Hercules Capital, Inc.

to press star 11 on your telephone. You will then hear a message advising your hand is raised. To withdraw your question, simply press star 11 again. And please be advised that today's conference is being recorded. I will hand the call over to the Managing Director of Investor Relations, Michael Hara. Please go ahead.

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

Thank you, Michael, and thank you all for joining the Hercules Capital Q2 2024 earnings call. Following our record funding activity in Q1 2024, we followed up with a record second quarter of total gross fundings of $461.5 million. which led to record total gross fundings of 1.07 billion for the first half of 2024. This is the first time in our 20-year history where we have delivered more than 1 billion of gross fundings in the first half of a calendar year. Our origination and funding performance in the first half continues to reflect the benefits of being able to operate an institutional venture and growth stage lending platform at scale and being the clear market leader in the asset class. Our ability to again deliver creative solutions for our new borrowers and strong results for our shareholders in Q2 while managing our balance sheet and business conservatively positions us well heading into the second half of 2024. Hercules' strong performance continues to be driven by our committed employees, our team-first culture that emphasizes internal and external collaboration, and a balance sheet that is liquid, long-term oriented, and institutional. As of the end of Q2, Hercules Capital is now managing approximately 4.6 billion of assets, an increase of 14.7% from where we were a year ago. We continue to expect the second half of 2024 to experience higher than normal market and macro volatility, given the presidential election and potential changes in the global geopolitical environment. As we discussed on our last call, we expected the market environment for new originations to improve throughout 2024 and we have certainly witnessed this in the first half of the year. While Q3 is typically a seasonally slow quarter for new originations, we remain optimistic about our funding activity over the second half of the year. We intend to continue to manage our business and our balance sheet defensively while maintaining maximum flexibility to take advantage of market opportunities. This includes continuing to enhance our liquidity position, maintaining low leverage, tightening our credit screens for new underwritings, and maintaining our higher than normal first lien exposure, which increased again in Q2 to 90.1%, up from 88.4% in Q1. Let me now recap some of the key highlights of our performance for Q2. Given the strength of the technology markets and the moderate improvement in valuations, we continue to see a steady volume of quality later stage companies looking to add new capital to their balance sheets. We are enthusiastic about the profile of the companies that we have been able to partner with over the last several quarters, and our primary focus remains on quality credits. In Q2, we originated total gross debt and equity commitments of over $686 million. and record Q2 gross fundings of nearly $462 million. Given the strong funding start for the first half, for Q2 we generated record total investment income of $125 million, up nearly 8% year-over-year, and net investment income of $82.4 million, up nearly 9% year-over-year, or 51 cents per share. and providing 128% coverage of our base distribution of 40 cents per share. We were able to achieve 128% coverage of our base distribution despite ending the quarter with very conservative gap leverage of 94.8%. This is our fifth consecutive quarter of over 100 million of quarterly core income, which excludes the benefit of prepayment fees, or fee accelerations from early repayments. We also generated a return on equity in Q2 of 19.2%. Our portfolio generated a gap effective yield of 14.7% in Q2 and a core yield of 13.7%. The small decrease in core yield in Q2 was largely attributable to more first lien exposure an emphasis on later stage transactions, and heavier payoffs from legacy higher yielding assets. Our balance sheet with conservative leverage and low cost of capital remains very well positioned to support our continued growth objectives and provides us with the ability to go lower on yield for higher quality assets when warranted. This serves as a key differentiator of our business. relative to our closest competition. The focus of our origination efforts in Q2 was once again on quality and diversification. Our Q2 origination activity was driven by both our technology and life sciences teams, delivering record funding performance during the quarter, although new business activity was weighted slightly more towards technology companies. In Q2, approximately 63% of our fundings were to technology companies, while approximately 55% of our commitments during the quarter were to technology companies. Our new commitments in Q2 reflect our more optimistic view on the technology sector and an increase in the number of later stage quality technology transactions that our team is currently seeing in the market. The equity markets have been particularly robust for public life sciences companies, which has caused some life sciences companies to push out decisions on debt financings by a quarter or two. We funded debt capital to 25 different companies in Q2, of which 10 were new borrower relationships. Consistent with what we saw in previous quarters, we expanded our funding relationship with numerous portfolio companies that continued to show strength and achieve performance milestones during the second quarter. Our available unfunded commitments decreased slightly to approximately $479.5 million from $483.4 million in Q1. Since the close of Q2 and as of July 29, 2024, our deal team has closed $28.1 million of new commitments and funded $45.4 million. We have pending commitments of an additional 210 million in signed non-binding term sheets, and we expect this number to continue to grow as we progress in Q3. Similar to what we saw in Q2, our expectation is that Q3 funding activity will be back-end weighted. Consistent with our historical approach to underwriting credit, we will remain disciplined on new originations, and we will continue to prioritize asset quality over chasing high-risk transactions with a slight yield premium. Our portfolio exit activity moderated a bit in Q2. In Q2, we had two technology portfolio companies complete acquisitions. We continue to have two portfolio companies that have previously filed registration statements for an IPO. As we anticipated, early loan repayments increased in Q2. to approximately 306 million, which was at the upper range of our guidance of 200 million to 300 million. Over 44% of our Q2 prepayments were attributable to M&A events or new equity capital events, which we view as a positive signal overall. For Q3 2024, we expect prepayments to remain similar to Q2 levels, and be in the range again of $200 million to $300 million, although this could change as we progress in the quarter. We also anticipate that the majority of payoffs will come in the first half of the quarter, which will likely lead to a lower weighted average debt balance for the third quarter. Credit quality of the debt investment portfolio remains steady quarter over quarter. Our weighted average internal credit rating of 2.18 increased slightly from the 2.16 rating in Q1 and remains at the lower end of our normal historical range. Our grade one and two credits decreased slightly to 67.2% compared to 68% in Q1. Grade three credits increased slightly to 31% in Q2 versus 29.2% in Q1. Our rated four credits decreased modestly to 0.9% from 2.6% in Q1, and rated five credits were 0.9%. In Q2, the number of loans on non-accrual remained the same, with the write-off of one loan and the addition of a new one. We had two debt investments on non-accrual with an investment cost and fair value of approximately $91.8 million and $32.1 million respectively, or 2.5% and 0.9% as a percentage of the company's total investment portfolio at cost and value respectively. With respect to our broader credit book and outlook, we generally remain pleased by what we are seeing on a portfolio level. and our monitoring remains enhanced. Our focus on credit underwriting and a diversified asset base is continuing to serve us well. We are continuing to see general outperformance and positive momentum in terms of capital raising, M&A activity, and milestone achievement throughout our life sciences book, while things are beginning to improve on the technology side with respect to the same metrics. Companies with slower growth rates and thin liquidity positions continue to struggle broadly throughout the ecosystem, and we are seeing some indications that the higher-for-longer rate environment is beginning to have an impact on certain sponsor-backed companies. During Q2, capital raising across our portfolio was very strong, with 24 companies raising approximately $1.7 billion in new capital, which was again heavily weighted towards our life sciences portfolio. For the first half of the year, we had 56 portfolio companies raise over 4.3 billion of new capital. During Q2 2024, Hercules had net realized losses of 5.8 million, comprised of gross realized gains of 5.8 million, primarily due to the gain on warrant and equity investments, offset by 11.6 million due to the loss on debt investments, warrant and equity investments, and losses resulting from fluctuations in foreign exchange rates. Our net asset value per share in Q2 was $11.43, a decrease of 1.7% from Q1 2024. We ended Q2 with strong liquidity of $482 million. Our balance sheet puts us in a strong position to be able to benefit from a new business environment that we believe is as strong as we have seen in several years. We further strengthened our balance sheet with the approval of our fourth SBIC license, which we received in July. This fourth license will provide access to $175 million of additional growth capital and help us to maintain our overall blended cost of capital. Also, subsequent to Q2, we retired our July 2024 unsecured notes, which Seth will discuss in more detail. Venture capital ecosystem fundraising and investment activity moderately picked up in Q2 with year-to-date fundraising activity at approximately $37.4 billion and investment activity at approximately $93.4 billion, according to data gathered by PitchBook NVCA. Both fundraising and investment activity are on pace with 2023 levels. We expect investment activity to remain at these levels, driven by more selectivity in terms of the profile of the companies receiving equity funding. Given our strong operating performance in Q2, we exited the quarter with undistributed earnings spillover increasing to approximately 145 million, or 89 cents per ending shares outstanding.