Michael Hara - Senior Director, Investor Relations Manuel Henriquez - Founder, Chairman & CEO David Lund - Interim CFO Gerald Waldt - Corporate Controller & Interim Chief Accounting Officer.

John Hecht - Jefferies Ryan Lynch - KBW Casey Alexander - Compass Point Research Tim Hayes - B. Riley FBR Aaron Deer - Sandler O'Neill & Partners Christopher Nolan - Ladenburg Thalmann Henry Coffey - Wedbush Robert Dodd - Raymond James Finian O'Shea - Wells Fargo Securities.

Good day, ladies and gentlemen, and welcome to the Hercules Capital Second Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference Mr. Michael Hara, Senior Director of Investor Relations. Sir, you may begin..

Thank you, Joel. Good afternoon, everyone, and welcome to Hercules' conference call for the second quarter of 2018. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO; David Lund, our Interim Chief Financial Officer and Gerald Waldt, our Corporate Controller and Interim Chief Accounting Officer.

Hercules' second quarter 2018 financial results released just after today's market close and can be accessed from Hercules' Investor Relations section at htgc.com. We have arranged for a replay of the call on Hercules' webpage or by using the telephone number and passcode provided in today's earnings release.

During this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delayed between the date of this release and in the confirmation in the 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 reasonable, any of those assumptions can be proved 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 our website, htgc.com.

With that, I will turn the call over to Manuel Henriquez, Hercules Chairman and Chief Executive Officer..

Thank you, Michael, and good afternoon, everyone, and thank you for joining us today on the call today. We have plenty of outstanding news to share with you today about our very strong and record-breaking start to the first half of 2018 and our continued optimism and strong outlook for the remainder of 2018.

Assuming reports the current market just remained as stable as they are currently throughout the second half of 2018.

First regarding our strong earnings performance in the second quarter 2018, we achieved another strong quarterly performance with an adjusted net investment income of $0.29 per share after adding back the previously announced $0.03 non-cash expense related to the retirement of our $100 million bond of the 2024 notes, which on a GAAP basis would have equaled to about $0.26 and NII after taking effect of the $0.03 impact of the retirement of those bonds.

In addition, given our strong loan portfolio growth and core yield growth during the quarter we now expect to cover our dividend from net investment income beginning in Q3 2018, a quarter sooner than we had anticipated and even after including the impact a higher share count from our previously issued equity offering ensuring us to maintain our leverage levels below 1 to 1.

We also achieved another milestone during the quarter as a company thanks to our tremendous team of employees who made it possible at our growing brand within the venture capital industry as a venture lender of choice among many other venture capital firms and their portfolio companies.

I am proud to share with you today that because of our strong new origination activities in the second quarter, we now have surpassed a major milestone of $8 billion in total commitments it's a start of Hercules in December 2013.

We have financed more than 430 different innovative and destructive venture capital and private equity backed companies who have chosen Hercules Capital as one of their capital partners of choice.

This is an amazing achievement that I take immense pride in as the founder and CEO and it underscores the amazing level of talent, discipline and intelligence that origination team and in fact all of our employees have contributed towards the amazing milestone. I say to you thank you very much for everything you have done to make that goal possible.

Surpassing the $8 billion mark also reflects the importance of the Hercules Capital platform within the venture capital community and of our industry leading reputation and brand and leadership position that we have established over the past 13 years.

We are deeply grateful to the trust and faith that our venture capital partners and entrepreneurs have bestowed to us, their confidence in us as a venture capital lender of choice to help support their companies in achieving the $8 billion goal.

No other BDC venture lender has our capacity or capabilities or depth of platform to originate, finance at these levels or assemble an investment portfolio of this size let alone originate e-loans at these levels on a quarterly basis. And now for today's call, I will be discussing the following select achievements and highlights.

I will provide an overview of highlights of our outstanding financial performance and key achievement during the quarter.

I will provide a brief commentary to our continued optimism as we enter the second half of 2018 and our outlook in a revised upward forecast of NII and NII covering our dividend in Q3 based on of course continued loan origination and growth.

I will also offer some perspective and insight into the very robust venture capital marketplace and activities realized in Q2 2018 including of course fundraising, investment activities as well as realized exits from both IPO and M&A events which were both quite robust.

And then, I will turn over the call to our finance and accounting team led by David and Gerald for more detailed specifics regarding our financial performance and financials during the quarter. And finally, I'll conclude the call with a Q&A session to address any other questions you may have. Now, for some highlights and key events of Q2 2018.

Let me begin by saying that we had an outstanding and record-breaking second quarter with exceptionally robust origination activities across all of our sectors that we focus on.

We achieved another strong quarterly performance with adjusted net investment income as I indicated earlier of $0.29 per share after adding back the $0.03 of non-cash related to retirement of our notes. We saw unprecedent demand for capital in the first half of 2018, especially the second quarter of 2018.

This demand was driven by very favorable market conditions which we expect to continue through at least the third quarter of 2018 if not the rest of 2018.

Based on this increased optimism and revised upward outlook for the second half of 2018 coupled in no small part with our strong origination performers and achievements during the first half of 18, we now have a potential to exceed over $1 billion and actually even potentially topping $1.1 billion in total new loan commitment in 2018 and potentially ending 2018 with a total debt investment portfolio in the upwards revised range of $1.6 billion to $1.7 billion assuming of course early payoff remain at our expected abated level or marginally levels of less than $100 million per quarter for each Q3 and Q4 respectively.

Our origination team delivered a historical strong and record level new origination in a single quarter. We entered into new total debt and equity commitments of more than $460 million in the second quarter up nearly 125% year-over-year.

Equally strong was our total new debt and equity commitments for the first six months of 2018 topping over $725 million representing an increase of over 84% on a year-over-year basis and putting us well within the reach of $1 billion if not up to the $1.1 billion given that we still have close to seven months more origination activities to go, excuse me six months origination activities to go.

During the second quarter, we also close-end funded an impressive $727 million of new commitments also up an impressive 35% on a year-over-year basis.

As for the first six months of 2018, we funded over $0.5 billion or $564 million of new investment funded assets representing an increase of 65% year-over-year these are tremendous numbers in achievements thanks to no small part to our team in what they have done.

This combination of a healthy new deal flow, new pipeline of transaction pending and being reviewed coupled with new funding and tempered competitive environment all contributed to driving higher our core yields and exceeding the high-end of our expected yield ranges or 15 -- 11.5% and 12.5%.

In fact, core yields in second quarter were 12.7% up meaningfully from 11.9% in the first quarter of 2018. However, given the tempered early payoff activities that we witnessed in the second quarter, we also realized a slight down decline in our overall effective yields of 13.5%.

This reduction in our effective yield was directly attributed to a meaningful and material decline in early loan pay off activities from $244 million in Q1 to less than half in Q2 of $114 million.

Our total debt investment portfolio now stands at a record high of $1.55 billion at cost an impressive single quarter growth of 13.5% on a quarter-over-quarter basis.

We expect to continue this controlled growth through the second half of 2018 and potentially growing our debt portfolio as I indicated earlier to the $1.6 billion and most likely the $1.7 billion level by year-end assuming again the robust activities remain in the second part of 2018.

This of course does not assume any aberration anomalies that may be attributed to the mid-term elections or anything else surrounding, any geopolitical risk that may inadvertently come into the markets and affect the capital markets.

We achieved many of these results while maintaining our historical focus in improving credit discipline as evidenced by our historically low sub 1% non-accrual of loans while also maintaining a very strong balance sheet and high liquidity position with over $221 million of available capital for new investments and continued loan portfolio growth.

In addition to our robust deal loan origination activities during the second quarter, we also were extremely active in the capital markets as well. We actively managed our leverage to within the desired target levels while also bolstering a liquidity and positioning us well to continue to drive loan portfolio growth in the second half of 2018.

For example, just in the second quarter alone we successfully completed the falling capital markets activities. We raised $81 million of equity at an above NAV accretive equity offering adding equity capital to help bolster our net assets as well as manage our leverage position within the tolerance level that we have set.

We also actively use and engage our just in time equity ATM program raising an additional $26 million at highly accretive above net asset value and low offering cost.

If that were not enough, we also raised $75 million in a new bond offering of seven years part 25 at a coupon rate 5.25% extending out new maturities of our bonds out in 2025, while also managing to work and increasing our credit lines with Union Bank of California where we actually increased our credit facilities but additional $25 million to provide continued flexibility to grow our investment portfolio.

And lastly, we also were actively redeeming as I indicated earlier and retiring $100 million of our 6.25% 2024 notes that led to the impact of a $0.03 per charge -- $0.03 earnings hit in the quarter related to a non-cash charge of $2.4 million related to these bonds. These 2024 bonds had an effective cost of capital approximately 6.6%.

So, the retirement of this bond ends up being quite an accretive to the transaction on a go forward basis.

All of these activities allowed us to finish Q2 with an enhanced and strong liquidity position which along with adjusted time equity program and continue to enable access to the equity and debt capital markets will allow us to continue to drive the loan growth further while also helping to bring overall cost of funds and manage our leverage levels lower to within the towers of which one that we want to operate the business on.

Now, let me take a few minutes to share with you the activities related to new business which remains extremely robust during by very strong venture capital investment activities and continue encouraging signs of an emerging IPO market and beginning to take a good shape.

We saw a very strong loan demand and transactional deal flow driven in no small part by the very impressive performance by the venture capital industry and investment activities during the second quarter of 2018 with nearly $28 billion of capital invested by the venture capitalists in the second quarter.

This is a record new level of investment activities and making it one of the best quarter since 2000 according to Dow Jones venture source, which is a data provider that we use to align our facts and figures.

At this level, the venture capital investment activities for 2018 are on pace to shatter all previous records of new investment levels by venture capitalists and are expected to potentially even exceed $100 billion of new venture capital investments in 2018.

At that level, this would dramatically outpace the $90 billion or so that were invested during the .com era of 99 and 2000.

Liquidity, liquidity activities or realized exits by the venture capital in industry or investments were also very encouraging signs during the second quarter much of which the Hercules portfolio reap benefits itself by seeing multiple liquidity events in M&A and IPO.

Our own investment portfolio has dramatically benefitted from this new activity and is very encouraged by the IPO and M&A marketplace activity that we witness during the second quarter.

We remain very optimistic as the IPO markets are continuing to show signs of very encouraging receptivity to new IPO candidates and it's dramatically showing and improvement in delivering sustained IPO offerings.

In fact, in Q2 we were in 31 US venture capital backed IPO's complete, the successful IPO debuts in the second quarter for a total of 46 companies in the first half of 2018. Those are quite strong numbers we have not seen for quite some time.

In fact, we are seeing meaningful signs in our own portfolio of charter and improved outlook from our own investment portfolio companies with many of them preparing themselves for potential exit through an IPO later in the second half of 18 or surely in the beginning of 2019.

This renewed IPO optimism is something we have not seen for quite some time and is a very encouraging sign.

As evidence of this continued optimism during the second quarter, we saw various Hercules portfolio company such as DocuSign, Tricida, and Eidos complete their IPO debuts with DocuSign being the stand out which is one of Hercules equity investment holdings.

DocuSign completed very successful IPO debut generating an unrealized appreciation of approximately $13.8 million or nearly $0.16 in net asset value appreciation based on its closing price as recently as July 30 and well above our cost base of 15.79 per share in Q1 2018 representing a multiple investment of 3.2 times in an unrealized position all our invested capital at cost.

As a reminder of the importance and benefit of a robust and open for business IPO and M&A marketplace Hercules Capital holds equity, warrants in approximately 133 different companies many of these companies are leading innovative destructive companies backed by many of the top peer venture capital firms in the country.

Many of these companies eventually may achieve liquidity advance through either an IPO or M&A event and Hercules Capital is well-positioned to potentially monetize in those in the money warrants when they complete for realized and exit opportunity.

So, one so example is DocuSign, we expect and hope to see many of our companies complete DocuSign type liquidity even so that benefit our shareholders.

In addition to our 133 different warrant positions that we hold in various companies, Hercules Capital also holds a direct equity position in over 50 venture-backed to private equity-backed companies which is like a warrant portfolio positions us well to potentially benefit from any future gains if and when any companies choose to pursue or complete an IPO event.

However, as we have always said and as a word of caution not all of our warrants or equity positions are expected to complete or realize and exit or a monetization event. We generally expect approximately 50% or less of our portfolio to achieve such an event in the future. Now with respect to Hercules companies and IPO registration.

At the end of the second quarter, we actually had two companies that had IPO registration. We anticipate many more potential to be filing in the second half of 18. Another sign is that of the early payoff activities which are finally showing signs of abatement and helping to drive portfolio loan growth.

After adjusting for a deliberate sector portfolio adjustments and pruning that we did in Q1 which resulted in $243 million or early payoff activities. We're now beginning to see signs of early payoff activities begin to taper and abate.

And in fact, we expect early payoff activities to once again start modeling back to historical levels over $100 million as evidenced in Q2 with $140 million early loan payoff activities.

When we combine our record level of new funding's in Q2 we have returned to a net portfolio growth a quarter earlier than expected with net new loan portfolio growth of approximately $185 million and Q2 representing a healthy 30.5% increase over Q1 2018. Furthermore, as I indicated earlier.

We do expect and anticipate early payoff activities to return back to $75 million to $100 million for Q3 and Q4 in 2018. As a reminder, predicting early payoff is still very very difficult task since we do not control or have insight as to which company or when a company may choose to pay off its loan balances early.

In fact, we typically have less than 30 days' notice or visibility so it's obviously tremendous and significant variability and market conditions that may alter the ultimate outcome of early payoff activities. Now, let me discuss our pipeline of new commitments in finding as we enter the third quarter.

As I shared with you earlier during the call, just in the first month of the third quarter July, Hercules has already received and closed over $170 million of new or pending commitments so far just in the month of July.

On a year-to-date basis when you factor in the first half of the year activities we are already at $899 million of closer pending commitments just through the first seven months of the year.

This is why we are quite optimistic on achieving the $1.1 billion or $1 billion in new commitments in fiscal 2018 when in the first seven months we're already at $899 million of that activities.

Assuming that all these signed term sheets and commitments convert into new funded loans in the third quarter, we would find ourselves in a very favorable if not exceeding our previously set portfolio goals of $1.55 billion to $1.65 billion and putting us in great positions to potentially achieve or revise portfolio of loan portfolio assets of $1.6 billion to $1.7 billion in total new with us portfolio by the end of 2018.

Now let me take a brief opportunity to discuss our views of the marketplace and activity as we enter the third quarter and the second half of 2018.

We're extremely encouraged by what we are seeing entering Q3, as evidenced by already strong and closed new commitments of $170 million and growing and a new pipeline of over $1.2 billion of potential new opportunities that we are evaluating as potential new investment.

In an effort to address the increasing loan demand, we're actively expanding our offices in Boston and Palo Alto. We're adding additional new headcounts across all levels of the company, which we expect to continue throughout the remainder 2018 and early part of 2019.

We see tremendous opportunities continue to grow our loan portfolio rolling into 2019 and we want to make sure that we're properly capitalized as well as staffed to continue to address the strong demand that we are seeing for our capital.

Notwithstanding the strong loan demand, our view at Hercules Capital to continue its discipline and effective time proven strategy of slow and steady. It's not about getting to the end of the race, it's about having a perseverance to run the race and continue to deliver aon strong performance. We are well positioned to achieve just that.

We have begun a steady but controlled loan portfolio growth and we expected to continue to see that. In fact, as I mentioned the slow and steady strategy, we expect the loan portfolio growth in Q3 to grow by approximately $50 million plus or minus $20 million in either direction.

Our slow and steady strategy has served us well for over a decade and we see further signs of an improving competitive environment and economic outlook that we anticipate should accelerate our own disciplined growth and continue to drive portfolio growth even potentially beyond our expectations currently.

In closing, we had an outstanding for example 2018 with record commitments and findings, delivering overall net portfolio growth a quarter ahead of schedule and putting us on pace to return to covering our dividend in Q3 through NII investment income and not having to use our capital gains to further grow our undistributed earnings for later distribution for our shareholders.

I recognize that the importance of covering the dividend right is very important to many of you, that will be occurring in Q3 as I stated.

Our outlook for the second half of 2018 has continue to remain very optimistic and we're very encouraged about how things are trending early so far in Q3, as evidenced by the $170 million of already terms which was executed in the first month of the third quarter and we're only at the midway point of the year.

As I always say, a quarter does not make a trend but it certainly helps to point at one direction and we are well positioned to do just that with over $220 million of liquidity to invest in the second half of 2018.

And finally, to wrap things up an update on Hercules Capital's view related to the recently passed Small Business Credit Availability Act or the SBCAA that Congress recently passed in March on asset coverage ratios requires being lowered to 150% from 200% or as its more commonly referred to the increase in leverage to two to one from one to one.

First, I'd like to say thank you to all of our institutional bond and equity holders for your time, feedback and support over the last few weeks in recognizing the many advantages which modest and gradual controlled increase in leverage could have on hercules and economic benefit could bestow on Hercules Capital's performance especially as internally managed BDC.

Secondly, as we have previously shared with you we have chosen to take the slow path forward on leverage and preferred to take a more pragmatic and slower path to an increase in leverage.

It was crucial and critical to meet and speak all of our institutional accounts as many as we could, as well as find time to speak with all of our stakeholders, including our stockholders, our bond holders, our rating agency partners, our industry analyst community and all interested parties that would like to discuss leverage.

It was a very important process and one that beared a lot of fruit in the process. We enjoy the many conversation we had with many of you and we took your feedback to heart as very important here.

We expect to report our final conclusions on leverage sometime late in Q3, if not early Q4 at which point we'll give clarity and guidance as to what if anything we tend to do related to leverage. And now for one last and very important item that was amplified by the tremendous achievements during the quarter.

None of these tremendous achievements or accomplishments would have been made possible if not for our greatest assets. Our wonderful and dedicated team of outstanding employees. Our human capital, who continue to step up and deliver strong results for our shareholders. And they all will make Hercules Capital successful.

Thank you very much everyone and truly an outstanding job once again. Now let me turn the call over. Thank you everybody..

Thank you, Manuel and good afternoon ladies and gentlemen. Today we are pleased to report our second quarter results. This afternoon I will focus on the following financial areas. Our origination platform, income statement performance NAV performance and realize and unrealize activity and credit outlook.

With that, let's turn our attention to the origination platform. Origination performance continues to demonstrate our strength as the market leading platform in venture landing. We had a record quarter for total investment fundings of $327.5 million. These investments came from a total of 29 portfolio companies 15 of which were new portfolio company.

This investment activity brings our fundings for the first six months of 2018 to a total of $563.7 million putting us on pace for a record year. This investment activity was offset by early repayments during the quarter of $114.3 million and amortization of $16.7 million.

As a result of this activity, on a cost basis our debt investment portfolio balance ended at $1.55 billion representing an increase of approximately 13.6% from the first quarter. Our core yields increased 12.7% which was up from 11.9% in the prior quarter.

The increase in core yields was primarily attributed to early origination activity during the quarter, the weighted average yield of loans onboarded during the quarter of approximately 12.7% and the impact of the full quarters prime rate increase in March. Moving into Q3, we expect our core yields to be between 12.4% to 12.7%.

With that, I'd like to discuss our income statement performance for the second quarter. On a GAAP basis, our net investment income was $22.8 million in the second quarter or $0.26 per share.

On a proforma basis our NII per share was $0.29 after taking into account the acceleration of $2.4 million a one-time unamortized fees and interest related to the early payoff of $100 million of our 2024 notes in April. Total investment income was $49.6 million in the second quarter an increase of 1.8% from $48.7 million in the first quarter.

The increase in total investment income is due to higher interest income of $2.0 million on the larger weighted loan portfolio and higher core yields of 12.7% as I mentioned previously. Our weighted average principal outstanding increased by approximately $106 million to $1.47 billion from $1.36 billion in the first quarter.

Our fee income decreased by 35.5% to $3.7 million during the second quarter due to the lower early payoff activity. NII margin was 46% in the second quarter which was a decrease from the first quarter at 53.5%. The decrease is due to the higher interest and fee expense on the redemption of $100 million of our 2024 notes.

Our NIM would have been approximately 50.8% without the impact of the higher interest and fees related to the note redemption.

Our SG&A increased to $13.5 million in the second quarter from $12.1 million in the prior quarter driven by an increase in variable compensation due to performance and funding objectives relative to plan and higher stock-based compensation.

We just played our operating expenses to be between $13.5 million to $14 million in each of the next two quarters due to variable compensation expense and employer related retention programs. Our net interest margin was $36.3 million in the second quarter compared to $38.1 million in the prior quarter.

The decrease is due to the impact of interest and fees from the 2024 note redemption. Lastly, we have a very well positioned portfolio with a highly asset sensitive balance sheet in the event of interest rate movements. 97% of our loans are variable interest rate loans with floors and 93% of our debt outstanding was fixed interest rate debt.

A 25 basis point or 50 basis point increase in benchmark interest rates would be accretive to interest income and net investment income by approximately $3.1 million and $6.2 million respectively on an annualized basis or $0.04 and $0.07 respectively of NII per share annually. Now, I would like to discuss our NAV performance and credit outlook.

We saw our NAV increase to $963.7 million in the second quarter from $828.7 million in the first quarter or an increase of $0.50 per share or 5.1% to $10.22 per share.

This $135 million increase was primarily as a result of our equity offering and ATM activity of $106.7 million and the net change in unrealized appreciation up $38.2 million during the period. During the second quarter, our net realized losses were $8.9 million.

This net realized loss was primarily the result of the write-off of one loan position for $8.6 million. In addition, we realized $2.7 million and net realized losses related to our warrant portfolio offset by $2.4 million of net realized gains in our equity portfolio.

The net realized loss activity did not have an impact to NAV since they were previously recognized at zero value in the prior quarter. We had a net change in unrealized appreciation of approximately $38.2 million on our investment portfolio during the quarter of which $37.1 million was related to our debt, equity, and warrant investments.

We had net unrealized appreciation in our debt investment portfolio of approximately $24.2 million. The appreciation in our debt investment was due to $20.8 million of reversals due to pay-offs, write-offs and or collateral base impairments. And $3.3 million of accretive market yield adjustments.

Depreciation in our equity portfolio of $8.2 million was made up of the appreciation of $12 million in our public portfolio offset by $2.2 million depreciation and our private portfolio at $1.6 million of reversals due to sales and or write-offs.

The appreciation in our warrant portfolio of $4.7 million was made up of approximately $700,000 and $1.6 million of appreciation in our public and private portfolios respectively and $2.4 million in reversals and realized losses due to sales or write offs.

We saw a return on average equity decrease to 10.2% in the second quarter down from 12.7% in the prior quarter. A return on average assets decreased to 5.4% from 6.5%. Excluding the one-time expense related to the pay-down of the 2024 notes, the return on our average equity and average assets would have been 11.3% and 6% respectively.

I now would like to discuss our credit and near-term outlook for the quarter. In the second quarter, our weighted average credit rating was 2.21 improving from 2.43 in the first quarter.

Improvement in credit rating was due to $87 million of loans on a cost basis moving credit one an additional 15 companies totaling $209 million being removed from our credit watchlist due to either early payoffs, write offs or credit rating improvements.

Furthermore the additional movements within the portfolio are consistent with our longstanding policy of generally downgrading credits to a grade three as the company's approach capital raised for critical milestones.

Traditionally our portfolio companies will need to raise capital every 9 to 14 months that is our expectation that our portfolio companies will migrate to a three rating at some point in their normal life cycle with Hercules.

Our credit 4 and 5 rated companies which are primary areas of focus decreased to 3.1% from 5.3% of a cost basis in the second quarter primarily related to pay offs and write offs. Our non-accruals remained at historic lows and moved 2% as a percentage of our total investment portfolio on a cost basis and from 0.8% in the prior quarter.

The non-accruals were zero add value basis in the second quarter. This makes four consecutive quarters were non-accruals as a percentage of total investments and cost are below 1%.

Finally, in addition to Manual's remarks regarding our overall liquidity as we disclose today in July we fully repaid our first SBA license retiring the remaining $41.2 million in debentures. Based on our remarks today and our overall financial performance, we are very pleased with our second quarter results.

That's in closing we're well positioned at the end of the second quarter heading into the remainder 2018 our long term focused approach and disciplined underwriting standards and access to diversify funding sources will enable us to deliver strong results for the foreseeable future.

With that report, I now turn the call over to the operator to begin the Q&A part of our call. Operator, over to you please..

Thank you. [Operator Instructions] Our first question comes from John Hecht with Jefferies. Your line is now open..

Thanks guys and congratulations. Big origination numbers, that's a good growth.

Related to the origination, I'm wondering Manuel can you tell us I guess the pace during the quarter was spread out over the quarter or were they back road just so we can kind of think about what that means to the upcoming quarters dollar interest income?.

Yes. As we have indicated since inception, the third quarter is simply our slowest quarter which is why we're only forecasting probably net up $50 million plus or minus $20 million. It's now plus or minus $20 million - but the typical deal size is twice. So, one deal flows and one deal sliding can make an impact on that.

With that said, we will expect to do more funding in August. So, you go, July strong, quiet August, and then you pick up the second week or so of September in the third quarter. So, it's going to be more lumpier. As to your question in Q2, it was fairly ratably distributed throughout the quarter. So, you saw a nice cadence of fundings taking place.

In fact, you saw the average inter-quarter way to balance was pretty tight compared to historical levels. So, we saw pretty good activities in the second quarter keeping that breach steadily across which ended up with a weighted average, as you'll see in press release page 4.

You'll see that we had an inter-quarter weighted average about $1.47 billion and we ended the quarter with $1.55 billion. So, you'll see there was good cadence inter-quarter activity of fundings..

And then I'm wondering can you talk about what the average investment size at this point in time given the size of balance sheet are you willing to go larger and obviously given which is making more as you are not protected with the larger average sizes as well?.

We are. Okay Hercules comfort zone is doing transactions from $3 million to $80 million in size. We can handle and hold on balance sheet that level quite comfortably and in fact we have the capabilities give our strong origination team to do deals in that range of that sizes.

I think to answer your question, the arithmetic average today is approximately $18 million is a whole position that we have an arithmetic average on the median, it's probably little higher than that but that said $18 million is because arithmetic average we have there..

Okay. And final question, I think David mentioned some comp numbers, the [indiscernible] numbers for Q3 and Q4 and I heard that.

Yes, how I guess the capacity organization and if this type of environment persisted which you need to add a lot of bodies to just manage the pipeline?.

Well, as I think we said earlier and to answer your question I think Dave's number I believe that 13.5 to 14 is what we believe the SG&A number will be in interest expense and fees.

We think at that level, we feel comfortable that the next two quarters are sustaining and maintaining those levels as probably within the range of tolerance that will come to with..

Okay. Thanks very much guys..

Thank you. Our next question comes from Ryan Lynch with KBW. Your line is now open..

Good afternoon guys and thanks for taking my questions. In the last quarter and actually I guess in Q1 you guys had very strong prepayment. You guys had a little bit heavier prepayment this quarter those are going to abate. I know part of those prepayments were driven by you guys wanting to prune some of the weaker investment from your portfolio.

You talked about this still being a very robust VC environment.

So, as you look through the back half of the year, you still looking to kind of prune or rotate out of some of those weaker credits or is that largely been completed the first half of the year?.

So, they are not actually weak credit. So, I just want to make an adjustment to that. I think that we were taking a more exantus [ph] view on consumer related industries is an area I think that we had some concern about it, if the economy were to turn if you will. So, we decided to kind of sector out portfolio rotate, in sectors I would say.

As the salient point of your question, we think that we're pretty much done with any sector rotations that we're looking for the second half of 18. So, we do not expect any anomalies above the $100 million per quarter, early payoff activities. Now obviously one deal that we're not aware of could pop-up. $10 million $15 million in either direction.

But I think that we have enough cover right now, what we are seeing the activity that we think that $100 million for the next two quarters. For each quarter, it's probably in a good level.

Now, that said this sounds very conservative but when you actually add up together the first two quarters plus another $200 million for the next two quarter, it's going to be in excess of $500 million and I'm not aware many VC's can still absorb $500 million plus of early payoff and then a $100 million plus in amort and still grow the loan portfolio which we're going to do.

We feel very comfortable with our strong brand and leadership position and the venture industry that we are seeing tremendous amount of deal flow right now..

Okay. That's helpful. And then I know effective yields can kind of be all over the place depending on prepayments but core yields are typically little more steadier. They jumped about 80 basis points in the quarter and your guidance for Q3 was for the core yield mentality.

Can just talk about what is driving core yields to stay at this kind of elevated level?.

Yes. It's one is our leadership position in the category.

Having a balance sheet that we have and the capabilities really makes the venture capital partners and their underlying portfolio companies have lot more confidence when they look at our balance sheet, and look at our access to liquidity that we are a capital partner that they can rely on and therefore get comfortable with.

Number two, it has to be an arithmetic issue where in Q1 part of that sector rotation that we talked about was vacating or cycling out few obligors that had a prevailing lower interest rate but had larger dollar size and when you remove that weight of larger dollars and lower yield you automatically get this balance back up again in your overall portfolio core yields.

And so, I think that what we're saying now is that we feel comfortable that core yields in Q3 and probably Q4 will sustain themselves after considerably 12.5% to 12.7% level in the next few quarters..

Okay. And then one more on the right side of the balance sheet, you guys and in the third quarter or I guess in the second quarter you guys paid down some bonds and the third quarter you guys are paying down your SPI C debentures. I know this quarter you guys had about $60 million. Draw on your credit facility.

I know in the past you have typically wanted to not draw significant amounts on those and kind of use those as a temporary funding vehicle.

Can you just talk about your plans for maybe the right side of the balance sheet as we look into the back half of 2018?.

I mean, look it's no secret when you actually do the math. The reason why we did a $100 million plus equity raise in Q2 was a mere fact that we were at a GAAP leverage at 95% in Q2. We actually went above that intra-quarter and because we have said we want to maintain leverage at 0.9 or 0.95 or below for the time being.

We wanted to stay true to our word and maintain leverage levels in those areas which is why we did the equity raise which was a very great capital raise and ended up being quite accretive top of that. That said, there is no question that the bank lines continue to serve the purpose which are intra-quarter short-term funding vehicles.

As we look at the capital markets and we look at our leverage position to either proceed forward with an additional equity offering and proceed forward with a longer duration debt facility.

I will say as we've said multiple times in the past, we are evaluating additional bond offering whether in the formal securitization or other bond offerings in the near term, as we continue to drive growth in our book and yes, we will consume the 221 liquidities, so you can expect us to continue that for the liquidity into the equation as we go into the later of the second half of 18 to position us for continued growth in 2019.

We are seeing unprecedented demand for loan capital and we wanted to take advantage of that. Market prices that we have. However, I will tell you that our screens have not changed, we remain highly selective.

But because we have such a strong demand for capital, we're continuing to able to maintain our underwriting parameters of discipline and in some cases actually raise pricing that you can't always say in a market that we're seeing the opportunities in venture lending right now..

Okay. Those are all my questions thank you for your time and good quarter..

Thank you very much..

Thank you. Our next question comes from Casey Alexander with Compass Point. Your line is now open..

Hi good afternoon. I just want to make sure that I understand the operating expense guidance and I hate to ask you to go over this again. But I assume when you're guiding over the next couple of quarter to $13.5 million or $14 million if I understand it right, what we're talking about is G&A plus compensation and benefits in stock-based comp.

Those three put together?.

Ten-fourth..

Okay. Alright, that's great. Secondly, and then I'll jump out. The repayment in the third quarter of the SBA debentures.

Did you fund that with the credit facility?.

No, we took some of the excess cash flows that we had and did that. But the truth be told, cash is fungible. So, let's be realistic about that, but the answer is that it came off of some proceeds but yes, the borrowing on the bank line. So again, cash is fungible either way but we used early payment activities and amortization..

Okay. Great. All right thanks. Appreciate it..

Thank you. Our next question comes from Tim Hayes with B. Riley FBR. Your line is now open..

Hi guys. Good evening.

Can you talk a little bit more about the drivers behind the favorable market conditions you're seeing? You talked about the robot VC capital investment but as it relates to the competitive environment are you still seeing newer entrants leave the market and is there still in absence in bank participation or anything else driving the demand?.

I think that Tim you've been on some calls, or seen some of our smaller venture lenders out there. I mean some reported $30 million some reported $50 million a quarter. That's one deal for us.

I think that you're seeing that you know that our size and our balance sheet really affords the ability to kind of look at multiple different transactions and have the underlying venture capital partners and the end underlying entrepreneurs really see the strength of our balance sheet and our partnership and our success with what we have done.

So, we're very grateful for that recognition. As to competition, we don't see any sustained consistent player in the market. I think that it's both regional and sector driven competition as opposed to a national competition.

We of course continue to see the standard usual suspects which are the venture banks they're out there but size also makes differentiation that we see lots of competition about $20 million and we see fierce competition below $6 million [ph]..

Okay. Got it. Thanks for the color there, switching gears a little bit.

How productive have talks been with the rating agencies over the past couple of months? Do you feel any better today about potentially being able to increase leverage while maintaining your investment grade rating than you did say month or two ago?.

You know in fairness the rating agencies, I think that they are all have taken a more thoughtful process and I think that they're evaluating the obligors or the issuers independently now from each other and I think that I would kind of characterize my conversation as constructive but ongoing and it is certainly our hope to continue to work with the rating agencies to sustain and maintain our investment grade ratings.

I suspect that that will probably happen, but I don't know until those conversations conclude which is why we expect to report sometime in late September on what the outcome on those conversation our position is.

That said it's important to note that we don't have the same conflicts and challenges that other VCs do because we're not in the highly competitive lower middle market lending. Number two, we have ample access to the equity capital markets because they trade above net asset value, we have an ATM program and we're internally managed.

So, there's a lot of differences that we the Hercules platform has that we're encouraged that the rating agencies are taking into account in understanding our business as an internally managed VC and our hyper focus on credit and credit quality that we have earned over the last 13 plus years.

We think all that should get back into the ultimate decision, but again it's an ongoing conversations, they are very positive and very supportive. But I cannot speak for them nor do I know where they are going to end up. But we are surely going to work hard as we can to maintain our invested grade ratings if and when we seek higher leverage.

But I will also say, if and when we see higher leverage, it's not going to go from zero to two to one immediately. No, in fact it's going to be a very gradual methodical process via the prepayment and the sheer nature of venture leading is the short duration asset.

We don't anticipate, if we go on higher leverage it will probably take us 24 to 36 months. So, you can get to 1.3 times leverage if you will or higher. It's going to be difficult. So, to answer the very methodical slow process and we're hoping the rating agencies will take that into account..

Got it. Appreciate the color there. And then on the early repayments obviously more moderate activity there, but if you look back early payoffs in one Q and three Q of last year they were roughly around the same levels yet contributed more to the GAAP effective yield.

I'm just wondering if that's a function of the credit this quarter being more seasoned and older not driving as much the income from that standpoint?.

Usually on the high. Once a credit breaks over 24 months there's not a lot of acceleration of unamortized income and the prepayment oftentimes collapses in some cases zero or less than 1% or so. So yes, it has to do with the longevity of the credit. We saw older credits kind of cycle off and that kind of draw a little bit of that distribution..

Okay. Got it. And then just one more for me. You almost had a full quarter of Gibraltar on the books now.

Maybe you started to really reap the benefits from that acquisition and do you think that had any impact on the lower level of repayments during the quarter?.

So, we are yet to integrate and work with the Gibraltar team. The Gibraltar team on their own are doing a tremendous and frankly a great job. We are very very delighted as partners and owner of that franchise and how well they are doing. It's being run by a highly credit won and focused guy over there Scott.

And I think that we are without giving specific, I think we've enjoyed in a short time that we've acquired them. I believe the number are 35%, 40% loan growth already and we're seeing equally growth on our income numbers and they have yet to hit the gas for its acquisition. So, I think that the Gibraltar acquisition has been fantastic.

It's contributing to our earnings as we expected in Q2, in the second half of 18. And they are ahead of schedule as we expect them to be and we're very delighted with the continued discipline and growth that they are doing that property..

Okay. Thank you for taking my questions..

Thank you. Our next question comes from Aaron Deer with Sandler O'Neill. Your line is now open..

Good afternoon guys..

Hi Aaron..

I think you actually addressed pretty much all my questions maybe just one kind of modelling kind of question.

What's the scheduled amortization that you guys are looking at for the next couple of quarters?.

I think because of the newness to the other portfolios since we have been originating so robustly over the last three quarters. I think you're going to see a marginally level probably around $20 million to $25 million for each of the next two quarters as opposed to a typical $35 million to $40 million.

Because now you have a portfolio, which is what gives us comfort on lower early prepayment. The portfolio itself on a season weighted basis is somewhere around 13 months to 14 months in duration. So, we typically don't see portfolio activity percolating [ph] upward until you cross over that month 16 and 18.

So, we don't expect much more early payoff activity as I said, but $100 million in the next two quarters because of the young seasoned portfolio it is..

Okay. That's great. Thanks for helping me out there. I appreciate it..

Thank you. Our next question comes from Christopher Nolan with Ladenburg Thalmann. Your line is now open..

Hi, guys. - income..

I'm sorry, it's spillover income..

Yes..

We're at $21 million as of the end of Q2, but I got to remind everybody intra-year spillover income has a lot of variability for realized gains or realized losses that may have between now and year-end, but yes, it's $21 million at the second quarter mark, but if you move up or down quite dramatically later on in a year by those activities..

And what was cost of debt excluding the non-recurring items?.

No, no. 5.2% excluding the one-time events. So, our spreads are nice. As you'll do the calculation..

Final question, why haven't you seen, are you seeing more new comers come into debt market to you for the venture debt?.

As always said the water is warm and everyone is welcome. It's a very hard asset class with a lot of various entry. We make it look easy, it's anything but that. It's a very hard asset class I think that there are new entrants that always come in from time to time but very few have the scale and the capabilities that we do..

Correct. Okay. Thanks for taking my questions..

Thank you. Our next question comes from Henry Coffey with Wedbush. Your line is now open..

Yes. Good afternoon and let me add my congratulations. I haven't seen you guys this excited about where the business is going since the ancient days. And when I look around and I made this maybe on fair assessment, but the large identified competitors that we saw back in the 00's.

I don't hear them or maybe they are out there and I just don't know who they are but the growth opportunity is fairly large.

And then the only other question I'd sort of throw into this discussion is the access to a robust source of financing with sub 5% is there such a beast out there that you can find that doesn't have any negative features or past facilities like that? Were you part of a conduit or something or is it just the nature of the credits such that you get the yields, you get but you have to suffer the higher funding cost?.

Okay. We said this all along, scale in this business is very critical whether you are Aries Capital or Apollo, TPG, scale does matter in VC world and it certainly has a huge significance and importance venture lending because exactly your point. When you have the largest scale, you can access a wide array of different types of capital.

You can laterite your maturities, you can kind of blend your different cost of funds to get to be very effective as we've been managing since 2011 with a treasury function. Our cost of funds are now are hovering around 5.2%, while our total yields are 12.7% and effective yields higher than that. So you can use the spread.

So when you look at leverage in this business and we're operating at historically at about a 75% leverage level, when you actually maintain that discipline without changing any of your investment parameters and start adding gradual leverage of 1 to 1, or 1 to 1.15 or 1.20 to 1 it only magnifies the strong credit performance you've had into strong ROE's.

So scale is a big driver in that issue and maintain a discipline. But no Henry, to your point we are not aware of nor do we see any competitive threat of our size anywhere in the marketplace aside from one or two of the large venture banks. But beyond that no, we don't see that..

And when you think about leveraging in 2019 and 2019.

Is it going to be more likely to be some form of unsecured rated term debt or do you think there is room for an asset based facility?.

As we all know, the yield curve right now is signaling some complex mixed messages with the inversion that some people argue it [indiscernible] earlier this week. But looking at the elongated part of the yield curve it's actually more economical for me to later our maturities to 10-15 year levels.

Then it is to do near term bonds at the three to five-year level right now because of the yield curve. It's a very good instrument for the rating agencies and also for ourselves to maintain a wide distribution or diversifying liquidity structure or capital stack. So, we always like to have bank lines.

We like to have the SBA, the SBA has been a great partner of ours for over a decade. We want -- we've now done two securitization, we'll probably do a third securitization.

We've access to the invested grade bond market, we have accessed the five year retail market, the five and the seven year retail market and the 10 year retail market and we do a convert.

So we have a pretty robust treasury function to manage the cost of capital and natural liquidities that we're looking for a lathering out maturities and that's part of the overall corporate strategies that we have here given our size is managing that cost of funds and managing the different levels and maturities and different maturity dates one has out there..

So, it's going to be a complex structure going forward?.

I would argue that we already have one now, but yes it will somewhat what we have now and probably even further enhanced..

Great. Thank you..

Thank you. Our next question comes from Robert Dodd with Raymond James. Your line is now open..

Hi guys, two questions. First on kind of the core yield. The 12.7 very good number, historically for 17, even though that's 19 you are talking about kind of the range typically being 11.5 to 12.5. Is this quarter, the 12.7 kind of obviously base rates have moved higher. You'd talked about the advantages you've gotten the credibility in the market.

Is this 12.7 an indicator of kind about a structural shift that maybe you are going to live at the high end of the range or maybe above the high end of the historic range of is it just? We've seen high quarters and poor yields before as it's just a good quarter but not indicative of some kind of overall trend?.

So, I think in fairness to your question with all the above. There's certainly embedded benefits for now nearly four rate increase that occurred and the portfolio now stabilizing without having a lot of release activation.

Again, to reap the benefits of that lower portfolio turn were some of the earlier assets are benefitting through those rate increases.

So yes, that's [indiscernible] factor to that increase of 12.7 and the second part of your question there's no structural change in what we're doing, it happens to be a benefit of the market catching up with where the core yields are now in the marketplace they are originating and the benefit of those four previously increases in the overall rate.

We do not anticipate us going much below 12% for quite some time in our modeling right now. In fact, as I said at the earlier part of the call 12.5 or 12.7 is a range that we're pretty comfortable looking at for Q3 right now from what we're seeing in the portfolio on a core basis..

Got it. I appreciate. And maybe just one more if I can. You just mentioned obviously the diversity of the funding sources so do you want to utilize.

You just paid off all the debentures in HT2 any update on or where you are on getting the next license if the application is still outstanding I don't even know?.

I think that we have begun that process. I don't want to handicap that or speculate as for the time being. But I would say to you that given that we've been great partners with the SBA that we have paid back the debentures.

We continue to find the economic hub zones, but they want us to be invested in, and helping American companies and helping American employment and American innovation. I think that we remain and continue to be one of the poster child of what the SBA program stands for and helping them advance American ingenuity.

So, we're very hopeful and remain optimistic that the SBA will move quickly and also grant us our license. If it happens in 18, that's the cherry on the sundae. If it happens early 19, that the beans on the ice cream..

Appreciate it. Thank you..

Thank you. Our next question comes from Finian O'Shea with Wells Fargo Securities. Your line is now open..

Hi guys, good afternoon. Thanks for taking my question and congratulations on the pretty good quarter on originations and gains we saw. They've been a lot of questions today, I'll do a higher level one on the $1.55 billion to $1.65 billion year-end target.

Let's assume you hit this and raise it again, given the opportunities that remains large, which I believe it does given your deployment.

Can you give us just some color on the conversations you have say in January regarding the year-end targets just assuming you still value growing the might of Hercules? Where are you in the lifetime context as to turning to optimize the ROE profile for example run higher leverage, kind of focus on asset yields as Robert was just touching on et cetera..

So, I assume you are referring to fiscal January 19?.

Yes. Just I guess I can ask or work that much more shortly how big do you want to grow given the current opportunity set. And I recognize you continually, you do this in a measured pace but you look on pace to hit the year-end target just trying to get a feel of how big Hercules gets..

I think that we're comfortable saying for the time being is that one of the drivers on growth is certainly the vibrancy of the venture capital industry. Because we are directly correlated with venture capital investments in new activities and funding of those companies.

So we have a great slide in our investor deck that actually points to that we typically represent about 1.4% of the total venture equity dollars that are invested are matched by Hercules debt capital out there.

So by extrapolation, if you assume that the venture capital industry would do $100 billion in fiscal 18 and you keep that same percentage of 1.4% participation that Hercules Capital has had historically, you would see that that would be great about $1.4 billion.

Now would you probably do that, but what I'm not comfortable and we're not comfortable going to that level. I think we much more prefer to be at the $1.2 billion level of the commitment this fiscal 2018. So that means that I think that we're not just looking to grow to grow because that's something we don't believe in.

We grow when the asset quality makes sense and the deals and yields make sense. That is to grow to grow, is what we don't get paid for AUM. So, it doesn't matter us, we get paid for strong asset performance. So that means is you got to distill all that down.

I think that we're comfortable saying that the loan book grow on a net basis on an annual level between $250 million and $350 million is kind of the cadence that we would like to see the loan portfolio grow on a year-over-year basis.

And so, in fiscal 2018 you're probably somewhere in that $250 million to $350 million on a net base that we talked about and that's kind of the way we look at on how we want to grow the loan book and a much more controlled in a slow and steady growth that we talked about earlier..

Very well. I thank you for the color. And thanks again for taking my question..

Thank you. I am not showing any further questions at this time. I would now like to turn the call back over to Manuel Henriquez for closing remarks..

Thank you, operator. Thank you all for joining us today. We will probably going out and having non-deal roadshows over the next couple of months. We're scheduled conferences are not to begin probably till late September early October, at which point we'll make those announcements. With that, thank you everybody for joining on the call today.

And thank you very much for continuing support and being a Hercules shareholder and bondholder. Thank you everybody and have a good day..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a great day..