Hercules Capital Inc (HTGC) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2011 Hercules Technology Growth Capital earnings conference call. At this time all participants are in a listen only mode. Later we will conduct 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 our host for today, Mr. [Colin Hoover], with Investor Relations. Sir, please go ahead.

Thank you, operator, and good afternoon everyone. On the call today we have Manuel Henriquez, Hercules' Co-founder, Chairman and CEO, and Jessica Baron, Vice President of Finance and Interim Chief Financial Officer.

Hercules' second-quarter 2011 financial results were just released after the market closed. They can be accessed from the Company's website at www.htgc.com. We have arranged for a replay of the call at Hercules' webpage or by using the telephone numbers and passcode provided in today's earnings release.

I would also like to call your attention to the Safe Harbor disclosure in our earnings release regarding forward-looking information. 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 in the confirmation and final audit results.

In addition, the statements contained in this release are not purely historical -- 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 limitations the risk 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 based are reasonable, any of those assumptions could prove to be inaccurate and as a result the forward-looking statements based on these 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 visit the website, www.HTGC.com. Now I will turn the call over to Manuel Henriquez, Hercules' Co-founder, Chairman and CEO.

Well, good afternoon everybody. And I can only hope that we have people on this call after today's lovely stock market performance. Most of you, I'm sure, felt the pain as we all did. So hopefully we get a Q&A we have people here who want to learn about what we did and how well we performed in the quarter. So, good afternoon everybody. And good morning, good day to everybody as well. It is a tough day today.

Let me start off by saying that it has been an interesting time in the market over the last couple of weeks in the last couple months or so. A lot of which I will be speaking to you today, and a lot of which are strategy that we laid out about three to four quarters ago, unfortunately, has come to our benefit by maintaining a very conservative balance sheet in anticipation of such an event that we saw and experiencing today and the last couple of days.

I also like to preface it by giving a little heads up that we are operating on a very similar mindset than we did in 2007. We are operating a very offensive and defensive balance sheet and portfolio.

You'll hear me talk a little bit more about that as we get into the presentation here. But you will see why we have been doing what we have been doing over the last couple of quarters and why we are well-positioned for this current market that we are facing today.

After my remarks are completed, Jessica, our Interim CFO, will take over the call and run you through our financial performance in greater detail. And then, of course, Jessica and I will be more than happy to answer any questions that you may have during the Q&A session, assuming we have folks on the call after today's market.

So with that let me start off with -- give you an overview of Hercules. Hercules is extremely well-positioned in an offensive, defensive standpoint in markets such as ones we are facing today. We have a low leverage balance sheet, which makes us quite -- excuse me -- which allows us to be well-positioned to take advantage of building assets when others in our marketplace have no access to liquidity or leverage to speak of.

The strong balance sheet. We have over $300 million -- $330 million of dry powder to invest in new assets and continue to selectively grow our portfolio by taking a very surgical approach to asset origination and asset investing than simply looking at building assets to build assets to build earnings. We continue to remain very disciplined in that approach and we continue to remain very yield stingy as we look at new assets.

Solid credit performance. As most of you know, have seen in our public filings and earnings release you will see that the overall credit performance improved quite dramatically in Q2 from Q1. And that is the highest I have seen on a weighted credit performance since 2005. We worked very hard during the quarter to purge and get rid of assets that we consider to be highly susceptible to a double dip recession and highly susceptible to any decline or changes in a broader economy.

Those assets are lower middle market assets. By divesting ourselves of some significant lower middle market assets we actually were able to improve the credit performance of the portfolio, while also lowering the overall leverage in those particular assets we were invested in by booking prepayment penalties and acceleration of fees, thereby driving a solid earnings growth while improving the overall credit performance of Hercules.

In addition to that, we continue to move in a very defensive position by moving our asset allocation models much more towards recessionary -- I am sorry, recessionary risk -- pardon me, with asset who are less exposed to recessionary trends, such as life sciences, where life sciences assets are more susceptible to clinical trials -- FDA clinical trials than they are to near-term recessionary changes in the overall economy.

What that means is that life sciences assets tend to look at three to five year horizons as opposed to not worrying about near-term economic changes, because of their more subject to FDA clinical trial approval than anything else.

And you will see our portfolio has shifted quite strongly to almost a 50% weighting to life sciences in the second quarter, and divesting ourselves to the lower middle market assets, which I will speak to later on in the call.

Further, on bolstering our balance sheet and our income statement, is that 90% of our loans today are floating-rate loans with LIBOR or prime floors, allowing us to be very conservatively positioned for any rate changes that may occur in the market up or down, allowing us to preserve our income statement and earnings power in that changing environment.

In addition to that, we have also had 99% of our loans -- and I repeat 99% of our loans are currently senior secured assets. By disgorging some of our lower middle market assets we actually improved the credit, and we also solidify our position on a senior secured loan portfolio, allowing us to be well-positioned in this environment.

Similar to that, we maintain a similar conservative position on our balance sheet. We spend an inordinate amount of time making sure that our liabilities are matching our asset in terms of risk mitigation. What that means is that we have no liability maturing in the next five years, with the earliest maturity being the $75 million convertible debt which matures on April 2016. No debt outstanding today has a maturity earlier than April 16 and all debt outstanding today has a fixed coupon rate.

Beyond that we have a very strong pipeline. We have over $500 million of signed term sheets and closed commitments, which as of today, August 4 -- which will surpass our 2010 originations of approximately $520 million. However, even though we may have a strong pipeline, I want to caution that assets will close later in the quarter and they take longer to fund, which I will speak to as I go through this presentation.

Beyond our strong pipeline of signed term sheet and closed commitments, we also have a strong deal flow. Our deal flow today in terms of our pipeline is as strong as I've seen it in the past 2.5 years. We have over $1 billion in transactions looking for capital today.

All of this allows Hercules to be well-positioned in this uncertain economic times that we are in. I'm very happy to see our balance sheet the way it is today with over $330 million of liquidity and a strong balance sheet -- and a strong pipeline of deals to look at for asset growth.

While most people are struggling to look for assets, the venture community continues to see a very robust pipeline, and we are able to continue to build our loan portfolio with assets that are countercyclical to that of typical lower middle market recessionary prone companies.

Now let me speak to the actual quarter results, and get into more details that are on a high-level our quarterly performance and let Jessica expand on those results.

Total investment income is up 43% year-over-year. Net interest income at $10.4 million is up 51% year-over-year and and EPS level of $0.24 a share. DNOI, equally as strong, up 49% for the same time last year at $0.26 per share.

Now let me turn to our quarterly earnings -- quarterly asset growth. During the quarter we successfully originated $551 million of new commitments during the quarter. Conversely, we funded $105 million of those assets in the second quarter. This more than shows our ability to continue to identify assets and continue to grow our loan book.

However, we also saw, and continue to see, early prepayments of approximately $76 million, which is substantially all supported by lower middle market assets, which we as the incumbent lender chose not to defend the position and allow those assets to run out, given the insatiable appetite that commercial banks seem to have looking for [EBITDA] producing assets in the marketplace.

We in turn took a more conservative approach, by allowing those assets to run off and be able to record prepayment penalties at the same time as I said earlier deleverage on these highly leveraged transactions and also improve our credit outlook in our loan book, which we will speak to later on in the presentation.

As of June 30, our total assets were $475 million, an increase of 10% over the same time last year. Now as I alluded to earlier on, an important side note in our business is understanding and gaining visibility to loan growth and what that loan growth may look like in the quarters to come. One indication of that is our unfunded commitment number. Our unfunded commitment represents $93 million in unfunded assets at the end of June 30.

However, and as a reminder, unfunded commitments may not generally fully draw down and may take longer to draw down than anticipated. Further, to visibility -- backlog. We have as of today, August 4, $214 million of signed term sheets in-house representing future earnings growth or earning assets, which we expect to see a conversion to funded assets in the coming weeks, and so with the unfunded commitments that all commitments turn into funded assets.

Also, so far in the quarter as of the beginning of Q3, we have already closed on $46 million of closed commitments, and we funded approximately $35 million in new earning assets during the quarter. We continue to show very robust pipeline and a very robust continuation of conversion of assets.

Given that we have purged ourselves significantly from many of our lower middle market exposures, you have now see the portfolio revert back to its historical norms of higher concentration in venture assets, and currently a higher concentration in life sciences assets, as we position ourselves for a very conservatively managed portfolio in the coming quarters.

That said, we have an extremely robust pipeline. That pipeline is a factor of our origination team's relationship with the venture capital industry, are growing brand awareness of Hercules in the venture industry. And, more importantly, our strong liquid balance sheet, allowing prospective venture capitalists and entrepreneurs to gain confidence that their particular lender has the capital and the wherewithal to fund their commitments and grow with them as they seek and need additional capital in the future. Unfortunately, many of our recent competitors no longer have that benefit and no longer have access to the capital as much as we do in the marketplace.

We continue to expect, and I would like to remind everybody, as we turn to the third quarter, the third quarter historically is our lowest quarter in terms of performance and origination. This year, coupled with this current stock market performance, I do not expect to see much activities beyond August 15, and a lot of that will not start picking up again until sometime in the first week of September or so.

In this marketplace we expect to see a disproportionate amount of venture capitalists taking on vacation, thereby not allowing underlying portfolio companies to hold Board meetings until final approval of the loan and security agreements are signed regarding our debt.

As such, we expect much of the loans to close at the end of the quarter in the third quarter, thereby causing most of the earnings growth to occur late in the quarter, early into Q4, which Jessica will also add in her discussion.

In terms of what we are seeing in the marketplace, I would like to provide you some traditional color as we do in the venture industry, some color in the venture marketplace, the competitive landscape and, of course, some of our perspective on the lower middle market environment that we are seeing out there. To that end, let me speak to the venture capital marketplace and I'll come back to our balance sheet and liquidity.

During the second quarter we saw 14 venture capital-backed IPOs completed raising $1.7 billion. This is slightly down in terms of number of companies where we saw 15 companies last year, however, the number of dollars of capital raised is dramatically higher, representing a 98% increase in the dollars raised by IPOs in the second quarter of 2011 as compared to that of 2010. A very healthy sign of investors looking for growth stocks, particularly in the technology sector.

M&A was also equally as a boss. Although the number of M&A companies is down, 91 companies completed M&A transaction in the second quarter, from 105 companies in the second quarter of last year, however, the value of those transactions is dramatically higher than it was in the same period last year with less companies.

For example, we had 91 IPOs completed in [2000] -- the second quarter of 2011, for $9.2 billion in value compared to 105 companies only raising $7.2 billion, representing a 28% increase in aggregate dollars year-over-year with 100 -- excuse me, with 10 companies or so less than it was at the same time.

The venture capital marketplace remains very robust. We currently have 45 venture stage companies in IPO registration as of June 30, based on Dow Jones VentureSource data. The interesting part about that, approximately 20% of those companies, 7, if you will, of the 45, are currently Hercules portfolio companies that are in IPO registration today, making up just over 60% of the existing venture stage companies in IPO registration.

I would like to remind everybody that Hercules also has 99 warrant positions, which Jessica will talk about during her presentation as well.

Further to the venture capital ecosystem. The pace venture capital investment is critical to that of the correlation of Hercules and its investment activities. We make this point every call and it is important to remind our listeners that the venture capital performance is indicative of Hercules' performance in terms of its correlation on invested dollars in our investment activities.

In the second quarter the venture capitalists invested $8 billion in approximately 776 transactions during the second quarter. Although it is a modest increase from the same time last year, it is still a very healthy pace of investment activity of $8 billion.

The allocations were quite interesting as well. We saw health care received $2.3 billion to 184 deals during the quarter, albeit a slight drop year-over-year. We also saw information technology in the second quarter -- the second highest performing sector receiving $2.3 billion through 255 transactions year-over-year, with software companies seeing the highest growth of 25% year-over-year, and networking, com and semiconductors seeing modest declines in that period of time.

Business services and financial services also saw $1 billion invested, a 15% increase year-over-year. And for those who may not be familiar, the term business and financial services companies generally refers to Internet advertising company, data management and payment processing plays.

The highest segment of venture capital dollars, and most of you will make this a point of being very obvious, was consumer services, primarily referred to in the media as social networking and social media and entertainment and gaming. 51% of venture capital dollars flowed into this category without any surprise, given the successful IPOs that we've seen on LinkedIn and others out there. $1.3 billion was invested in that segment of the market place to 138 transactions.

Lastly, and rounding out the venture capital investment dollars, is the clean tech industry, or renewables industry, which received $566 million of capital in the second quarter. There is also very much a correlation in terms of significant dollars invested in the rounds -- staging rounds of companies, as we have seen in previous quarters.

Later stage companies, meaning companies that have technology development risk behind them, saw the lion's share of capital at 58% of the capital. And you saw ceded first round capital receive approximately 19% of the capital, with the balance going into expansion stage companies.

Last in the venture capital fund, VC fundraising. The venture capitalists successfully saw a 20% increase year-over-year in the amount of capital raised through their venture funds, at $8.1 billion. This was earmarked to approximately 50 venture capital funds that occurred.

Overall, for the first half of the year 81 venture fund have raised -- excuse me -- I misspoke in my numbers. The first half of the year -- sorry -- saw $8.1 billion of venture capital fund raising to 50 venture funds themselves.

On the private equity side of the industry, we saw a 35% increase year-over-year in private equity capital raised at $64.7 billion of capital raised by the private equity industry.

Now turning my attention back to our balance sheet, I would like to speak to our liquidity. During the quarter we successfully renewed and increased our line of credit with Wells Fargo Foothill in a $300 million accordion facility. That is a three-year term committed facility which Jessica will talk about those details.

We also extended the maturity of our Union Bank line of credit to December 31 to allow us time to continue to build the syndicate of additional lenders to join that.

We expect to leverage our balance sheet in the second half of the year. And we are working very aggressively to continue to bring lenders into both of those accordion credit facilities we have in the marketplace today.

With that, we have a total of $330 million of liquidity, which I spoke to earlier in the call, and Jessica will elaborate further in her discussions.

Lastly, on our [exit] in our portfolio. We still expect to see 10 to 12 venture stage companies in our portfolio achieve liquidity events. Today we currently have seven Hercules venture stage companies in IPO registration, as I referred to earlier today, making up roughly 16% or so of these all venture stage companies in IPO registration according to Dow Jones VentureSource.

We also expect and are aware of at least two or three additional companies that should be found to go public in the next quarter or so that we have been made aware of. However, no assurance can be made until those public registration and offering statements are made public that they will actually complete those endeavors.

Of the seven companies in IPO registration today we have BrightSource Energy, Enphase Energy, Reply!, Intelepeer, Horizon, which by the way, went effective earlier last week, Nexx Systems, WageWorks. And subsequent to quarter end we had Merrimack join as additional company of Hercules in IPO registration today.

We currently have 99 warrant positions, as I said earlier, and 40 equity positions in venture stage companies, providing us additional levels of future growth of net assets for our shareholders as of June 30 itself.

Typically, in our warrant liquidation we have seen liquidation of -- or monetization of warrant multiples between 1.04 and 8.7 times warrant multiple exits. We think that the 1 times multiple is low; we think the 8.7 times exit is high. However, we like to caution and remind our investors, that we do not expect to see monetization of -- at least 50% of our warrant portfolio should not monetize into any value, if you seem to follow industry norms that we have seen in the past.

With that let me turn the call over to Jessica and she can speak to our performance for the quarter. Jessica.

Thank you, Manuel. It is a pleasure to speak with you all today for the first time on the earnings call. I'm looking forward to the future now leading the Finance and Accounting team here. And I have always considered Hercules to be a best-in-class organization.

So onto the second-quarter numbers. And then we will open the call to address questions. As Manuel summarized, we delivered solid results for the second quarter of 2011. We achieved approximately $20.8 million in total investment income for the quarter, compared to $19.2 million for the first quarter of 2011 and $14.5 million in the second quarter of 2010.

This growth was due to a higher average outstanding balance for our interest-bearing investment portfolio and one-time fees related to early payoffs.

I would like to note that PIK income, which is non-cash revenue, which we must in turn pay our shareholders in dividends, continues to represent a small component of less than 3% of our total investment income.

We continue to generate a start effective yield on our portfolio investments during the quarter. The second-quarter yield was 19.1% compared to 18.1% in Q1 2011 and 16.7% in the second quarter of 2010. As Manuel indicated, our second-quarter yield was positively impacted by acceleration of investment income related to the early payoffs of six portfolio companies.

Excluding the income acceleration impact from early payoffs, the effective yield would have been 15.7% for the quarter as compared to 15.9% in the preceding quarter. Fee income increased to $2.8 million in Q2 as compared to $1.7 million in the second quarter of 2010, and was essentially flat with fee income of $2.7 million recorded in Q1 2011.

Once again, the year-over-year increase is driven by unamortized fee acceleration and early payoff. As we have shared with you in our prior earnings calls, the level of our fee income is very hard to predict quarter to quarter. We believe a normalized run rate, excluding early payoffs, would be $1.1 million to $1.3 million per quarter.

Our total cost of debt increased from $3.2 million in Q1 2011 to $3.8 million in Q2 2011 and from $2.4 million incurred in Q2 2010. These increases are driven by $1.1 million of expense incurred on our $75 million of convertible notes issued on April 15 of this year.

As a reminder, these expenses related to the convertible debt negatively impact earnings in the near term by approximately $0.03 per share per quarter until the capital is deployed.

Know however that our weighted average cost of debt has declined from 7% in Q2 2010 to 6.6% in Q2 2011, primarily due to a lower weighted average cost of debt on outstanding SBA debentures at 5.6% in the second quarter of 2011 versus 6.58% in the second quarter of 2010.

Operating expenses for the quarter, excluding interest expense and loan fees, totaled $6.6 million as compared to $6.2 million in the prior quarter and $5.3 million in the second quarter of 2010. These increases have primarily been related to higher comp expenses which have been a function of expanding our origination team. Additionally, during the quarter we incurred costs associated with executive recruiting and executive severance.

Q2 2011 net investment income, as Manuel mentioned, was $10.4 million or $0.24 per share based on 43 million shares outstanding compared with $9.8 million and $0.23 per share based on 42.7 million shares outstanding in Q1 2011 and $6.9 million or $0.19 per share based on 35.3 million shares outstanding in Q2 of 2010.

Our net unrealized appreciation during the quarter of $13.3 million was primarily attributed to fair value adjustments on our warrant and equity holdings in accordance with [ASA 20] and because of the positive performance of our portfolio companies and our publicly traded investments during the quarter.

Net realized gains for the second quarter were approximately $660,000, primarily due to approximately $500,000 of gain on the sale of a portion of our equity investments in Aegerion Pharmaceuticals. Since inception net realized losses total approximately $47.8 million on a GAAP basis. This represents 2% of total commitment since inception of greater than $2.4 billion or approximately only 30 bips on an annualized basis.

A final point on our P&L. Our change in net asset value for the quarter, which is total -- the total of our net investment income, net unrealized appreciation and net realized gains, was approximately $24.3 million or $0.56 per share versus a loss of $11.5 million and $1.1 million or $0.14 and $0.03 for the quarters ended June 30, 2010 and March 31, 2011.

Now moving on to the balance sheet. I would like to first provide a summary of the investment portfolio. As Manuel mentioned, we closed approximately $151 million in commitments and funded approximately $105 million to new and existing portfolio companies in the second quarter.

Once again, we experienced a high level at $92 million of principal payments during the quarter, which includes $75.7 million of early payoffs and $16.3 million of normal amortization. At this time we do not expect to see a similar high-level of payoff during the third quarter.

Since the and of Q2 2011, as Manuel mentioned, we have funded $34.7 million and currently have $214.3 million of nonbinding signed term sheets in house. Even though this quarter has historically been weak, a seasonally soft period for new commitments, we believe these pipeline figures, combined with our $92 million of unfunded commitments as of quarter end, signal that our strategy for growth is on pace for 2011.

Further points to the loan portfolio. As of quarter end 89.2 of our loans have floating-rate or floating rates with floors, and as Manuel mentioned, 99% of our loan investments are in senior debt investments.

We are particularly pleased with the loans portfolio credit quality as well. The weighted average loan rating for our portfolio was 2.04 at June 30 compared with 2.44 on March 31. This result is the highest-quality grade the portfolio has reflected since 2005.

Quarter-over-quarter the rating improvement is due to the early payoff of three rated 3 companies, the improvement from rating 3 to 2 of three portfolio companies, and due to the onboarding of our new $105 million of investments at a rating of 2 during this quarter.

We had just one loan on nonaccrual at the end of the quarter that we are carrying at a zero value, consistent with prior quarter. As of June 30, 2011, combined, our equity and warrant investments at fair value represent approximate 13.4% of our total portfolio.

Our warrant positions in 99 portfolio companies provide us with the option to potentially invest approximately $70 million of additional capital. We believe these noninterest-bearing assets could provide capital returns to the Company the future, particularly against the active and approving IPO and M&A back up Manuel just described.

Turning to the ample -- turning to describe our ample liquidity, as I previously mentioned, in April we successfully closed an offering a $75 million of 6% convertible senior notes, which mature in April 2016. As a reminder, the conversion price for these notes is at $0.1189 per share subject to customary antidilution adjustments.

During the quarter we renewed our credit facility with a commitment of $75 million with Wells Fargo Capital Finance. The facility contains an accordion feature, which we can increase the credit line up to an aggregate of $300 million. Note that we cannot provide assurance that additional lenders will join this facility.

We paid a closing fee of $1.1 million related to the renewal that will be amortized over the facility's three-year term. And starting on September 1, we will incur an unused fee expense of approximately $0.005 per share per quarter on this facility until the capital is deployed.

Moving onto the Union Bank $20 million credit facility, as Manuel mentioned, in June we closed an extension on the commitment with Union Bank from July 31 to September 30, and a maturity date has been extended to December 31, 2011. As of June 30 we had no borrowings outstanding on the two credit facilities.

Finally, during the quarter we borrowed $25 million of debentures under the SBA program. The interest rate on these new debentures will be set during the September 2011 SBA pooling.

During the quarter we received a $25 million commitment from the SBA that provides us with full access to the $225 million available under the program. As of June 30, 2011, we have remaining availability under the program of approximately $36.3 million.

So to sum up our liquidity again, as of June 30 we had approximately $330 million of availability, comprised of $198.2 million of cash, $95 million of borrowing capacity under our credit facilities, and approximately $36.3 million of capacity under the SBA program.

Finally, moving onto the dividend, as you have -- may have seen from our press release this afternoon, we distributed a dividend of $0.22 per share during the first quarter of 2011, and announced that the Board has declared a $0.22 dividend payable on September 15 to shareholders of record on August 15, 2011.

So in closing, we had a solid second quarter that we believe set the stage for a strong remainder of 2011. Our credit quality is the highest that it has been since 2005. We can maintain our disciplined approach investing in portfolio companies as our top cost origination team grows the pipeline. Our liquidity places us in a great position to service this investment demand, and build our portfolio during the second half of 2011 and into 2012.

Operator, we are now ready to open the call for questions.

(Operator Instructions). John Hecht, JMP Securities.

Congrats on a good quarter. I wonder if you guys have any details regarding the yield on the new commitments during the quarter versus the yield on the repayments or exits during the quarter?

Sure. The answer is, as I indicated in the call, a lot of the runoff that took place was lower middle market credits. And lower middle market credits by and large do not have warrants associated with them.

But to answer your question on a pure yield basis, we saw about 100 to -- about 150 basis points or so yield compression on those assets running off between lower middle market and the new onboarding of venture assets.

But, like I indicated, the venture assets have the warrants portfolio -- warrants associated with them. But on a pure interest-to-interest basis we saw about 150 basis points difference in those onboarding (inaudible) offboarding.

So that sounds like more of a mix shift situation. Can you maybe -- apples-to-apples compare on a venture -- excuse me, VC-backed company with warrants, has there been a material change or has it been pretty stable (multiple speakers)?

No, those are pretty stable. You may see -- and again the problem with that question is that I need to look at and discriminate between the clean tech assets, the life sciences assets, medical devices that are slightly different than life sciences assets, and of course technology. All have slightly different yields, but by and far there wasn't a material change in those yields.

And maybe if I look at it at a high level you probably have 30 or 50 basis points difference when you blend them out. But we don't see -- we are still holding onto not this massive -- or I should say anticipated 150 basis points or so yield erosion on the overall portfolio. That had still not manifested itself because we have not had to do that.

Okay, and you might have come commented on this, I missed it if you did. Have you disgorged all of the middle market assets you would like to or is there more to go?

No, I think that, without tipping our hand, we actually like these commercial banks' insatiable appetite for [EBITDA] positive companies when we are concerned about the economy. We believe that in the second -- sorry, in the third quarter we suspect that another $30 million -- $25 million to $30 million in lower middle market type companies may end up running off as well.

Okay. Would that facilitate -- or at that point you're done with that rotation or is there more to go?

No, at that point the remaining lower middle market that we have are heavily technology related companies. And we are comfortable to look at the intellectual property and collateral of those companies beyond just looking at EBITDA, which we are more used to underwriting.

The remaining companies we don't think are -- well, they shouldn't -- but one was taken out by a commercial bank the other day that we don't think it should have been taken out by a commercial bank, but these banks have this hunger for assets.

The remaining assets in the lower middle market is a very solid book that we see right there. We do have one asset that we have spoken to in the past that is impaired. That this is a company that experienced the horrific outcome on the tornadoes. It is an asset we have depreciated and are working very diligently with the management team and the investors to stabilize that asset. But beyond that, I think most of our lower middle market is where we want it to be.

Okay, and the final question is, the last couple of quarters you talked about, I guess, utilization rates and draw down periods and that maybe utilization was low, and draw down was slow of commitment as people were just tepid in coming back to the market and borrowing. Are your sentiments around that changing out now given what you see in the last quarter?

Well, make sure that we couch my sentiment in a little slightly differently. I do expect to see a decline in draw down. Historical levels are 75% to 80% of commitments to drawdown. I think today you're looking at more of a 65%, 70% correlation of commitments to draw down. But the reason why it is happening is not a negative issue, it is the other way around.

The reason why they are not drawing fully down is that they're getting equity capital dollars are flowing so briskly into the industry that they're able to see high evaluations and thereby not needing to drawdown the capital, or they are achieving their IPO or M&A events much sooner than expected so they don't need to have all that capital. So that insurance policy of an additional committed capital is not being drawn down for positive reasons, not for negative reasons.

Now as a lender, obviously I like to see outstandings not unfunded commitments.

Great, thanks for the color.

Troy Ward, Stifel Nicolaus.

Jessica, can you clarify for us -- I know the effective yield without the accelerations is in there. Can you quantify that on a dollar basis in the quarter, how much was from the early payoffs in the quarter?

You could do the math based on our revenue, but I would say that a few million dollars, which is typical on a quarterly basis. It is hard to model though because it is a function of where the asset is in a slice. And where the fees may have been on an unamortized basis, and the latter that we have for prepayment penalties. For example, a loan in its first year has typically a prepayment penalty of 3%, and that ladders down year after year. is down year after year. But that was the performance for the quarter.

Just to remind you when you have a loan payoff early you have multiple components that get kicked in. You have any unrecognized deferred revenues or deferred fees that you may have recorded at the onboarding of the loan, those getting accelerated. As Jessica said, you get a prepayment penalty, it gets accelerated. And, of course, your OID also gets accelerator.

Right.

Right, we just -- I just was trying to get a feel for what the core number was for the quarter. We obviously haven't had time to drop in all the numbers in our model since you released this.

Ken you also, Manuel, speak to a couple of modeling questions. On both the G&A and the stock-based compensation, the last couple of quarters have been just elevated a little bit. Is this a new run rate or is specifically in the G&A is there -- dollars in there for the search for the CFO that will eventually come out?

Good question, by the way. We still think that SG&A will probably run at the -- right now I would probably say 22.5 to 23.5 range is probably where we expect to be on an annualized basis. However, we could tweak that. If we don't see the conversion and performance in certain areas we could reduce some of those expenses. Not dramatically, by the way, that we can.

But the second part of your question is there is no question that in the second quarter that it is overly burdened by the departure of the CFO, any severance that may have been associated with that, as well as the executive recruiting fees that are attributed to that search, as well as some of the additional recruiters that we paid for increasing the staff at both the accounting level and the origination level that we had during the quarter as well. Because we did cycle through and add additional staffing to multiple areas of the Company.

Then, finally, I know in subsequent events you revealed that quarter-to-date you have about $35 million of fundings. Have you had any prepayments quarter-to-date? And how do you view that? I think you said this quarter would be light because August pretty much everybody shuts down. Is that right?

No, I didn't quite say that. I said it will be light in terms of funding. But let me get specific to your question. We anticipate probably $25 million to $30 million of early -- additional early payoffs this quarter.

The reason why we somewhat know that, the existing credit -- the existing portfolio company asked us if we wanted to defend our incumbency position, and we basically said no. We would rather take the prepayment penalty and record the income and let the asset run-off. It is just part of our recycling out some of our lower middle market assets.

So we are aware of at least one to two remaining lower middle market assets to the tune of $30 million in aggregate that may be running off in the third quarter.

In terms of fundings, what I said is I expect to see findings happen between now and August 15, and then just basically drop dead. Nothing happening between August 15 and probably the first week of September. So you will see it much more backend loaded.

In terms of the quarter you probably will see anywhere on a gross basis conservatively $110 million to $130 million of assets on a gross basis funding during the quarter. But that could change quite dramatically, especially in this marketplace, where before we fund we do what is called a [bring down] due diligence.

If we become uncomfortable with the outlook of the company or the market that we are seeing, we could choose not to move forward and fund the assets. And in this market, especially indicative today, we have adopted a very conservative underwriting stance, no dissimilar to what we did in 2007.

So although we are expecting to see north of $100 million in fundings on a gross basis this quarter, we are going to be very judicious prior to that funding going out the door that we want to make sure that the credits are the ones we want to be in.

Great, thanks.

Jason Arnold, RBC Capital Markets.

Congrats on the great results here this quarter. I was just curious, if you were to break out the prepaids this quarter by middle market or VC-backed, could you give us the percentage or a dollar value of how that would break out?

Back to Manuel's point, the majority of our early payments were in the middle market sector. I can't give you off the top of my head, nor do I have in front of me, the breakout specifically per industry, but the majority of those fees, I would say 75% were middle market oriented.

Okay, and then, I guess, Manuel, you commented that prepay is quarter-to-date from the middle market perspective could be anticipated to be maybe $30 million. Beyond that what would you say would be an anticipated run rate for the exits or ere prepayment here in the next couple of quarters?

You know, I will say what I say every quarter. I have no idea. That is a crystal ball that is very foggy and very cloudy. Every quarter if I even tried to tell you what it is, I can't. We get blindsided all the time in terms of early payoffs.

This time around, because of our somewhat concerning outlook for the second half of this year, we are purposely allowing, or if not encouraging, any asset that we believe has a high recessionary risk to it to runoff or get paid out.

Remember, one of the things that most people don't realize as the incumbent lender you always have the optionality to defend the exit of that credit before it runs off -- that portfolio company before it comes runs off. Because you can always choose to say -- look at, because you've got to pay a 2% to 3% prepayment penalty, you, portfolio company, you've got to weigh that. And we can always decide whether or not we want to lower our yields, if you will, to match the new spread that they are being offered by the commercial bank or let it go. In this environment we are opting to let it go.

It makes sense. Okay. Then just one other quick question. You had a portfolio company complete an IPO post quarter end, Horizon Pharma. Can you comment on any anticipated warrant gain on that?

You can see from our soon-to-be filed Q., I don't think you will see a warrant gain on that transaction. This is a tough take. I think that we rarely even try to forecast or give indications of warrant gains. We just never know. But on the case of Horizon our warrants are under water from a fair value pricing point of view to that of the liquidity price.

Okay. Thanks for the color. I appreciate it.

Steven Kwok, Keefe, Bruyette & Woods.

Thanks for taking my question. Just a quick question on quarter-to-date trends that you have seen. Given the volatility in the market have you seen any perhaps yields coming -- going up because of the volatility? And then the second question is with the volatility does that affect the ability for the portfolio companies to complete the IPOs? Thanks.

Well, one day doesn't make a trend. Although it has been trending down for the last two or three weeks, and obviously our lovely legislators are not helping the process. Look, I think it would be -- I have heard some of the other VCs try to allude that in this volatility marketplace they expect to see higher yields. I think it is way too early to make that call.

Clearly, that would mean that commercial banks are going to contract their interest levels on continuing to originate assets. We are certainly not necessarily seeing it. We are certainly are saying a robust pickup in lower middle market activity out there, but we are not seeing any yield appreciation of lower middle market.

As to the venture side on the other hand, we are seeing some stabilization on venture yields, primarily driven by two, if not three, of our weaker competitors that were in the marketplace are now having massive problems on liquidity on their own side. And they have not been able to path any additional growth capital to fund their businesses, and we are able to see that deal flow coming more to us. And given that there is less competition, we are just continuing to hold out for what yields we are think are appropriate. And if the yields are not there that we like, we have no problems letting the asset go.

Then the follow-up on the portfolio companies continuing the IPOs in this environment?

Well, if today is an indication, you can kiss the IPO window goodbye. But I don't think this market -- I hope for all of our benefit it doesn't continue at a 500 point drop in one day.

That said, I think that investors are clamoring for and seeking growth stocks. Growth stocks historically have been driven by technology companies. You saw that LinkedIn I think either reported today or will report tomorrow. I don't remember exactly when. But you do have a lot of good bellwether still to come out. Zynga is a good one that is still looking to go out.

You have, of course, the one everybody is waiting for is Facebook. You have Twitter. And you have many, many other high-profile companies, including Box.net in our own portfolio, that people are expecting to see a liquidity event take place in the next year or so.

But all these tech companies are not in a rush to go public just to go public. They are building their business models soundly. And they're looking for the right window to exit. We are fine with that. We have 99 warrant positions and we are fine taking the control view that when it is the right time to go public, they will go public. But we are well positioned with 99 companies, seven of which (inaudible) originations today. So we are very encouraged and very happy that our investment team is picking the right companies.

Got it. Got it. Then just on the yields, what sort of run rate. Your effective yield is 15.7%, and then the -- that is excluding the fees -- while the total amount was 19.1%. If we simply do the math, with 15.%7 over 19.1%, that is like 82%. Would that be roughly the true run rate?

If your question is the effective yield mature run rate at 15.7%, I think that is historically still a little bit strong. I know over the course of the past few years we have been more around 13.5% to 14% for our effective yield.

I think, we have some assets that just definitely have a little higher yield in them still. So it will take some time to burn those off. Those are not typical bank candidates that get taken out by banks. So that means we would be able to start seeing a stabilization. Look, without giving you any guidance, when we have to run some numbers here, I think you will see yield stabilizing probably in the 14.5% to 15.5% range is kind of a yield stabilizing at that point.

It will, as I have been indicating now for now three earnings calls, we still expect to see 150 basis points, maybe 200 basis points decline in the overall yield over time as the new assets get on boarded that are -- and the 13% range or so, you will start seeing that start modulating down by that 150 basis points or so by the end of the year.

So I still expect to see the overall yield in the portfolio to creep down from that 15.5% down to, as Jessica said, if you put the full 2 point on it, to 13.5% by the end of the year.

Yes, yes. What I was trying to get to was the core run rate on the interest income side. Where the number you reported was based off 19.1%. I am saying if you use 15.7% would that be roughly 82% of that number?

In all -- I really don't have the answer to your question, because I don't have those models in front of me to actually be able to answer it. And any answer I give you will be a speculative answer at that point. So we can take it off-line and try to look at it and see what we have, but I don't have an answer for you right here in front of me.

Sure, sure. We definitely can do that. Thanks.

Douglas Harter, Credit Suisse.

Manuel, I was hoping you could talk about -- obviously, your liquidity position is quite strong right now. You have authorization for a share buyback. How will you be thinking about that?

If today is indicative of that -- look, in all fairness, I don't mean to be tongue-in-cheek about what happened today. It is actually terrible, on everybody's loss of net worth today.

In all fairness, when you do a stock buyback program, without tipping our hand exactly how we do it, you have to temper the deployment of capital to buy back your stock against the backdrop of originating new earning assets. And you have to balance as to all the new onboarding assets that can originate better in quality and yield than buying back my own stock from an accretion point of view.

So it is not as simple as saying the stock is at $9, I am going to buy stock at $9. I think there is a multitude of factors, including our pipeline, our backlog, and the competitive landscape all are factors in looking at a buyback program or not. Because the last thing I want to do is overspend my liquidity on a stock buyback program I can have accretive long-term assets.

All right. I guess it just sort of along that, it seems like you're paydowns have remained elevated for a longer time, which has continued despite the good pipeline, which has I guess has continued to leave you with more liquidity. So it seems like you have been able to balance putting on new assets and maintaining liquidity.

Right. But go one step further. That exacerbated liquidity, driven by the commercial banks taking our lower middle market asset has also dramatically improved our credit book. And that is a key factor. When I am going to defensive portfolio position, I want to be able to disgorge any assets that I feel that are highly economic sensitive into more recessionary protective assets, such as life sciences where you have a longer gestation period for a clinical trial purposes.

And also look to certain technology companies that are in very attractive areas that are continuing to receive strong levels of support and funding for the venture capital industry. So we have taken a very clinical approach to balancing out and cycling out certain assets in the portfolio into this defensive position.

Now my liquidity may look very strong, however, I need to caution everybody that with $93 million of unfunded commitments, $214 million of signed term sheet, you're looking at -- assuming all get funded, which we shouldn't -- you're looking at almost $300 million of deals already in-house that could convert into earning assets.

So it looks tantalizingly high, but it is something that we're monitoring very closely, and making we bolster our balance sheet with (inaudible) credit providers going into the second half of there to leverage the balance sheet as opposed to looking for an equity capital raise in the near term.

Just on that point, can you -- any update now on adding any additional lenders to that accordion warehouse feature?

You know, I am going to probably parrot what other guys have said on the call the last week or so. We remain and continue to active dialogue with both domestic, large commercial banks, as well as multinational large banks as well. In all fairness, they are all over the map.

The geopolitical crisis that has been going on around the world, coupled with sovereign debt, is not necessarily helping the asset class. And stock market crashes or corrections, like today, don't really give these guys warm tummies right now. So I think it is more of a Q4 activity to early Q1. of next year.

Great, thanks.

Henry Coffey, Sterne Agee.

Just tell them to take a stiff drink, Manuel, and stop worrying about their tummies.

The beaker is empty.

I think everyone's beaker emptied around lunch time. To look at the obvious, you've got a pretty solid pipeline. Is there a cash level at which you would just put on the brakes and then start borrowing against your bank lines?

Yes, that is a fantastic question. Hercules is continuing to mature and develop as a specialty finance organization. What does that mean is that we are now allocating more time and resources to treasury functions and looking at the optimization of our weighted average cost of capital to make sure that we optimize our various bank lines, where each bank line has lending conditions that we don't over-collateralize the bank line by accident and not be able to utilize more efficiently our access to capital.

So, yes, it is an important question. And to answer your question specifically, I've have said this historically over the last two quarters that I am reluctant to allow the balance sheet to grow greater than 35% on short-term commercial bank lines only.

I have learned my lesson in the fall of 2007 -- or 2008, excuse me, and I don't want to be highly reliant upon commercial bank lines where they may get skittish and decide to [pull] for whatever reason and change the conditions of the bank line itself.

So I like to see a broadly diversified balance sheet. And this is why we worked very hard to do the convertible debt and having no near-term debt coming due for the next five years or April 16.

April 2016.

April 2016. But specific to your question, I think when cash starts getting to the $25 million level, it is an area that you will see me materially pullback in originations.

On a related subject, as you pull away from the middle market, and I certainly can understand the advantage of going back to your core roots, are there going to be changes in staffing or -- you've got different blending groups that have all been very successful for you.

Look it, I want to make sure that I don't disparage or destroy the lower middle market for other BDCs out there, because I am also long certain other BDCs in the lower middle-market category.

The issue for us is, under the Hercules purview of our underwriting standard, and what we look for in underwriting, we are very uncomfortable with underwriting that lower middle-market risk. That means another BDC out there may be might be more comfortable than we are underwriting that risk.

We are concerned about the increase in leverage that we are seeing I lower middle market, and the declining spread that we are seeing in lower middle market. To us we don't understand that business. If our lower middle market asset would be generating 14%, 15% in return, I think you'll see us venture back into that area.

But we are seeing lower middle market of 10% or 11% all in yields. We get better assets in our venture side of the business which has numerous barriers to entry into it that we would rather go and defend and protect that area where we have a lot of confidence.

As to the staffing, there is no question that as we migrate away from lower middle market, just like you do with the portfolio, you will probably see some staffing levels rebalancing going on in some of our lower middle market team. Those that can be repotted into other areas of the business, will be repotted.

Those who cannot will be given an opportunity to try to do so. But you will probably see some FTE adjustment in the coming quarter related to lower middle market.

Thank you.

This concludes the Q&A portion for today. I would like to turn the call back over to Manuel Henriquez, Hercules' Co-founder, Chairman and CEO, for any closing comments.

Thank you, operator, and thank you everybody for being on this call after an incredible horrific day today. I appreciate your continued understanding and support of the hard work that the employees of Hercules are doing on behalf of our shareholders.

Jessica and I will be meeting with investors in the coming weeks. If you have an interest in meeting with Hercules, please feel free to give us a call and arrange for a meeting at 650-289-3060. And contact Jessica, our interim CFO, who will be happy to arrange a call or a meeting in the next coming weeks in our trips.

Again, thank you very much for being one of our shareholders, and for continuing to stick by Hercules in these difficult market times. Thank you, operator.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. And you may now disconnect. Everyone, have a wonderful day.