefits of being able to operate an institutional venture and growth-stage lending platform at scale, and being the clear market leader in the asset class. Our ability to again deliver creative solutions for our new borrowers and strong results for our shareholders in Q2, while managing our balance sheet and business conservatively, positions us well heading into the second half of 2024. Hercules' strong performance continues to be driven by our committed employees, our team-first culture that emphasizes internal and external collaboration, and a balance sheet that is liquid, long-term oriented, and institutional. As of the end of Q2, Hercules Capital is now managing approximately $4.6 billion of assets, an increase of 14.7% from where we were a year ago. We continue to expect the second half of 2024 to experience higher than normal market and macro volatility, given the Presidential Election and potential changes in the global geopolitical environment. As we discussed on our last call, we expected the market environment for new originations to improve throughout 2024, and we have certainly witnessed this in the first half of the year. While Q3 is typically a seasonally slow quarter for new originations, we remain optimistic about our funding activity over the second half…

Please stand by. Please stand by, ladies and gentlemen, we have some technical audio difficulties. Please, Scott, continue.

In Q2, Hercules delivered its fifth consecutive quarter of over $100 million of quarterly core income, which excludes the benefit of prepayment fees or fee accelerations from early repayments. Our success is attributable to the tremendous dedication, efforts and capabilities of our 100-plus employees, and the trust that our venture capital and private equity partners place with us every day. We are thankful to the many companies, management teams and investors that continue to make Hercules their partner of choice. I will now turn the call over to Seth.

Thank you, Scott. And good afternoon, ladies and gentlemen. Q2 marked another quarter of solid execution, record financial performance, and conservative balance sheet management for Hercules Capital. We continued to see the benefits of operating at scale and the diversity of our balance sheet with no near-term material maturities. In Q2, we had record total investment income of $125 million and record net interest margin of $103.5 million, thanks to our year-to-date portfolio growth and low average borrowing cost. We continue to maintain strong available liquidity of approximately $0.5 billion as of quarter-end, and more than $750 million across the platform, including the advisor funds managed by our wholly-owned subsidiary, Hercules Advisor, LLC. Post quarter-end, we repaid at maturity $105 million of institutional notes issued in July 2019, and received approval for our fourth SBIC license, unlocking another $175 million of liquidity to help us maintain our very competitive low cost of capital. With all this in mind, let's review the income statement performance and highlights, NAV, unrealized and realized activity, leverage and liquidity, and then finally the financial outlook. On the income statement performance and highlights, total investment income, as I mentioned, was a record of $125 million, driven by the record first quarter growth in the debt portfolio. Core investment income, a non-GAAP measure, increased to a record of $116.4 million. Core investment income excludes the benefit of income recognized as a result of loan prepayments. Net investment income increased to $82.4 million or $0.51 per share in Q2, a 4% quarter-over-quarter increase, driven by the increase in total investment income on the portfolio growth in the first half of 2024. Our effective and core yields decreased modestly in the second quarter to 14.7% and 13.7%, respectively, compared to 14.9% and 14% in the prior quarter. The second…

Thank you so much. [Operator Instructions] One moment for our first question. And it comes from the line of Crispin Love with Piper Sandler. Please proceed.

Thanks. Good afternoon. Appreciate taking my questions. First off, just a big picture question on rate cuts. We seem to be getting closer to rate cuts from the Fed. So, can you just discuss how you expect how lower rates might impact VC deal activity? And how you think that could impact you on a funding and activity basis going forward as we get to the end of '24 and probably more likely in 2025?

Thanks, Crispin. I think our expectation internally is that we will see demand activity pick up in a declining rate environment. I think one of the things that our team has consistently been hearing over the last several quarters from some quality late-stage companies that they're holding off just given the current rate environment. And so, I think our operating assumption is that as rates do start to come down, which we expect to happen in the second half of the year, and then potentially throughout the course of next year, that if anything, demand will likely increase in terms of the amount of quality venture-stage companies that are looking for secure debt solutions.

Great. Thank you, Scott. And then just on credit quality, Scott, I believe you mentioned a write-off on one loan in the quarter. Just first, is that the $6 million realized loss? And just any other color that you can provide there? And then just credit broadly, any leading indicators that you're looking at that makes you confident going forward, or are there just any pockets of stress that you want to call out?

Sure. So overall, continue to be optimistic about credit. Broadly speaking, when looking at our portfolio, there are certain key metrics that we evaluate and track on a quarterly basis. Our weighted average credit rating maintains at 2.18, that's just a slight uptick from 2.16. So that continues to show strength and stability. Second metric that we look at pretty closely is what percentage of our entire portfolio do our Grade 4 and Grade 5 credits make up. As of the end of Q2, that was approximately 1.8% of the portfolio, that was actually down from 2.8% of the portfolio in Q1, and down from 3.4% of the portfolio in Q4 of last year. So that shows a pretty optimistic trend in terms of Rated 4 and Rated 5 credits as a percentage of our total investment portfolio. As I mentioned in my remarks, we do have two loans on non-accrual. From a fair value perspective, that makes up less than 1% of our debt investment portfolio. With respect to the one particular write-off that we spoke about and that you just referenced in your question, that was a small loan that was placed on non-accrual. We took action in cooperation with the company and Board and ended up selling the assets of that company, which culminated and completed in Q2, then resulted in a small net realized loss in the quarter. So, nothing more to add on that one unless you have additional questions on it.

No. I appreciate the color, and thanks for taking my questions.

Sure. Thanks, Crispin.

Thank you. Our next question comes from the line of Casey Alexander with Compass Point Research. Please proceed.

Yeah, hi, good afternoon. Thanks for taking my questions. Seth, you mentioned that you expect interest expense to be up slightly, but you have a debt repayment in July. Are you funding that with the credit facility, because that comes at a reasonably higher rate? And is your strategy to let that sit in the credit facility for a while until hopefully rates come down and maybe you can refinance in the unsecured market at a better rate than you can right now?

Yeah, let me take that in pieces, Casey. Thanks for your question. So, we did utilize the credit facilities to repay the $105 million. We had ample availability in those to cover that. Certainly, as we see the interest rates move in the direction for that opportunity, we'll take advantage of it on an opportunistic basis. But we did as well add to our liquidity availability with the SBIC license, which obviously is more attractive than what we could get in the open market at the moment. So, it was a takeout that was liquidity and leverage neutral, because we used the credit facilities. And we will be opportunistically looking at the market. But at the moment, we still -- as Scott mentioned, we have very strong liquidity and the balance sheet is in great shape for a continuing growth.

Okay. Thank you. Scott, this is for you. It kind of strikes me that, is Hercules becoming sort of a hybrid lender? And what I mean by that is, sort of, you've moved up-market to a lot of big companies and many times public companies. Kind of what percentage of your originations or portfolio, however you would like to characterize it, don't really involve direct interface with a venture capital company, but are more direct lending to a technology or life science company where it's your core competency, but maybe it's not really what you would call a traditional venture capital loan anymore?

Yeah. Casey, a great observation and great question. Our business has really transformed itself over the course of our 20 years operating history. In the early years, Hercules was exclusively focused primarily on private venture-backed companies in the two verticals that we cover, technology and life sciences. And then, if you look at the business sort of 10 years in, as we started to mature, as we started to scale, as we started to develop our own capabilities, the business began to transition away from that traditional sort of venture-backed model into more institutionally-backed companies that still continue to be growth stage. If you look at the business today, 20 years in and $20 billion later, we no longer sort of describe the business as a venture-lending firm, we describe it as a venture and growth stage-lending firm. The vast majority of companies in our portfolio continue to be institutionally backed by venture capital firms, but the reality is these are later-stage companies. Many of these companies are now publicly traded. Just because they are publicly traded does not mean that the venture capital firms no longer have equity at risk or an investment in these companies, but that certainly has been a change that we've seen over the last several years. We also look at the technology business differently than we look at the life sciences business. On the life sciences side, and this is just a virtue of the way the life sciences ecosystem works, about 80% to 85% of our investments are in publicly-traded companies. On the technology side of our business, about 90% of our investments are in privately-held companies. So, it really depends on which part of the business we're speaking about. But in broad terms, we have transitioned away from that early-stage venture model that we had 20 years ago into more of an institutionally-backed growth-stage lender.

Thank you. That's all my questions. I appreciate that answer very much. Thanks.

Thank you. Our next question comes from the line of Christopher Nolan with Ladenburg Thalmann. Please go ahead.

Hey, guys. Two quick questions. Scott, the comments you made on the increase in activity for the life science -- excuse me, tech area, is there a particular focus on that such as AI? Any color you can give in terms of specifics?

Pretty broad based, Chris. Our investment team on the technology side has been very active over the last quarter or two, both from a closed deal perspective and from a pipeline perspective. And there's really no specific sectors or subsectors that we're focused on. We're focused on overall quality credit underwriting, and there's a number of different profiles from a sector perspective within technology that we've been aggressive in.

Great. And then, a follow-up for Seth. The interest rate sensitivity on the press release shows if 25 bps cut impacts NII by $0.03. Would that likely be offset by just higher investment volumes pursuant to your earlier comments?

Yeah, that's a good question. So, I think what's interesting is when you look at that on the 100 basis points movement, the big difference it really shows are floating with a floor structure because there's a 20% difference. But you're absolutely correct, we could grow away that $0.03 NII hit, and it's an annual basis, it's not a quarterly basis. And so, that could be covered by the growth over time. But as we're standing today without additional growth or any other change, that would be the impact.

Great. That's it for me. Thanks, guys.

Thanks, Chris.

Thank you. And our next question comes from the line of Douglas Harter with UBS. Please proceed.

Thanks. Just sticking with the growth thought, how are you thinking about the outlook for growth in the coming quarters? And how that mix might be between third-party capital and on-balance sheet?

We're optimistic about what the second half of the year is going to look like in terms of new commitments and gross fundings. We don't give growth guidance on a quarterly basis, just given the unpredictability associated with the early repayments. In Q2, we had $306 million of prepayments. Our guidance for Q3 is that we expect to have $200 million to $300 million again, so that's two healthy quarters in a row of expected prepayments. And how much ultimate growth there is in terms of the BDC balance sheet will largely be driven by the level of prepayments. We're not cautious at all in terms of our ability to deliver in terms of new commitments and new fundings. With respect to the private fund business, the business continues to operate above our initial expectations. We do disclose in our press release the allocations that are going to the private fund business on a quarterly basis. If you look at that just in terms of aggregate numbers, in 2022, for example, we funded about $400 million out of the private funds. In 2023, we funded about $350 million out of the private funds. In Q1, we funded about $113 million out of the private funds. And then, in Q2, we just funded about another $117 million. So, the pace of fundings out of our private fund business continues to be fairly robust.

Great. Thank you.

Thank you. Our next question comes from the line of Finian O'Shea with Wells Fargo Securities. Please proceed.

Hey, everyone. Good afternoon. A quick follow there on the private fund discussion. What was the input that led to -- I think, Seth gave higher go-forward guidance on that. think at least our impression last quarter was that it was -- the economics weren't in place for the lot for a while. If you could touch on that and, like, how likely that is to happen going forward? Thanks.

Thanks, Fin, for the question. What we did was kind of narrow the range. We've been a little bit over my guidance or at the top end of the guidance for each of the past two quarters. And so, all we did was narrowed it a little bit. Rather than $1 million to $1.5 million, I just shortened it up to $1.25 million to $1.5 million. As I said, just because we've been at the top end or over for the last two quarters.

Okay, helpful. Thank you. I guess one for Scott. There's been a bit reported in the financial community, at least, about the comeback of Silicon Valley Bank. And seeing what your views are or what your observations are on that front? Thanks.

Thanks, Fin. I think our observations with respect to SVB, First Citizens would be very consistent with respect to what we've said now several quarters in a row. They continue to be active. We continue to see them in the market. We don't see them to the same extent that we did a year, year and a half, two years ago, but they continue to be active. We have continued to partner with them on a select number of transactions. And so, I would sort of characterize them as a viable competitor in the market that we both compete with from time to time, and partner with from time to time. Nothing else to add outside of what I just said.

Great. Thanks so much.

Thank you. Our next question comes from the line of Paul Johnson with KBW. Please proceed.

Yeah, good evening. Thanks for taking my questions. Most of mine have been asked, but one I did want to ask is, over the last few quarters, it seems that PIK income as a percent of interest income has been increasing. I was wondering if there was anything specific that's been driving that, or have we just been seeing more of that as you move up market and some of these borrowers are getting that option within their structure. But just wondering what's been driving that over the last few quarters.

Sure. Thanks, Paul. I'd say a couple of things. First and foremost, PIK income on a relative basis, when you look at our entire income, continues to be a really small part of the overall income or top-line from Hercules Capital. With respect to why it has been increasing slightly over the last couple of quarters, there's really three things contributing to that. Number one, that focus on stage again, we're going after larger, later stage, more quality companies. The competitive environment for those deals tends to be a little bit more PIK-centric. So, we are utilizing a small amount of PIK in some of these later-stage transactions. That's the first thing. Second thing, in a lot of our straight down the fairway deals, we do give some of our companies an option to toggle between cash and PIK to a small degree. And so, as rates have stayed higher for longer, some companies are choosing to pay, for example, 1% of cash by transitioning that to 1.1% or 1.2% of PIK. And that's really the second driver. And then, the third piece is just, we have selectively been utilizing PIK for a certain profile of transaction. I really don't want to speak to what that is just from a competitive perspective, but on a small number of transactions, we've been utilizing PIK a little bit more aggressively. But we have limits and we do not intend to go above it.

Yeah, I would just add one thing. From a balance sheet perspective, it's less than 1% on our balance sheet, so it's completely insignificant as far as the profile of the balance sheet.

Got it. Thanks. That's very helpful. And then, just one more. But just, again, I think you've talked about this on your remarks, but the overall compression on just the core yields and the coupon rate on the portfolio, I assume that's been driven by these same things we're talking about, moving up the market, moving up higher in the cap structure, more first lien. But should investors just overall be expecting this to continue, tighter spreads, lower core yield on the portfolio as you continue to do so? Or kind of where would you expect that to trend here given the kind of compression over the last one to two quarters or so?

Yeah. Thanks, Paul. So, a couple of things with respect to yield. First, each of those things that you just mentioned in the question have certainly contributed to some of that, but the biggest driver is actually the mix between prepayments and fundings. If you look at the prepayment activity that we've had over the last three to four quarters, the mix is largely centered around older legacy assets, where the core yield on those deals tends to be 14% to 16%. The new fundings that we're putting on the books right now tend to be in the range of 13% to 14% core. And so, just that shift in mix in terms of the higher-yielding assets paying off, being replaced by new deals in that 13% to 14% core, are causing some of that slight degradation in terms of core yield. The thing that we're really managing to is solving for the ultimate GAAP yield that we can deliver. And if you look at the effective yield in the portfolio today at 14.7%, it is identical, just by way of example, to the 14.7% effective yield that we delivered in Q4 of 2022. And so, the goal for us is to make sure that we are delivering an above-market acceptable yield with appropriate spreads. And that's what we've been able to do. Our expectation, per Seth's updated guidance is that we will continue to see some small incremental degradation in terms of core yield, but we certainly don't expect any material changes or decrease in core yield, obviously, barring any activity from the Fed.

Thank you very much. It's very helpful. It's all for me.

Thank you. And we have a follow-up from the line of Casey Alexander from Compass Point Research. Please proceed.

Yeah. I'm sorry, maybe I missed this, or maybe it was in the technical blackout, but can you discuss and give us an idea of what the situation is surrounding [Khoros] (ph), the company that was put on non-accrual this quarter?

Sure. So, that is an ongoing active situation. Can't provide a ton of color because it is a private company and we have certain confidentiality provisions. That is a loan that we have participated in with several other large BDCs and investment firms. We made the decision this quarter to impair that loan. So, Khoros has a cost basis of roughly $60 million, and we've impaired that down to about $32 million. And per your observation, we did also make the decision to put that loan on non-accrual this quarter. That's largely based on two factors. Number one, we did believe that it warranted a significant collateral-based impairment, which means that our expectation, based on what we know today is that we will not have a full recovery on principal. And then, the second component is that the cash coupon in that transaction has now transitioned to PIK, and so that investment is no longer paying cash income, which in our model, turns that into a non-accrual loan.

All right. Thanks. Very helpful.

Thank you. And I see no further questions in the queue. I will turn the call back to Scott Bluestein for closing remarks.

Thank you, Carmen, and thanks to everyone for joining our call today. As a final note, we will be participating in the KBW BDC conference on October 2nd in New York. If you're interested in meeting with us at this event, please contact KBW directly or Michael Hara. We look forward to reporting our progress on our Q3 2024 earnings call. Thanks, everybody, and have a great rest of the day.

And thank you all for participating in today's conference. You may now disconnect.