Good afternoon, ladies and gentlemen, and welcome to the Hercules Capital Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduction a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Michael Hara, Senior Director of Investor Relations.

Thank you, Sharon. Good afternoon, everyone, and welcome to Hercules' conference call for the second quarter 2016. With us on the call today from Hercules are Manuel Henriquez, Founder, Chairman and CEO; and Mark Harris, Chief Financial Officer. Hercules' second quarter 2016 financial results released just after today's market close and can be accessed from Hercules' Investor Relations section at htgc.com. We've arranged for a replay of the call at Hercules' webpage or by using the telephone number and passcode provided in today's earnings release. During the course of 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 delays between the date of this release and then the confirmation of 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 uncertainty 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 on 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 thereof. And Hercules assumes no obligation to update the forward-looking statements for subsequent events. To obtain copies of related SEC filings, please visit sec.gov or visit our website, htgc.com. For today's agenda, Manuel will begin with a brief overview of our second quarter business highlights, followed by an overview of the competitive environment and venture capital markets, and our perspective and outlook for the third quarter of 2016. Mark will follow with a summary of our financial performance results for the second quarter of 2016. And following the conclusion of our prepared remarks, we will open up the call for question-and-answers. With that, I will turn the call over the Manuel Henriquez, Hercules Chairman & Chief Executive Officer.

Thank you, Michael. And good afternoon, everyone, and thank you for joining us today for Hercules Capital second quarter 2016 earnings call. First and foremost, I am very pleased and proud to announce another outstanding and very, very busy second quarter for Hercules Capital which culminated and not only delivering $0.32 in net investment income, but also exceeding our dividend of $0.31 as well as exceeding that strict consensus by $0.02. This is a very important achievement for Hercules. Just one year ago, we made a conscious decision to invest in our organization – in our infrastructure to ensure our platform was capable and ready to support future additional portfolio of growth. We made that investment consciously expecting a portfolio over time to grow to $2 billion to $2.5 billion. By doing so, we made the decision not only to merely focus – we made the decision not to merely focus on short term performance, but to ensure that we're making long-term investments for the greater good of our shareholders long term. By doing so, we caused a dip in earnings in the early part of 2015. However, since then, we have steadily risen our quarterly earnings each quarter thereafter, culminating in second quarter of 2016 of achieving $0.32 in earnings for our shareholders. Our decision to invest in our future has begun to generate significant and expected dividends and returns on behalf of our shareholders as evidenced by our continuation of earnings growth as well as our achievement in the second quarter. In just one year, we have successfully grown earnings from $0.23 in Q2 2015 to over $0.32 NII in Q2 2016, representing nearly a 40% earnings growth year-over-year. While this earnings growth in itself is impressive achievement, it was, nonetheless, overshadowed by an equally important achievement and…

Thank you, Manuel, and good afternoon or evening, ladies and gentlemen. I'll now briefly discuss the financial results for the second quarter of 2016 and add some detail and direction to the reported numbers. With regards to portfolio growth, we had a strong total investment fundings of $159.8 million in the second quarter including the addition of eight new portfolio companies. While we had $117.6 million of unscheduled early payoffs and normal amortization of $24.1 million, we were still able to grow our debt investment book accordingly. This resulted in our debt investment portfolio increasing to a cost basis of $1.26 billion at the end of the second quarter. The unscheduled early payoffs drove our effective yield to 14.4% in the second quarter, which was up significantly from the 13.2% in the first quarter. As we have early unscheduled payoffs of $117.6 million in the second quarter compared to that of $55 million in the first quarter, that's an increase of 114%. As Manuel stated, we expect to see $50 million to $75 million of unscheduled early payoffs in the third quarter of 2016 with our effective yields to maintain between 13.5% and 14% given the age of our debt investment book. Our core yield which exclude the effect of prepayment penalty season accelerations from our payoffs was 13.4% in the second quarter, which was up nearly 4% from the first quarter. Our core yields continue to maintain their increasing momentum within the portfolio, which is driven by the addition of new debt investments at more favorable terms, offset by older payoffs in the period. As Manuel discussed, we expect our core yields to maintain around 13.25% to 13.5% on a going forward basis. Net investment income was up to $23.4 million in the second quarter or 16.4% from the…

[Operator Instructions] And your first question comes from Jonathan Bock from Wells Fargo Securities. Your line is open.

Good afternoon, and thank you for taking my question. Manuel, your comment about reaching that equilibrium was very interesting and fascinating point. And so, we do understand that the math can work where if you keep the assets on the balance sheet, you're going to effectively be at the same earnings level to the extent that you would proceed with early payoff. I'm curious, if you look at the asset that is Sungevity, just because of its size at roughly $70 million and $68 million, to the extent – and it's also in a definitive merger agreement and do they keep the debt? Do they not? Do we receive a significant back-end fee as a result of that repayment that would effectively allow us to go into that equilibrium that you suggest, or not? I'm interested in that one in specific just because it is so large.

So, I mean the good news is like you speak about is that tripping up any confidential information that we have on behalf of Sungevity, which is a company that we actually have a very solid position in. Sungevity actually has a publicly filed S-4, and you'll see in their publicly filed S-4 with the SEC that they specifically do not mention or discuss the repayment of Hercules debt So, we do not anticipate nor do they anticipate from what we know today and they know today of any intention of paying off that debt at all. We are perfectly happy to remain a very strong partner of theirs. We are delighted to see the mergers that they're involved in and further bolstering their liquidity position. But at this juncture, there is no expectations of any early payoff activities from Sungevity, merely with the confirmation of the mergers that they're contemplating right now. So, I hope that is responsive to your question.

Yes. I appreciate that. And then, also talking about the ability to fund new investment growth using leverage, but of course, we also see the small and also prudent issuance of equity via the ATM. Manuel, it's the $64,000 question I always gets asked in the BDC space as it relates to need for additional equity capital to fund opportunity without sacrificing substantial growth. So as you look through your modeled plans, do you happen to see any additional need for equity outside of the small dribs and drabs as you're able to issue through the ATM program?

Well, having to run a publicly company for nearly 12 years, the answer is that I'm not going to answer that question. The issue on equity rates is one that is evaluated by us and our board of directors. We continue to trade above book and we recognized that that privilege that we have and that premium and we are very, very cognizant as me being one of the largest shareholders on the impact of any dilutive capital raise. Even though it will be highly accretive to book, so the response to that question is in the near term, we were not under any pressure or needed to raise equity capital. We prefer to continue to deploy our available headroom that we have in our leverage. Continue to drive even higher ROEs that we're already generating nearly 12.5% ROEs and drive that higher. And then once reached the $1.4 billion loan book or so, we will then take a pause at that point and reevaluate the March conditions and whether or not we believe we continue to take any new equity capital raise that we do. And put it to work in relatively short order that doesn't at all threaten the possibility of a dividend cut which – dividend adjustment [indiscernible] dividend. So one of the things I will not do is sacrifice the earnings on behalf of the dividend itself. So there is no immediate need for us to raise equity. But we reserve the right to evaluate that especially post the election of what we want to do. But at this point ATM is more than adequate and it doesn't raise that much money, but it's a nice tool to have. This is accretive to shareholders.

Got it. And as we continue to look at the venture space in particular, venture leaders such as yourselves, we're starting to see effectively to, we'll call it, distinct pathways or thoughts in terms of how one underwrites. One can be an extremely credit-focused shop and great at – everyone is credit focused, I want to try to be clear, but one where you can take more episodic investments that allow you to earn above average returns or perhaps a more sponsor-oriented pathway where you're focusing on a subset of individual venture sponsors in an environment and have multiple deals, right? And those high-quality sponsors could effectively support those deals going forward. As we look at where we sit in this stage today where – and I understand that both sponsor and credit, they kind of weave together but you can see some venture lenders on one side or the other of the aisle. Where do you see more opportunity between focusing specifically on a subgroup of sponsors versus always trying to focus on more episodic credits across the wide variety of industry? Where do you see more opportunity between the two and more importantly, why?

Okay. No disrespect to you but that comment that you may have been fed is completely, as Ryan said, malarkey. This pretense that somehow dealing with a privileged group of venture capitalists that somehow we don't think that access to you is completely ridiculous. You don't do $425 million of new commitments in the first six months of the year without having a broad access to all the top-edged capital firms in the country. So this pretense that somehow another venture lender may have a privileged relation with the venture capital firm is completely idiotic. So, that's non-existent. On the episodic thing, I think that investing in episodic events can in itself be very dangerous. I think that you have to first be a prudent leader and use a credit discipline. So whether it's sponsored or not is important but it's not the end or deal. When you [indiscernible] simply relying on sponsors, you're actually deriving very low yields or you're being forced into a subordinated secondary credit position [indiscernible] behind a bank which you have no credit control. So, we don't ascribe to that either. I think that our testament of our performance speaks for itself and I think that you cannot just invest in trendy value deals and you cannot simply invest in a subset of venture capital firms because somehow they have the golden keys of the kingdom. I think that is not existent. I think fundamental underwriting of credit and understanding industry trend is far by most important part of the underwriting process. And having four specialized uniquely structured lending teams or groups is what really makes us different and allow us to have a deal flow and the access to capital that we do. But I don't ascribe to that rhetoric, with that ideology. I think it's baseless.

I appreciate it, Manuel. And you're correct; the performance does speak for itself. So, thank you for taking my questions.

Your next question comes from John Hecht from Jefferies. Your line is open.

Thanks very much, and Manuel, congratulations on covering the dividend in the timeframe you told us you would. The first question is for Mark. Mark, just clarification, did you say we should expect the combined interest expense and fees on the debt to be about $9.5 million a quarter or is it just the interest?

No. Sorry. It's interest expense and fees. I combined those to be between $9.5 million and $10 million on a going forward basis.

And then you guys detailed the – I guess you took some small impairments across a few different assets. I mean, any detail you might recapture some of that but is there any, – was that just market pricing that drove that, was there any kind of characteristic of things that turned in the market that you saw that you wanted to address evaluation?

No. My overall comment on that would be that, first of all, is deal-specific. So each one has its own story. But again, being pretty conservative [indiscernible] we look at each one. We make a determination based on events that have happened, they're tracking, et cetera, and then we make the appropriate adjustments to those. So it's not really specific in the sense that it would be one, certain vertical but the specifics for example [indiscernible] to an M&A event, or what's going in terms of their activity. Manuel, I guess I'll turn it over to you as well if you want to add anything to that?

I think it's fine.

Yeah.

Okay. And then I know Manuel, you talked about [indiscernible] there in Q4 to kind of figure out the specific repayment pattern debt in Q4. But I guess just more generically, at what point – how far in advance do you get indications of prepayments in order you'll get some bit of forecasting available to us?

So, on an M&A event, if the company's is in the process of M&A event, typically, we'll have an indication that can be as much as 45 days out. On a refinancing, by commercial bank for example, you may have two weeks’ notice if that. So it varies dramatically. Obviously, an IPO, it's a long lead time because these are filed and they state in the prospectus S1 or S4 that an event of refinancing would take place. So generically speaking, 30 days is probably the most you have visibility to, with a confidence level and that's about it. And that could change quite a bit. As you saw in our own portfolio and rolling from Q1 to Q2, we had two events of M&A that were to take place in Q2, that – one fell apart and one slid. It's just the nature of [indiscernible] when you acquire innovative companies that the M&A that are announced not all the time close as well.

Okay. Appreciate the color. Thanks, guys.

Thank you.

Your next question comes from Ryan Lynch from KBW. Your line is open.

Hey. Good afternoon, guys. Just the first question relates to you guys' public equity portfolio. You guys experienced some pretty big depreciation from that portfolio in the quarter. So, can you just maybe talk a little bit about your exit philosophy on some of your public equity positions? How long – what is your philosophy on how long you guys plan on typically keeping those in the portfolio after you guys – those companies IPO and go public and maybe particularly with the Box situation?

Sure. So specific to your question, oftentimes, we're still subject to a lock up that can range 180 days or more post the IPO. But typically, 180 days is what we see. Oftentimes, our public portfolio may have cost bases which you could see in our [indiscernible] investment that even though the company may have gone public, it may have experienced a downdraft as a sector or specific to that company, which means that selling equities at that point would be a capital loss, a realized capital loss event. And so, we're not necessarily interested in doing that because we still believe this confidently in the company's ability to achieve what we expect to achieve. So we'll be long on that position. Specifically on Box, it's one that – I think it's safe to say it's been frustrating for a lot of people including ourselves. We think the company continues to execute extremely well. I think we continue to be a leader in the category and I think that they more than us but I think together we're all frustrated that stock is still at $12 and not a $20 a share for example. But that said, I think that our holding of box is kind of running against its timeframe. So our philosophy the answer to your question more specifically, once we achieve a strike price on the underlying securities, meaning for appreciation, we will sell the position. Because unlike an external manager, we're not being paid more or less by AUMs asset under management. So we have no [indiscernible] incentive to keep the stock on our books unless it makes a prudent sense to actually sell it or realize the gain. So in that context we're fully aligned with our shareholders in that point of view. Because incentive for us and only unless it make sense to hold it.

Sure. Okay. And then next is kind of following up on your commentary you made around pulling back a little bit or being a little more conservative around the election. It feels like at least in the second quarter certainly is you'll think it was a pretty good time to deploy capital in the markets you guys core yields increase nicely. Feels like a competitive standpoint some of the competitors may have pulled back being low in capital allowed you guys to put out some really good loans, have some really higher yields. So just how were you guys balancing the election risk that you guys see in the third quarter with the potential risk of losing out on maybe some high quality transactions to competitors?

Well, I'm not sure we're losing high quality transaction to competitors. I can pretty much assure you that. And again, I didn't say we're not in the market, I didn't say we're not doing deals. We've already done $120 million in the first 40 days [indiscernible] 40 days – first 37 days of the quarter already. So we're active and remember what I said, we're expecting up to $75 million in early payoff, and we're growing the loan book by $20 million to $40 million. So, that's essentially funding $100 million in transactions growth in the quarter, which means that you're probably originating $150 million or more in new commitments. So, we are quite active in the third quarter. We're just not stepping on the gas because I believe strongly that once you go into the mid- to late-September timeframe, so October and early part of November are going to be hold on to liquidity because who the hell knows what's going to happen in this election? And the capital markets may be adversely impacted. I want to be in a position fortuitously to take advantage of strong liquidity in the fourth quarter while others may not have access to the equity and capital markets at that point where I could actually capitalize on exactly your point on wider yield spreads and better credit quality in the fourth quarter.

Okay. That's all the questions for me. Thanks, guys.

Thank you.

Your next question comes from Aaron Deer from Sandler O'Neill & Partners. Your line is open.

Hi, guys.

Hey. How are you, Aaron?

Good. Say, Mark, I guess following -up on the earlier credit question, you talked a little bit about the impairments taken in the quarter. Looking specifically at the non-accruals, those were down sharply. I was wondering if you can just give some color in terms of what were the inflows and what were the outflows and kind of what drove those trends.

Sure. So, basically we had one big transaction that we had on non-accrual that came off. We've restructured that. It also kind of goes back to one of the earlier questions that was asked under the impairment side which, when I first got here, we had an impairment, but it's done a great job in turning [indiscernible] around and we restructured accordingly, and now it's producing quite well. And then we added two other loans that were put on non-accrual if you will, too, to mix. So, it really is just a net outflow of cost bases over non-accruals which again over the loan net cost kind of drove that down for us.

Maybe specific, we have basically four transactions they can isolate the variance attributed to all the non-accruals and the credit impairments that we took. Three of those transactions are absolutely earmarked and actively engaged in some form of an M&A transaction one way or the other with respect to the companies. Two of which we have a high confidence levels of where are they in the process and definitive agreements. They're at or about to sign to conclude those events that may lead to, in some cases, full recovery of the impairments meaning full recovery of the initial investment itself. So as Mark, indicated in his opening comments, there's a possibility of seeing recovery of anywhere between $5 million, $10 million, $20 million of recovery just by the consummation or completion of some of these pending M&A events that these companies are contemplating on right now. And then third example, we had a company that was engaged in an M&A event but that transaction fell through. However, the underlying in terms of property of the company is quite valuable, and so we expect to see monetization of the intellectual property value in that company. However, that monetization in that particular company will not be fully recovering of our initial investment which is why we're taking a more aggressive markdown on that investment itself.

Okay. That's helpful. Thank you, guys. And then I also just wanted to inquire on the yields. Manuel, you made a couple of comments regarding the – you're getting higher rates on your new debt originations. A lot of conversations that I've had with other lenders over the past quarter, really the past couple of years has been just continuous [indiscernible] of more pressures on rates due to the rate environment and competitive pressures. What's unique about what you're doing that's allowing you to get even better rates on your originations?

Well, [indiscernible] it’s really wide timeframe there, a couple of years. I mean the way market has changed dramatically only in the past honestly, three to five months. I would now sit here and tell you that we saw a great rate in Q4 2015. I think we didn't see – not great rates in the January and February timeframe. I think what has happened subsequent to that is that, you've seen many commercial banks reporting credit stresses and credit issues, you're seeing some commercial banks vacating [indiscernible] lighting. So the answer to your question broadly speaking is, over the course of the last three to five months, we've seen a dramatic shift in competition, and we've seen a pullback in various sectors of – by commercial banks and certain types of asset classes that we are involved with, and having that revert back to more of an ABL revolver type structure and less in the term loan area.

Okay. That's right. Thanks.

[Indiscernible] occurring in the short-term not over again, greater than three or five months ago, no. It's just in near term, that's what's happening.

Yeah. I understand. Okay. Thank you.

You're welcome.

[Operator Instructions] And your next question comes from Robert Dodd from Raymond James. Your line is open.

Hi, guys. On the kind of the election question, following up [indiscernible] I mean, if you're hesitant or your commentary there related to an expectations that the market is going to slow heading into – slow is relative, obviously everybody put out a lot of money, slow heading into the election or is it a decision by you at Hercules to not want to risk shareholders' capital ahead of such an uncertain event? So is it a market issue or is it your particular choice separate from the market?

I honestly can answer the question, it's our choice. I think that to serve as a witness to what happened with the Brexit, I think that you have total opposite, and I'm not taking any political view on this call nor expressing any political view, but I think that if you use Brexit as a proxy as to what may happen when you go one way or the other, the ramifications or the repercussions to which, are now self-evident with the outcome of Brexit. I think that when you look at Canada, whichever camp that you want to be in, and you exercise your judgment as to one channel over the other, there are material implication on the victory of one candidate over the other on the implication in the equity and debt capital markets. Because of that, election is so tight and because of its inability to make that prediction, I rather be long liquidity than short liquidity going into this election. And since I'm talking about a 60-day window here between sometime in mid-September to November something, once we have that outcome behind us, I think that that point will decide – judge it whether to go back in the market or not. And depending on the outcome, you may see a very favorable capital market or you may see a very challenged capital market thereafter. And so rather than speculate – just like we did by the way, when I executed the bond trade that we went out as an organization and end up raising $142 million ahead of the Brexit vote, I think that tells you what we thought about the Brexit vote and where we came out and how well we feel today like holding on liquidity. So we're thinking the same view, that same pragmatic view going to this election that I don't know who's going to win. I'm not calling who's going to win. But I do know is that not being long liquidities, probably the wrong side of trade.

Okay. That's very fair, very fair.. Going back to the collateral base, impairments on the debt. In the past, you told us how – I mean, obviously, you tend to mark down portfolio as they come up to a funding need just to be conservative. I mean, is that a factor in play there when you talk about obviously the M&A maybe being obviously forced in those situations by company needing capital in that? Is that being a source of where you can get the recoveries from, or is it just struggling companies right there?

Well, no. I mean, there's some plethora of source of repaying our debt that takes place. I mean, here's a good example. Post the second quarter, BIND, one of our biopharmaceutical companies we have investment in prior to quarter went into bankruptcy. I'm happy to report and disclose in our earnings release that BIND successfully was able to sell its intellectual property [indiscernible] our pharmaceutical for nearly $40 million and was able to successfully fully repaid our debt as an example. Further occurring is a company called [indiscernible] in our portfolio also publicly traded and also publicly filed for bankruptcy. And subsequent to that, we have a mark on our book at the end of the second quarter about $1.75 million on our mark. And I'm happy to report that subsequent to that, even though the company is [indiscernible] liquidation, we have received just a few weeks ago $1.6 billion in cash payments already paying down their obligations. So just because the company is an M&A, and just because the company is in bankruptcy Hercules because of our historical experience and working with our companies and our financial partners, we structure and know what is the right level as best as we can on that loan to debt ratio or capital into that company. It is not an exact, it's more of an art and therefore it's a very difficult thing to do. But we have enormous amount of experience in this area in doing this. And just like I said and Mark has reiterated in his commentary, even though because we are very much in line with shareholders, we will take markdowns as evidence of historic performance because we feel that is the appropriate thing to do under fair value accounting. In difference to what impact it may have on assets under management or incentive fees. We will do markdown because we think that's the appropriate thing to do. And we hope as we continue to work with those companies as Mark said, and many of those companies we markdown during the quarter, we are still very optimistic that if the M&A engagement that they are currently underway on come to fruition, we see $10 million, $20 million, $15 million of principal recovery for loans that we have previously marked down not to mention full recover of those investments just like we've done in the past. But fair value accounting requires us to do what's right actually what is the value of that asset at that time. And that is what we do without any shame we will mark the assets appropriately down.

Yeah. I appreciate that, great color. One last question particular if your loan liquidity going into the end of the year. Obviously you got $103 million bond, 7% materially higher cost to capital than any of the other debt you can probably expand the 6.25% again, any thoughts to refinancing that towards the end of the year?

Well, you said – various important points there. Number one, my actual loan liquidity related to the bonds at the end of the quarter is just merely $50 million. And that $50 million will be invested here very shortly which means that I have no negative spread at that point because I don't have cash that's not earning much interest. So at which point you can be confident that we'll be tapping our bank lines which are undrawn that serves from the abundance of that liquidity of $55 million. So, I have $195 million of undrawn bank liquidity available to me that's not burning a hole in our pockets from the negative spread. As to the second part of your question, the seven-year bonds, we feel that the short-term range of the curve is completely mispriced. When short-term rates are demanding much higher credit spreads than are wanted, we are not very actively looking to do a refinancing under five years given the right spreads that we're seeing on the five-year end of the curve versus the 10, 20, or even 30-year end of the curve which are much more attractive. As you know, the yield curve is flatting dramatically when you go further out. So, I think that the short term of the curve is mispriced. We're hoping that as the market stabilized, that we'll see tightened yield spreads over the five-year rates. And once that occurs, I think that you'll definitely see us actively go out and refinance those 7% bonds you've been referring to which as I'm sure you'll realize in the event of refinancing those 7% bonds, that alone can be a 1 to 3 – sorry, $0.01 to $0.015 in quarterly earnings and prove it by resizing those bonds. But we'll make sure people understand this comment. The five-year treasury rate is acting like an Internet stock. Today alone, the five-year rate dropped nearly 4% to 1.03%. This is a five-year treasury rate. It's not supposed to be that volatile. That tells you what is going on. The 10-year rate is only 47 basis points wider than the five-year rate. That means I can borrow 10-year at 47 basis points higher plus the spread. That tells you that there's no incentive to the short-term borrowing in the capital markets right now.

Okay. I appreciate that. Thanks a lot.

At this time, I would like to turn it back to the speakers for any further remarks.

Thank you, operator, and thanks, everyone, for joining us on the call today. We will be attending the JMP conference in New York City on September 27th. If you have any interest in attending, please contact JMP Securities or Mike O'Hara in our Investor Relations department. Again, thank you very much, and thank you for being our investors.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.