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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended June 30, 2018
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 814-00702
HERCULES CAPITAL, INC.
(Exact Name of Registrant as Specified in its Charter)
Maryland
743113410
(State or Jurisdiction of
Incorporation or Organization)
(IRS Employer
Identification No.)
400 Hamilton Ave., Suite 310
Palo Alto, California
(Address of Principal Executive Offices)
94301
(Zip Code)
(650) 289-3060
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☐ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with a new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
On July 30, 2018, there were 95,831,773 shares outstanding of the Registrant’s common stock, $0.001 par value.
FORM 10-Q TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
3
Item 1.
Consolidated Financial Statements
Consolidated Statement of Assets and Liabilities as of June 30, 2018 and December 31, 2017 (unaudited)
Consolidated Statement of Operations for the three and six months ended June 30, 2018 and 2017 (unaudited)
5
Consolidated Statement of Changes in Net Assets for the six months ended June 30, 2018 and 2017 (unaudited)
6
Consolidated Statement of Cash Flows for the six months ended June 30, 2018 and 2017 (unaudited)
7
Consolidated Schedule of Investments as of June 30, 2018 (unaudited)
9
Consolidated Schedule of Investments as of December 31, 2017 (unaudited)
24
Notes to Consolidated Financial Statements (unaudited)
39
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
73
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
92
Item 4.
Controls and Procedures
93
PART II. OTHER INFORMATION
94
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
95
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits and Financial Statement Schedules
96
SIGNATURES
99
2
PART I: FINANCIAL INFORMATION
In this Quarterly Report, the “Company,” “Hercules,” “we,” “us” and “our” refer to Hercules Capital, Inc. and its wholly owned subsidiaries and its affiliated securitization trusts on or after February 25, 2016 and “Hercules Technology Growth Capital, Inc.” and its wholly owned subsidiaries and its affiliated securitization trusts prior to February 25, 2016, unless the context otherwise requires.
ITEM 1.
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES
(unaudited)
(dollars in thousands, except per share data)
June 30, 2018
December 31, 2017
Assets
Investments:
Non-control/Non-affiliate investments (cost of $1,614,160 and $1,506,454, respectively)
$
1,616,515
1,491,458
Control investments (cost of $59,337 and $25,419, respectively)
56,716
19,461
Affiliate investments (cost of $84,063 and $87,956, respectively)
28,705
31,295
Total investments in securities, at value (cost of $1,757,560 and $1,619,829, respectively)
1,701,936
1,542,214
Cash and cash equivalents
59,461
91,309
Restricted cash
15,886
3,686
Interest receivable
14,408
12,262
Other assets
906
5,244
Total assets
1,792,597
1,654,715
Liabilities
Accounts payable and accrued liabilities
25,115
26,896
SBA Debentures, net (principal of $190,200 and $190,200, respectively) (1)
188,457
188,141
2022 Notes, net (principal of $150,000 and $150,000, respectively) (1)
147,728
147,572
2024 Notes, net (principal of $83,510 and $183,510, respectively) (1)
81,694
179,001
2025 Notes, net (principal of $75,000 and $0, respectively) (1)
72,616
—
2021 Asset-Backed Notes, net (principal of $31,088 and $49,153, respectively) (1)
30,698
48,650
2022 Convertible Notes, net (principal of $230,000 and $230,000, respectively) (1)
224,269
223,488
Credit Facilities
58,323
Total liabilities
828,900
813,748
Net assets consist of:
Common stock, par value
85
Capital in excess of par value
1,026,313
908,501
Unrealized appreciation (depreciation) on investments (2)
(56,760
)
(79,760
Accumulated undistributed realized gains (losses) on investments
(34,205
(20,374
Undistributed net investment income
28,255
32,515
Total net assets
963,697
840,967
Total liabilities and net assets
Shares of common stock outstanding ($0.001 par value, 200,000,000 authorized)
94,260
84,424
Net asset value per share
10.22
9.96
(1)
The Company’s SBA Debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes and 2022 Convertible Notes, as each term is defined herein, are presented net of the associated debt issuance costs for each instrument. See “Note 4 – Borrowings”.
(2)
Amounts include $1.1 million and $2.1 million in net unrealized depreciation on other assets and accrued liabilities, including escrow receivables, and estimated taxes payable as of June 30, 2018 and December 31, 2017, respectively.
See notes to consolidated financial statements.
The following table presents the assets and liabilities of our consolidated securitization trust for the 2021 Asset-Backed Notes (see Note 4), which is a variable interest entity (“VIE”). The assets of our securitization VIE can only be used to settle obligations of our consolidated securitization VIE, these liabilities are only the obligations of our consolidated securitization VIE, and the creditors (or beneficial interest holders) do not have recourse to our general credit. These assets and liabilities are included in the Consolidated Statement of Assets and Liabilities above.
(Dollars in thousands)
Restricted Cash
Total investments in securities, at value (cost of $98,105 and $146,208, respectively)
97,924
144,513
113,810
148,199
The Company’s 2021 Asset-Backed Notes are presented net of the associated debt issuance costs. See “Note 4 – Borrowings”.
4
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
Three Months Ended June 30,
Six Months Ended June 30,
2018
2017
Investment income:
Interest income
Non-control/Non-affiliate investments
44,535
39,979
86,369
82,324
Control investments
841
527
1,427
1,041
Affiliate investments
500
1,061
Total interest income
45,876
40,506
88,857
83,367
Fee income
Commitment, facility and loan fee income:
1,930
2,440
4,370
5,374
10
84
192
Total commitment, facility and loan fee income
2,014
2,445
4,562
5,384
One-time fee income:
1,672
5,501
4,843
6,066
Total one-time fee income
Total fee income
7,946
9,405
11,450
Total investment income
49,562
48,452
98,262
94,817
Operating expenses:
Interest
9,878
9,254
19,264
18,861
Loan fees
3,362
1,348
4,537
4,186
General and administrative
Legal Expenses
637
2,141
1,212
2,867
Other Expenses
3,037
2,609
6,471
5,947
Total general and administrative
3,674
4,750
7,683
8,814
Employee compensation:
Compensation and benefits
7,017
5,916
12,775
11,262
Stock-based compensation
2,857
1,909
5,166
3,742
Total employee compensation
9,874
7,825
17,941
15,004
Total operating expenses
26,788
23,177
49,425
46,865
Net investment income
22,774
25,275
48,837
47,952
Net realized gain (loss) on investments
(3,953
(5,319
(7,465
(2,030
(2,900
(394
(4,308
(445
(2,058
Total net realized gain (loss) on investments
(8,911
(5,713
(13,831
(2,475
Net change in unrealized appreciation (depreciation) on investments
32,700
66,255
18,360
34,100
3,957
(53,349
3,337
(53,135
1,540
681
1,303
1,119
Total net unrealized appreciation (depreciation) on investments
38,197
13,587
23,000
(17,916
Total net realized and unrealized gain (loss)
29,286
7,874
9,169
(20,391
Net increase (decrease) in net assets resulting from operations
52,060
33,149
58,006
27,561
Net investment income before investment gains and losses per common share:
Basic
0.26
0.31
0.57
0.58
Change in net assets resulting from operations per common share:
0.59
0.40
0.67
0.33
Diluted
Weighted average shares outstanding
87,125
82,292
85,868
81,858
87,199
82,395
85,939
81,953
Distributions declared per common share:
0.62
CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS
(dollars and shares in thousands)
Accumulated
Unrealized
Undistributed
Capital in
Appreciation
Realized
Common Stock
excess
(Depreciation)
Gains (Losses)
Net Investment
Net
Shares
Par Value
of par value
on Investments
Income
Balance at December 31, 2016
79,555
80
839,657
(89,025
14,314
22,918
787,944
Public offering, net of offering expenses
3,309
46,908
46,911
Issuance of common stock due to stock option exercises
27
211
Retired shares from net issuance
(18
(170
Issuance of common stock under restricted stock plan
Retired shares for restricted stock vesting
(145
(1,988
Distributions reinvested in common stock
81
1,122
Issuance of Convertible Notes
3,413
Distributions
(51,330
Stock-based compensation (1)
3,777
Balance at June 30, 2017
82,819
83
892,930
(106,941
11,839
19,540
817,451
Balance at December 31, 2017
9,486
112,617
112,626
38
433
(36
(447
336
(57
(688
69
854
(53,097
5,043
Balance at June 30, 2018
Stock-based compensation includes $20 and $35 of restricted stock and option expense related to director compensation for the six months ended June 30, 2018 and 2017, respectively.
CONSOLIDATED STATEMENT OF CASH FLOWS
(dollars in thousands)
For the Six Months Ended June 30,
Cash flows from operating activities:
Adjustments to reconcile net increase in net assets resulting from
operations to net cash provided by (used in) operating activities:
Purchase of investments
(563,744
(340,632
Principal and fee payments received on investments
414,347
349,519
Proceeds from the sale of investments
9,768
18,450
Net unrealized depreciation (appreciation) on investments
(23,000
17,916
Net realized loss (gain) on investments
13,831
2,475
Accretion of paid-in-kind principal
(4,696
(4,656
Accretion of loan discounts
(1,562
(3,776
Accretion of loan discount on Convertible Notes
280
Accretion of loan exit fees
(8,923
(10,653
Change in deferred loan origination revenue
3,415
19
Unearned fees related to unfunded commitments
1,616
769
Amortization of debt fees and issuance costs
3,999
3,557
Depreciation
105
Stock-based compensation and amortization of restricted stock grants (1)
Change in operating assets and liabilities:
Interest and fees receivable
(2,146
1,410
Prepaid expenses and other assets
518
589
Accounts payable
244
Accrued liabilities
(1,016
898
Net cash provided by (used in) operating activities
(93,870
67,608
Cash flows from investing activities:
Purchases of capital equipment
(116
(89
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Issuance of common stock, net
Retirement of employee shares
(701
(1,947
Distributions paid
(52,243
(50,208
Issuance of 2022 Convertible Notes
230,000
Issuance of 2024 Notes
5,637
Issuance of 2025 Notes
75,000
Repayments of 2019 Notes
(110,364
Repayments of 2024 Notes
(100,000
Repayments of 2021 Asset-Backed Notes
(18,065
(21,527
Borrowings of credit facilities
150,700
8,497
Repayments of credit facilities
(92,377
(13,513
Cash paid for debt issuance costs
(519
(4,480
Fees paid for credit facilities and debentures
(83
(253
Net cash provided by (used in) financing activities
74,338
88,753
Net increase (decrease) in cash, cash equivalents and restricted cash
(19,648
156,272
Cash, cash equivalents and restricted cash at beginning of period
94,995
21,366
Cash, cash equivalents and restricted cash at end of period
75,347
177,638
Supplemental non-cash investing and financing activities:
Distributions reinvested
The following table presents a reconciliation of cash, cash equivalents and restricted cash reported within the Consolidated Statement of Assets and Liabilities that sum to the total of the same such amounts in the Consolidated Statement of Cash Flows:
160,412
17,226
Total cash, cash equivalents and restricted cash presented in the Consolidated Statements of Cash Flows
See “Note 2 – Summary of Significant Accounting Policies” and “Note 11- Recent Accounting Pronouncements” for a description of restricted cash and cash equivalents.
8
CONSOLIDATED SCHEDULE OF INVESTMENTS
Portfolio Company
Sub-Industry
Type of
Investment(1)
Maturity Date
Interest Rate and Floor(2)
Principal Amount
Cost(3)
Value(4)
Debt Investments
Biotechnology Tools
1-5 Years Maturity
Exicure, Inc. (12)
Senior Secured
September 2019
Interest rate PRIME + 6.45%
or Floor rate of 9.95%, 3.85% Exit Fee
4,999
5,152
5,172
Subtotal: 1-5 Years Maturity
Subtotal: Biotechnology Tools (0.54%)*
Consumer & Business Products
Under 1 Year Maturity
Gadget Guard (p.k.a Antenna79) (15)
December 2018
Interest rate PRIME + 1.5%
or Floor rate of 11.00%
1,000
Subtotal: Under 1 Year Maturity
December 2019
Interest rate PRIME + 2.95%
or Floor rate of 12.45%, 2.95% Exit Fee
16,814
17,072
17,064
WHOOP, INC.
July 2021
Interest rate PRIME + 3.75%
or Floor rate of 8.50%, 6.95% Exit Fee
6,000
5,915
22,987
22,980
Subtotal: Consumer & Business Products (2.49%)*
23,987
23,980
Diversified Financial Services
Gibraltar Business Capital, LLC. (7)
Unsecured
March 2023
Interest rate FIXED 14.50%
10,000
9,809
Subtotal: Diversified Financial Services (1.02%)*
Drug Delivery
Agile Therapeutics, Inc. (11)
Interest rate PRIME + 4.75%
or Floor rate of 9.00%, 3.70% Exit Fee
7,625
8,160
ZP Opco, Inc. (p.k.a. Zosano Pharma) (11)
Interest rate PRIME + 2.70%
or Floor rate of 7.95%, 2.87% Exit Fee
3,233
3,570
11,730
AcelRx Pharmaceuticals, Inc. (11)(15)
March 2020
Interest rate PRIME + 6.05%
or Floor rate of 9.55%, 11.69% Exit Fee
14,891
15,567
15,486
Antares Pharma Inc. (10)(15)
July 2022
Interest rate PRIME + 4.50%
or Floor rate of 9.25%, 4.25% Exit Fee
25,000
25,155
25,124
40,722
40,610
Subtotal: Drug Delivery (5.43%)*
52,452
52,340
Drug Discovery & Development
Auris Medical Holding, AG (5)(10)
February 2019
or Floor rate of 9.55%, 5.75% Exit Fee
3,067
3,695
CytRx Corporation (11)(15)
August 2018
Interest rate PRIME + 6.00%
or Floor rate of 9.50%, 7.09% Exit Fee
7,884
9,576
Epirus Biopharmaceuticals, Inc. (8)
Interest rate PRIME + 4.70%
or Floor rate of 7.95%, 3.00% Exit Fee
2,277
2,561
33
15,832
13,304
Acacia Pharma Inc.
January 2022
or Floor rate of 9.25%, 3.95% Exit Fee
9,759
Aveo Pharmaceuticals, Inc. (10)(13)
or Floor rate of 9.45%, 5.40% Exit Fee
9,993
9,861
or Floor rate of 9.45%, 3.00% Exit Fee
10,066
10,011
Total Aveo Pharmaceuticals, Inc.
20,000
20,059
19,872
Axovant Sciences Ltd. (5)(10)(13)(16)
March 2021
Interest rate PRIME + 6.80%
or Floor rate of 10.55%
55,000
53,942
53,958
Brickell Biotech, Inc. (12)
Interest rate PRIME + 5.70%
or Floor rate of 9.20%, 7.49% Exit Fee
5,581
5,960
5,967
BridgeBio Pharma LLC
Interest rate PRIME + 4.35%
or Floor rate of 9.35%, 6.35% Exit Fee
35,000
34,651
Chemocentryx, Inc. (10)(15)(17)
December 2021
Interest rate PRIME + 3.30%
or Floor rate of 8.05%, 6.25% Exit Fee
15,000
14,892
14,833
Genocea Biosciences, Inc. (11)
May 2021
Interest rate PRIME + 2.75%
or Floor rate of 7.75%, 10.12% Exit Fee
14,000
14,591
14,568
Mesoblast (5)(10)
March 2022
Interest rate PRIME + 4.95%
or Floor rate of 9.45%, 6.95% Exit Fee
34,894
Metuchen Pharmaceuticals LLC (12)(14)
October 2020
Interest rate PRIME + 7.25%
or Floor rate of 10.75%,
PIK Interest 1.35%, 2.25% Exit Fee
20,731
21,252
21,184
Motif BioSciences Inc. (5)(10)(15)
September 2021
Interest rate PRIME + 5.50%
or Floor rate of 10.00%, 2.15% Exit Fee
14,774
14,665
Myovant Sciences, Ltd. (5)(10)(13)
Interest rate PRIME + 4.00%
or Floor rate of 8.25%, 6.55% Exit Fee
40,000
39,772
39,408
Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.) (10)(15)(16)
September 2020
or Floor rate of 8.50%, 4.50% Exit Fee
40,558
40,128
10,151
10,033
or Floor rate of 8.50%, 2.25% Exit Fee
10,029
9,935
Total Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.)
60,000
60,738
60,096
Stealth Bio Therapeutics Corp. (5)(10)(12)
January 2021
or Floor rate of 9.50%, 5.00% Exit Fee
20,069
19,878
Tricida, Inc. (15)(17)
Interest rate PRIME + 3.35%
or Floor rate of 8.35%, 11.14% Exit Fee
24,864
uniQure B.V. (5)(10)(11)
May 2020
Interest rate PRIME + 3.00%
or Floor rate of 8.25%, 5.48% Exit Fee
20,761
20,711
Verastem, Inc. (12)
December 2020
or Floor rate of 10.50%, 4.50% Exit Fee
5,000
5,005
4,982
5,037
5,014
5,003
4,979
9,904
9,781
Total Verastem, Inc.
24,949
24,756
415,927
414,064
Subtotal: Drug Discovery & Development (44.35%)*
431,759
427,368
Electronics & Computer Hardware
908 DEVICES INC. (15)
or Floor rate of 8.25%, 4.25% Exit Fee
10,016
9,963
Glo AB (5)(10)(13)(14)
February 2021
Interest rate PRIME + 6.20%
or Floor rate of 10.45%,
PIK Interest 1.75%, 2.95% Exit Fee
12,084
12,042
22,058
22,005
Subtotal: Electronics & Computer Hardware (2.28%)*
Healthcare Services, Other
Medsphere Systems Corporation (14)(15)
or Floor rate of 9.00%,
PIK Interest 1.75%
17,764
17,635
17,691
5,053
5,019
5,034
Total Medsphere Systems Coporation
22,817
22,654
22,725
Oak Street Health (12)
Interest rate PRIME + 5.00%
or Floor rate of 9.75%, 5.95% Exit Fee
30,000
30,100
29,823
PH Group Holdings (13)
Interest rate PRIME + 7.45%
or Floor rate of 10.95%
19,913
19,785
9,944
9,843
Total PH Group Holdings
29,857
29,628
82,611
82,176
Subtotal: Healthcare Services, Other (8.53%)*
Information Services
MDX Medical, Inc. (14)(15)(19)
or Floor rate of 8.25%,
PIK Interest 1.70%
15,157
14,807
14,608
Netbase Solutions, Inc. (13)(14)
August 2020
or Floor rate of 10.00%,
PIK Interest 2.00%, 3.00% Exit Fee
9,142
8,985
8,965
23,792
23,573
Subtotal: Information Services (2.45%)*
11
Internet Consumer & Business Services
Intent Media, Inc. (14)(15)
May 2019
Interest rate PRIME + 5.25%
or Floor rate of 8.75%,
PIK Interest 1.00%, 2.00% Exit Fee
5,076
5,096
PIK Interest 2.35%, 2.00% Exit Fee
2,044
2,042
PIK Interest 2.50%, 2.00% Exit Fee
2,047
2,045
Total Intent Media, Inc.
9,167
9,183
The Faction Group LLC
January 2019
or Floor rate of 8.25%
2,000
11,183
AppDirect, Inc. (13)(19)
or Floor rate of 9.95%, 3.45% Exit Fee
19,859
19,738
Art.com, Inc. (14)(15)
April 2021
Interest rate PRIME + 5.40%
or Floor rate of 10.15%,
PIK Interest 1.70%, 1.50% Exit Fee
10,030
9,873
Cloudpay, Inc. (5)(10)
April 2022
Interest rate PRIME + 4.05%
or Floor rate of 8.55%, 6.95% Exit Fee
11,000
10,884
EverFi, Inc. (14)(16)
May 2022
Interest rate PRIME + 3.90%
or Floor rate of 8.65%,
PIK Interest 2.30%
50,115
50,067
First Insight, Inc. (15)(17)
November 2021
Interest rate PRIME + 6.25%
or Floor rate of 11.25%
5,876
Greenphire, Inc. (17)
Interest rate 3-month LIBOR + 8.00%
or Floor rate of 9.00%
3,433
3,432
3,437
or Floor rate of 7.00%
1,500
1,488
Total Greenphire Inc.
4,933
4,932
4,925
Interactions Corporation (19)
Interest rate 3-month LIBOR + 8.60%
or Floor rate of 9.85%, 1.75% Exit Fee
25,052
25,128
LogicSource (15)
October 2019
or Floor rate of 9.75%, 5.00% Exit Fee
4,820
5,145
5,144
RumbleON, Inc.
Interest rate PRIME + 5.75%
or Floor rate of 10.25%, 4.55% Exit Fee
4,945
Snagajob.com, Inc. (13)(14)
July 2020
Interest rate PRIME + 5.15%
or Floor rate of 9.15%,
PIK Interest 1.95%, 2.55% Exit Fee
41,429
41,398
41,552
Tectura Corporation (7)(8)(9)(14)
June 2021
Interest rate FIXED 6.00%,
PIK Interest 3.00%
20,608
19,127
PIK Interest 8.00%
10,680
240
Total Tectura Corporation
31,288
20,848
The Faction Group LLC.
Interest rate 3-month LIBOR + 9.25%
or Floor rate of 10.25%
8,000
8,008
Wheels Up Partners LLC
Interest rate 3-month LIBOR + 8.55%
or Floor rate of 9.55%
21,701
21,503
Xometry, Inc. (17)(19)
Interest rate PRIME + 3.95%
or Floor rate of 8.45%, 7.45% Exit Fee
7,000
6,942
235,324
233,712
Subtotal: Internet Consumer & Business Services (25.41%)*
246,507
244,895
12
Media/Content/Info
Bustle (14)(15)
Interest rate PRIME + 4.10%
or Floor rate of 8.35%,
PIK Interest 1.95%, 1.95% Exit Fee
15,164
15,133
15,156
FanDuel, Inc. (9)(10)(12)(14)
November 2019
or Floor rate of 10.75%, 10.41% Exit Fee
19,354
20,380
Convertible Debt
PIK Interest 25.00%
1,723
Total FanDuel, Inc.
20,354
21,380
22,103
36,513
37,259
Subtotal: Media/Content/Info (3.87%)*
Medical Devices & Equipment
Aspire Bariatrics, Inc. (15)
October 2018
or Floor rate of 9.25%, 6.85% Exit Fee
1,793
2,208
829
Quanterix Corporation (11)
March 2019
or Floor rate of 8.00%
7,688
7,673
9,881
8,502
Intuity Medical, Inc. (15)
or Floor rate of 9.25%, 4.95% Exit Fee
17,500
17,251
17,278
Micell Technologies, Inc. (12)
August 2019
or Floor rate of 10.50%, 5.00% Exit Fee
3,942
4,291
4,251
Quanta Fluid Solutions (5)(10)(11)
April 2020
Interest rate PRIME + 8.05%
or Floor rate of 11.55%, 5.00% Exit Fee
7,864
8,290
8,250
Rapid Micro Biosystems, Inc. (13)(15)
or Floor rate of 9.65%, 7.25% Exit Fee
18,000
17,929
Sebacia, Inc. (15)
or Floor rate of 8.85%, 6.05% Exit Fee
8,054
8,066
Transenterix, Inc. (10)
June 2022
Interest rate PRIME + 4.55%
or Floor rate of 9.55%, 6.95% Exit Fee
19,827
75,642
75,601
Subtotal: Medical Devices & Equipment (8.73%)*
85,523
84,103
Software
Pollen, Inc. (15)
April 2019
Interest rate PRIME + 4.25%
or Floor rate of 8.50%, 4.00% Exit Fee
7,084
13
Banker's Toolbox, Inc (13)(18)
Interest rate 3-month LIBOR + 7.88%
or Floor rate of 8.88%
39,900
39,085
Businessolver.com, Inc. (16)(17)
May 2023
Interest rate 3-month LIBOR + 7.50%
51,000
50,000
Clarabridge, Inc. (12)(14)
Interest rate PRIME + 4.80%
or Floor rate of 8.55%,
PIK Interest 3.25%
41,570
41,549
41,724
Dashlane, Inc. (14)(19)
PIK Interest 1.10%, 9.25% Exit Fee
9,932
Emma, Inc. (17)(18)
September 2022
Interest rate 3-month LIBOR + 9.39%
37,037
35,728
35,962
Evernote Corporation (14)(15)(17)(19)
Interest rate PRIME + 5.45%
or Floor rate of 8.95%
5,980
6,072
or Floor rate of 9.50%,
PIK Interest 1.25%
4,048
4,028
4,022
2,500
2,483
Total Evernote Corporation
12,548
12,491
12,577
Fuze, Inc. (13)(14)(15)(16)(19)
Interest rate PRIME + 3.70%
or Floor rate of 7.95%,
PIK Interest 1.55%, 3.55% Exit Fee
50,728
51,097
51,014
Impact Radius Holdings, Inc. (12)(14)
PIK Interest 1.55%, 1.75% Exit Fee
10,111
10,055
PIK Interest 1.55%
1,977
Total Impact Radius Holdings, Inc.
12,111
12,151
12,032
Insurance Technologies Corporation (17)
Interest rate 3-month LIBOR + 7.75%
or Floor rate of 8.75%
12,500
12,261
Lightbend, Inc. (14)(15)
August 2021
or Floor rate of 8.50%,
PIK Interest 2.00%
11,066
Lithium Technologies, Inc. (17)
October 2022
12,000
11,762
Microsystems Holding Company, LLC (13)(19)
Interest rate 3-month LIBOR + 8.25%
or Floor rate of 9.25%
11,837
11,873
OneLogin, Inc. (14)(15)
Interest rate PRIME + 5.95%
or Floor rate of 10.70%,
21,153
20,953
20,935
Quid, Inc. (14)(15)
PIK Interest 2.25%, 3.00% Exit Fee
8,398
8,533
8,554
RapidMiner, Inc. (12)(14)
or Floor rate of 9.75%,
PIK Interest 1.65%
7,060
7,037
6,963
Regent Education (14)
Interest rate FIXED 10.00%,
PIK Interest 2.00%, 6.35% Exit Fee
3,275
3,299
2,144
Salsa Labs, Inc. (17)
April 2023
Interest rate 3-month LIBOR + 8.15%
or Floor rate of 9.15%
5,884
Signpost, Inc. (14)
February 2020
Interest rate PRIME + 4.15%
or Floor rate of 8.15%,
PIK Interest 1.75%, 3.75% Exit Fee
15,647
15,932
15,840
Vela Trading Technologies (18)
Interest rate 3-month LIBOR + 9.50%
or Floor rate of 10.50%
19,543
19,434
Wrike, Inc. (13)(14)(19)
10,268
10,056
10,180
ZocDoc (19)
or Floor rate of 10.50%, 1.00% Exit Fee
20,043
20,165
10,020
10,082
Total ZocDoc
30,063
30,247
420,077
419,287
Subtotal: Software (44.24%)*
427,161
426,371
14
Surgical Devices
Gynesonics, Inc. (9)(14)(15)
Unsecured Convertible Debt
132
Subtotal: Surgical Devices (0.01%)*
Sustainable and Renewable Technology
ChargePoint Inc. (19)
Interest rate 3-month LIBOR + 8.75%
or Floor rate of 9.75%, 2.00% Exit Fee
15,758
FuelCell Energy, Inc. (12)
or Floor rate of 9.90%, 6.68% Exit Fee
13,091
12,997
13,024
or Floor rate of 9.90%, 8.50% Exit Fee
11,909
13,531
13,542
Total FuelCell Energy, Inc.
26,528
26,566
Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.) (6)
Interest rate PRIME + 8.70%
or Floor rate of 12.95%, 4.50% Exit Fee
10,500
10,468
10,382
Impossible Foods, Inc. (17)
or Floor rate of 8.95%, 10.00% Exit Fee
14,768
Metalysis Limited (5)(10)
or Floor rate of 9.25%, 6.95% Exit Fee
7,500
7,494
Proterra, Inc. (11)(14)(17)
November 2020
PIK Interest 1.75%, 5.95% Exit Fee
25,259
26,388
26,479
PIK Interest 1.75%, 7.00% Exit Fee
5,052
5,276
5,285
Total Proterra, Inc.
30,311
31,664
31,764
106,762
106,814
Subtotal: Sustainable and Renewable Technology (11.08%)*
Total: Debt Investments (160.43%)*
1,554,191
1,545,997
15
Series
Equity Investments
NuGEN Technologies, Inc. (15)
Equity
55,780
Subtotal: Biotechnology Tools (0.00%)*
Communications & Networking
GlowPoint, Inc. (4)
114,192
102
23
Peerless Network Holdings, Inc.
Preferred Series A
1,135,000
1,229
6,204
Subtotal: Communications & Networking (0.65%)*
1,331
6,227
Diagnostic
Singulex, Inc.
937,998
750
407
Subtotal: Diagnostic (0.04%)*
Gibraltar Business Capital, LLC (7)
830,000
1,884
10,602,752
25,896
Total Gibraltar Business Capital, LLC.
11,432,752
27,780
Subtotal: Diversified Financial Services (2.88%)*
AcelRx Pharmaceuticals, Inc. (4)
54,240
108
183
BioQ Pharma Incorporated (15)
Preferred Series D
165,000
705
Edge Therapeutics, Inc. (4)
49,965
309
51
Neos Therapeutics, Inc. (4)(15)
125,000
781
Subtotal: Drug Delivery (0.18%)*
2,417
1,720
Aveo Pharmaceuticals, Inc. (4)(10)(15)
1,901,791
1,715
4,481
Axovant Sciences Ltd. (4)(5)(10)(16)
129,827
1,269
293
Cerecor, Inc. (4)
119,087
517
Dare Biosciences, Inc. (p.k.a. Cerulean Pharma, Inc.) (4)
13,550
16
Dicerna Pharmaceuticals, Inc. (4)(15)
142,858
1,749
Dynavax Technologies (4)(10)
550
305
Eidos Therapeutics, Inc. (4)(10)
255
Genocea Biosciences, Inc. (4)
223,463
191
Insmed, Incorporated (4)
70,771
1,724
Melinta Therapeutics (4)
51,821
330
Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.) (4)(10)(16)
76,362
2,744
779
Rocket Pharmaceuticals, Ltd (p.k.a. Inotek Pharmaceuticals Corporation) (4)
944
Tricida, Inc. (4)
105,260
3,147
Subtotal: Drug Discovery & Development (1.44%)*
18,033
13,856
Identiv, Inc. (4)
6,700
34
25
Subtotal: Electronics & Computer Hardware (0.00%)*
DocuSign, Inc. (4)
385,000
6,081
20,386
Subtotal: Information Services (2.12%)*
Blurb, Inc. (15)
Preferred Series B
220,653
175
90
Brigade Group, Inc. (p.k.a. Philotic, Inc.)
9,023
Lightspeed POS, Inc. (5)(10)
Preferred Series C
230,030
250
283
198,677
Total Lightspeed POS, Inc.
428,707
538
OfferUp, Inc.
286,080
1,663
1,920
Preferred Series A-1
108,710
632
729
Total OfferUp, Inc.
394,790
2,295
2,649
Oportun (p.k.a. Progress Financial)
Preferred Series G
218,351
337
Preferred Series H
87,802
247
Total Oportun (p.k.a. Progress Financial)
306,153
584
RazorGator Interactive Group, Inc.
Preferred Series AA
34,783
Tectura Corporation (7)
414,994,863
900
Preferred Series BB
1,000,000
415,994,863
Subtotal: Internet Consumer & Business Services (0.40%)*
4,478
3,861
Pinterest, Inc.
Preferred Series Seed
620,000
4,085
4,681
Subtotal: Media/Content/Info (0.49%)*
AtriCure, Inc. (4)(15)
7,536
266
204
Flowonix Medical Incorporated
221,893
Gelesis, Inc. (15)
198,202
657
191,210
425
Preferred Series A-2
191,626
680
Total Gelesis, Inc.
581,038
925
2,066
Medrobotics Corporation (15)
Preferred Series E
136,798
Preferred Series F
73,971
155
86
163,934
252
Total Medrobotics Corporation
374,703
905
431
Optiscan Biomedical, Corp. (6)(15)
6,185,567
3,000
411
1,927,309
655
119
55,103,923
5,257
3,721
31,199,131
2,843
Total Optiscan Biomedical, Corp.
94,415,930
11,521
7,094
Outset Medical, Inc. (p.k.a. Home Dialysis Plus, Inc.)
232,061
723
Quanterix Corporation (4)
84,778
1,217
Subtotal: Medical Devices & Equipment (1.22%)*
16,644
11,735
Braxton Technologies, LLC
Class A Units
62,735
188
267
CapLinked, Inc.
Preferred Series A-3
53,614
Druva, Inc.
Preferred Series 2
458,841
1,455
Preferred Series 3
93,620
300
358
Total Druva, Inc.
552,461
1,300
1,813
HighRoads, Inc.
190
307
NewVoiceMedia Limited (5)(10)
669,173
963
1,570
Palantir Technologies
727,696
5,431
4,797
326,797
2,211
2,155
Total Palantir Technologies
1,054,493
7,642
6,952
Sprinklr, Inc.
700,000
3,749
4,069
WildTangent, Inc. (15)
100,000
402
Subtotal: Software (1.55%)*
14,602
14,944
17
Gynesonics, Inc. (15)
219,298
61
656,538
282
1,991,157
712
2,786,367
429
610
Total Gynesonics, Inc.
5,653,360
1,673
1,662
Transmedics, Inc.
88,961
1,100
447
119,999
418
260,000
650
1,160
100,200
591
Total Transmedics, Inc.
569,160
2,550
2,616
Subtotal: Surgical Devices (0.44%)*
4,223
4,278
Flywheel Building Intelligence, Inc. (p.k.a. SCIEnergy, Inc.)
761
Modumetal, Inc.
3,107,520
91
Proterra, Inc.
Preferred Series 5
99,280
522
288
61,502
10,996
Subtotal: Sustainable and Renewable Technology (1.20%)*
63,263
11,609
Total: Equity Investments (12.61%)*
164,221
121,509
18
Warrant Investments
Labcyte, Inc. (15)
Warrant
1,127,624
323
514
Subtotal: Biotechnology Tools (0.05%)*
3,328
Spring Mobile Solutions, Inc.
2,834,375
Subtotal: Communications & Networking (0.00%)*
1,662,441
228
Intelligent Beauty, Inc. (15)
190,234
230
The Neat Company (15)
Preferred Series C-1
540,540
365
68,627
Subtotal: Consumer & Business Products (0.02%)*
206
AcelRx Pharmaceuticals, Inc. (4)(15)
176,730
786
174
Agile Therapeutics, Inc. (4)
180,274
730
BioQ Pharma Incorporated
459,183
1
658
Celsion Corporation (4)
13,927
428
Dance Biopharm, Inc. (15)
110,882
74
78,595
390
20
Kaleo, Inc. (p.k.a. Intelliject, Inc.)
82,500
594
1,222
70,833
285
Pulmatrix Inc. (4)
25,150
116
ZP Opco, Inc. (p.k.a. Zosano Pharma) (4)
3,618
Subtotal: Drug Delivery (0.22%)*
3,670
2,102
Acacia Pharma Inc. (4)
201,330
304
ADMA Biologics, Inc. (4)
89,750
295
30
Auris Medical Holding, AG (4)(5)(10)
15,672
249
Brickell Biotech, Inc.
26,086
60
22,328
70
Chroma Therapeutics, Ltd. (5)(10)
325,261
490
Cleveland BioLabs, Inc. (4)(10)(15)
7,813
Concert Pharmaceuticals, Inc. (4)(10)(15)
132,069
545
CTI BioPharma Corp. (p.k.a. Cell Therapeutics, Inc.) (4)
29,239
165
CytRx Corporation (4)(15)
105,694
160
17,190
369
200
28
Evofem Biosciences, Inc. (p.k.a Neothetics, Inc.) (4)(15)
7,806
Fortress Biotech, Inc. (p.k.a. Coronado Biosciences, Inc.) (4)
73,009
142
403,136
Immune Pharmaceuticals (4)
10,742
164
40,545
626
Motif BioSciences Inc. (4)(5)(10)(15)
73,452
198
Myovant Sciences, Ltd. (4)(5)(10)
73,710
460
892
Neuralstem, Inc. (4)(15)
5,783
77
Ology Bioservices, Inc. (p.k.a. Nanotherapeutics, Inc.) (15)
171,389
838
Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.) (4)(10)(15)(16)
75,214
178
Savara Inc. (p.k.a. Mast Therapeutics, Inc.) (4)(15)
32,467
203
130
Sorrento Therapeutics, Inc. (4)(10)
306,748
889
1,075
Stealth Bio Therapeutics Corp. (5)(10)
650,000
158
Tricida, Inc. (4)(15)
53,458
222
918
uniQure B.V. (4)(5)(10)
37,174
218
701
XOMA Corporation (4)(10)(15)
9,063
279
Subtotal: Drug Discovery & Development (0.56%)*
8,332
5,350
79,856
100
68
Clustrix, Inc.
Subtotal: Electronics & Computer Hardware (0.01%)*
112
Chromadex Corporation (4)(15)
139,673
157
126
Subtotal: Healthcare Services, Other (0.01%)*
INMOBI Inc. (5)(10)
65,587
82
InXpo, Inc. (15)
898,134
49
MDX Medical, Inc. (15)
2,812,500
296
Netbase Solutions, Inc.
Preferred Series 1
356
367
RichRelevance, Inc. (15)
112,612
98
Subtotal: Information Services (0.08%)*
868
737
Aria Systems, Inc.
231,535
Art.com, Inc. (15)
311,005
66
106
234,280
636
42
ClearObject, Inc. (p.k.a. CloudOne, Inc.)
968,992
177
4,960
45
62
8,703
234
525
First Insight, Inc. (15)
45,551
56
57
Intent Media, Inc. (15)
140,077
168
Interactions Corporation
Preferred Series G-3
68,187
422
Just Fabulous, Inc.
206,184
1,102
3,003
245,610
133
79,625
26
174,562
78
RumbleON, Inc. (4)
81,818
72
ShareThis, Inc. (15)
493,502
547
Snagajob.com, Inc.
1,800,000
782
332
Tapjoy, Inc.
748,670
316
Thumbtack, Inc.
102,821
124
101
TraceLink, Inc.
283,353
1,832
2,705
Xometry, Inc.
87,784
47
Subtotal: Internet Consumer & Business Services (0.85%)*
6,451
8,200
FanDuel, Inc. (10)
15,570
4,648
1,875
20,218
Machine Zone, Inc.
1,552,710
1,958
3,972
Napster (p.k.a. Rhapsody International, Inc.) (15)
715,755
385
122
WP Technology, Inc. (Wattpad, Inc.) (5)(10)
255,818
Zoom Media Group, Inc.
1,204
348
Subtotal: Media/Content/Info (0.63%)*
3,425
6,038
Amedica Corporation (4)(15)
8,603
459
Preferred Series B-1
112,858
455
Avedro, Inc. (15)
300,000
401
382
155,325
362
74,784
144
InspireMD, Inc. (4)(5)(10)
1,124
242
Preferred Series 4
1,819,078
294
458
455,539
370
Micell Technologies, Inc.
Preferred Series D-2
84,955
262
NetBio, Inc.
7,841
408
NinePoint Medical, Inc. (15)
587,840
170
Optiscan Biomedical, Corp. (6)
7,442,491
572
233
500,000
630
66,039
199
778,301
173
SonaCare Medical, LLC (p.k.a. US HIFU, LLC)
6,464
Tela Bio, Inc. (15)
387,930
195
ViewRay, Inc. (4)(15)
128,231
333
239
Subtotal: Medical Devices & Equipment (0.32%)*
5,395
3,049
Semiconductors
Achronix Semiconductor Corporation (15)
360,000
159
475
750,000
718
Total Achronix Semiconductor Corporation
1,110,000
258
1,193
Aquantia Corp. (4)
19,683
Avnera Corporation
141,567
248
Subtotal: Semiconductors (0.15%)*
1,451
21
Actifio, Inc.
73,584
31,673
343
76
Total Actifio, Inc.
105,257
592
CareCloud Corporation (15)
413,433
Clickfox, Inc. (15)
1,038,563
592,019
53
Preferred Series C-A
2,218,214
427
Total Clickfox, Inc.
3,848,796
1,290
546
DNAnexus, Inc.
909,091
97
Evernote Corporation (15)
62,500
Fuze, Inc. (15)(16)
256,158
89
Lightbend, Inc. (15)
391,778
79
Mattersight Corporation (4)
357,143
Message Systems, Inc. (15)
503,718
334
451
Neos, Inc. (15)
221,150
22
225,586
OneLogin, Inc. (15)
305,296
224
284
Poplicus, Inc.
132,168
Quid, Inc. (15)
71,576
RapidMiner, Inc.
RedSeal Inc. (15)
Preferred Series C-Prime
640,603
36
Signpost, Inc.
324,005
314
180
Wrike, Inc.
698,760
462
1,676
Subtotal: Software (0.43%)*
4,529
4,171
Specialty Pharmaceuticals
Alimera Sciences, Inc. (4)
1,717,709
861
Subtotal: Specialty Pharmaceuticals (0.02%)*
180,480
75
1,575,965
320
360
1,756,445
395
380
175,000
568
50,544
225,544
138
669
Subtotal: Surgical Devices (0.11%)*
533
1,049
Agrivida, Inc. (15)
471,327
120
American Superconductor Corporation (4)
58,823
Calera, Inc. (15)
44,529
513
Fluidic, Inc.
61,804
5,310
181
Preferred Series 2-A
63
50
Total Flywheel Building Intelligence, Inc. (p.k.a. SCIEnergy, Inc.)
5,373
231
Fulcrum Bioenergy, Inc.
280,897
274
472
GreatPoint Energy, Inc. (15)
Preferred Series D-1
393,212
548
Kinestral Technologies, Inc.
325,000
104
131,883
32
Total Kinestral Technologies, Inc.
456,883
136
Polyera Corporation (15)
311,609
338
477,517
41
470
Rive Technology, Inc. (15)
234,477
TAS Energy, Inc.
428,571
299
Tendril Networks
Preferred Series 3-A
1,019,793
189
Subtotal: Sustainable and Renewable Technology (0.12%)*
2,924
1,152
Total: Warrant Investments (3.57%)*
39,148
34,430
Total Investments in Securities (176.60%)*
1,757,560
*
Value as a percent of net assets
Preferred and common stock, warrants, and equity interests are generally non-income producing.
Interest rate PRIME represents 5.00% at June 30, 2018. Daily LIBOR, 1-month LIBOR, 3-month LIBOR and 12-month LIBOR represent 1.93%, 2.09%, 2.34% and
2.76%, respectively, at June 30, 2018.
(3)
Gross unrealized appreciation, gross unrealized depreciation, and net unrealized depreciation for federal income tax purposes totaled $38.1 million, $102.0 million and $64.0 million respectively. The tax cost of investments is $1.7 billion.
(4)
Except for warrants in 41 publicly traded companies and common stock in 21 publicly traded companies, all investments are restricted at June 30, 2018 and were valued at fair value using Level 3 significant unobservable inputs as determined in good faith by the Company’s board of directors (the “Board of Directors”). No unrestricted securities of the same issuer are outstanding. The Company uses the Standard Industrial Code for classifying the industry grouping of its portfolio companies.
(5)
Non-U.S. company or the company’s principal place of business is outside the United States.
(6)
Affiliate investment as defined under the Investment Company Act of 1940, as amended, (the “1940 Act”) in which Hercules owns at least 5% but generally less than 25% of the company’s voting securities.
(7)
Control investment as defined under the 1940 Act in which Hercules owns at least 25% of the company’s voting securities or has greater than 50% representation on its board.
(8)
Debt is on non-accrual status at June 30, 2018, and is therefore considered non-income producing. Note that at June 30, 2018, only the $10.7 million PIK, or payment-in-kind, loan is on non-accrual for the Company’s debt investment in Tectura Corporation.
(9)
Denotes that all or a portion of the debt investment is convertible debt.
(10)
Indicates assets that the Company deems not “qualifying assets” under section 55(a) of 1940 Act. Qualifying assets must represent at least 70% of the Company’s total assets at the time of acquisition of any additional non-qualifying assets.
(11)
Denotes that all or a portion of the debt investment secures the notes offered in the Debt Securitization (as defined in Note 4).
(12)
Denotes that all or a portion of the debt investment is pledged as collateral under the Wells Facility (as defined in Note 4).
(13)
Denotes that all or a portion of the debt investment is pledged as collateral under the Union Bank Facility (as defined in Note 4).
(14)
Denotes that all or a portion of the debt investment principal includes accumulated PIK interest and is net of repayments.
(15)
Denotes that all or a portion of the investment in this portfolio company is held by Hercules Technology II, L.P., or HT II, or Hercules Technology III, L.P., or HT III, the Company’s wholly owned small business investment companies, or SBIC, subsidiaries.
(16)
Denotes that the fair value of the Company’s total investments in this portfolio company represent greater than 5% of the Company’s total assets at June 30, 2018.
(17)
Denotes that there is an unfunded contractual commitment available at the request of this portfolio company at June 30, 2018. Refer to Note 10.
(18)
Denotes unitranche debt with first lien “last-out” senior secured position and security interest in all assets of the portfolio company whereby the “last-out” portion will be subordinated to the “first-out” portion in a liquidation, sale or other disposition.
(19)
Denotes second lien senior secured debt.
5,115
5,146
Subtotal: Biotechnology Tools (0.61%)*
OpenPeak, Inc. (8)
April 2018
Interest rate PRIME + 8.75%
or Floor rate of 12.00%
11,464
8,228
Antenna79 (p.k.a. Pong Research Corporation) (15)
or Floor rate of 9.50%
or Floor rate of 10.95%, 2.95% Exit Fee
18,440
18,580
18,571
Second Time Around (Simplify Holdings, LLC) (7)(8)(15)
or Floor rate of 10.75%, 4.75% Exit Fee
1,746
1,781
20,361
Subtotal: Consumer & Business Products (2.33%)*
21,361
19,571
10,888
11,292
Pulmatrix Inc. (9)(11)
July 2018
or Floor rate of 9.50%, 3.50% Exit Fee
3,259
3,455
6,316
6,609
21,356
AcelRx Pharmaceuticals, Inc. (10)(11)(15)
18,653
18,925
18,875
or Floor rate of 9.00%, 4.25% Exit Fee
25,006
24,958
Edge Therapeutics, Inc. (12)
Interest rate PRIME + 4.65%
or Floor rate of 9.15%, 4.95% Exit Fee
20,377
20,331
64,308
64,164
Subtotal: Drug Delivery (10.17%)*
85,664
85,520
9,986
11,172
3,027
3,310
340
14,482
11,512
January 2020
10,341
10,610
10,563
10,345
10,344
9,918
9,915
20,263
20,259
Axovant Sciences Ltd. (5)(10)
53,631
53,448
or Floor rate of 9.20%, 6.75% Exit Fee
6,090
6,380
6,361
4,947
Interest rate PRIME + 2.25%
or Floor rate of 7.25%, 4.95% Exit Fee
13,851
14,385
Insmed, Incorporated (11)
or Floor rate of 9.25%, 4.86% Exit Fee
55,425
54,963
25,561
25,721
25,643
Motif BioSciences Inc. (15)
14,651
Myovant Sciences, Ltd. (5)(10)(13)(17)
24,704
Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.) (15)
40,144
39,829
10,040
9,958
9,964
9,895
60,148
59,682
PhaseRx, Inc. (15)
or Floor rate of 9.25%, 5.85% Exit Fee
4,694
4,842
1,917
14,898
14,847
20,579
20,543
Verastem, Inc. (12)(17)
4,957
4,910
4,996
4,949
4,953
4,907
14,906
14,766
346,187
341,679
Subtotal: Drug Discovery & Development (42.00%)*
360,669
353,191
10,014
9,887
Subtotal: Electronics & Computer Hardware (1.18%)*
17,607
17,437
5,009
4,963
Total Medsphere Systems Corporation
22,616
22,400
19,965
19,803
9,922
9,840
29,800
29,643
72,165
72,008
Subtotal: Healthcare Services, Other (8.56%)*
MDX Medical, Inc. (14)(15)(17)
7,568
7,369
7,327
9,051
8,730
16,099
16,057
Subtotal: Information Services (1.91%)*
AppDirect, Inc.
9,885
Aria Systems, Inc. (11)(14)
June 2019
Interest rate PRIME + 3.20%
or Floor rate of 6.95%,
PIK Interest 1.95%, 1.50% Exit Fee
2,103
2,104
1,803
Interest rate PRIME + 5.20%
or Floor rate of 8.95%,
18,832
18,839
16,144
Total Aria Systems, Inc.
20,943
17,947
Greenphire Inc.
3,883
4,883
5,050
5,011
5,027
2,020
1,987
1,991
2,022
1,988
1,992
9,092
8,986
9,010
25,013
6,452
6,701
6,726
41,023
40,633
41,036
20,298
19,219
11,015
31,313
20,538
The Faction Group
Total The Faction Group
147,582
143,719
Subtotal: Internet Consumer & Business Services (17.09%)*
Machine Zone, Inc. (14)(16)
May 2018
Interest rate PRIME + 2.50%
or Floor rate of 6.75%,
106,986
106,641
15,016
14,935
FanDuel, Inc. (9)(12)(14)
19,762
19,695
20,762
20,695
35,697
35,630
Subtotal: Media/Content/Info (16.92%)*
142,338
142,271
Amedica Corporation (9)(15)
January 2018
Interest rate PRIME + 7.70%
or Floor rate of 10.95%, 8.25% Exit Fee
605
2,255
or Floor rate of 9.25%, 5.42% Exit Fee
2,527
2,848
5,103
IntegenX, Inc. (15)
or Floor rate of 10.05%, 6.75% Exit Fee
13,042
12,991
2,599
2,598
or Floor rate of 10.05%, 9.75% Exit Fee
2,618
2,601
Total IntegenX, Inc.
18,259
18,190
17,013
5,469
5,744
5,708
10,117
10,432
10,386
or Floor rate of 8.00%, 4.00% Exit Fee
9,043
9,477
7,927
7,919
or Floor rate of 9.45%, 3.15% Exit Fee
4,991
4,973
73,843
73,666
Subtotal: Medical Devices & Equipment (9.37%)*
78,946
78,769
Achronix Semiconductor Corporation (15)(17)
Interest rate PRIME + 7.00%
or Floor rate of 11.00%, 12.50% Exit Fee
5,084
5,100
or Floor rate of 10.00%
4,274
4,273
9,274
9,358
9,373
Subtotal: Semiconductors (1.11%)*
Clickfox, Inc. (13)
Interest rate PRIME + 8.00%
or Floor rate of 11.50%, 12.01% Exit Fee
6,378
7,671
Digital Train Limited (p.k.a. Jumpstart Games, Inc.) (15)
Interest rate 12-month LIBOR + 2.50%
5,671
4,073
13,342
11,744
40,893
40,870
41,063
Emma, Inc.
Interest rate daily LIBOR + 7.75%
48,565
Evernote Corporation (14)(15)(17)
5,974
6,100
4,023
3,992
10,023
9,973
10,092
Fuze, Inc. (13)(14)(15)
50,332
50,464
50,420
Impact Radius Holdings, Inc. (14)(17)
7,544
7,552
7,498
Interest rate 1-month LIBOR + 8.00%
11,740
Microsystems Holding Company, LLC
11,821
or Floor rate of 9.95%,
15,883
15,811
16,071
PerfectServe, Inc.
Interest rate 3-month LIBOR + 9.00%
or Floor rate of 10.00%, 2.50% Exit Fee
16,000
16,023
4,000
4,005
Total PerfectServe, Inc.
20,028
6,964
Poplicus, Inc. (8)(14)
1,250
8,303
8,397
8,430
RapidMiner, Inc. (14)
7,001
6,971
3,285
3,291
15,510
15,603
15,685
Vela Trading Technologies
Interest rate daily LIBOR + 9.50%
19,495
19,557
Wrike, Inc. (14)(17)
10,165
9,971
10,007
ZocDoc
20,011
10,005
30,016
318,782
318,219
Subtotal: Software (39.24%)*
332,124
329,963
29
Jaguar Animal Health, Inc. (11)
Interest rate PRIME + 5.65%
or Floor rate of 9.90%, 7.00% Exit Fee
1,089
1,496
Alimera Sciences, Inc. (11)(14)
Interest rate PRIME + 7.50%
or Floor rate of 11.00%,
PIK Interest 1.00%, 4.00% Exit Fee
35,398
35,517
Subtotal: Specialty Pharmaceuticals (4.40%)*
37,013
Transmedics, Inc. (13)
Interest rate PRIME + 5.30%
or Floor rate of 9.55%, 6.70% Exit Fee
8,500
8,756
8,757
Subtotal: Surgical Devices (1.04%)*
or Floor rate of 9.50%, 8.50% Exit Fee
16,806
Kinestral Technologies Inc.
or Floor rate of 8.75%, 3.23% Exit Fee
3,867
3,882
22,072
ChargePoint Inc.
19,394
19,416
13,604
25,036
25,997
26,097
5,007
5,173
5,190
30,043
31,170
31,287
or Floor rate of 9.45%, 4.00% Exit Fee
4,258
4,498
4,515
Tendril Networks (12)
Interest rate FIXED 9.25%, 8.50% Exit Fee
13,156
13,863
13,845
82,551
82,667
Subtotal: Sustainable and Renewable Technology (12.45%)*
104,623
104,739
Total: Debt Investments (168.38%)*
1,440,055
1,415,984
Investment (1)
Cost (3)
Value (4)
Achilles Technology Management Co II, Inc. (7)(15)
3,100
5,865
Subtotal: Communications & Networking (0.73%)*
4,202
6,148
720
Subtotal: Diagnostic (0.09%)*
AcelRx Pharmaceuticals, Inc. (4)(10)
109
826
468
1,275
Subtotal: Drug Delivery (0.32%)*
2,678
5,315
Axovant Sciences Ltd. (4)(5)(10)
1,270
707
381
374
Epirus Biopharmaceuticals, Inc. (4)
200,000
259
Inotek Pharmaceuticals Corporation (4)
3,778
2,154
43,840
693
Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.) (4)
2,743
1,367
Subtotal: Drug Discovery & Development (1.50%)*
16,778
12,579
DocuSign, Inc.
8,011
Subtotal: Information Services (0.95%)*
31
46
213
446
2,236
850
3,086
706
Subtotal: Internet Consumer & Business Services (0.52%)*
3,578
4,333
5,055
Subtotal: Media/Content/Info (0.60%)*
879
939
894
2,712
302
225
532
1,059
114
4,232
15,638,888
1,307
1,457
78,855,687
10,219
6,205
596
1,820
Subtotal: Medical Devices & Equipment (1.49%)*
15,342
12,530
1,044
312
1,356
ForeScout Technologies, Inc. (4)
199,844
529
6,373
1,544
4,923
7,134
4,600
179
Subtotal: Software (2.53%)*
14,943
21,276
44
795
521
1,420
376
957
531
2,173
Subtotal: Surgical Devices (0.43%)*
3,593
19,250
477
539
11,400
Subtotal: Sustainable and Renewable Technology (1.48%)*
12,416
Total: Equity Investments (10.63%)*
136,196
89,361
PeerApp, Inc.
298,779
135,000
501
Subtotal: Communications & Networking (0.06%)*
574
221
Subtotal: Consumer & Business Products (0.03%)*
823
AcelRx Pharmaceuticals, Inc. (4)(10)(15)
65
968
148
72,379
Subtotal: Drug Delivery (0.36%)*
3,016
Anthera Pharmaceuticals, Inc. (4)(15)
5,022
984
Audentes Therapeutics, Inc. (4)(10)(15)
9,914
147
156,726
Cleveland BioLabs, Inc. (4)(15)
Concert Pharmaceuticals, Inc. (4)(15)
1,344
58
64,194
276
73,725
31,655
Motif BioSciences Inc. (4)(15)
414
49,800
128
Neothetics, Inc. (p.k.a. Lithera, Inc.) (4)(15)
46,838
Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.) (4)(15)
212
PhaseRx, Inc. (4)(15)
63,000
125
453
487,500
107
Subtotal: Drug Discovery & Development (0.40%)*
8,869
3,403
329
Subtotal: Healthcare Services, Other (0.04%)*
35
648,400
1,165,183
37
Total InXpo, Inc.
1,813,583
172
2,250,000
246
129
363
Subtotal: Information Services (0.07%)*
954
154
207
2,627
196
1,257
1,833
Subtotal: Internet Consumer & Business Services (0.82%)*
6,041
6,857
FanDuel, Inc.
Machine Zone, Inc. (16)
3,743
Rhapsody International, Inc. (15)
Subtotal: Media/Content/Info (0.67%)*
5,672
275
216
39,364
547,752
150
10,535,275
1,252
430
205
536
127
Strata Skin Sciences, Inc. (p.k.a. MELA Sciences, Inc.) (4)
13,864
153
Subtotal: Medical Devices & Equipment (0.39%)*
6,492
3,296
308
519
827
Subtotal: Semiconductors (0.12%)*
1,033
163
168,750
113
4,458
4,766
Fuze, Inc. (15)
639
Mobile Posse, Inc. (15)
396,430
353
228,972
227
129,073
1,040
Subtotal: Software (1.06%)*
5,413
8,884
488
Subtotal: Specialty Pharmaceuticals (0.06%)*
291
306
40,436
265,980
505
Subtotal: Surgical Devices (0.10%)*
758
811
88
Alphabet Energy, Inc. (15)
Preferred Series 1B
13,667
Brightsource Energy, Inc.
116,666
EcoMotors, Inc. (15)
437,500
530,811
6,229
537,040
357
599
Stion Corporation (6)
1,378
Subtotal: Sustainable and Renewable Technology (0.15%)*
1,277
Total: Warrant Investments (4.38%)*
43,578
36,869
Total Investments in Securities (183.39%)*
1,619,829
Interest rate PRIME represents 4.50% at December 31, 2017. Daily LIBOR, 1-month LIBOR, 3-month LIBOR and 12-month LIBOR represent 1.44%, 1.57%, 1.69% and 2.11%, respectively, at December 31, 2017.
Gross unrealized appreciation, gross unrealized depreciation, and net unrealized depreciation for federal income tax purposes totaled $32.5 million, $119.7 million and $87.2 million respectively. The tax cost of investments is $1.6 billion.
Except for warrants in 43 publicly traded companies and common stock in 20 publicly traded companies, all investments are restricted at December 31, 2017 and were valued at fair value using Level 3 significant unobservable inputs as determined in good faith by the Company’s board of directors (the “Board of Directors”). No unrestricted securities of the same issuer are outstanding. The Company uses the Standard Industrial Code for classifying the industry grouping of its portfolio companies.
Debt is on non-accrual status at December 31, 2017 and is therefore considered non-income producing. Note that at December 31, 2017, only the $11.0 million PIK, or payment-in-kind, loan is on non-accrual for the Company’s debt investment in Tectura Corporation.
Denotes that the fair value of the Company’s total investments in this portfolio company represent greater than 5% of the Company’s total assets at December 31, 2017.
Denotes that there is an unfunded contractual commitment available at the request of this portfolio company at December 31, 2017. Refer to Note 10.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Basis of Presentation
Hercules Capital, Inc. (the “Company”) is a specialty finance company focused on providing senior secured loans to high-growth, innovative venture capital-backed companies in a variety of technology, life sciences, and sustainable and renewable technology industries. The Company sources its investments through its principal office located in Palo Alto, CA, as well as through its additional offices in Boston, MA, New York, NY, Washington, DC, Hartford, CT, Reston, VA, and San Diego, CA. The Company was incorporated under the General Corporation Law of the State of Maryland in December 2003.
The Company is an internally managed, non-diversified closed-end investment company that has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). From incorporation through December 31, 2005, the Company was subject to tax as a corporation under Subchapter C of the Internal Revenue Code of 1986, as amended (the “Code”). Effective January 1, 2006, the Company elected to be treated for tax purposes as a regulated investment company, or RIC, under Subchapter M of the Code (see Note 5). As an investment company, the Company follows accounting and reporting guidance as set forth in Topic 946 (“Financial Services – Investment Companies”) of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification, as amended (“ASC”).
Hercules Technology II, L.P. (“HT II”), Hercules Technology III, L.P. (“HT III”), and Hercules Technology IV, L.P. (“HT IV”), are Delaware limited partnerships that were formed in January 2005, September 2009 and December 2010, respectively. HT II and HT III were licensed to operate as small business investment companies (“SBICs”) under the authority of the Small Business Administration (“SBA”) on September 27, 2006 and May 26, 2010, respectively. As SBICs, HT II and HT III are subject to a variety of regulations concerning, among other things, the size and nature of the companies in which they may invest and the structure of those investments. HT IV was formed in anticipation of receiving an additional SBIC license; however, the Company has not received such license, and HT IV currently has no material assets or liabilities. The Company also formed Hercules Technology SBIC Management, LLC, or (“HTM”), a limited liability company in November 2003. HTM is a wholly owned subsidiary of the Company and serves as the limited partner and general partner of HT II and HT III (see Note 4 to the Company’s consolidated financial statements).
HT II and HT III hold approximately $115.4million and $294.8 million in assets, respectively, and they accounted for approximately 5.2% and 13.4% of the Company’s total assets, respectively, prior to consolidation at June 30, 2018. The Company completed repayment of the remaining outstanding HT II debentures on July 13, 2018. See “Note 12 – Subsequent Events.”
The Company also established wholly owned subsidiaries, all of which are structured as Delaware corporations and limited liability companies, to hold portfolio companies organized as limited liability companies, or LLCs (or other forms of pass-through entities). By investing through these wholly owned subsidiaries, the Company is able to benefit from the tax treatment of these entities and create a tax structure that is more advantageous with respect to the Company’s RIC status. These taxable subsidiaries are consolidated for financial reporting purposes and in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), and the portfolio investments held by these taxable subsidiaries are included in the Company’s consolidated financial statements and recorded at fair value. These taxable subsidiaries are not consolidated with Hercules for income tax purposes and may generate income tax expense, or benefit, and tax assets and liabilities as a result of their ownership of certain portfolio investments.
The consolidated financial statements include the accounts of the Company, its subsidiaries and its consolidated securitization VIE. All significant inter-company accounts and transactions have been eliminated in consolidation. As provided under Regulation S-X and ASC 946, the Company will not consolidate its investment in a portfolio company other than an investment company subsidiary or a controlled operating company whose business consists of providing services to the Company. Rather, an investment company’s interest in portfolio companies that are not investment companies should be measured at fair value in accordance with ASC Topic 946.
The accompanying consolidated interim financial statements have been prepared in conformity with U.S. GAAP for interim financial information, and pursuant to the requirements for reporting on Form 10-Q and Articles 6 and 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with U.S. GAAP are omitted. In the opinion of management, all adjustments consisting solely of normal recurring accruals considered necessary for the fair presentation of consolidated financial statements for the interim periods have been included. The current period’s results of operations are not necessarily indicative of results that ultimately may be achieved for the full fiscal year. Therefore, the interim unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the period ended December 31, 2017. The year-end Consolidated Statement of Assets and Liabilities data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP.
Financial statements prepared on a U.S. GAAP basis require management to make estimates and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company and its subsidiaries and all VIEs of which the Company is the primary beneficiary. All intercompany accounts and transactions have been eliminated in consolidation.
A VIE is an entity that either (i) has insufficient equity to permit the entity to finance its activities without additional subordinated financial support or (ii) has equity investors who lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the party with both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses or the right to receive benefits that could be significant to the VIE.
To assess whether the Company has the power to direct the activities of a VIE that most significantly impact its economic performance, the Company considers all the facts and circumstances including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes identifying the activities that most significantly impact the VIE’s economic performance and identifying which party, if any, has power over those activities. In general, the party that makes the most significant decisions affecting the VIE is determined to have the power to direct the activities of a VIE. To assess whether the Company has the obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE, the Company considers all of its economic interests, including debt and equity interests, servicing rights and fee arrangements, and any other variable interests in the VIE. If the Company determines that it is the party with the power to make the most significant decisions affecting the VIE, and the Company has a potentially significant interest in the VIE, then it consolidates the VIE.
The Company performs periodic reassessments, usually quarterly, of whether it is the primary beneficiary of a VIE. The reassessment process considers whether the Company has acquired or divested the power to direct the activities of the VIE through changes in governing documents or other circumstances. The Company also reconsiders whether entities previously determined not to be VIEs have become VIEs, based on certain events, and therefore are subject to the VIE consolidation framework.
As of the date of this report, the only VIE consolidated by the Company is its securitization VIE formed in conjunction with the issuance of the 2021 Asset-Backed Notes (as defined herein). See “Note 4 – Borrowings”.
Reclassification
Certain balances from prior years have been reclassified in order to conform to the current year presentation.
Valuation of Investments
The most significant estimate inherent in the preparation of the Company’s consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.
At June 30, 2018, approximately 94.9% of the Company’s total assets represented investments in portfolio companies whose fair value is determined in good faith by the Board of Directors. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. The Company’s investments are carried at fair value in accordance with the 1940 Act and ASC Topic 946 and measured in accordance with ASC Topic 820 (“Fair Value Measurements”). The Company’s debt securities are primarily invested in venture capital-backed companies in technology-related industries including technology, drug discovery and development, biotechnology, life sciences, healthcare, and sustainable and renewable technology at all stages of development. Given the nature of lending to these types of businesses, substantially all of the Company’s investments in these portfolio companies are considered Level 3 assets under ASC Topic 820 because there is no known or accessible market or market indexes for these investment securities to be traded or exchanged. As such, the Company values substantially all of its investments at fair value as determined in good faith pursuant to a consistent valuation policy by the Company’s Board of Directors in accordance with the provisions of ASC Topic 820 and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments determined in good faith by its Board of Directors may differ significantly from the value that would have been used had a readily available market existed for such investments, and the differences could be material.
40
The Company may from time to time engage an independent valuation firm to provide the Company with valuation assistance with respect to certain portfolio investments. The Company engages independent valuation firms on a discretionary basis. Specifically, on a quarterly basis, the Company will identify portfolio investments with respect to which an independent valuation firm will assist in valuing. The Company selects these portfolio investments based on a number of factors, including, but not limited to, the potential for material fluctuations in valuation results, credit quality and the time lapse since the last valuation of the portfolio investment by an independent valuation firm.
The Company intends to continue to engage an independent valuation firm to provide management with assistance regarding the Company’s determination of the fair value of selected portfolio investments each quarter unless directed by the Board of Directors to cancel such valuation services. The scope of services rendered by an independent valuation firm is at the discretion of the Board of Directors. The Company’s Board of Directors is ultimately, and solely, responsible for determining the fair value of the Company’s investments in good faith.
With respect to investments for which market quotations are not readily available or when such market quotations are deemed not to represent fair value, the Company’s Board of Directors has approved a multi-step valuation process each quarter, as described below:
(1) the Company’s quarterly valuation process begins with each portfolio company being initially valued by the investment professionals responsible for the portfolio investment;
(2) preliminary valuation conclusions are then documented and business based assumptions are discussed with the Company’s investment committee;
(3) the Audit Committee of the Board of Directors reviews the preliminary valuation of the investments in the portfolio as provided by the investment committee, which incorporates the results of the independent valuation firm as appropriate; and
(4) the Board of Directors, upon the recommendation of the Audit Committee, discusses valuations and determines the fair value of each investment in the Company’s portfolio in good faith based on the input of, where applicable, the respective independent valuation firm and the investment committee.
ASC Topic 820 establishes a framework for measuring the fair value of assets and liabilities and outlines a fair value hierarchy which prioritizes the inputs used to measure fair value and the effect of fair value measures on earnings. ASC Topic 820 also requires disclosure for fair value measurements based on the level within the hierarchy of the information used in the valuation. ASC Topic 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
The Company has categorized all investments recorded at fair value in accordance with ASC Topic 820 based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels, defined by ASC Topic 820 and directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities, are as follows:
Level 1—Inputs are unadjusted, quoted prices in active markets for identical assets at the measurement date. The types of assets carried at Level 1 fair value generally are equities listed in active markets.
Level 2—Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset in connection with market data at the measurement date and for the extent of the instrument’s anticipated life. Fair valued assets that are generally included in this category are publicly held debt investments and warrants held in a public company.
Level 3—Inputs reflect management’s best estimate of what market participants would use in pricing the asset at the measurement date. It includes prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. Generally, assets carried at fair value and included in this category are the debt investments and warrants and equities held in a private company.
Investments measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations as of June 30, 2018 and as of December 31, 2017. The Company transfers investments in and out of Level 1, 2 and 3 as of the beginning of the period, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period. During the six months ended June 30, 2018, there were no transfers between Levels 1 or 2.
(in thousands)
Balance
June 30,
Quoted Prices In
Active Markets For
Identical Assets
Significant
Other Observable
Inputs
Unobservable
Description
(Level 1)
(Level 2)
(Level 3)
Senior Secured Debt
1,536,056
Unsecured Debt
9,941
Preferred Stock
66,768
54,741
36,728
18,013
Warrants
6,418
28,012
Escrow Receivable
1,115
Total
1,703,051
1,659,905
December 31,
40,683
48,678
22,825
25,853
5,664
31,205
752
1,542,966
1,514,477
The table below presents a reconciliation for all financial assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3) for the six months ended June 30, 2018 and the year ended December 31, 2017.
January 1, 2018
Net Realized
Gains (Losses) (1)
Net Change in
(Depreciation) (2)
Purchases (5)
Sales
Repayments (6)
Gross
Transfers
into
Level 3 (3)
out of
Senior Debt
(13,295
15,850
524,301
(406,784
15,585
(5,671
(1,172
27,257
878
2,761
(200
(8,379
(2,418
324
809
(1,692
(216
(143
875
(18,535
15,764
571,588
(2,339
(412,455
(8,595
January 1, 2017
Level 3 (4)
1,323,978
(24,684
29,610
776,648
(626,897
(62,671
39,418
(7,531
11,955
2,683
(468
(5,374
10,965
(487
(49,462
3,748
(1,582
62,671
24,246
727
8,450
5,449
(7,303
(364
1,382
261
3,127
(4,018
1,399,989
(31,714
553
791,655
(13,371
(68,409
Included in net realized gains or losses in the accompanying Consolidated Statement of Operations.
Included in net change in unrealized appreciation (depreciation) in the accompanying Consolidated Statement of Operations.
Transfers out of Level 3 during the six months ended June 30, 2018 relate to the initial public offerings of DocuSign, Inc., and Tricida, Inc.
Transfers out of Level 3 during the year ended December 31, 2017 relate to the conversion of the Company’s debt investment in Sungevity, Inc. and a portion of the Company’s debt investment in Gamma Medica, Inc. to common stock through bankruptcy transactions. Initial public offerings of ForeScout Technologies, Inc., Aquantia Corporation, and Quanterix Corporation, and merger of our former portfolio company Cempra, Inc. and current portfolio company Melinta Therapeutics, Inc. into NASDAQ-listed company Melinta Therapeutics, Inc. Transfers into Level 3 during the year ended December 31, 2017 relate to the conversion of the Company’s debt investment in Sungevity, Inc. and a portion of the Company’s debt investment in Gamma Medica, Inc. to common stock through bankruptcy transactions.
Amounts listed above are inclusive of loan origination fees received at the inception of the loan which are deferred and amortized into fee income as well as the accretion of existing loan discounts and fees during the period. Escrow receivable purchases may include additions due to proceeds held in escrow from the liquidation of level 3 investments.
Amounts listed above include the acceleration and payment of loan discounts and loan fees due to early payoffs or restructures.
For the six months ended June 30, 2018, approximately $1.2 million in net unrealized depreciation and $2.0 in net unrealized depreciation was recorded for preferred stock and common stock Level 3 investments, respectively, relating to assets still held at the reporting date. For the same period, approximately $3.5 million in net unrealized depreciation and $2.1 million in net unrealized depreciation was recorded for debt and warrant Level 3 investments, respectively, relating to assets still held at the reporting date.
For the year ended December 31, 2017, approximately $4.2 million in net unrealized appreciation and $49.2 million in net unrealized depreciation was recorded for preferred stock and common stock Level 3 investments, respectively, relating to assets still held at the reporting date. The depreciation on common stock during the period reflects the conversion of the Company’s debt investment in Sungevity, Inc. to common stock at cost through a bankruptcy transaction and subsequent depreciation to fair value. For the same period, approximately $10.5 million in net unrealized depreciation and $9.0 million in net unrealized appreciation was recorded for debt and warrant Level 3 investments, respectively, relating to assets still held at the reporting date.
The following tables provide quantitative information about the Company’s Level 3 fair value measurements as of June 30, 2018 and December 31, 2017. In addition to the techniques and inputs noted in the tables below, according to the Company’s valuation policy the Company may also use other valuation techniques and methodologies when determining the Company’s fair value measurements. The tables below are not intended to be all-inclusive, but rather provide information on the significant Level 3 inputs as they relate to the Company’s fair value measurements.
The significant unobservable input used in the fair value measurement of the Company’s escrow receivables is the amount recoverable at the contractual maturity date of the escrow receivable.
Investment Type - Level
Three Debt Investments
Fair Value at
Valuation
Techniques/Methodologies
Unobservable Input (1)
Range
Weighted
Average (2)
Pharmaceuticals
59,758
Originated Within 4-6 Months
Origination Yield
12.53% - 13.01%
12.73%
360,183
Market Comparable Companies
Hypothetical Market Yield
10.46% - 16.04%
13.50%
Premium/(Discount)
(0.50%) - 0.50%
Liquidation (3)
Probability weighting of alternative outcomes
50.00%
Technology
60,760
11.17% - 12.52%
11.53%
421,695
10.05% - 18.48%
13.43%
(0.25%) - 0.50%
Sustainable and Renewable
19,535
14.27% - 15.19%
14.84%
68,713
11.25% - 21.16%
13.98%
0.00% - 0.50%
Medical Devices
62,968
11.18% - 16.05%
13.21%
0.00% - 1.00%
5.00% - 75.00%
Lower Middle Market
19,682
14.16% - 16.39%
15.27%
87,722
9.48% - 13.89%
12.96%
0.00% - 0.25%
10.00% - 55.00%
Debt Investments Where Fair Value Approximates Cost
272,833
Debt Investments originated within 3 months
37,943
Imminent Payoffs (4)
52,072
Debt Investments Maturing in Less than One Year
Total Level Three Debt Investments
The significant unobservable inputs used in the fair value measurement of the Company’s debt securities are hypothetical market yields and premiums/(discounts). The hypothetical market yield is defined as the exit price of an investment in a hypothetical market to hypothetical market participants where buyers and sellers are willing participants. The premiums (discounts) relate to company specific characteristics such as underlying investment performance, security liens, and other characteristics of the investment. Significant increases (decreases) in the inputs in isolation may result in a significantly lower (higher) fair value measurement, depending on the materiality of the investment. Debt investments in the industries noted in the Company’s Consolidated Schedule of Investments are included in the industries noted above as follows:
•
Pharmaceuticals, above, is comprised of debt investments in the Healthcare Services - Other, Drug Discovery & Development, Drug Delivery and Biotechnology Tools industries in the Consolidated Schedule of Investments.
Technology, above, is comprised of debt investments in the Software, Electronics & Computer Hardware, Media/Content/Info, Internet Consumer & Business Services, Consumer & Business Products, and Information Services industries in the Consolidated Schedule of Investments.
Sustainable and Renewable Technology, above, is comprised of debt investments in the Sustainable and Renewable Technology, Internet Consumer & Business Services, and Electronics & Computer Hardware industries in the Consolidated Schedule of Investments.
Medical Devices, above, is comprised of debt investments in the Drug Delivery, Surgical Devices and Medical Devices & Equipment industries in the Consolidated Schedule of Investments.
Lower Middle Market, above, is comprised of debt investments in the Healthcare Services - Other, Internet Consumer & Business Services, Diversified Financial Services, Sustainable and Renewable Technology, and Software industries in the Consolidated Schedule of Investments.
The weighted averages are calculated based on the fair market value of each investment.
The significant unobservable input used in the fair value measurement of impaired debt securities is the probability weighting of alternative outcomes.
Imminent payoffs represent debt investments that the Company expects to be fully repaid within the next three months, prior to their scheduled maturity date.
43
44,301
Originated Within 6 Months
10.71% - 12.61%
11.89%
379,841
10.14% - 16.14%
12.94%
(0.25%) - 0.75%
2,257
100.00%
158,916
9.4% - 25.11%
11.68%
290,561
9.47% - 19.21%
13.55%
(0.25%) - 1.00%
22,020
5.00% - 100.00%
33,020
11.97% - 20.06%
15.31%
49,647
11.15% - 14.16%
12.13%
13.49%
89,869
9.66% - 17.57%
12.28%
97,291
8.29% - 12.68%
12.01%
10.00% - 100.00%
176,512
Pharmaceuticals, above, is comprised of debt investments in the Specialty Pharmaceuticals, Drug Discovery and Development, Drug Delivery and Biotechnology Tools industries in the Consolidated Schedule of Investments.
Technology, above, is comprised of debt investments in the Software, Semiconductors, Internet Consumer and Business Services, Consumer and Business Products, Information Services, and Communications and Networking industries in the Consolidated Schedule of Investments.
Sustainable and Renewable Technology, above, aligns with the Sustainable and Renewable Technology Industry in the Consolidated Schedule of Investments.
Medical Devices, above, is comprised of debt investments in the Surgical Devices and Medical Devices and Equipment industries in the Consolidated Schedule of Investments.
Lower Middle Market, above, is comprised of debt investments in the Communications and Networking, Electronics and Computer Hardware, Healthcare Services - Other, Information Services, Internet Consumer and Business Services, Media/Content/Info, and Specialty Pharmaceuticals industries in the Consolidated Schedule of Investments.
Investment Type - Level Three
Equity and Warrant Investments
Valuation Techniques/
Methodologies
Weighted Average (6)
11,411
EBITDA Multiple (2)
8.3x - 24.9x
2.7x
Revenue Multiple (2)
0.7x - 12.4x
2.6x
Discount for Lack of Marketability (3)
10.49% - 23.88%
20.57%
Average Industry Volatility (4)
34.06% - 106.41%
65.88%
Risk-Free Interest Rate
2.02% - 2.45%
2.37%
Estimated Time to Exit (in months)
5 - 20
15,975
Market Adjusted OPM Backsolve
Market Equity Adjustment (5)
(87.43%) - 49.59%
16.59%
34.79% - 81.59%
74.30%
0.92% - 2.18%
2.08%
11 - 23
Liquidation
75%
46,399
Other(7)
17,143
8.3x - 18.4x
0.9x
0.4x - 7.9x
1.7x
10.49% - 30.06%
19.97%
34.06% - 102.64%
67.77%
2.28% - 2.68%
2.36%
11 - 48
8,994
(23.4%) - 200.72%
14.52%
34.79% - 103.09%
49.66%
1.08% - 2.50%
1.41%
8 - 44
Total Level Three
Warrant and Equity Investments
112,793
The significant unobservable inputs used in the fair value measurement of the Company’s warrant and equity-related securities are revenue and/or EBITDA multiples, market equity adjustment factors, and discounts for lack of marketability. Additional inputs used in the Black Scholes option pricing model (“OPM”) include industry volatility, risk free interest rate and estimated time to exit. Significant increases (decreases) in the inputs in isolation would result in a significantly higher (lower) fair value measurement, depending on the materiality of the investment. For some investments, additional consideration may be given to data from the last round of financing or merger/acquisition events near the measurement date. The significant unobservable input used in the fair value measurement of impaired equity securities is the probability weighting of alternative outcomes.
Represents amounts used when the Company has determined that market participants would use such multiples when pricing the investments.
Represents amounts used when the Company has determined market participants would take into account these discounts when pricing the investments.
Represents the range of industry volatility used by market participants when pricing the investment.
Represents the range of changes in industry valuations since the portfolio company's last external valuation event.
Weighted averages are calculated based on the fair market value of each investment.
The fair market value of these investments is derived based on recent private market and merger and acquisition transaction prices.
7,684
5.1x - 40.2x
13.2x
0.5x - 6.2x
2.9x
7.49% - 12.97%
8.77%
27.8% - 77.3%
53.35%
1.40% - 1.90%
1.47%
3 - 10
19,323
(16.43%) - 29.4%
11.79%
33.17% - 78.77%
68.99%
0.84% - 1.51%
1.42%
5 - 26
39,529
Other (7)
19,310
5x - 40.2x
14.6x
0.5x - 6.4x
5.16% - 27.41%
13.57%
27.8% - 102.77%
55.15%
1.31% - 2.09%
1.66%
2 - 48
6,713
(68.52%) - 154.5%
11.76%
33.17% - 110.32%
66.97%
0.96% - 2.09%
1.59%
5 - 48
5,182
97,741
The significant unobservable inputs used in the fair value measurement of the Company’s warrant and equity-related securities are revenue and/or EBITDA multiples, market equity adjustment factors, and discounts for lack of marketability. Additional inputs used in the Black Scholes OPM include industry volatility, risk free interest rate and estimated time to exit. Significant increases (decreases) in the inputs in isolation would result in a significantly higher (lower) fair value measurement, depending on the materiality of the investment. For some investments, additional consideration may be given to data from the last round of financing or merger/acquisition events near the measurement date.
The Company follows the guidance set forth in ASC Topic 820 which establishes a framework for measuring the fair value of assets and liabilities and outlines a fair value hierarchy, which prioritizes the inputs used to measure fair value and the effect of fair value measures on earnings. The Company’s debt securities are primarily invested in venture capital-backed companies in technology-related industries including technology, drug discovery and development, biotechnology, life sciences, healthcare, and sustainable and renewable technology at all stages of development. Given the nature of lending to these types of businesses, substantially all of the Company’s investments in these portfolio companies are considered Level 3 assets under ASC Topic 820 because there is no known or accessible market or market indexes for debt instruments for these investment securities to be traded or exchanged. In addition, the Company may, from time to time, invest in public debt of companies that meet the Company’s investment objectives. These investments are considered Level 2 assets.
In making a good faith determination of the value of the Company’s investments, the Company generally starts with the cost basis of the investment, which includes the value attributed to the original issue discount (“OID”), if any, and payment-in-kind (“PIK”) interest or other receivables which have been accrued as earned. The Company then applies the valuation methods as set forth below.
The Company applies a procedure for debt investments that assumes the sale of each investment in a hypothetical market to a hypothetical market participant where buyers and sellers are willing participants. The hypothetical market does not include scenarios where the underlying security was simply repaid or extinguished, but includes an exit concept. The Company determines the yield at inception for each debt investment. The Company then uses senior secured, leveraged loan yields provided by third party providers to determine the change in market yields between inception of the debt investment and the measurement date. Industry specific indices and other relevant market data are used to benchmark/assess market based movements.
Under this process, the Company also evaluates the collateral for recoverability of the debt investments. The Company considers each portfolio company’s credit rating, security liens and other characteristics of the investment to adjust the baseline yield to derive a credit adjusted hypothetical yield for each investment as of the measurement date. The anticipated future cash flows from each investment are then discounted at the hypothetical yield to estimate each investment’s fair value as of the measurement date.
The Company’s process includes an analysis of, among other things, the underlying investment performance, the current portfolio company’s financial condition and market changing events that impact valuation, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. The Company values its syndicated debt investments using broker quotes and bond indices amongst other factors. If there is a significant deterioration of the credit quality of a debt investment, the Company may consider other factors to estimate fair value, including the proceeds that would be received in a liquidation analysis.
The Company records unrealized depreciation on investments when it believes that an investment has decreased in value, including where collection of a debt investment is doubtful or, if under the in-exchange premise, when the value of a debt investment is less than amortized cost of the investment. Conversely, where appropriate, the Company records unrealized appreciation if it believes that the underlying portfolio company has appreciated in value and, therefore, that its investment has also appreciated in value or, if under the in-exchange premise, the value of a debt investment is greater than amortized cost.
When originating a debt instrument, the Company generally receives warrants or other equity-related securities from the borrower. The Company determines the cost basis of the warrants or other equity-related securities received based upon their respective fair values on the date of receipt in proportion to the total fair value of the debt and warrants or other equity-related securities received. Any resulting discount on the debt investments from recordation of the warrant or other equity instruments is accreted into interest income over the life of the debt investment.
Debt investments that are traded on a public exchange are valued at the prevailing market price as of the valuation date.
Equity-Related Securities and Warrants
Securities that are traded in the over-the-counter markets or on a stock exchange will be valued at the prevailing bid price at period end. The Company has a limited amount of equity securities in public companies. In accordance with the 1940 Act, unrestricted publicly traded securities for which market quotations are readily available are valued at the closing market quote on the measurement date.
The Company estimates the fair value of warrants using a Black Scholes OPM. At each reporting date, privately held warrant and equity-related securities are valued based on an analysis of various factors including, but not limited to, the portfolio company’s operating performance and financial condition and general market conditions, price to enterprise value or price to equity ratios, discounted cash flow, valuation comparisons to comparable public companies or other industry benchmarks. When an external event occurs, such as a purchase transaction, public offering, or subsequent equity sale, the pricing indicated by that external event is utilized to corroborate the Company’s valuation of the warrant and equity-related securities. The Company periodically reviews the valuation of its portfolio companies that have not been involved in a qualifying external event to determine if the enterprise value of the portfolio company may have increased or decreased since the last valuation measurement date.
Escrow Receivables
Escrow receivables are collected in accordance with the terms and conditions of the escrow agreement. Escrow balances are typically distributed over a period greater than one year and may accrue interest during the escrow period. Escrow balances are measured for collectability on at least a quarterly basis and fair value is determined based on the amount of the estimated recoverable balances and the contractual maturity date. As of June 30, 2018, there were no material past due escrow receivables.
Portfolio Composition
As required by the 1940 Act, the Company classifies its investments by level of control. “Control investments” are defined in the 1940 Act as investments in those companies that the Company is deemed to “control.” Under the 1940 Act, the Company is generally deemed to “control” a company in which it has invested if it owns 25% or more of the voting securities of such company or has greater than 50% representation on its board. “Affiliate investments” are investments in those companies that are “affiliated companies” of the Company, as defined in the 1940 Act, which are not control investments. The Company is deemed to be an “affiliate” of a company in which it has invested if it owns 5% or more, but generally less than 25%, of the voting securities of such company. “Non-control/non-affiliate investments” are investments that are neither control investments nor affiliate investments.
The following table summarizes the Company’s realized gains and losses and changes in unrealized appreciation and depreciation on control and affiliate investments for the three and six months ended June 30, 2018 and 2017.
For the Three Months Ended June 30, 2018
For the Six Months Ended June 30, 2018
Type
Fair Value at June 30, 2018
Interest Income
Fee Income
Net Change in Unrealized (Depreciation)/ Appreciation
Realized Gain/(Loss)
Control Investments
Achilles Technology Management Co II, Inc.
Control
2,983
2,858
Gibraltar Business Capital, LLC
37,589
373
Second Time Around (Simplify Holdings, LLC)
(1,743
Tectura Corporation
974
926
(1,302
335
Total Control Investments
Affiliate Investments
Optiscan BioMedical, Corp.
Affiliate
1,480
(680
415
Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.)
21,378
(1,318
(490
Stion Corporation
-
(1,378
Total Affiliate Investments
Total Control & Affiliate Investments
85,421
1,341
5,497
(4,958
2,488
4,640
(6,366
For the Three Months Ended June 30, 2017
For the Six Months Ended June 30, 2017
June 30, 2017
Appreciation/ (Depreciation)
Gain/(Loss)
2,116
(267
(2,208
HercGamma, Inc.
1,169
SkyCross, Inc.
19,991
454
899
(51
8,288
(53,215
(53,214
31,564
5,991
37,555
(52,668
1,043
(52,016
In March 2018, the Company acquired 100% ownership in Gibraltar Business Capital LLC and classified it as a control investment in accordance with the requirements of the 1940 Act. Gibraltar Business Capital LLC is focused on providing asset-based and other secured financing solutions.
In July 2017, the Company acquired the primary assets of Second Time Around (Simplify Holdings, LLC) as part of an article 9 consensual foreclosure and public auction. These assets represent the remaining possible recovery on the Company’s debt and as such this investment is classified as a control investment as of September 30, 2017. As of February 2018, all material recoveries had been made and subsequently the Company’s investments were deemed wholly worthless and written off for a realized loss.
48
In April 2017, the Company’s investment in Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.) became classified as a control investment as a result of obtaining more than 25% of the portfolio company’s voting securities. In April 2017, under Section 363 of the Bankruptcy Code, Sungevity, Inc. entered into a $50.0 million asset purchase agreement and DIP financing facility with a group of investors, led by Northern Pacific Group and including the Company. On April 7, 2017, the U.S. Bankruptcy Court approved the DIP financing facility and on April 17, the U.S. Bankruptcy Court approved the asset purchase agreement. On April 26, 2017, Solar Spectrum Holdings LLC, a new company backed by the investment group, announced that it had acquired certain assets of Sungevity, Inc. as part of the bankruptcy court-approved sale. As a result, the cost basis of the Company’s debt investment in Sungevity, Inc. was converted to an equity position in Solar Spectrum Holdings LLC and the Company’s warrant and equity positions in Sungevity, Inc. were written off for a realized loss.
In August 2017, the Company’s ownership in Solar Spectrum Holdings LLC was diluted below 25% as a result of additional equity contributions by other investors to fund the acquisition of Horizon Solar Power, Inc. by Solar Spectrum Holdings LLC. The Company made a $15.0 million debt investment to fund the acquisition. Accordingly, the Company’s equity and new debt investment in Solar Spectrum Holdings LLC became classified as affiliate investments as of September 30, 2017.
In January 2017, the Company’s investment in Tectura Corporation became classified as a control investment as a result of obtaining more than 50% representation on the portfolio company’s board. In March 2017, the Company’s warrants in Tectura Corporation expired and were written off for a realized loss. In May 2018, the Company purchased common shares, thereby obtaining greater than 25% of voting securities of Tectura as of June 30, 2018.
In June 2016, the Company acquired 100% ownership of the equity of Achilles Technology Management Co II, Inc. and classified it as a control investment in accordance with the requirements of the 1940 Act. In August 2017, the Company’s debt investment in Achilles Technology Management II, Inc. was fully repaid by net proceeds from sales of the portfolio company’s assets. In addition, the Company’s equity investment in Achilles Technology Management II, Inc. was reduced by $900,000 in lieu of a success fee on the repayment of our debt investment. In May 2018, the Company received $375,000 as part of a legal settlement and the remaining equity investment in Achilles Technology Management II, Inc. was deemed wholly worthless and written off for realized loss as of June 30, 2018.
The following table shows the fair value of the Company’s portfolio of investments by asset class as of June 30, 2018 and December 31, 2017:
Investments at
Fair Value
Percentage of
Total Portfolio
Senior Secured Debt with Warrants
700,793
41.2
%
880,115
57.1
869,693
51.1
572,738
37.1
0.6
3.9
2.6
3.2
100.0
The increase in senior secured debt and the decrease in senior secured debt with warrants during the period is primarily due to an increase in new debt investments that do not include detachable equity enhancement features.
A summary of the Company’s investment portfolio, at value, by geographic location as of June 30, 2018 and December 31, 2017 is shown as follows:
United States
1,471,237
86.4
1,404,235
91.1
United Kingdom
137,881
8.1
91,105
5.9
Australia
2.1
0.0
Netherlands
21,412
1.3
20,783
Cayman Islands
20,066
1.2
14,954
1.0
Sweden
0.7
Switzerland
0.2
10,581
Canada
709
556
The following table shows the fair value of the Company’s portfolio by industry sector at June 30, 2018 and December 31, 2017:
446,575
26.3
369,173
23.9
445,486
26.2
360,123
23.4
256,956
15.1
154,909
10.0
119,575
7.1
118,432
7.7
98,887
5.8
94,595
6.1
82,302
4.8
72,337
4.7
56,161
3.3
91,214
47,977
2.8
152,998
9.9
44,696
24,618
1.6
2.2
24,186
1.4
19,792
22,099
9,982
6,241
0.4
6,649
5,686
0.3
5,604
5,459
13,161
0.9
0.1
10,406
37,501
2.4
No single portfolio investment represents more than 10% of the fair value of the investments as of June 30, 2018 and December 31, 2017.
Investment Collateral
In the majority of cases, the Company collateralizes its investments by obtaining a first priority security interest in a portfolio company’s assets, which may include its intellectual property. In other cases, the Company may obtain a negative pledge covering a company’s intellectual property. At June 30, 2018, approximately 85.9% of the Company’s debt investments were in a senior secured first lien position, with 49.2% secured by a first priority security in all of the assets of the portfolio company, including its intellectual property, 29.3% secured by a first priority security in all of the assets of the portfolio company and the portfolio company was prohibited from pledging or encumbering its intellectual property, 1.4% of the Company’s debt investments were senior secured by the equipment of the portfolio company and 6.1% of the Company’s debt investments were in a first lien “last-out” senior secured position with security interest in all of the assets of the portfolio company, whereby the “last-out” loans will be subordinated to the “first-out” portion of the unitranche loan in a liquidation, sale or other disposition. Another 13.5% of the Company’s debt investments were secured by a second priority security interest in the portfolio company’s assets, and 0.6% were unsecured.
Cash, Restricted Cash, and Cash Equivalents
Cash and cash equivalents consists solely of funds deposited with financial institutions and short-term liquid investments in money market deposit accounts. Cash and cash equivalents are carried at cost, which approximates fair value. Restricted cash and cash equivalents include amounts that are collected and are held by trustees who have been appointed as custodians of the assets securing certain of the Company’s financing transactions.
Income Recognition
The Company records interest income on an accrual basis and recognizes it as earned in accordance with the contractual terms of the loan agreement, to the extent that such amounts are expected to be collected. OID initially represents the value of detachable equity warrants obtained in conjunction with the acquisition of debt securities and is accreted into interest income over the term of the loan as a yield enhancement. When a loan becomes 90 days or more past due, or if management otherwise does not expect that principal, interest, and other obligations due will be collected in full, the Company will generally place the loan on non-accrual status and cease recognizing interest income on that loan until all principal and interest due has been paid or the Company believes the portfolio company has demonstrated the ability to repay the Company’s current and future contractual obligations. Any uncollected interest related to prior periods is reversed from income in the period that collection of the interest receivable is determined to be doubtful. However, the Company may make exceptions to this policy if the investment has sufficient collateral value and is in the process of collection.
At June 30, 2018, the Company had two debt investments on non-accrual with a cumulative investment cost and approximate fair value of $2.8 million and $33,000, respectively. At December 31, 2017, the Company had five debt investments on non-accrual with cumulative investment cost and fair value of approximately $14.8 million and $340,000, respectively. The decrease in the cost of debt investments on non-accrual between December 31, 2017 and June 30, 2018 is the result of the write-off of two debt investments that were on non-accrual at December 31, 2017 which resulted in a realized loss of approximately $10.3 million, and a repayment in full from one debt investment.
Fee income, generally collected in advance, includes loan commitment and facility fees for due diligence and structuring, as well as fees for transaction services and management services rendered by us to portfolio companies and other third parties. Loan and commitment fees are amortized into income over the contractual life of the loan. Management fees are generally recognized as income when the services are rendered. Loan origination fees are capitalized and then amortized into interest income using the effective interest rate method. In certain loan arrangements, warrants or other equity interests are received from the borrower as additional origination fees. The Company had approximately $33.7 million of unamortized fees at June 30, 2018, of which approximately $27.9 million was included as an offset to the cost basis of the Company’s current debt investments and approximately $5.8 million was deferred contingent upon the occurrence of a funding or milestone. At December 31, 2017 the Company had approximately $33.3 million of unamortized fees, of which approximately $29.3 million was included as an offset to the cost basis of the Company’s current debt investments and approximately $4.0 million was deferred contingent upon the occurrence of a funding or milestone.
The Company recognizes nonrecurring fees amortized over the remaining term of the loan commencing in the quarter relating to specific loan modifications. Certain fees may still be recognized as one-time fee income, including prepayment penalties, fees related to select covenant default, waiver fees and acceleration of previously deferred loan fees and OID related to early loan pay-off or material modification of the specific debt outstanding. The Company recorded approximately $1.7 million and $5.5 million in one-time fee income during the three months ended June 30, 2018 and 2017, respectively. The Company recorded approximately $4.8 million and $6.1 million in one-time fee income during the six months ended June 30, 2018 and 2017, respectively.
In addition, the Company may also be entitled to an exit fee that is amortized into income over the life of the loan. Loan exit fees to be paid at the termination of the loan are accreted into interest income over the contractual life of the loan. At June 30, 2018, the Company had approximately $23.8 million in exit fees receivable, of which approximately $21.6 million was included as a component of the cost basis of the Company’s current debt investments and approximately $2.2 million was a deferred receivable related to expired commitments. At December 31, 2017, the Company had approximately $27.5 million in exit fees receivable, of which approximately $23.9 million was included as an offset to the cost basis of the Company’s current debt investments and approximately $3.6 million was deferred related to expired commitments.
The Company has debt investments in its portfolio that contain a PIK provision. Contractual PIK interest, which represents contractually deferred interest added to the loan balance that is generally due at the end of the loan term, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. The Company will generally cease accruing PIK interest if there is insufficient value to support the accrual or management does not expect the portfolio company to be able to pay all principal and interest due. The Company recorded approximately $2.3 million and $2.5 million in PIK income during the three months ended June 30, 2018 and 2017, respectively. The Company recorded approximately $4.6 million and $4.7 million in PIK income during the six months ended June 30, 2018 and 2017, respectively.
To maintain the Company’s ability to be subject to tax as a RIC, PIK and exit fee income generally must be accrued and distributed to stockholders in the form of dividends for U.S. federal income tax purposes even though the cash has not yet been collected. Amounts necessary to pay these distributions may come from available cash or the liquidation of certain investments.
In certain investment transactions, the Company may provide advisory services. For services that are separately identifiable and external evidence exists to substantiate fair value, income is recognized as earned, which is generally when the investment transaction closes. The Company had no income from advisory services in the three and six months ended June 30, 2018 and 2017.
3. Fair Value of Financial Instruments
Fair value estimates are made at discrete points in time based on relevant information. These estimates may be subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. The Company believes that the carrying amounts of its financial instruments, consisting of cash and cash equivalents, receivables including escrow receivables, accounts payable and accrued liabilities, approximate the fair values of such items due to the short maturity of such instruments. The borrowings of the Company are recorded at amortized cost and not at fair value on the Consolidated Statement of Assets and Liabilities. The fair value of the Company’s outstanding borrowings is based on observable market trading prices or quotations and unobservable market rates as applicable for each instrument.
Based on market quotations on or around June 30, 2018, the 2022 Notes, 2021 Asset-Backed Notes and 2022 Convertible Notes were quoted for 0.999, 1.000 and 1.012 per dollar at par value, respectively. At June 30, 2018, the 2024 Notes and 2025 Notes were trading on the NYSE for $25.27 and $24.83, respectively, per unit at par value. The par value at underwriting for the 2024 Notes and 2025 Notes was $25.00 per unit. Calculated based on the net present value of payments over the term of the notes using estimated market rates for similar notes and remaining terms, the fair value of the SBA debentures is approximately $193.8 million, compared to the carrying amount of $190.2 million as of June 30, 2018. The fair value of the outstanding borrowings under the Union Bank Facility is equal to its principal outstanding balance as of June 30, 2018.
See the accompanying Consolidated Schedule of Investments for the fair value of the Company’s investments. The methodology for the determination of the fair value of the Company’s investments is discussed in Note 2.
The following tables provide additional information about the fair value and level in the fair value hierarchy of the Company’s outstanding borrowings at June 30, 2018 and December 31, 2017:
Observable Inputs
Unobservable Inputs
Description (1)
SBA Debentures
193,778
2022 Notes
149,781
2024 Notes
84,412
2025 Notes
74,490
2021 Asset-Backed Notes
31,098
2022 Convertible Notes
232,696
Union Bank Facility
824,578
572,477
252,101
Description(1)
198,038
152,091
188,061
49,199
236,470
823,859
625,821
As of June 30, 2018, there were no borrowings outstanding on the Wells Facility and no borrowings outstanding on both the Wells Facility and Union Bank Facility as of December 31, 2017.
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4. Borrowings
Outstanding Borrowings
At June 30, 2018 and December 31, 2017, the Company had the following available and outstanding borrowings:
Total Available
Principal
Carrying Value (1)
SBA Debentures (2)
190,200
150,000
83,510
183,510
31,088
49,153
Wells Facility (3)
120,000
Union Bank Facility (3)
979,798
818,121
803,785
997,863
802,863
786,852
Except for the Wells Facility and Union Bank Facility, all carrying values represent the principal amount outstanding less the remaining unamortized debt issuance costs and unaccreted premium or discount, if any, associated with the loan as of the balance sheet date.
At both June 30, 2018 and December 31, 2017, the total available borrowings under the SBA debentures were $190.2 million, of which $41.2 million was available in HT II and $149.0 million was available in HT III.
Availability subject to the Company meeting the borrowing base requirements.
Debt issuance costs are fees and other direct incremental costs incurred by the Company in obtaining debt financing and are recognized as prepaid expenses and amortized over the life of the related debt instrument using the effective yield method or the straight line method, which closely approximates the effective yield method. In accordance with ASC Subtopic 835-30 (“Interest – Imputation of Interest”), debt issuance costs are presented as a reduction to the associated liability balance on the Consolidated Statement of Assets and Liabilities, except for debt issuance costs associated with line-of-credit arrangements. Debt issuance costs, net of accumulated amortization, were as follows as of June 30, 2018 and December 31, 2017:
1,743
2,059
1,559
1,633
1,871
4,591
416
503
3,269
3,715
Wells Facility (1)
Union Bank Facility (1)
273
379
9,709
13,107
As the Wells Facility and Union Bank Facility are line-of-credit arrangements, the debt issuance costs associated with these instruments are presented separately as an asset on the Consolidated Statement of Assets and Liabilities in accordance with ASC Subtopic 835-30.
Long-Term SBA Debentures
On September 27, 2006, HT II received a license to operate as a SBIC under the SBIC program and is able to borrow funds from the SBA against eligible investments and additional contributions to regulatory capital. Under the Small Business Investment Company Act and current SBA policy applicable to SBICs, a SBIC can have outstanding at any time SBA guaranteed debentures up to twice the amount of its regulatory capital. With the Company’s net investment of $44.0 million in HT II as of June 30, 2018, HT II has the capacity to issue a total of $41.2 million of SBA guaranteed debentures, subject to SBA approval, of which $41.2 million was outstanding as of June 30, 2018. As of June 30, 2018, HT II has paid the SBA commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of June 30, 2018 the Company held investments in HT II in 33 companies with a fair value of approximately $78.5 million, accounting for approximately 4.6% of the Company’s total investment portfolio at June 30, 2018. HT II held approximately $115.4 million in assets and accounted for approximately 5.2% of the Company’s total assets prior to consolidation at June 30, 2018. The Company completed repayment of the remaining outstanding HT II debentures on July 13, 2018. See “Note 12 – Subsequent Events.”
On May 26, 2010, HT III received a license to operate as a SBIC under the SBIC program and is able to borrow funds from the SBA against eligible investments and additional contributions to regulatory capital. With the Company’s net investment of $74.5 million in HT III as of June 30, 2018, HT III has the capacity to issue a total of $149.0 million of SBA guaranteed debentures, subject to SBA approval, of which $149.0 million was outstanding as of June 30, 2018. As of June 30, 2018, HT III has paid the SBA commitment fees and facility fees of approximately $1.5 million and $3.6 million, respectively. As of June 30, 2018, the Company held investments in HT III in 45 companies with a fair value of approximately $255.2 million, accounting for approximately 15.0% of the Company’s total investment portfolio at June 30, 2018. HT III held approximately $294.8 million in assets and accounted for approximately 13.4% of the Company’s total assets prior to consolidation at June 30, 2018.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years. In addition, SBICs must devote 25.0% of its investment activity to “smaller” enterprises as defined by the SBA. A smaller enterprise is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services. Through the Company’s wholly owned subsidiaries HT II and HT III, the Company plans to provide long-term loans to qualifying small businesses, and in connection therewith, make equity investments.
HT II and HT III are periodically examined and audited by the SBA’s staff to determine their compliance with SBA regulations. If HT II or HT III fails to comply with applicable SBA regulations, the SBA could, depending on the severity of the violation, limit or prohibit HT II’s or HT III’s use of debentures, declare outstanding debentures immediately due and payable, and/or limit HT II or HT III from making new investments. In addition, HT II or HT III may also be limited in their ability to make distributions to the Company if they do not have sufficient capital in accordance with SBA regulations. Such actions by the SBA would, in turn, negatively affect the Company because HT II and HT III are the Company’s wholly owned subsidiaries. HT II and HT III were in compliance with the terms of the SBIC’s leverage as of June 30, 2018 as a result of having sufficient capital as defined under the SBA regulations.
The rates of borrowings under various draws from the SBA beginning in March 2009 are set semiannually in March and September and range from 2.25% to 4.62% excluding annual fees. Interest payments on SBA debentures are payable semiannually. There are no principal payments required on these issues prior to maturity and no prepayment penalties. Debentures under the SBA generally mature ten years after being borrowed. Based on the initial draw down date of March 2009, the initial maturity of SBA debentures will occur in March 2019. In addition, the SBA charges a fee that is set annually, depending on the Federal fiscal year the leverage commitment was delegated by the SBA, regardless of the date that the leverage was drawn by the SBIC. The annual fees related to HT II debentures that pooled on September 22, 2010 were 0.406% and 0.285%, depending upon the year in which the underlying commitment was closed. The annual fees on other debentures have been set at 0.906%. The annual fees related to HT III debentures that pooled on March 27, 2013 were 0.804%. The annual fees on other debentures have been set at 0.515%. The rates of borrowings on the Company’s SBA debentures range from 3.05% to 5.53% when including these annual fees.
The average amount of debentures outstanding for the three and six months ended June 30, 2018 for HT II was approximately $41.2 million with an average interest rate of approximately 4.51% and 4.48%, respectively. The average amount of debentures outstanding for the three and six months ended June 30, 2018 for HT III was approximately $149.0 million with an average interest rate of approximately 3.42% and 3.40%, respectively.
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the SBA debentures are as follows:
Interest expense
1,737
3,456
Amortization of debt issuance cost (loan fees)
156
317
Total interest expense and fees
1,895
1,893
3,773
3,780
Cash paid for interest expense
3,442
In aggregate, at June 30, 2018, with the Company’s net investment of $118.5 million, HT II and HT III have the capacity to issue a total of $190.2 million of SBA-guaranteed debentures, subject to SBA approval. At June 30, 2018, the Company has issued $190.2 million in SBA-guaranteed debentures in the Company’s SBIC subsidiaries.
54
The Company reported the following SBA debentures outstanding principal balances as of June 30, 2018 and December 31, 2017:
Issuance/Pooling Date
Interest Rate (1)
March 25, 2009
March 1, 2019
5.53%
18,400
September 23, 2009
September 1, 2019
4.64%
3,400
September 22, 2010
September 1, 2020
3.62%
6,500
3.50%
22,900
March 29, 2011
March 1, 2021
4.37%
28,750
September 21, 2011
September 1, 2021
3.16%
March 21, 2012
March 1, 2022
3.28%
3.05%
11,250
September 19, 2012
September 1, 2022
24,250
March 27, 2013
March 1, 2023
24,750
Total SBA Debentures
Interest rate includes annual charge
2019 Notes
In April and July 2012, the Company issued $84.5 million in aggregate principal amount of 7.00% notes due 2019 (the “April 2019 Notes”). In September and October 2012, the Company issued $85.9 million in aggregate principal amount of 7.00% notes due 2019 (the “September 2019 Notes”). The April 2019 Notes and September 2019 Notes are together referred to as the “2019 Notes.”
In April 2015, the Company redeemed $20.0 million of the $84.5 million issued and outstanding aggregate principal amount of April 2019 Notes, as previously approved by the Board of Directors. In December 2015, the Company redeemed $40.0 million of the $85.9 million issued and outstanding aggregate principal amount of September 2019 Notes, as previously approved by the Board of Directors. The remaining 2019 Notes were fully redeemed on February 24, 2017.
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the 2019 Notes are as follows:
1,159
1,546
1,911
On October 23, 2017, the Company issued $150.0 million in aggregate principal amount of 4.625% Notes due 2022 (the “2022 Notes”). The 2022 Notes were issued pursuant to the Fourth Supplemental Indenture to the Base Indenture, dated October 23, 2017 (the “2022 Notes Indenture”), between the Company and U.S. Bank, National Association, as trustee (the “2022 Trustee”). The sale of the 2022 Notes generated net proceeds of approximately $147.4 million, including a public offering discount of $826,500. Aggregate estimated offering expenses in connection with the transaction, including the underwriter’s discounts and commissions of approximately $975,000, were approximately $1.8 million.
The 2022 Notes mature on October 23, 2022, unless previously repurchased in accordance with their terms. The 2022 Notes bear interest at a rate of 4.625% per year payable semiannually in arrears on April 23 and October 23 of each year, commencing on April 23, 2018.
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The 2022 Notes are unsecured obligations of the Company that rank senior in right of payment to all of the Company’s existing and future indebtedness that is expressly subordinated, or junior, in right of payment to the 2022 Notes. The 2022 Notes are not guaranteed by any of the Company’s current or future subsidiaries. The 2022 Notes rank pari passu, or equally, in right of payment with all of the Company’s existing and future liabilities that are not so subordinated, or junior. The 2022 Notes effectively rank subordinated, or junior, to any of the Company’s secured indebtedness (including unsecured indebtedness that the Company later secures) to the extent of the value of the assets securing such indebtedness. The 2022 Notes rank structurally subordinated, or junior, to all existing and future indebtedness (including trade payables) incurred by subsidiaries, financing vehicles or similar facilities of the Company.
The Company may redeem some or all of the 2022 Notes at any time, or from time to time, at the redemption price set forth under the terms of the indenture after September 23, 2022. No sinking fund is provided for the 2022 Notes. The 2022 Notes were issued in denominations of $2,000 and integral multiples of $1,000 thereof. As of June 30, 2018, the Company was in compliance with the terms of the 2022 Notes Indenture.
As of June 30, 2018 and December 31, 2017, the components of the carrying value of the 2022 Notes were as follows:
Principal amount of debt
Unamortized debt issuance cost
(1,559
(1,633
Original issue discount, net of accretion
(713
(795
Carrying value of 2022 Notes
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the 2022 Notes are as follows:
1,734
3,469
171
Accretion of original issue discount
1,861
3,722
On July 14, 2014, the Company and U.S. Bank, N.A. (the “2024 Trustee”), entered into the Third Supplemental Indenture (the “Third Supplemental Indenture”) to the Base Indenture between the Company and the 2024 Trustee, dated July 14, 2014, relating to the Company’s issuance, offer and sale of $100.0 million aggregate principal amount of 6.25% unsecured notes due 2024 (the “2024 Notes”). On August 6, 2014, the underwriters issued notification to exercise their over-allotment option for an additional $3.0 million in aggregate principal amount of the 2024 Notes.
On May 2, 2016, the Company closed an underwritten public offering of an additional $72.9 million in aggregate principal amount of the 2024 Notes. The $72.9 million in aggregate principal amount includes $65.4 million from the initial offering on April 21, 2016 and $7.5 million as a result of underwriters exercising a portion of their option to purchase up to an additional $9.8 million in aggregate principal to cover overallotments on April 29, 2016.
On June 27, 2016, the Company closed an underwritten public offering of an additional $60.0 million in aggregate principal amount of the 2024 Notes. On June 30, 2016, the underwriters exercised their option to purchase up to an additional $9.0 million in aggregate principal to cover overallotments, resulting in total aggregate principal of $69.0 million from the offering.
On October 11, 2016, the Company entered into a debt distribution agreement, pursuant to which it may offer for sale, from time to time, up to $150.0 million in aggregate principal amount of 2024 Notes through FBR Capital Markets & Co. acting as its sales agent (the “2024 Notes Agent”). Sales of the 2024 Notes may be made in negotiated transactions or transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), including sales made directly on the NYSE, or similar securities exchange or sales made through a market maker other than on an exchange at prices related to prevailing market prices or at negotiated prices.
On October 24, 2017, the Board of Directors approved a redemption of $75.0 million of outstanding aggregate principal amount of the 2024 Notes, which were redeemed on November 23, 2017.
On February 9, 2018, the Company’s Board of Directors approved a redemption of $100.0 million of outstanding aggregate principal amount of the 2024 Notes and notice for such redemption was provided. The Company redeemed this portion of the 2024 Notes on April 2, 2018.
The 2024 Notes Agent receives a commission from the Company equal to up to 2.00% of the gross sales of any 2024 Notes sold through the 2024 Notes Agent under the debt distribution agreement. The 2024 Notes Agent is not required to sell any specific principal amount of 2024 Notes, but will use its commercially reasonable efforts consistent with its sales and trading practices to sell the 2024 Notes. The 2024 Notes are expected to trade “flat,” which means that purchasers in the secondary market will not pay, and sellers will not receive, any accrued and unpaid interest on the 2024 Notes that is not reflected in the trading price.
During the six months ended June 30, 2018, the Company did not sell any notes under the debt distribution agreement. During the year ended December 31, 2017, the Company sold 225,457 notes for approximately $5.6 million in aggregate principal amount. As of June 30, 2018, approximately $136.4 million in aggregate principal amount remains available for issuance and sale under the debt distribution agreement.
All issuances of 2024 Notes rank equally in right of payment and form a single series of notes.
The 2024 Notes will mature on July 30, 2024 and may be redeemed in whole or in part at the Company’s option at any time or from time to time on or after July 30, 2017, upon not less than 30 days nor more than 60 days written notice by mail prior to the date fixed for redemption thereof, at a redemption price of 100% of the outstanding principal amount thereof plus accrued and unpaid interest payments otherwise payable for the then-current quarterly interest period accrued to but not including the date fixed for redemption. The 2024 Notes bear interest at a rate of 6.25% per year payable quarterly on January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2014, and trade on the NYSE under the trading symbol “HTGX.”
The 2024 Notes are the Company’s direct unsecured obligations and rank: (i) pari passu with the Company’s other outstanding and future senior unsecured indebtedness; (ii) senior to any of the Company’s future indebtedness that expressly provides it is subordinated to the 2024 Notes; (iii) effectively subordinated to all the Company’s existing and future secured indebtedness (including indebtedness that is initially unsecured to which the Company subsequently grants security), to the extent of the value of the assets securing such indebtedness; (iv) structurally subordinated to all existing and future indebtedness and other obligations of any of the Company’s subsidiaries.
The Base Indenture, as supplemented by the Third Supplemental Indenture, contains certain covenants including covenants requiring the Company to comply with (regardless of whether it is subject to) the asset coverage requirements set forth in Section 18 (a)(1)(A) of the 1940 Act as modified by Section 61(a)(1) of the 1940 Act and to comply with the restrictions on dividends and other distributions as well as the purchase of capital stock set forth in Section 18(a)(1)(B) of the 1940 Act as modified by Section 61(a)(1) of the 1940 Act. These covenants are subject to important limitations and exceptions that are described in the Base Indenture, as supplemented by the Third Supplemental Indenture. The Base Indenture, as supplemented by the Third Supplemental Indenture, also contains certain reporting requirements, including a requirement that the Company provide financial information to the holders of the 2024 Notes and the 2024 Trustee if the Company should no longer be subject to the reporting requirements under the Exchange Act of 1934, as amended (the “Exchange Act”). The Base Indenture provides for customary events of default and further provides that the 2024 Trustee or the holders of 25% in aggregate principal amount of the outstanding 2024 Notes in a series may declare such 2024 Notes immediately due and payable upon the occurrence of any event of default after expiration of any applicable grace period. As of June 30, 2018, the Company was in compliance with the terms of the Base Indenture as supplemented by the Third Supplemental Indenture.
As of June 30, 2018 and December 31, 2017, the components of the carrying value of the 2024 Notes were as follows:
(1,871
(4,591
Original issue premium, net of amortization
Carrying value of 2024 Notes
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the 2024 Notes are as follows:
1,340
4,039
4,220
8,026
2,546
2,720
Amortization of original issue premium
(14
(13
(27
(29
3,872
6,913
8,498
2,381
5,249
8,016
On April 26, 2018, the Company issued $75.0 million in aggregate principal amount of 5.25% notes due 2025 (the “2025 Notes”). The 2025 Notes were issued pursuant to the Fifth Supplemental Indenture to the Base Indenture, dated April 26, 2018 (the “2025 Notes Indenture”), between the Company and U.S. Bank, National Association, as trustee. The sale of the 2025 Notes generated net proceeds of approximately $72.6 million. Aggregate estimated offering expenses in connection with the transaction, including the underwriter’s discount and commissions were approximately $2.4 million.
The 2025 Notes will mature on April 30, 2025, unless previously repurchased in accordance with their terms. The 2025 Notes bear interest at a rate of 5.25% per year payable quarterly in arrears on January 30, April 30, July 30 and October 30 of each year, commencing on July 30, 2018 and trade on the NYSE under the symbol “HCXZ.”
The 2025 Notes will be the Company’s direct unsecured obligations and rank pari passu, or equally in right of payment, with all outstanding and future unsecured unsubordinated indebtedness issued by Hercules Capital, Inc.
The Company may redeem some or all of the 2025 Notes at any time, or from time to time, at the redemption price set forth under the terms of the indenture after April 30, 2021. No sinking fund is provided for the 2025 Notes. The 2025 Notes were issued in denominations of $25 and integral multiples of $25 thereof. As of June 30, 2018, the Company was in compliance with the terms of the 2025 Notes Indenture.
As of June 30, 2018, and December 31, 2017, the components of the carrying value of the 2025 Notes were as follows:
(2,384
Carrying value of 2025 Notes
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the 2025 Notes are as follows:
711
768
On November 13, 2014, the Company completed a $237.4 million term debt securitization in connection with which an affiliate of the Company made an offer of $129.3 million in aggregate principal amount of fixed rate asset-backed notes (the “2021 Asset-Backed Notes”), which were rated A(sf) by Kroll Bond Rating Agency, Inc. The 2021 Asset-Backed Notes were sold by Hercules Capital Funding Trust 2014-1 pursuant to a note purchase agreement, dated as of November 13, 2014, by and among the Company, Hercules Capital Funding 2014-1, LLC as trust depositor (the “2014 Trust Depositor”), Hercules Capital Funding Trust 2014-1 as issuer (the “2014 Securitization Issuer”), and Guggenheim Securities, LLC, as initial purchaser, and are backed by a pool of senior loans made to certain of the Company’s portfolio companies and secured by certain assets of those portfolio companies and are to be serviced by the Company. The securitization has an 18-month reinvestment period during which time principal collections may be reinvested into additional eligible loans. Interest on the 2021 Asset-Backed Notes is paid, to the extent of funds available, at a fixed rate of 3.524% per annum. The 2021 Asset-Backed Notes have a stated maturity of April 16, 2021.
As part of this transaction, the Company entered into a sale and contribution agreement with the 2014 Trust Depositor under which the Company has agreed to sell or have contributed to the 2014 Trust Depositor certain senior loans made to certain of the Company’s portfolio companies (the “2014 Loans”). The Company has made customary representations, warranties and covenants in the sale and contribution agreement with respect to the 2014 Loans as of the date of their transfer to the 2014 Trust Depositor.
In connection with the issuance and sale of the 2021 Asset-Backed Notes, the Company has made customary representations, warranties and covenants in the note purchase agreement. The 2021 Asset-Backed Notes are secured obligations of the 2014 Securitization Issuer and are non-recourse to the Company. The 2014 Securitization Issuer also entered into an indenture governing the 2021 Asset-Backed Notes, which includes customary representations, warranties and covenants. The 2021 Asset-Backed Notes were sold without being registered under the Securities Act (A) in the United States to “qualified institutional buyers” as defined in Rule 144A under the Securities Act and to institutional “accredited investors” (as defined in Rules 501(a)(1), (2), (3) or (7) under the Securities Act) who in each case, are “qualified purchasers” as defined in Section 2(a)(51)(A) of the 1940 Act and pursuant to an exemption under the Securities Act and (B) to non-U.S. purchasers acquiring interest in the 2021 Asset-Backed Notes outside the United States in accordance with Regulation S under the Securities Act. The 2014 Securitization Issuer is not registered under the 1940 Act in reliance on an exemption provided by Section 3(c)(7) thereof and Rule 3a-7 thereunder. In addition, the 2014 Trust Depositor entered into an amended and restated trust agreement in respect of the 2014 Securitization Issuer, which includes customary representation, warranties and covenants.
The 2014 Loans are serviced by the Company pursuant to a sale and servicing agreement, which contains customary representations, warranties and covenants. The Company performs certain servicing and administrative functions with respect to the 2014 Loans. The Company is entitled to receive a monthly fee from the 2014 Securitization Issuer for servicing the 2014 Loans. This servicing fee is equal to the product of one-twelfth (or in the case of the first payment date, a fraction equal to the number of days from and including October 5, 2014 through and including December 5, 2014 over 360) of 2.00% and the aggregate outstanding principal balance of the 2014 Loans plus collections on deposit in the 2014 Securitization Issuer’s collections account, as of the first day of the related collection period (the period from the 5th day of the immediately preceding calendar month through the 4th day of the calendar month in which a payment date occurs, and for the first payment date, the period from and including October 5, 2014, to the close of business on December 5, 2014).The Company also serves as administrator to the 2014 Securitization Issuer under an administration agreement, which includes customary representations, warranties and covenants.
At June 30, 2018 and December 31, 2017, the 2021 Asset-Backed Notes had an outstanding principal balance of $31.1 million and $49.2 million, respectively.
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the 2021 Asset-Backed Notes are as follows:
807
623
1,695
421
1,018
736
289
848
676
1,788
Under the terms of the 2021 Asset-Backed Notes, the Company is required to maintain a reserve cash balance, funded through interest and principal collections from the underlying securitized debt portfolio, which may be used to pay monthly interest and principal payments on the 2021 Asset-Backed Notes. The Company has segregated these funds and classified them as restricted cash. There was approximately $15.9 million and $3.7 million of restricted cash as of June 30, 2018 and December 31, 2017, respectively, funded through interest collections.
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Convertible Notes
On January 25, 2017, the Company issued $230.0 million in aggregate principal amount of 4.375% Convertible Notes due 2022 (the “2022 Convertible Notes”), which amount includes the additional $30.0 million aggregate principal amount of 2022 Convertible Notes issued pursuant to the initial purchaser’s exercise in full of its overallotment option. The 2022 Convertible Notes were issued pursuant to an Indenture, dated January 25, 2017 (the “2022 Convertible Notes Indenture”), between the Company and U.S. Bank, National Association, as trustee (the “2022 Trustee”). The sale of the 2022 Convertible Notes generated net proceeds of approximately $225.5 million, including $4.5 million of debt issuance costs.
The 2022 Convertible Notes mature on February 1, 2022, unless previously converted or repurchased in accordance with their terms. The 2022 Convertible Notes bear interest at a rate of 4.375% per year payable semiannually in arrears on February 1 and August 1 of each year, commencing on August 1, 2017.
The 2022 Convertible Notes are unsecured obligations of the Company and rank senior in right of payment to the Company’s future indebtedness that is expressly subordinated in right of payment to the 2022 Convertible Notes; equal in right of payment to the Company’s existing and future indebtedness that is not so subordinated; effectively junior in right of payment to any of the Company’s secured indebtedness (including unsecured indebtedness that the Company later secures) to the extent of the value of the assets securing such indebtedness; and structurally junior to all existing and future indebtedness (including trade payables) incurred by the Company’s subsidiaries, financing vehicles or similar facilities.
Prior to the close of business on the business day immediately preceding August 1, 2021, holders may convert their 2022 Convertible Notes only under certain circumstances set forth in the 2022 Convertible Notes Indenture. On or after August 1, 2021 until the close of business on the scheduled trading day immediately preceding the maturity date, holders may convert their 2022 Convertible Notes at any time. Upon conversion, the Company will pay or deliver, as the case may be, at its election, cash, shares of its common stock or a combination of cash and shares of its common stock. The conversion rate is initially 60.9366 shares of common stock per $1,000 principal amount of 2022 Convertible Notes (equivalent to an initial conversion price of approximately $16.41 per share of common stock). The conversion rate will be subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. In addition, if certain corporate events occur prior to the maturity date, the Company will increase the conversion rate for a holder who elects to convert its 2022 Convertible Notes in connection with such a corporate event in certain circumstances. As of June 30, 2018, the conversion rate was 60.9366 shares of common stock per $1,000 principal amount of Convertible Senior Notes (equivalent to an adjusted conversion price of approximately $16.41 per share of common stock).
The Company may not redeem the 2022 Convertible Notes at its option prior to maturity. No sinking fund is provided for the 2022 Convertible Notes. In addition, if certain corporate events occur, holders of the 2022 Convertible Notes may require the Company to repurchase for cash all or part of their 2022 Convertible Notes at a repurchase price equal to 100% of the principal amount of the 2022 Convertible Notes to be repurchased, plus accrued and unpaid interest through, but excluding, the required repurchase date.
The 2022 Convertible Notes Indenture contains certain covenants, including covenants requiring the Company to comply with Section 18(a)(1)(A) of the 1940 Act as modified by Section 61(a)(1) of the 1940 Act and to provide financial information to the holders of the 2022 Convertible Notes and the 2022 Trustee if the Company ceases to be subject to the reporting requirements of the Exchange Act. These covenants are subject to important limitations and exceptions that are described in the 2022 Convertible Notes Indenture. The Company offered and sold the 2022 Convertible Notes to the initial purchaser in reliance on the exemption from registration provided by Section 4(a)(2) of the Securities Act, for resale by the initial purchaser to qualified institutional buyers (as defined in the Securities Act) pursuant to the exemption from registration provided by Rule 144A under the Securities Act. The Company relied on these exemptions from registration based in part on representations made by the initial purchaser in connection with the sale of the 2022 Convertible Notes.
The 2022 Convertible Notes are accounted for in accordance with ASC Subtopic 470-20 (“Debt Instruments with Conversion and Other Options”). In accounting for the 2022 Convertible Notes, the Company estimated at the time of issuance that the values of the debt and the embedded conversion feature of the 2022 Convertible Notes were approximately 98.5% and 1.5%, respectively. The original issue discount of 1.5%, or $3.4 million, attributable to the conversion feature of the 2022 Convertible Notes was recorded in “capital in excess of par value” in the Consolidated Statement of Assets and Liabilities. As a result, the Company records interest expense comprised of both stated interest expense as well as accretion of the original issue discount resulting in an estimated effective interest rate of approximately 4.76%.
As of June 30, 2018 and December 31, 2017, the components of the carrying value of the 2022 Convertible Notes were as follows:
(3,269
(3,715
(2,462
(2,797
Carrying value of 2022 Convertible Notes
For the three and six months ended June 30, 2018 and 2017, the components of interest expense, fees and cash paid for interest expense for the 2022 Convertible notes were as follows:
2,516
5,031
223
345
2,907
2,896
5,813
4,899
As of June 30, 2018, the Company is in compliance with the terms of the indentures governing the 2022 Convertible Notes.
As of June 30, 2018 and December 31, 2017, the Company has two available credit facilities, the Wells Facility and the Union Bank Facility (together, the “Credit Facilities”).
Wells Facility
On June 29, 2015, the Company, through a special purpose wholly owned subsidiary, Hercules Funding II LLC (“Hercules Funding II”), entered into an Amended and Restated Loan and Security Agreement (the “Wells Facility”) with Wells Fargo Capital Finance, LLC, as a lender and as the arranger and the administrative agent, and the lenders party thereto from time to time.
The Wells Facility matures on August 2, 2019, unless terminated sooner in accordance with its terms.
Under the Wells Facility, Wells Fargo Capital Finance, LLC made commitments of $75.0 million, Alostar Bank of Commerce made commitments of $20.0 million, and Everbank Commercial Finance Inc. made commitments of $25.0 million. The Wells Facility contains an accordion feature, in which the Company can increase the credit line up to an aggregate of $300.0 million, funded by additional lenders and with the agreement of Wells Fargo and subject to other customary conditions. The Company expects to continue discussions with various other potential lenders to join the facility; however, there can be no assurances that additional lenders will join the Wells Facility. Borrowings under the Wells Facility generally bear interest at a rate per annum equal to LIBOR plus 3.25%, and the Wells Facility has an advance rate of 50% against eligible debt investments. The Wells Facility is secured by all of the assets of Hercules Funding II. The Wells Facility requires payment of a non-use fee on a scale of 0.0% to 0.50% depending on the average monthly outstanding balance under the facility relative to the maximum amount of commitments at such time. For the three and six months ended June 30, 2018, this non-use fee was $78,000 and $228,000, respectively. For the three and six months ended June 30, 2017, this non-use fee was $152,000 and $297,000, respectively.
The Wells Facility also includes various financial and other covenants applicable to the Company and the Company’s subsidiaries, in addition to those applicable to Hercules Funding II, including covenants relating to certain changes of control of the Company and Hercules Funding II. Among other things, these covenants also require the Company to maintain certain financial ratios, including a maximum debt to worth ratio, minimum interest coverage ratio, minimum portfolio funding liquidity, and a minimum tangible net worth in an amount, when added to outstanding subordinated indebtedness, that is in excess of $500.0 million plus 90% of the cumulative amount of equity raised after June 30, 2014.
As of June 30, 2018, the minimum tangible net worth covenant increased to $841.5 million as a result of the public offering of 18.2 million shares of common stock issued for a total gross proceeds of approximately $242.8 million under an At-The-Market (“ATM”) equity distribution agreement (the “Prior Equity Distribution Agreement”) with JMP Securities (“JMP”) through February 2017, and a new ATM equity distribution agreement in September 2017 (the “Equity Distribution Agreement”) with JMP for the issuance of 1.6 million shares for gross proceeds of $20.5 million during 2017, and the issuance of 9.5 million shares for gross proceeds of $116.1 million during the six months ended June 30, 2018. See “Note 6 – Stockholder’s Equity.”
The Wells Facility provides for customary events of default, including, without limitation, with respect to payment defaults, breach of representations and covenants, certain key person provisions, cross acceleration provisions to certain other debt, lien and judgment limitations, and bankruptcy.
On June 20, 2011, the Company paid $1.1 million in structuring fees in connection with the original Wells Facility. In connection with an amendment to the original Wells Facility in August 2014, the Company paid an additional $750,000 in structuring fees and in connection with the amendment in December 2015, the Company paid an additional $188,000 in structuring fees. These fees are being amortized through the end of the term of the Wells Facility.
The Company had aggregate draws of $75.7 million on the available facility during the six months ended June 30, 2018, offset by repayments of $75.7 million. The Company had aggregate draws of $8.5 million on the available facility during the six months ended June 30, 2017, offset by repayments of $13.5 million. There were no borrowings outstanding on the facility as of June 30, 2018 and December 31, 2017.
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the Wells Facility are as follows:
746
790
835
215
478
214
On May 5, 2016, the Company, through a special purpose wholly owned subsidiary, Hercules Funding III LLC (“Hercules Funding III”), as borrower, entered into the credit facility (the “Union Bank Facility”) with MUFG Union Bank, as the arranger and administrative agent, and the lenders party to the Union Bank Facility from time to time. The Union Bank Facility replaced the company’s credit facility (the “Prior Union Bank Facility”) entered into on August 14, 2014 (as amended and restated from time to time) with MUFG Union Bank, as the arranger and administrative agent, and the lenders party to the Prior Union Bank Facility from time to time. Any references to amounts related to the Union Bank Facility prior to May 5, 2016 were incurred and relate to the Prior Union Bank Facility.
On July 18, 2016, the Company entered into the First Amendment to the Loan and Security Agreement, dated as of May 5, 2016 with MUFG Union Bank, N.A. The Amendment amends certain definitions relating to borrowings which accrue interest based on the London Interbank Offered Rate (“LIBOR Loans”) and (ii) the method(s) for calculating interest on and the paying of certain fees related to such LIBOR Loans.
The Union Bank Facility contains an accordion feature, in which the Company can increase the credit line up to an aggregate of $200.0 million, funded by additional lenders and with the agreement of MUFG Union Bank and subject to other customary conditions. There can be no assurances that additional lenders will join the Union Bank Facility to increase available borrowings. Borrowings under the Union Bank Facility generally bear interest at either (i) if such borrowing is a base rate loan, a base rate per annum equal to the federal funds rate plus 1.00%, LIBOR plus 1.00% or MUFG Union Bank’s prime rate, in each case, plus a margin of 1.25% or (ii) if such borrowing is a LIBOR loan, a rate per annum equal to LIBOR plus 3.25%, and the Union Bank Facility generally has an advance rate of 50% against eligible debt investments. The Union Bank Facility is secured by all of the assets of Hercules Funding III.
The Company paid a one-time $562,500 structuring fee in connection with the Union Bank Facility. The Union Bank Facility requires payment of a non-use fee during the revolving credit availability period on a scale of 0.25% to 0.50% depending on the average monthly outstanding balance under the facility relative to the maximum amount of commitments at such time. For the three and six months ended June 30, 2018, the company incurred non-use fees of $50,000 and $143,000, respectively. For the three and six months ended June 30, 2017, the company incurred non-use fees under the Prior Union Bank Facility of $95,000 and $189,000, respectively.
The Union Bank Facility also includes various financial and other covenants applicable to the Company and its subsidiaries, in addition to those applicable to Hercules Funding III, including covenants relating to certain changes of control of the Company and Hercules Funding III. Among other things, these covenants also require the Company to maintain certain financial ratios, including a maximum debt to worth ratio, minimum interest coverage ratio, minimum portfolio funding liquidity, and a minimum tangible net worth in an amount that is in excess of $500.0 million plus 90% of the cumulative amount of equity raised after June 30, 2014.
On May 25, 2018, the Company entered into the Second Amendment (the “Amendment”) to the Union Bank Facility with MUFG Union Bank, N.A., as the arranger and administrative agent, and the lenders party thereto from time to time. The Amendment amends certain provisions of the Union Bank Facility to increase MUFG Union Bank’s commitments thereunder from $75.0 million to $100.0 million.
As of June 30, 2018, the minimum tangible net worth covenant increased to $885.2 million as a result the public offering of 18.2 million shares of common stock issued for a total net proceeds of approximately $239.8 million under the Prior Equity Distribution Agreement through February 2017, and the issuance of 1.6 million shares for net proceeds of $20.0 million during 2017, and the issuance of 9.5 million shares for net proceeds of $112.6 million during the six months ended June 30, 2018. See “Note 6 - Stockholder’s Equity.”
The Union Bank Facility provides for customary events of default, including with respect to payment defaults, breach of representations and covenants, servicer defaults, certain key person provisions, cross default provisions to certain other debt, lien and judgment limitations, and bankruptcy.
The Union Bank Facility matures on May 5, 2020, unless terminated sooner in accordance with its terms.
In connection with the Union Bank Facility, the Company and Hercules Funding III also entered into the Sale Agreement, by and among Hercules Funding III, as borrower, the Company, as originator and servicer, and MUFG Union Bank, as agent. Under the Sale Agreement, the Company agrees to (i) sell or transfer certain loans to Hercules Funding III under the MUFG Union Bank Facility and (ii) act as servicer for the loans sold or transferred.
The Company had aggregate draws of $75.0 million on the available facility during the six months ended June 30, 2018, offset by repayments of $16.7 million. The Company did not make any draws or repayments on the available facility during the six months ended June 30, 2017. At December 31, 2017, there were no borrowings outstanding on the Union Bank Facility.
For the three and six months ended June 30, 2018 and 2017, the components of interest expense and related fees and cash paid for interest expense for the previous and current Union Bank Facility are as follows:
565
152
643
717
281
238
5. Income Taxes
The Company intends to operate so as to qualify to be subject to tax as a RIC under Subchapter M of the Code and, as such, will not be subject to U.S. federal income tax on the portion of taxable income (including gains) distributed as dividends for U.S. federal income tax purposes to stockholders. Taxable income includes the Company’s taxable interest, dividend and fee income, reduced by certain deductions, as well as taxable net realized securities gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses, and generally excludes net unrealized appreciation or depreciation, as such gains or losses are not included in taxable income until they are realized.
To qualify and be subject to tax as a RIC, the Company is required to meet certain income and asset diversification tests in addition to distributing dividends of an amount generally at least equal to 90% of its investment company taxable income, as defined by the Code and determined without regard to any deduction for distributions paid, to its stockholders. The amount to be paid out as a distribution is determined by the Board of Directors each quarter and is based upon the annual earnings estimated by the management of the Company. To the extent that the Company’s earnings fall below the amount of dividend distributions declared, however, a portion of the total amount of the Company’s distributions for the fiscal year may be deemed a return of capital for tax purposes to the Company’s stockholders.
During the three months ended June 30, 2018, the Company declared a distribution of $0.31 per share. The determination of the tax attributes of the Company’s distributions is made annually as of the end of the Company’s taxable year generally based upon its taxable income for the full taxable year and distributions paid for the full taxable year. As a result, a determination made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full taxable year. If the Company had determined the tax attributes of our distributions taxable year-to-date as of June 30, 2018, 100% would be from our current and accumulated earnings and profits. However, there can be no certainty to stockholders that this determination is representative of what the actual tax attributes of the Company’s 2018 distributions to stockholders will be.
As a RIC, the Company will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income unless the Company makes distributions treated as dividends for U.S. federal income tax purposes in a timely manner to its stockholders in respect of each calendar year of an amount at least equal to the sum of (1) 98% of the Company’s ordinary income (taking into account certain deferrals and elections) for each calendar year, (2) 98.2% of the Company’s capital gain net income (adjusted for certain ordinary losses) for the 1-year period ending October 31 of each such calendar year and (3) any ordinary income and capital gain net income realized, but not distributed, in preceding calendar years (the “Excise Tax Avoidance Requirement”). The Company will not be subject to this excise tax on any amount on which the Company incurred U.S. federal corporate income tax (such as the tax imposed on a RIC’s retained net capital gains).
Depending on the level of taxable income earned in a taxable year, the Company may choose to carry over taxable income in excess of current taxable year distributions from such taxable income into the next taxable year and incur a 4% excise tax on such taxable income, as required. The maximum amount of excess taxable income that may be carried over for distribution in the next taxable year under the Code is the total amount of distributions paid in the following taxable year, subject to certain declaration and payment guidelines. To the extent the Company chooses to carry over taxable income into the next taxable year, distributions declared and paid by the Company in a taxable year may differ from the Company’s taxable income for that taxable year as such distributions may include the distribution of current taxable year taxable income, the distribution of prior taxable year taxable income carried over into and distributed in the current taxable year, or returns of capital.
The Company has taxable subsidiaries which hold certain portfolio investments in an effort to limit potential legal liability and/or comply with source-income type requirements contained in the RIC tax provisions of the Code. These taxable subsidiaries are consolidated for U.S. GAAP and the portfolio investments held by the taxable subsidiaries are included in the Company’s consolidated financial statements, and are recorded at fair value. These taxable subsidiaries are not consolidated with the Company for income tax purposes and may generate income tax expense, or benefit, and tax assets and liabilities as a result of their ownership of certain portfolio investments. Any income generated by these taxable subsidiaries generally would be subject to tax at normal corporate tax rates based on its taxable income.
Taxable income for the six months ended June 30, 2018 was approximately $51.0 million or $0.59 per share. Taxable net realized gains for the same period were $4.2 million or approximately $0.05 per share. Taxable income for the six months ended June 30, 2017 was approximately $42.3 million or $0.52 per share. Taxable net realized losses for the same period were $1.2 million or approximately $0.01 per share.
For the six months ended June 30, 2018, the Company paid approximately $671,000 of tax expense and had no accrued but unpaid tax expense as of the balance sheet date. For the six months ended June 30, 2017, the Company paid approximately $1.0 million of tax expense and had no accrued but unpaid tax expense as of the balance sheet date.
The Company intends to distribute 100% of spillover earnings from ordinary income from the Company’s taxable year ended December 31, 2017 to the Company’s stockholders during 2018.
6. Stockholder’s Equity
On August 16, 2013, the Company entered into the Prior Equity Distribution Agreement. On March 7, 2016, the Company renewed the Prior Equity Distribution Agreement and on December 21, 2016, we further amended the agreement to increase the total shares available under the program. The Prior Equity Distribution Agreement, as amended, provided that the Company may offer and sell up to 12.0 million shares of its common stock from time to time through JMP, as its sales agent.
On September 7, 2017, the Company terminated the Prior Equity Distribution Agreement and entered into the new Equity Distribution Agreement. As a result, the remaining shares that were available under the Prior Equity Distribution agreement are no longer available for issuance. The Equity Distribution Agreement provides that the Company may offer and sell up to 12.0 million shares of its common stock from time to time through JMP, as its sales agent. Sales of the Company’s common stock, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices.
During the three and six months ended June 30, 2018, the Company sold 2.1 million and 2.6 million shares of common stock for total accumulated net proceeds of approximately $25.4 million and $31.4 million, respectively, including $566,000 and $877,000 of offering expenses, respectively, under the Equity Distribution Agreement.
During the six months ended June 30, 2017, the Company sold 3.3 million shares of common stock under the Prior Equity Distribution Agreement for total accumulated net proceeds of approximately $46.9 million, including $532,000 of offering expenses. The Company did not sell any shares under the program during the three months ended June 30, 2017.
64
The Company generally uses net proceeds from these offerings to make investments, to repurchase or pay down liabilities and for general corporate purposes. As of June 30, 2018, approximately 7.8 million shares remain available for issuance and sale under the Equity Distribution Agreement. See “Note 12 – Subsequent Events.”
On June 14, 2018, the Company closed its underwritten public offering of 6.9 million shares of common stock, including an over-allotment option to purchase an additional 900,000 shares of common stock (“June 2018 Equity Offering”). The offering generated net proceeds, before expenses, of $81.3 million, including the underwriting discount and commissions of $2.6 million.
The Company has issued stock options for common stock subject to future issuance, of which 573,038 and 590,525 were outstanding at June 30, 2018 and December 31, 2017, respectively.
7. Equity Incentive Plans
The Company and its stockholders authorized and adopted the 2004 Equity Incentive Plan (the “2004 Plan”) for purposes of attracting and retaining the services of its executive officers and key employees.
The Company and its stockholders have authorized and adopted the 2006 Non-Employee Director Plan (the “2006 Plan” and, together with the 2004 Plan, the “Plans”) for purposes of attracting and retaining the services of its Board of Directors. On June 21, 2017, the 2006 Plan expired in accordance with its terms and no additional awards may be granted under the 2006 Plan.
On June 21, 2007, the stockholders approved amendments to the 2004 Plan and the 2006 Plan allowing for the grant of restricted stock. The amended Plans limit the combined maximum amount of restricted stock that may be issued under both Plans to 10% of the outstanding shares of the Company’s stock on the effective date of the Plans plus 10% of the number of shares of stock issued or delivered by the Company during the terms of the Plans. The amendments further specify that no one person shall be granted awards of restricted stock relating to more than 25% of the shares available for issuance under the 2004 Plan. Further, the amount of voting securities that would result from the exercise of all of the Company’s outstanding warrants, options and rights, together with any restricted stock issued pursuant to the Plans, at the time of issuance shall not exceed 25% of its outstanding voting securities, except that if the amount of voting securities that would result from such exercise of all of the Company’s outstanding warrants, options and rights issued to the Company’s directors, officers and employees, together with any restricted stock issued pursuant to the Plans, would exceed 15% of the Company’s outstanding voting securities, then the total amount of voting securities that would result from the exercise of all outstanding warrants, options and rights, together with any restricted stock issued pursuant to the Plans, at the time of issuance shall not exceed 20% of the Company’s outstanding voting securities.
During 2012, the Compensation Committee adopted a policy that provided for awards with different vesting schedules for short and long-term awards. All restricted stock grants under the 2004 Plan made prior to March 4, 2013 continue to vest on a monthly basis following their one year anniversary over the succeeding 36 months. Under the 2004 Plan, restricted stock awarded subsequent to March 3, 2013 vests subject to continued employment based on two vesting schedules: short-term awards vest one-half on the one year anniversary of the date of the grant and quarterly over the succeeding 12 months, and long-term awards vest one-fourth on the one year anniversary of the date of grant and quarterly over the succeeding 36 months. No restricted stock was granted pursuant to the 2004 Plan prior to 2009.
On December 29, 2016, the Company’s Board of Directors approved an amendment and restatement of the 2004 Plan. The amended plan provides, in addition to the preexisting types of awards available for grant thereunder and among other things, (1) for the grant of restricted stock units; (2) for the deferral of the receipt of the shares of the Company’s common stock underlying vested restricted stock units; (3) that grantees may receive up to 10% of the value of the tentative restricted stock unit grants proposed for any grantee in the form of an option to acquire shares of the Company’s common stock; (4) that awards of restricted stock units may include performance vesting conditions; (5) that awards may require that all or a portion of the shares of the Company’s common stock delivered in respect of any vested restricted stock unit award be subject to a specified post-delivery holding period; and (6) that restricted stock unit awards may accrue dividend equivalents in respect of the Company’s common stock underlying any restricted stock unit award payable in the form of cash or additional shares of the Company’s common stock to the extent, and in respect of, any vested restricted stock units.
On May 2, 2018, the Company granted long-term Retention Performance Stock Unit awards (the “Retention PSUs”) and separate cash bonus awards with similar terms (the “Cash Awards”) to senior personnel under its 2004 Equity Incentive Plan. The awards are designed to provide incentives that increase along with the total shareholder return (“TSR”). The target number of Retention PSUs granted to senior personnel is 1,299,757 in the aggregate. The target amount of the Cash Awards granted to senior personnel is $4,000,000 in the aggregate.
The Retention PSUs and Cash Awards do not vest until the fourth anniversary “cliff vest” of the grant date (or a change in control of the Company, if earlier) and the Retention PSUs must generally be held and not disposed of until the fifth anniversary of the grant date, except in the event of death, disability or a change in control (the “Performance Period”). No Retention PSUs or Cash
Awards will vest if the Company’s TSR relative to certain specified publicly traded business development companies (BDCs) is not at or above the 25th percentile level of such BDCs. 50% of the target Cash Award and target number of Retention PSUs will vest if the Company’s TSR performance relative to such BDCs is at the 25th percentile level. 100% of the target Cash Award and target number of Retention PSUs will vest if the Company’s TSR performance relative to such BDCs is at the 50th percentile level. 200% of the target Cash Award and target number of Retention PSUs will vest if the Company’s TSR performance relative to such BDCs is at the 90th percentile level. If the Company’s TSR performance is between the 25th percentile and the 50th percentile, or between the 50th percentile and the 90th percentile, of such BDCs, the amount of the Cash Awards vested and payable and the number of vested and payable Retention PSUs will be determined by linear interpolation between the foregoing metrics. Dividend equivalents will accrue in respect only of the Retention PSUs in the form of additional Retention PSUs, but will not be paid unless the Retention PSUs to which such dividend equivalents relate actually vest. The Cash Awards are not eligible to accrue dividend equivalents.
The Company follows ASC Topic 718 (“Compensation – Stock Compensation”) to account for the Retention PSUs and Cash Awards granted. Under ASC Topic 718, compensation cost associated with Retention PSUs is measured at the grant date based on the fair value of the award and is recognized over the Performance Period. As the Cash Awards are settled in cash, the award is expensed as a liability, and will be re-measured at each reporting period until the Performance Period is complete. The compensation expense for these awards is based on the per unit grant date valuation using a Monte-Carlo simulation multiplied by the target payout level. The payout level is calculated based the Company’s TSR relative to specified BDCs during the performance period.
As of June 30, 2018, all of Retention PSUs and Cash Awards were unvested. During the three and six months ended June 30, 2018, the Company had approximately $751,000 of compensation expense related to the Retention PSUs and $143,000 of compensation expense related to the Cash Awards. The expense related to the Cash Awards is included within the Consolidated Statement of Assets and Liabilities.
On May 13, 2018, the Company’s Board of Directors further amended and restated the 2004 Plan and renamed it the Hercules Capital, Inc. Amended and Restated 2018 Equity Incentive Plan (the “2018 Equity Incentive Plan”). Under the 2004 Plan, prior to the amendment and restatement, the Company was authorized to issue 12.0 million shares of common stock. The 2018 Equity Incentive Plan, among other things, increases the number of shares available for issuance to eligible participants by an additional 6,700,000 shares. Unless sooner terminated by the Board, the 2018 Equity Incentive Plan will terminate on the day before the tenth anniversary of the date the 2018 Equity Incentive Plan was initially adopted in 2018 by the Board. On May 13, 2018, the Company’s Board of Directors adopted the Hercules Capital, Inc. 2018 Non-employee Director Plan (the “Director Plan”). The Director Plan provides equity compensation in the form of restricted stock to the Company’s non-employee directors. Subject to certain adjustments, the maximum aggregate number of shares of stock that may be authorized for issuance as restricted stock awards granted under the Director Plan is 300,000 shares. Unless sooner terminated by the Board, the Director Plan will terminate on the day before the tenth anniversary of the date the Director Plan was initially adopted in 2018 by the Board. The 2018 Equity Incentive Plan and the Director Plan were each approved by stockholders on June 28, 2018. For further information, please see our Proxy Statement filed with the SEC on May 29, 2018 in connection with our 2018 Annual Meeting of Stockholders. Additionally, on May 29, 2018, the Company filed an exemptive application with the SEC with respect to the 2018 Equity Incentive Plan and the Director Plan for an exemptive order from certain provisions of the 1940 Act. If granted by the SEC, the exemptive order would allow the Company to issue restricted stock to non-employee directors under the Director Plan and restricted stock and restricted stock units to certain of its employees, officers, and directors (excluding non-employee directors) under the 2018 Equity Incentive Plan. Similar to an exemptive order previously received by the Company with respect to Plans, the exemptive order would also (i) allow participants in the Director Plan and the 2018 Equity Incentive Plan to elect to have the Company withhold shares of the Company’s common stock to pay for the exercise price and applicable taxes with respect to an option exercise (“net issuance exercise”) and (ii) permit the holders of restricted stock to elect to have the Company withhold shares of the Company’s stock to pay the applicable taxes due on restricted stock at the time of vesting. Each individual would be able to make a cash payment at the time of option exercise or to pay taxes on restricted stock. The Company may not make awards under the Director Plan or the 2018 Equity Incentive Plan unless and until the Company receives the exemptive order from the SEC.
The following table summarizes the common stock option activities for the six months ended June 30, 2018 and 2017:
Common
Stock
Options
Average
Exercise Price
Outstanding at December 31,
590,525
13.60
668,171
13.73
Granted
78,000
12.48
76,000
14.69
Exercised
(38,319
11.31
(26,657
11.24
Forfeited
(26,073
13.00
(33,058
14.03
Expired
(31,095
14.43
(42,445
15.43
Outstanding at June 30,
573,038
13.58
642,011
13.82
Shares Expected to Vest at June 30,
198,300
259,343
The following table summarizes common stock options outstanding and exercisable at June 30, 2018:
(Dollars in thousands,
except exercise price)
Options Outstanding
Options Exercisable
Range of exercise prices
Number of
shares
Remaining
Contractual Life
Aggregate
Intrinsic
Value
Exercise
Price
Number
of shares
$9.25 - $14.56
360,038
5.45
194,830
12.44
173,962
4.49
150,951
12.09
$14.86 - $16.34
213,000
3.52
15.51
200,776
3.38
15.54
$9.25 - $16.34
4.73
374,738
3.89
13.94
Options generally vest 33% one year after the date of grant and ratably over the succeeding 24 months.
All options may be exercised for a period ending seven years after the date of grant. At June 30, 2018 options for 374,738 shares were exercisable at a weighted average exercise price of approximately $13.94 per share with a weighted average remaining contractual term of 3.89 years.
The Company determined that the fair value of options granted under the Plans during the six months ended June 30, 2018 and 2017 was approximately $44,000 and $54,000, respectively. During the six months ended June 30, 2018 and 2017, approximately $28,000 and $39,000 of share-based cost due to stock option grants was expensed, respectively. As of June 30, 2018, there was approximately $102,000 of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a weighted average remaining vesting period of 2.13 years.
The Company follows ASC Topic 718 (“Compensation – Stock Compensation”) to account for stock options granted. Under ASC Topic 718, compensation expense associated with stock-based compensation is measured at the grant date based on the fair value of the award and is recognized over the vesting period. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rate and expected option life. The fair value of options granted is based upon a Black Scholes option pricing model using the assumptions in the following table for the six months ended June 30, 2018 and 2017:
Expected Volatility
21.19%
23.07%
Expected Dividends
10%
Expected term (in years)
4.5
Risk-free rate
2.19% - 2.90%
1.62% - 2.02%
During the six months ended June 30, 2018 and 2017, the Company granted 334,995 shares and 10,111 shares, respectively, of restricted stock awards pursuant to the Plans. The Company determined that the fair value, based on grant date close price, of restricted stock awards granted under the Plans during the six months ended June 30, 2018 and 2017 was approximately $4.4 million and $150,000, respectively. As of June 30, 2018, there was approximately $4.8 million of total unrecognized compensation costs related to restricted stock awards. These costs are expected to be recognized over a weighted average remaining vesting period of 2.09 years.
The following table summarizes the activities for the Company’s unvested restricted stock awards for the six months ended June 30, 2018 and 2017:
Restricted
Stock Awards
Weighted Average
Grant Date
Unvested at December 31,
261,245
12.43
799,558
12.54
334,995
13.04
14.83
Vested
(125,735
12.73
(330,689
12.56
(3,085
11.70
(5,576
13.27
Unvested at June 30,
467,420
12.79
473,404
12.57
67
During the six months ended June 30, 2018, and 2017, the Company granted 411,689 shares and 600,461 shares of restricted stock units pursuant to the Plans based on the December 2016 amended terms. The Company determined that the fair value, based on grant date close price, of restricted stock units granted under the Plans during the six months ended June 30, 2018 and 2017, was approximately $5.4 million and $8.5 million respectively. As of June 30, 2018, there was approximately $8.5 million of total unrecognized compensation costs related to restricted stock units. These costs are expected to be recognized over a weighted average remaining vesting period of 2.08 years.
The following table summarizes the activities for the Company’s unvested restricted stock units for the six months ended June 30, 2018:
Stock Units
594,322
12.99
411,689
600,461
Distribution Equivalent Unit Granted
39,617
11.90
26,717
Vested (1)
(251,194
12.70
(5,841
12.63
(2,874
13.92
788,593
624,304
Pursuant to the December 29, 2016 amendment and restatement of the 2004 plan, receipt of the shares of the Company’s common stock underlying vested restricted stock units will be deferred for 4 years from grant date unless certain conditions are met. As such, vested restricted stock units will not be issued as common stock upon vesting until the completion of the deferral period.
During the six months ended June 30, 2018, the Company expensed approximately $4.3 million of compensation expense related to restricted stock awards and restricted stock units. The Company had approximately $3.7 million in compensation expense related to restricted stock awards during the six months ended June 30, 2017.
8. Earnings Per Share
Shares used in the computation of the Company’s basic and diluted earnings per share are as follows:
Numerator
Net increase in net assets resulting from operations
Less: Distributions declared-common and restricted shares
(26,678
(25,663
Undistributed earnings
25,382
7,486
4,909
(23,769
Undistributed earnings-common shares
25,246
7,439
4,879
Add: Distributions declared-common shares
26,532
25,503
52,779
50,982
Numerator for basic and diluted change in net assets per common share
51,778
32,942
57,658
27,213
Denominator
Basic weighted average common shares outstanding
Common shares issuable
103
71
Weighted average common shares outstanding assuming dilution
Change in net assets per common share
In the table above, unvested share-based payment awards that have non-forfeitable rights to distributions or distribution equivalents are treated as participating securities for calculating earnings per share. Unvested common stock options and restricted stock units are also considered for the purpose of calculating diluted earnings per share.
For the three and six months ended June 30, 2018 and 2017, the effect of the 2022 Convertible Notes under the treasury stock method is anti-dilutive and, accordingly, is excluded from the calculation of diluted earnings per share.
The calculation of change in net assets resulting from operations per common share—assuming dilution, excludes all anti-dilutive shares. For the three months ended June 30, 2018, the number of anti-dilutive shares, as calculated based on the weighted average closing price of the Company’s common stock for the periods, consisted of 4.6 million shares related to 2022 Convertible Notes, 74,845 shares of unvested common stock options, 803 shares of unvested restricted stock units, and 97,777 shares of unvested Retention PSUs. For the six months ended June 30, 2018, the number of anti-dilutive shares, as calculated based on the weighted average closing price of the Company’s common stock for the periods, consisted of 4.5 million shares related to 2022 Convertible Notes, 74,006 shares of unvested common stock options, no shares of unvested restricted stock units, and 45,958 shares of unvested Retention PSUs. For the three and six months ended June 30, 2017, the number of anti-dilutive shares, as calculated based on the weighted average closing price of the Company’s common stock for the periods, consisted of 2.7 million and 1.9 million shares related to 2022 Convertible Notes, 43,723 shares and 31,039 shares of unvested common stock options, and no shares of unvested restricted stock units, respectively.
At June 30, 2018 and December 31, 2017, the Company was authorized to issue 200.0 million shares of common stock with a par value of $0.001. Each share of common stock entitles the holder to one vote.
9. Financial Highlights
Following is a schedule of financial highlights for the six months ended June 30, 2018 and 2017:
Per share data (1):
Net asset value at beginning of period
9.90
(0.16
(0.03
Net unrealized appreciation (depreciation) on investments
(0.22
Total from investment operations
0.34
Net increase (decrease) in net assets from capital share transactions (1)
0.15
0.21
Distributions of net investment income (6)
(0.62
(0.63
Distributions of capital gains (6)
Stock-based compensation expense included in investment income (2)
0.06
0.05
Net asset value at end of period
9.87
Ratios and supplemental data:
Per share market value at end of period
12.65
13.24
Total return (3)
1.24
(2.04
%)
Shares outstanding at end of period
Weighted average number of common shares outstanding
Net assets at end of period
Ratio of total expense to average net assets (4)
11.59
Ratio of net investment income before investment gains and losses to average net assets (4)
11.45
11.50
Portfolio turnover rate (5)
28.31
24.18
Weighted average debt outstanding
813,889
707,323
Weighted average debt per common share
9.48
8.64
All per share activity is calculated based on the weighted average shares outstanding for the relevant period, except net increase (decrease) in net assets from capital share transactions, which is based on the common shares outstanding as of the relevant balance sheet date.
Stock option expense is a non-cash expense that has no effect on net asset value. Pursuant to ASC Topic 718 (“Compensation – Stock Compensation”), net investment income includes the expense associated with the granting of stock options which is offset by a corresponding increase in paid-in capital.
The total return for the six months ended June 30, 2018 and 2017 equals the change in the ending market value over the beginning of the period price per share plus distributions paid per share during the period, divided by the beginning price assuming the distribution is reinvested on the date of the distribution. As such, the total return is not annualized. The total return does not reflect any sales load that must be paid by investors.
These ratios are calculated based on weighted average net assets for the relevant period and are annualized. The ratio of total expense to average net assets for the period ended June 30, 2017 was incorrectly computed. The ratio was revised from 7.63% as previously disclosed to 11.24% as adjusted.
The portfolio turnover rate for the six months ended June 30, 2018 and 2017 equals the lesser of investment portfolio purchases or sales during the period, divided by the average investment portfolio value during the period. As such, portfolio turnover rate is not annualized.
Includes distributions on unvested restricted stock awards.
10. Commitments and Contingencies
The Company’s commitments and contingencies consist primarily of unused commitments to extend credit in the form of loans to the Company’s portfolio companies. A portion of these unfunded contractual commitments are dependent upon the portfolio company reaching certain milestones before the debt commitment becomes available. Furthermore, the Company’s credit agreements contain customary lending provisions which allow the Company relief from funding obligations for previously made commitments in instances where the underlying company experiences materially adverse events that affect the financial condition or business outlook for the Company. Since a portion of these commitments may expire without being drawn, unfunded contractual commitments do not necessarily represent future cash requirements. As such, the Company’s disclosure of unfunded contractual commitments includes only those which are available at the request of the portfolio company and unencumbered by milestones.
At June 30, 2018, the Company had approximately $129.7 million of unfunded commitments, including undrawn revolving facilities, which were available at the request of the portfolio company and unencumbered by milestones.
The Company also had approximately $80.0 million of non-binding term sheets outstanding at June 30, 2018. Non-binding outstanding term sheets are subject to completion of the Company’s due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. These non-binding term sheets generally convert to contractual commitments in approximately 90 days from signing. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.
The fair value of the Company’s unfunded commitments is considered to be immaterial as the yield determined at the time of underwriting is expected to be materially consistent with the yield upon funding, given that interest rates are generally pegged to market indices and given the existence of milestones, conditions and/or obligations imbedded in the borrowing agreements.
As of June 30, 2018, the Company’s unfunded contractual commitments available at the request of the portfolio company, including undrawn revolving facilities, and unencumbered by milestones are as follows:
Unfunded
Commitments (1)
ThumbTack, Inc.
Tricida, Inc.
Contentful, Inc.
Impossible Foods, Inc.
Chemocentryx, Inc.
Evernote Corporation
Businessolver.com, Inc.
6,375
Achronix Semiconductor Corporation
2,963
First Insight, Inc.
Lithium Technologies, Inc.
Greenphire, Inc.
Insurance Technologies Corporation
Salsa Labs, Inc.
129,716
Amount represents unfunded commitments, including undrawn revolving facilities, which are available at the request of the portfolio company. Amount excludes unfunded commitments which are unavailable due to the borrower having not met certain milestones.
Certain premises are leased or licensed under agreements which expire at various dates through June 2027. Total rent expense amounted to approximately $510,000 and $961,000 during the three and six months ended June 30, 2018. Total rent expense amounted to approximately $449,000 and $893,000 during the three and six months ended June 30, 2017.
The Company’s contractual obligations as of June 30, 2018 include:
Payments due by period (in thousands)
Contractual Obligations (1)
Less than 1 year
1 - 3 years
3 - 5 years
After 5 years
Borrowings (2)(3)(5)
72,288
97,073
490,250
158,510
Operating Lease Obligations (4)
16,655
2,352
5,614
5,868
2,821
834,776
74,640
102,687
496,118
161,331
Excludes commitments to extend credit to the Company’s portfolio companies.
Includes $190.2 million in principal outstanding under the SBA debentures, $150.0 million of the 2022 Notes, $83.5 million of the 2024 Notes, $75.0 million of the 2025 Notes, $31.1 million of the 2021 Asset-Backed Notes, $230.0 million of the 2022 Convertible Notes and $58.3 million under the Union Credit Facility as of June 30, 2018.
Amounts represent future principal repayments and not the carrying value of each liability. See Note 4 to the Company’s consolidated financial statements.
Facility leases and licenses.
Reflects the Company’s intention to repay the remaining outstanding debentures in HT II in Q3 2018. See “Note 12 – Subsequent Events.”
The Company may, from time to time, be involved in litigation arising out of its operations in the normal course of business or otherwise. Furthermore, third parties may try to seek to impose liability on the Company in connection with the activities of its portfolio companies. While the outcome of any current legal proceedings cannot at this time be predicted with certainty, the Company does not expect any current matters will materially affect the Company’s financial condition or results of operations; however, there can be no assurance whether any pending legal proceedings will have a material adverse effect on the Company’s financial condition or results of operations in any future reporting period.
11. Recent Accounting Pronouncements
In January 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which, among other things, requires that (i) all equity investments, other than equity-method investments, in unconsolidated entities generally be measured at fair value through earnings and (ii) an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Additionally, the ASU changes the disclosure requirements for financial instruments. ASU 2016-01 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. The Company has adopted this standard, which did not have a material impact, on its consolidated financial statements and related disclosures for the periods presented.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which, among other things, requires recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Additionally, the ASU requires the classification of all cash payments on leases within operating activities in the Consolidated Statement of Cash Flows. ASU 2016-02 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2018. Early adoption is permitted. The Company anticipates an increase in the recognition of right-of-use assets and lease liabilities, however, the Company does not believe that ASU 2016-02 will have a material impact on its consolidated financial statements and disclosures.
In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which addresses eight specific cash flow issues including, among other things, the classification of debt prepayment or debt extinguishment costs. ASU 2016-15 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. The Company has adopted this standard, which did not have a material impact, on its consolidated financial statements and related disclosures for the periods presented.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230),” which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new guidance is effective for interim and annual periods beginning after December 15, 2017. The Company has adopted this standard, which did not have a material impact, on its consolidated financial statements and related disclosures for the periods presented.
In June 2018, the FASB issued ASU 2018-07, “Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting”. This amendment expands the scope of Topic 718, Compensation—Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees and is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2018. The Company does not believe that ASU 2018-07 will have a material impact on its consolidated financial statements and disclosures.
12. Subsequent Events
Distribution Declaration
On July 25, 2018 the Board of Directors declared a cash distribution of $0.31 per share to be paid on August 20, 2018 to stockholders of record as of August 13, 2018. This distribution represents the Company’s fifty-second consecutive distribution since the Company’s IPO, bringing the total cumulative distribution to date to $14.64 per share.
ATM Equity Program Issuances
Subsequent to June 30, 2018 and as of July 30, 2018, the Company sold 1.6 million shares of common stock for total accumulated net proceeds of approximately $19.8 million, including $150,000 of offering expenses, under the Equity Distribution Agreement with JMP. As of July 30, 2018, approximately 6.2 million shares remain available for issuance and sale under the Equity Distribution Agreement.
Hercules Technology II Debentures Full Redemption
On July 13, 2018, the Company completed repayment of the $41.2 million of outstanding HT II debentures.
On July 31, 2018, the Company entered into a further amendment to the Wells Facility to extend the maturity date and fully repay the pro-rata portion of outstanding balances of Alostar Bank of Commerce and Everbank Commercial Finance Inc., thereby resigning both as lenders and terminating their commitments thereunder.
Portfolio Company Developments
As of July 30, 2018, the Company held warrants or equity positions in two companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings. Both companies filed confidentially under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all. Subsequent to June 30, 2018 and as of July 30, 2018, there were no announced or completed liquidity events.
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The matters discussed in this report, as well as in future oral and written statements by management of Hercules Capital, Inc., that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward- looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, the availability of additional capital, and the ability to maintain certain debt to asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this report should not be regarded as a representation by us that our plans or objectives will be achieved. The forward-looking statements contained in this report include statements as to:
our current and future management structure;
our future operating results;
our business prospects and the prospects of our prospective portfolio companies;
the impact of investments that we expect to make;
our informal relationships with third parties including in the venture capital industry;
the expected market for venture capital investments and our addressable market;
the dependence of our future success on the general economy and its impact on the industries in which we invest;
our ability to access debt markets and equity markets;
the ability of our portfolio companies to achieve their objectives;
our expected financings and investments;
our regulatory structure and tax status;
our ability to operate as a business development company, a SBIC and a RIC;
the adequacy of our cash resources and working capital;
the timing of cash flows, if any, from the operations of our portfolio companies;
the timing, form and amount of any distributions;
the impact of fluctuations in interest rates on our business;
the valuation of any investments in portfolio companies, particularly those having no liquid trading market; and
our ability to recover unrealized losses.
The following discussion should be read in conjunction with our consolidated financial statements and related notes and other financial information appearing elsewhere in this report. In addition to historical information, the following discussion and other parts of this report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Item 1A— “Risk Factors” of Part II of this quarterly report on Form 10-Q, Item 1A— “Risk Factors” of our annual report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 22, 2018 and under “Forward-Looking Statements” of this Item 2.
Overview
We are a specialty finance company focused on providing senior secured loans to high-growth, innovative venture capital-backed companies in a variety of technology, life sciences, and sustainable and renewable technology industries. We source our investments through our principal office located in Palo Alto, CA, as well as through our additional offices in Boston, MA, New York, NY, Washington, DC, Hartford, CT, Reston, VA, and San Diego, CA.
Our goal is to be the leading structured debt financing provider for venture capital-backed companies in technology-related industries requiring sophisticated and customized financing solutions. Our strategy is to evaluate and invest in a broad range of technology-related industries including technology, drug discovery and development, biotechnology, life sciences, healthcare, and sustainable and renewable technology and to offer a full suite of growth capital products. We invest primarily in structured debt with warrants and, to a lesser extent, in senior debt and equity investments. We invest primarily in private companies but also have investments in public companies.
We use the term “structured debt with warrants” to refer to any debt investment, such as a senior or subordinated secured loan, that is coupled with an equity component, including warrants, options or other rights to purchase common or preferred stock. Our structured debt with warrants investments typically are secured by some or all of the assets of the portfolio company. We also provide “unitranche” loans, which are loans that combine both senior and mezzanine debt, generally in a first lien position.
Our investment objective is to maximize our portfolio total return by generating current income from our debt investments and capital appreciation from our warrant and equity-related investments. Our primary business objectives are to increase our net income, net operating income and NAV by investing in structured debt with warrants and equity of venture capital-backed companies in technology-related industries with attractive current yields and the potential for equity appreciation and realized gains. Our equity ownership in our portfolio companies may exceed 25% of the voting securities of such companies, which represents a controlling interest under the 1940 Act. In some cases, we receive the right to make additional equity investments in our portfolio companies in connection with future equity financing rounds. Capital that we provide directly to venture capital-backed companies in technology-related industries is generally used for growth and general working capital purposes as well as in select cases for acquisitions or recapitalizations.
We also make investments in qualifying small businesses through our two wholly owned small business investment companies (“SBICs”). Our SBIC subsidiaries, Hercules Technology II, L.P. (“HT II”) and Hercules Technology III, L.P. (“HT III”), hold approximately $115.4 million and $294.8 million in assets, respectively, and accounted for approximately 5.2% and 13.4% of our total assets, respectively, prior to consolidation at June 30, 2018. In aggregate, at June 30, 2018, with our net investment of $118.5 million, HT II and HT III have the capacity to issue a total of $190.2 million of SBA-guaranteed debentures, subject to Small Business Administration (“SBA”) approval. At June 30, 2018, we have issued $190.2 million in SBA-guaranteed debentures in our SBIC subsidiaries. On July 13, 2018, we fully redeemed the principal outstanding on our SBA HT II debenture. See “– Subsequent Events.”
We have qualified as and have elected to be treated for tax purposes as a RIC under Subchapter M of the Code. Pursuant to this election, we generally will not be subject to corporate-level taxes on any income and gains that we distribute as dividends for federal income tax purposes to our stockholders. However, our qualification and election to be treated as a RIC requires that we comply with provisions contained in Subchapter M of the Code. For example, as a RIC we must earn 90% or more of our gross income during each taxable year from qualified sources, typically referred to as “good income,” as well as satisfy certain quarterly asset diversification and annual income distribution requirements.
We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company under the 1940 Act. As a business development company, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in “qualifying assets,” which includes securities of private U.S. companies, cash, cash equivalents and high-quality debt investments that mature in one year or less.
Our portfolio is comprised of, and we anticipate that our portfolio will continue to be comprised of, investments primarily in technology related companies at various stages of their development. Consistent with requirements under the 1940 Act, we invest primarily in United-States based companies and to a lesser extent in foreign companies.
We regularly engage in discussions with third parties with respect to various potential transactions. We may acquire an investment or a portfolio of investments or an entire company or sell a portion of our portfolio on an opportunistic basis. We, our subsidiaries or our affiliates may also agree to manage certain other funds that invest in debt, equity or provide other financing or services to companies in a variety of industries for which we may earn management or other fees for our services. We may also invest in the equity of these funds, along with other third parties, from which we would seek to earn a return and/or future incentive allocations. Some of these transactions could be material to our business. Consummation of any such transaction will be subject to completion of due diligence, finalization of key business and financial terms (including price) and negotiation of final definitive documentation as well as a number of other factors and conditions including, without limitation, the approval of our board of directors and required regulatory or third party consents and, in certain cases, the approval of our stockholders. Accordingly, there can be no assurance that any such transaction would be consummated. Any of these transactions or funds may require significant management resources either during the transaction phase or on an ongoing basis depending on the terms of the transaction.
Portfolio and Investment Activity
The total fair value of our investment portfolio was approximately $1.7 billion at June 30, 2018 and $1.5 billion at December 31, 2017. The fair value of our debt investment portfolio at June 30, 2018 was approximately $1.5 billion, compared to a fair value of approximately $1.4 billion December 31, 2017. The fair value of the equity portfolio at June 30, 2018 was approximately $121.5 million, compared to a fair value of approximately $89.4 million at December 31, 2017. The fair value of the warrant portfolio at June 30, 2018 was approximately $34.4 million, compared to a fair value of approximately $36.8 million at December 31, 2017.
Portfolio Activity
Our investments in portfolio companies take a variety of forms, including unfunded contractual commitments and funded investments. From time to time, unfunded contractual commitments depend upon a portfolio company reaching certain milestones before the debt commitment is available to the portfolio company, which is expected to affect our funding levels. These commitments are subject to the same underwriting and ongoing portfolio maintenance as the on-balance sheet financial instruments that we hold. Debt commitments generally fund over the two succeeding quarters from close. Not all debt commitments represent future cash requirements. Similarly, unfunded contractual commitments may expire without being drawn and thus do not represent future cash requirements.
Prior to entering into a contractual commitment, we generally issue a non-binding term sheet to a prospective portfolio company. Non-binding term sheets are subject to completion of our due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. These non-binding term sheets generally convert to contractual commitments in approximately 90 days from signing. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.
Our portfolio activity for the six months ended June 30, 2018 and the year ended December 31, 2017 was comprised of the following:
(in millions)
Debt Commitments (1)
New portfolio company
637.1
773.2
Existing portfolio company
59.5
98.8
696.6
872.0
Funded and Restructured Debt Investments (2)
412.6
578.9
118.7
175.9
531.3
754.8
Funded Equity Investments
27.7
2.9
32.4
Unfunded Contractual Commitments (3)
129.7
73.6
Non-Binding Term Sheets
70.0
122.0
80.0
Includes restructured loans and renewals in addition to new commitments.
Funded amounts include borrowings on revolving facilities.
We receive principal payments on our debt investment portfolio based on scheduled amortization of the outstanding balances. In addition, we receive principal repayments for some of our loans prior to their scheduled maturity date. The frequency or volume of these early principal repayments may fluctuate significantly from period to period. During the six months ended June 30, 2018, we received approximately $404.3 million in aggregate principal repayments. Of the approximately $404.3 million of aggregate principal repayments, approximately $46.5 million were scheduled principal payments and approximately $357.8 million were early principal repayments related to 26 portfolio companies. Of the approximately $357.8 million early principal repayments, approximately $38.5 million were early repayments due to merger and acquisition transactions for three portfolio companies.
Total portfolio investment activity (inclusive of unearned income and excluding activity related to taxes payable, and escrow receivables) as of and for the six months ended June 30, 2018 and the year ended December 31, 2017 was as follows:
Beginning portfolio
1,542.2
1,423.9
New fundings and restructures
563.7
764.8
Warrants not related to current period fundings
Principal payments received on investments
(46.5
(119.5
Early payoffs
(357.8
(505.6
Accretion of loan discounts and paid-in-kind principal
16.9
36.5
Net acceleration of loan discounts and loan fees due to
early payoff or restructure
(8.1
New loan fees
(7.0
(9.8
Sale of investments
(1.6
(11.0
Loss on investments due to write offs
(22.0
(39.6
Net change in unrealized appreciation (depreciation)
21.9
Ending portfolio
1,701.9
As of June 30, 2018, we held warrants or equity positions in two companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings. Both companies filed confidentially under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all.
Changes in Portfolio
We generate revenue in the form of interest income, primarily from our investments in debt securities, and commitment and facility fees. Interest income is recognized in accordance with the contractual terms of the loan agreement to the extent that such amounts are expected to be collected. Fees generated in connection with our debt investments are recognized over the life of the loan or, in some cases, recognized as earned. In addition, we generate revenue in the form of capital gains, if any, on warrants or other equity-related securities that we acquire from our portfolio companies. Our investments generally range from $12.0 million to $40.0 million, although we may make investments in amounts above or below that range. As of June 30, 2018, our debt investments have a term of between two and seven years and typically bear interest at a rate ranging from 6.0% to 14.5%. In addition to the cash yields received on our debt investments, in some instances, our debt investments may also include any of the following: exit fees, balloon payment fees, commitment fees, success fees, PIK provisions or prepayment fees which may be required to be included in income prior to receipt.
Interest on debt securities is generally payable monthly, with amortization of principal typically occurring over the term of the investment. In addition, our loans may include an interest-only period ranging from three to eighteen months or longer. In limited instances in which we choose to defer amortization of the loan for a period of time from the date of the initial investment, the principal amount of the debt securities and any accrued but unpaid interest become due at the maturity date.
Loan origination and commitment fees received in full at the inception of a loan are deferred and amortized into fee income as an enhancement to the related loan’s yield over the contractual life of the loan. We recognize nonrecurring fees amortized over the remaining term of the loan commencing in the quarter relating to specific loan modifications. We had approximately $33.7 million of unamortized fees at June 30, 2018, of which approximately $27.9 million was included as an offset to the cost basis of our current debt investments and approximately $5.8 million was deferred contingent upon the occurrence of a funding or milestone. At December 31, 2017, we had approximately $33.3 million of unamortized fees, of which approximately $29.3 million was included as an offset to the cost basis of our current debt investments and approximately $4.0 million was deferred contingent upon the occurrence of a funding or milestone.
Loan exit fees to be paid at the termination of the loan are accreted into interest income over the contractual life of the loan. At June 30, 2018, we had approximately $23.8 million in exit fees receivable, of which approximately $21.6 million was included as a component of the cost basis of our current debt investments and approximately $2.2 million was a deferred receivable related to expired commitments. At December 31, 2017, we had approximately $27.5 million in exit fees receivable, of which approximately $23.9 million was included as a component of the cost basis of our current debt investments and approximately $3.6 million was a deferred receivable related to expired commitments.
We have debt investments in our portfolio that contain a PIK provision. The PIK interest, computed at the contractual rate specified in each loan agreement, is recorded as interest income and added to the principal balance of the loan on specified capitalization dates. To maintain our ability to be subject to tax as a RIC, this non-cash source of income must be distributed to stockholders with other sources of income in the form of dividend distributions even though we have not yet collected the cash. Amounts necessary to pay these distributions may come from available cash or the liquidation of certain investments. We recorded approximately $2.3 million and $2.5 million in PIK income during the three months ended June 30, 2018 and 2017, respectively. We recorded approximately $4.6 million and $4.7 million in PIK income during the six months ended June 30, 2018 and 2017, respectively.
The core yield on our debt investments, which excludes the effects of fee and income accelerations attributed to early payoffs, restructuring, loan modifications and other one-time events and includes income from expired commitments, was 12.7% and 12.1% during the three months ended June 30, 2018 and 2017, respectively. The effective yield on our debt investments, which includes the effects of fee and income accelerations attributed to early payoffs, restructuring, loan modifications and other one-time events, was 13.5% and 14.9% for the three months ended June 30, 2018 and 2017, respectively. The effective yield is derived by dividing total investment income by the weighted average earning investment portfolio assets outstanding during the quarter, excluding non-interest earning assets such as warrants and equity investments. Both the core yield and effective yield may be higher than what our common stockholders may realize as the core yield and effective yield do not reflect our expenses and any sales load paid by our common stockholders. The total yield on our investment portfolio was 11.8% and 12.8% during the three months ended June 30, 2018 and 2017, respectively. The total yield is derived by dividing total investment income by the weighted average investment portfolio assets outstanding during the quarter, including non-interest earning assets such as warrants and equity investments at amortized cost.
The total return for our investors was approximately 1.2% and -2.0% during the six months ended June 30, 2018 and 2017, respectively. The total return equals the change in the ending market value over the beginning of the period price per share plus dividend distributions paid per share during the period, divided by the beginning price assuming the distribution is reinvested on the date of the distribution. The total return does not reflect any sales load that must be paid by investors. See “Note 9 – Financial Highlights” included in the notes to our consolidated financial statements appearing elsewhere in this report.
Our portfolio companies are primarily privately held companies and public companies which are active in the software, drug discovery & development, internet consumer & business services, sustainable and renewable technology, drug delivery, healthcare services, medical devices & equipment, media/content/info, diversified financial services, information services, electronics & computer hardware, consumer & business products, surgical devices, communications & networking, biotechnology tools, semiconductors, diagnostic and specialty pharmaceuticals industry sectors. These sectors are characterized by high margins, high growth rates, consolidation and product and market extension opportunities. Value for companies in these sectors is often vested in intangible assets and intellectual property.
As of June 30, 2018, approximately 80.5% of the fair value of our portfolio was composed of investments in five industries: 26.3% investments in the drug discovery & development industry, 26.2% investments in the software industry, 15.1% investments in the internet consumer & business services industry, 7.1% investments in the sustainable and renewable technology industry, and 5.8% investments in the Medical Devices & Equipment industry.
Industry and sector concentrations vary as new loans are recorded and loans pay off. Loan revenue, consisting of interest, fees, and recognition of gains on equity and warrants or other equity-related interests, can fluctuate materially when a loan is paid off or a warrant or equity interest is sold. Revenue recognition in any given year can be highly concentrated in several portfolio companies.
For the six months ended June 30, 2018 and the year ended December 31, 2017, our ten largest portfolio companies represented approximately 27.4% and 34.6% of the total fair value of our investments in portfolio companies, respectively. At June 30, 2018 and December 31, 2017, we had five and seven investments, respectively, that represented 5% or more of our net assets. At June 30, 2018, we had six equity investments representing approximately 65.4% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments. At December 31, 2017, we had nine equity investments which represented approximately 67.1% of the total fair value of our equity investments, and each represented 5% or more of the total fair value of our equity investments.
As of June 30, 2018, approximately 97.2% of the debt investment portfolio was priced at floating interest rates or floating interest rates with a Prime or LIBOR-based interest rate floor. As a result, we believe we are well positioned to benefit should market interest rates continue to rise.
In the majority of cases, we collateralize our investments by obtaining a first priority security interest in a portfolio company’s assets, which may include its intellectual property. In other cases, we may obtain a negative pledge covering a company’s intellectual property. As of June 30, 2018, approximately 85.9% of our debt investments were in a senior secured first lien position, with 49.2% secured by a first priority security in all of the assets of the portfolio company, including its intellectual property, 29.3% secured by a first priority security in all of the assets of the portfolio company and the portfolio company was prohibited from pledging or encumbering its intellectual property, 1.4% of our debt investments were senior secured by the equipment of the portfolio company, and 6.1% were in a first lien “last-out” senior secured position with security interest in all of the assets of the portfolio company, whereby the “last-out” loans will be subordinated to the “first-out” portion of the unitranche loan in a liquidation, sale or other disposition. Another 13.5% of our debt investments were secured by a second priority security interest in all of the portfolio company’s assets, and 0.6% were unsecured.
Our investments in senior secured debt with warrants have detachable equity enhancement features, typically in the form of warrants or other equity-related securities designed to provide us with an opportunity for capital appreciation. These features are treated as OID and are accreted into interest income over the term of the loan as a yield enhancement. Our warrant coverage generally ranges from 3% to 20% of the principal amount invested in a portfolio company, with a strike price generally equal to the most recent equity financing round. As of June 30, 2018, we held warrants in 133 portfolio companies, with a fair value of approximately $34.4 million. The fair value of our warrant portfolio decreased by approximately $2.4 million, as compared to a fair value of $36.8 million at December 31, 2017 primarily related to the slight decrease in portfolio companies and valuation of the portfolio.
Our existing warrant holdings would require us to invest approximately $79.6 million to exercise such warrants as of June 30, 2018. Warrants may appreciate or depreciate in value depending largely upon the underlying portfolio company’s performance and overall market conditions. Of the warrants that we have monetized since inception, we have realized multiples in the range of approximately 1.02x to 29.06x based on the historical rate of return on our investments. However, our warrants may not appreciate in value and, in fact, may decline in value. Accordingly, we may experience losses from our warrant portfolio.
Portfolio Grading
We use an investment grading system, which grades each debt investment on a scale of 1 to 5 to characterize and monitor our expected level of risk on the debt investments in our portfolio with 1 being the highest quality. The following table shows the distribution of our outstanding debt investments on the 1 to 5 investment grading scale at fair value as of June 30, 2018 and December 31, 2017, respectively:
Investment Grading
Number of Companies
at Fair Value
247,542
16.0
345,191
24.4
791,931
51.2
583,017
463,702
30.0
443,775
31.3
41,960
2.7
41,744
862
As of June 30, 2018, our debt investments had a weighted average investment grading of 2.21 on a cost basis, as compared to 2.17 at December 31, 2017. Our policy is to lower the grading on our portfolio companies as they approach the point in time when they will require additional equity capital. Additionally, we may downgrade our portfolio companies if they are not meeting our financing criteria or are underperforming relative to their respective business plans. Various companies in our portfolio will require additional funding in the near term or have not met their business plans and therefore have been downgraded until their funding is complete or their operations improve. The decline in weighted average investment grading at June 30, 2018 from December 31, 2017 is primarily due to the payoff of four positions with a credit rating 1 as well as the downgrade of three positions from a credit rating 2 to a credit rating 3. In addition, one position was downgraded to a credit rating 5, while four positions that were rated 5 as of December 31, 2017 were sold or liquidated during the period.
At June 30, 2018, we had two debt investments on non-accrual with a cumulative investment cost and fair value of approximately $2.8 million and $33,000, respectively. At December 31, 2017, we had five debt investments on non-accrual with cumulative investment cost and fair value of approximately $14.8 million and $340,000, respectively. The decrease in the cumulative cost of debt investments on non-accrual between June 30, 2018 and December 31, 2017 is the result of the liquidation of two debt investments that were on non-accrual at December 31, 2017, which resulted in a realized loss of approximately $10.3 million, slightly offset by a loan repayment in full from one debt investment.
Results of Operations
Comparison of the three and six months ended June 30, 2018 and 2017
Investment Income
Total investment income for the three months ended June 30, 2018 was approximately $49.6 million as compared to approximately $48.5 million for the three months ended June 30, 2017. Total investment income for the six months ended June 30, 2018 was approximately $98.3 million as compared to approximately $94.8 million for the six months ended June 30, 2017.
Interest income for the three months ended June 30, 2018 totaled approximately $45.9 million as compared to approximately $40.5 million for the three months ended June 30, 2017. Interest income for the six months ended June 30, 2018 totaled approximately $88.9 million as compared to approximately $83.4 million for the six months ended June 30, 2017. The increase in interest income for the three and six months ended June 30, 2018 as compared to the same periods ended June 30, 2017, is primarily attributable to an increase in recurring interest income and an increase in the weighted average principal outstanding of loans.
Of the $45.9 million in interest income for the three months ended June 30, 2018, approximately $45.0 million represents recurring income from the contractual servicing of our loan portfolio and approximately $911,000 represents income related to the acceleration of income due to early loan repayments and other one-time events during the period. Income from recurring interest and the acceleration of interest income due to early loan repayments represented $37.9 million and $2.6 million, respectively, of the $40.5 million interest income for the three months ended June 30, 2017.
Of the $88.9 million in interest income for the six months ended June 30, 2018, approximately $84.3 million represents recurring income from the contractual servicing of our loan portfolio and approximately $4.6 million represents income related to the acceleration of income due to early loan repayments and other one-time events during the period. Income from recurring interest and the acceleration of interest income due to early loan repayments represented $77.9 million and $5.5 million, respectively, of the $83.4 million interest income for the six months ended June 30, 2017.
The following table shows the PIK-related activity for the six months ended June 30, 2018 and 2017, at cost:
Beginning PIK interest receivable balance
15,487
9,930
PIK interest income during the period
4,621
4,666
PIK accrued (capitalized) to principal
(1,153
Payments received from PIK loans
(9,107
(2,031
Realized gain (loss)
Ending PIK interest receivable balance
9,848
12,565
The slight decrease in PIK interest income during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017 is due to a decrease in the weighted average principal outstanding of loans which bear PIK interest. This decrease is offset by an increase in the number of PIK loans which bear interest.
Fee income from commitment, facility and loan related fees for the three months ended June 30, 2018 totaled approximately $3.7 million as compared to approximately $7.9 million for the three months ended June 30, 2017. Fee income from commitment, facility and loan related fees for the six months ended June 30, 2018 totaled approximately $9.4 million as compared to approximately $11.5 million for the six months ended June 30, 2017. The decrease in fee income for both three and six months ended June 30, 2018 is primarily due to a decrease in the acceleration of unamortized fees and one-time fees due to early repayments.
Of the $3.7 million in fee income for the three months ended June 30, 2018, approximately $1.8 million represents income from recurring fee amortization and approximately $1.9 million represents income related to the acceleration of unamortized fees due to early repayments, including one-time fees of $1.7 million for the period. Income from recurring fee amortization and the acceleration of unamortized fees due to early loan repayments represented $1.4 million and $6.5 million, respectively, of the $7.9 million in income for the three months ended June 30, 2017.
Of the $9.4 million in fee income for the six months ended June 30, 2018, approximately $3.1 million represents income from recurring fee amortization and approximately $6.3 million represents income related to the acceleration of unamortized fees due to early repayments, including one-time fees of $4.8 million for the period. Income from recurring fee amortization and the acceleration of
unamortized fees due to early loan repayments represented $3.6 million and $7.9 million, respectively, of the $11.5 million in income for the six months ended June 30, 2017.
In certain investment transactions, we may earn income from advisory services; however, we had no income from advisory services in the three and six months ended June 30, 2018 or 2017.
Operating Expenses
Our operating expenses are comprised of interest and fees on our borrowings, general and administrative expenses and employee compensation and benefits. Our operating expenses totaled approximately $26.8 million and $23.2 million during the three months ended June 30, 2018 and 2017, respectively. Our operating expenses totaled approximately $49.4 million and $46.9 million during the six months ended June 30, 2018 and 2017, respectively.
Interest and Fees on our Borrowings
Interest and fees on our borrowings totaled approximately $13.2 million and $10.6 million for the three months ended June 30, 2018 and 2017, respectively, and approximately $23.8 million and $23.0 million during the six months ended June 30, 2018 and 2017, respectively. Interest and fee expense during the three and six months ended June 30, 2018, as compared to the three and six months ended June 30, 2017, increased due to the issuance of our 2022 Notes in October 2017, 2025 Notes in April 2018 and interest related to our credit facilities, offset by the partial redemptions of our 2024 Notes and amortization of our 2021 Asset-Backed Notes.
We had a weighted average cost of debt, comprised of interest and fees, of approximately 6.4% and 5.5% for the three months ended June 30, 2018 and 2017, respectively, and a weighted average cost of debt of approximately 5.8% and 6.5% for the six months ended June 30, 2018 and 2017, respectively. The increase in the weighted average cost of debt for the three months ended June 30, 2018, as compared to the same period ended June 30, 2017 is attributable to the one-time non-cash acceleration of unamortized fees due to the partial redemption of our 2024 Notes in April 2018. The decrease in the weighted average cost of debt for the six months ended June 30, 2018 is primarily driven by a reduction in the weighted average principal outstanding on our higher yielding debt instruments compared to the prior period.
General and Administrative Expenses
General and administrative expenses include legal fees, consulting fees, accounting fees, printer fees, insurance premiums, rent, expenses associated with the workout of underperforming investments and various other expenses. Our general and administrative expenses decreased to $3.7 million from $4.7 million for the three months ended June 30, 2018 and 2017. Our general and administrative expenses decreased to $7.7 million from $8.8 million for the six months ended June 30, 2018 and 2017. The decrease for both three and six months ended June 30, 2018 was primarily attributable to a reduction in corporate legal and other expenses.
Employee Compensation
Employee compensation and benefits totaled $7.0 million for the three months ended June 30, 2018 as compared to $5.9 million for the three months ended June 30, 2017, and $12.8 million for the six months ended June 30, 2018 as compared to $11.3 million for the six months ended June 30, 2017. The increase between the comparative periods was primarily due to increased salaries and changes in variable compensation expenses due to company performance objectives.
Employee stock-based compensation totaled $2.9 million for the three months ended June 30, 2018 as compared to $1.9 million for the three months ended June 30, 2017, and $5.2 million for the six months ended June 30, 2018 as compared to $3.7 million for the six months ended June 30, 2017. The increase for the comparative periods was primarily related to restricted stock award vesting and retention rewards.
Net Investment Realized Gains and Losses and Net Unrealized Appreciation and Depreciation
Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the cost basis of an investment without regard to unrealized appreciation or depreciation previously recognized, and includes investments written off during the period, net of recoveries. Net change in unrealized appreciation or depreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.
A summary of realized gains and losses for the three and six months ended June 30, 2018 and 2017 is as follows:
Realized gains
6,880
5,083
7,988
11,553
Realized losses
(15,791
(10,796
(21,819
(14,028
Net realized gains (losses)
During the three and six months ended June 30, 2018 we recognized net realized losses of $8.9 million and $13.8 million, respectively. During the three months ended June 30, 2018, we recorded gross realized gains of $6.9 million primarily from the sale or acquisition of our holdings. These gains were offset by gross realized losses of $15.8 million primarily from the liquidation or write-off of our warrant and equity investments in seven portfolio companies and our debt investment in one portfolio company.
During the six months ended June 30, 2018, we recorded gross realized gains of $8.0 million primarily from the sale or acquisition of our holdings. These gains were offset by gross realized losses of $21.8 million primarily from the liquidation or write-off of our warrant and equity investments in thirteen portfolio companies and our debt investments in three portfolio companies
During the three and six months ended June 30, 2017, we recognized net realized losses of $5.7 million and $2.5 million respectively. During the three months ended June 30, 2017, we recorded gross realized gains of $5.1 million primarily from the sale of our holdings in one portfolio company. These gains were offset by gross realized losses of $10.8 million primarily from the liquidation or write-off of our warrant and equity investments in ten portfolio companies.
During the six months ended June 30, 2017, we recorded gross realized gains of $11.5 million primarily from the sale of our holdings in four portfolio companies. These gains were offset by gross realized losses of $14.0 million primarily from the liquidation or write-off of our warrant and equity investments in twelve portfolio companies and our debt investment in one portfolio company.
The following table summarizes the change in net unrealized appreciation/depreciation of investments for the three and six months ended June 30, 2018 and 2017:
Three Months Ended
Six Months Ended
Gross unrealized appreciation on portfolio investments
30,970
68,389
38,767
87,867
Gross unrealized depreciation on portfolio investments
(14,819
(61,292
(44,367
(109,562
Reversal of prior period net unrealized appreciation (depreciation) upon a realization event
20,925
6,015
27,591
3,610
Net unrealized appreciation (depreciation) on debt, equity, and warrant investments
37,076
13,112
21,991
(18,085
Other net unrealized appreciation (depreciation)
1,121
1,009
169
During the three months ended June 30, 2018, we recorded $38.2 million of net unrealized appreciation, of which $37.1 million was net unrealized depreciation from our debt, equity and warrant investments. We recorded $24.2 million of net unrealized appreciation on our debt investments which was attributable to $20.1 million of unrealized appreciation primarily due to the reversal of unrealized depreciation upon write-off of one portfolio company and loan repayments from three portfolio companies, along with $4.1 million of unrealized appreciation on the debt portfolio, including $1.8 million of unrealized appreciation on collateral-based impairments on one portfolio company.
We recorded $8.2 million of net unrealized appreciation on our equity investments and $4.7 million of net unrealized appreciation on our warrant investments during the three months ended June 30, 2018. This net unrealized appreciation of $12.9 million was primarily due to $12.1 million of unrealized appreciation on the equity and warrant portfolio investments.
During the six months ended June 30, 2018, we recorded $23.0 million of net unrealized appreciation, of which $22.0 million was net unrealized appreciation from our debt, equity and warrant investments. We recorded $15.9 million of net unrealized appreciation on our debt investments which was primarily related to $25.4 million of unrealized appreciation primarily due to the reversal of unrealized depreciation upon write-off of three portfolio companies and loan repayments from three portfolio companies. This unrealized appreciation was partially offset by $9.5 million of unrealized depreciation on the debt portfolio, including $8.3 million of unrealized depreciation on collateral-based impairments on four portfolio companies.
We recorded $4.1 million of net unrealized appreciation on our equity investments and $1.9 million of net unrealized appreciation on our warrant investments during the six months ended June 30, 2018. This net unrealized appreciation of $6.0 million was due to $3.9 million of unrealized appreciation on the equity and warrant portfolio and $2.1 million of unrealized appreciation primarily due to the reversal of unrealized depreciation upon being realized as a gain or loss due to the acquisition or liquidation of our equity and warrant investments.
During the three months ended June 30, 2017, we recorded $13.6 million of net unrealized appreciation, of which $13.2 million was net unrealized appreciation from our debt, equity and warrant investments. We recorded $50.9 million of net unrealized appreciation on our debt investments, which was primarily was attributed to the reversal of prior period collateral based impairments of $48.8 million unrealized depreciation for the prior period collateral-based impairments on two portfolio companies.
We recorded $42.9 million of net unrealized depreciation on our equity investments primarily due to the collateral-based impairment on one portfolio company, slightly offset by $6.8 million of unrealized appreciation for one portfolio company upon being realized as a gain. We also recorded $5.2 million of net unrealized appreciation on our warrant investments during the three months ended June 30, 2017.
During the six months ended June 30, 2017, we recorded $17.9 million of net unrealized depreciation, of which $18.0 million was net unrealized depreciation from our debt, equity and warrant investments. We recorded $19.7 million of net unrealized depreciation on our debt investments, which was primarily related to $38.5 million of unrealized depreciation for collateral-based impairments on seven portfolio companies offset by the reversal of $52.0 million unrealized depreciation for the prior period collateral-based impairments on three portfolio companies.
We recorded $45.7 million of net unrealized depreciation on our equity investments primarily due to $54.4 million of collateral based impairment on five portfolio companies and the reversal of approximately $2.1 million of unrealized appreciation for one portfolio company upon being realized as a gain. We also recorded $8.0 million of net unrealized appreciation on our warrant investments during six months ended June 30, 2017.
Income and Excise Taxes
We account for income taxes in accordance with the provisions of Topic 740 of the FASB’s Accounting Standards Codification, as amended (“ASC”), “Income Taxes”, under which income taxes are provided for amounts currently payable and for amounts deferred based upon the estimated future tax effects of differences between the financial statements and tax basis of assets and liabilities given the provisions of the enacted tax law. Valuation allowances may be used to reduce deferred tax assets to the amount likely to be realized. Based upon our previous election and anticipated continued qualification to be subject to taxation as a RIC, we are typically not subject to a material level of federal income taxes. We intend to distribute 100% of our spillover earnings from ordinary income for our taxable year ended December 31, 2017 to our stockholders in 2018.
Net Change in Net Assets Resulting from Operations and Earnings Per Share
For the three months ended June 30, 2018, we had a net increase in net assets resulting from operations of approximately $52.1 million and for the three months ended June 30, 2017, we had a net increase in net assets resulting from operations of approximately $33.1 million. For the six months ended June 30, 2018, we had a net increase in net assets resulting from operations of approximately $58.0 million and for the six months ended June 30, 2017, we had a net increase in net assets resulting from operations of approximately $27.6 million.
Both the basic and fully diluted net change in net assets per common share were $0.59 per share for the three months ended June 30, 2018 and $0.67 per share for the six months ended June 30, 2018. Both the basic and fully diluted net change in net assets per common share were $0.40 per share and $0.33 per share for the three and six months ended June 30, 2017.
For the purpose of calculating diluted earnings per share for three and six months ended June 30, 2018 and 2017, the effect of the 2022 Convertible Notes, outstanding options, and restricted stock units under the treasury stock method was considered. The effect of the 2022 Convertible Notes was excluded from these calculations for the three and six months ended June 30, 2018 and 2017 as our share price was less than the conversion price in effect which results in anti-dilution.
Financial Condition, Liquidity, and Capital Resources
Our liquidity and capital resources are derived from our SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes, Credit Facilities and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and payments of fees and other operating expenses we incur. We have used, and expect to continue to use, our borrowings and the proceeds from the turnover of our portfolio and from public and private offerings of securities to finance our investment objectives. We may also raise additional equity or debt capital through registered offerings off a shelf registration, ATM and private offerings of securities, by securitizing a portion of our investments, or by borrowing from the SBA through our SBIC subsidiaries.
On August 16, 2013, we entered into the Prior Equity Distribution Agreement. On March 7, 2016, we renewed the Prior Equity Distribution Agreement and on December 21, 2016, we further amended the agreement to increase the total shares available under the program. The Prior Equity Distribution Agreement, as amended, provided that we may offer and sell up to 12.0 million shares of our common stock from time to time through JMP, as our sales agent.
On September 7, 2017, we terminated the Prior Equity Distribution Agreement and entered into the Equity Distribution Agreement. As a result, the remaining shares that were available under the Prior Equity Distribution agreement are no longer available for issuance. The Equity Distribution Agreement provides that the Company may offer and sell up to 12.0 million shares of its common stock from time to time through JMP, as its sales agent. Sales of the Company’s common stock, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market,” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE or similar securities exchange or sales made to or through a market maker other than on an exchange, at prices related to the prevailing market prices or at negotiated prices.
During the six months ended June 30, 2018, we sold 2.6 million shares of common stock, which were issued under the Equity Distribution Agreement, for a total accumulated net proceeds of approximately $31.4 million, including $877,000 of offering expenses. As of June 30, 2018, approximately 7.8 million shares remain available for issuance and sale under the Equity Distribution Agreement. See “ – Subsequent Events.”
Our 2016 Convertible Notes were fully settled on or before their contractual maturity date of April 15, 2016. Throughout the life of the 2016 Convertible Notes, holders of approximately $74.8 million of our 2016 Convertible Notes exercised their conversion rights. These 2016 Convertible Notes were settled with a combination of cash equal to the outstanding principal amount of the converted notes and approximately 1.6 million shares of our common stock, or $24.3 million.
On May 2, 2016, we closed an underwritten public offering of an additional $72.9 million in aggregate principal amount of our 2024 Notes. The $72.9 million in aggregate principal amount includes $65.4 million from the initial offering on April 21, 2016 and $7.5 million as a result of underwriters exercising a portion of their option to purchase up to an additional $9.8 million in aggregate principal to cover overallotments on April 29, 2016. On June 27, 2016, we closed an underwritten public offering of an additional $60.0 million in aggregate principal amount of the 2024 Notes. On June 30, 2016, the underwriters exercised their option to purchase up to an additional $9.0 million in aggregate principal to cover overallotments, resulting in total aggregate principal of $69.0 million from the offering. The 2024 Notes rank equally in right of payment and form a single series of notes.
On May 5, 2016, we, through a special purpose wholly-owned subsidiary, Hercules Funding III, as borrower, entered the Union Bank Facility. The Union Bank Facility replaced the Prior Union Bank Facility. Any references to amounts related to the Union Bank Facility prior to May 5, 2016 were incurred and relate to the Prior Union Bank Facility.
On October 11, 2016, we entered into a debt distribution agreement, pursuant to which we may offer for sale, from time to time, up to $150.0 million in aggregate principal amount of 2024 Notes through FBR Capital Markets & Co. acting as our sales agent. Sales of the 2024 Notes, if any, may be made in negotiated transactions or transactions that are deemed to be “at the market offerings” as defined in Rule 415 under the Securities Act, including sales made directly on the NYSE, or similar securities exchange or sales made through a market maker other than on an exchange at prices related to prevailing market prices or at negotiated prices.
We did not sell any notes under the program during the three months ended June 30, 2018. During the year ended December 31, 2017, we sold 225,457 notes for approximately $5.6 million in aggregate principal amount. As of June 30, 2018, approximately $136.4 million in aggregate principal amount remains available for issuance and sale under the debt distribution agreement.
On January 25, 2017, we issued $230.0 million in aggregate principal amount of 2022 Convertible Notes, which amount includes the additional $30.0 million aggregate principal amount issued pursuant to the initial purchaser’s exercise in full of its overallotment option. The sale generated net proceeds of approximately $225.5 million, including $4.5 million of debt issuance costs. Aggregate issuances costs include the initial purchaser’s discount of approximately $5.2 million, offset by the reimbursement of $1.2 million by the initial purchaser.
On February 24, 2017, we redeemed the $110.4 million remaining outstanding balance of our 2019 Notes in full.
On October 23, 2017, we issued $150.0 million in aggregate principal amount of the 2022 Notes pursuant to the 2022 Notes Indenture. The sale of the 2022 Notes generated net proceeds of approximately $147.4 million, including a public offering discount of $826,500. Aggregate estimated offering expenses in connection with the transaction, including the underwriter’s discount and commissions of approximately $975,000, were approximately $1.8 million.
On November 23, 2017, we redeemed $75.0 million of the $258.5 million issued and outstanding aggregate principal amount of our 2024 Notes. On April 2, 2018, we redeemed an additional $100.0 million of the remaining outstanding aggregate principal amount of the 2024 Notes.
On April 26, 2018, we issued $75.0 million in aggregate principal amount of the 2025 Notes pursuant to the 2025 Notes Indenture. The sale of the 2025 Notes generated net proceeds of approximately $72.6 million. Aggregate estimated offering expenses in connection with the transaction, including the underwriter’s discount and commissions were approximately $2.4 million.
On May 25, 2018, the Company entered into the Amendment to the Union Bank Facility. The Amendment amends certain provisions of the Union Bank Facility to increase the commitments thereunder from $75.0 million to $100.0 million.
On June 14, 2018, we closed the June 2018 Equity Offering. The offering generated net proceeds, before expenses, of $81.3 million, including the underwriting discount and commissions of $2.6 million.
At June 30, 2018, we had $190.2 million of SBA debentures, $150.0 million of 2022 Notes, $83.5 million of 2024 Notes, $75.0 million of 2025 Notes, $31.1 million of 2021 Asset-Backed Notes, and $230.0 million of 2022 Convertible Notes payable, and $58.3 million of borrowings outstanding on the Union Bank Facility. We had no borrowings outstanding under the Wells Facility.
At June 30, 2018, we had $221.2 million in available liquidity, including $59.5 million in cash and cash equivalents. We had available borrowing capacity of $120.0 million under the Wells Facility and $41.7 million under the Union Bank Facility, both subject to existing terms and advance rates and regulatory requirements. We primarily invest cash on hand in interest bearing deposit accounts.
At June 30, 2018, we had $118.5 million of capital outstanding in restricted accounts related to our SBIC that we may use to fund new investments in the SBIC. With our net investments of $44.0 million and $74.5 million in HT II and HT III, respectively, we have the combined capacity to issue a total of $190.2 million of SBA guaranteed debentures, subject to SBA approval. At June 30, 2018, we have issued $190.2 million in SBA guaranteed debentures in our SBIC subsidiaries. On July 13, 2018, we fully redeemed the principal outstanding on our SBA HT II debentures.
At June 30, 2018, we had approximately $15.9 million of restricted cash, which consists of collections of interest and principal payments on assets that are securitized. In accordance with the terms of the related securitized 2021 Asset-Backed Notes, based on current characteristics of the securitized debt investment portfolios, the restricted funds may be used to pay monthly interest and principal on the securitized debt and are not distributed to us or available for our general operations.
During the six months ended June 30, 2018, we principally funded our operations from (i) cash receipts from interest, dividend and fee income from our investment portfolio and (ii) cash proceeds from the realization of portfolio investments through the repayments of debt investments and the sale of debt and equity investments.
During the six months ended June 30, 2018, our operating activities used $93.9 million of cash and cash equivalents, compared to $67.6 million provided during the six months ended June 30, 2017. This $161.5 million increase in cash used in operating activities is primarily related to an increase in investment purchases of $223.1 million, partially offset by an increase in investment repayments of $64.8 million.
During the six months ended June 30, 2018, our investing activities used approximately $116,000 of cash, compared to $89,000 used during the six months ended June 30, 2017.
During the six months ended June 30, 2018, our financing activities provided $74.3 million of cash, compared to $88.8 million provided during the six months ended June 30, 2017. $14.4 million decrease in cash provided by financing activities was primarily due to the repayment of $100.0 million of our 2024 Notes in April 2018, an increase of $63.3 million of net credit facilities repayments, offset by the increase in issuance of our common stock of $65.7 million and the issuance of $75.0 million of our 2025 Notes in April 2018.
As of June 30, 2018, net assets totaled $963.7 million, with a NAV per share of $10.22. We intend to continue to operate in order to generate cash flows from operations, including income earned from investments in our portfolio companies. Our primary use of funds will be investments in portfolio companies and cash distributions to holders of our common stock.
As required by the 1940 Act, our asset coverage must be at least 200% (or 150%, subject to certain approval and disclosure requirements) after each issuance of senior securities. As of June 30, 2018 our asset coverage ratio under our regulatory requirements as a business development company was 252.7% excluding our SBA debentures as a result of our exemptive order from the SEC that allows us to exclude all SBA leverage from our asset coverage ratio. As a result of the SEC exemptive order, our ratio of total assets on a consolidated basis to outstanding indebtedness may be less than 200% (or 150%, subject to certain approval and disclosure requirements), which while providing increased investment flexibility, also may increase our exposure to risks associated with leverage. Total asset coverage ratio when including our SBA debentures was 217.2% at June 30, 2018.
At June 30, 2018 and December 31, 2017, we had the following available borrowings and outstanding amounts:
Except for the Wells Facility and Union Bank Facility, all carrying values represent the principal amount outstanding less the remaining unamortized debt issuance costs and unaccreted discount, if any, associated with the loan as of the balance sheet date. See below for the amount of debt issuance cost associated with each borrowing.
Availability subject to us meeting the borrowing base requirements.
Debt issuance costs are fees and other direct incremental costs we incur in obtaining debt financing and are recognized as prepaid expenses and amortized over the life of the related debt instrument using the effective yield method or the straight line method, which closely approximates the effective yield method. In accordance with ASC Subtopic 835-30 (“Interest – Imputation of Interest”), debt issuance costs are presented as a reduction to the associated liability balance on the Consolidated Statement of Assets and Liabilities, except for debt issuance costs associated with line-of-credit arrangements. Debt issuance costs, net of accumulated amortization, as of June 30, 2018 and December 31, 2017 were as follows:
Refer to “Note 4 – Borrowings” included in the notes to our consolidated financial statements appearing elsewhere in this report for a discussion of the contract terms, interest expense, and fees associated with each outstanding borrowing as of and for the three and six months ended June 30, 2018.
Commitments
In the normal course of business, we are party to financial instruments with off-balance sheet risk. These consist primarily of unfunded contractual commitments to extend credit, in the form of loans, to our portfolio companies. Unfunded contractual commitments to provide funds to portfolio companies are not reflected on our balance sheet. Our unfunded contractual commitments may be significant from time to time. A portion of these unfunded contractual commitments are dependent upon the portfolio company reaching certain milestones before the debt commitment becomes available. Furthermore, our credit agreements contain customary lending provisions which allow us relief from funding obligations for previously made commitments in instances where the underlying company experiences materially adverse events that affect the financial condition or business outlook for the company. These commitments will be subject to the same underwriting and ongoing portfolio maintenance as are the on-balance sheet financial instruments that we hold. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. As such, our disclosure of unfunded contractual commitments includes only those which are available at the request of the portfolio company and unencumbered by milestones.
At June 30, 2018, we had approximately $129.7 million of unfunded commitments, including undrawn revolving facilities, which were available at the request of the portfolio company and unencumbered by milestones. We intend to use cash flow from normal and early principal repayments, and proceeds from borrowings and notes to fund these commitments.
We also had approximately $80.0 million of non-binding term sheets outstanding to two new and one existing company, which generally convert to contractual commitments within approximately 90 days of signing. Non-binding outstanding term sheets are subject to completion of our due diligence and final investment committee approval process, as well as the negotiation of definitive documentation with the prospective portfolio companies. Not all non-binding term sheets are expected to close and do not necessarily represent future cash requirements.
The fair value of our unfunded commitments is considered to be immaterial as the yield determined at the time of underwriting is expected to be materially consistent with the yield upon funding, given that interest rates are generally pegged to market indices and given the existence of milestones, conditions and/or obligations imbedded in the borrowing agreements.
As of June 30, 2018, our unfunded contractual commitments available at the request of the portfolio company, including undrawn revolving facilities, and unencumbered by milestones are as follows:
Contractual Obligations
The following table shows our contractual obligations as of June 30, 2018:
Excludes commitments to extend credit to our portfolio companies.
Amounts represent future principal repayments and not the carrying value of each liability. See Note 4 to our consolidated financial statements.
Reflects our intention to repay the remaining outstanding debentures in HT II in Q3 2018. See “– Subsequent Events.”
Indemnification Agreements
We have entered into indemnification agreements with our directors and executive officers. The indemnification agreements are intended to provide our directors and executive officers the maximum indemnification permitted under Maryland law and the 1940 Act. Each indemnification agreement provides that we shall indemnify the director or executive officer who is a party to the agreement, or an “Indemnitee,” including the advancement of legal expenses, if, by reason of his or her corporate status, the Indemnitee is, or is threatened to be, made a party to or a witness in any threatened, pending, or completed proceeding, to the maximum extent permitted by Maryland law and the 1940 Act.
We and our executives and directors are covered by Directors and Officers Insurance, with the directors and officers being indemnified by us to the maximum extent permitted by Maryland law subject to the restrictions in the 1940 Act.
The following table summarizes our distributions declared and paid, to be paid, or reinvested on all shares, including restricted stock, to date:
Date Declared
Record Date
Payment Date
Amount Per Share
Cumulative distributions declared and paid prior to January 1, 2016
11.23
February 17, 2016
March 7, 2016
March 14, 2016
April 27, 2016
May 16, 2016
May 23, 2016
July 27, 2016
August 15, 2016
August 22, 2016
October 26, 2016
November 14, 2016
November 21, 2016
February 16, 2017
March 6, 2017
March 13, 2017
April 26, 2017
May 15, 2017
May 22, 2017
July 26, 2017
August 14, 2017
August 21, 2017
October 25, 2017
November 13, 2017
November 20, 2017
February 14, 2018
March 5, 2018
March 12, 2018
April 25, 2018
May 14, 2018
May 21, 2018
July 25, 2018
August 13, 2018
August 20, 2018
14.64
On July 25, 2018, the Board of Directors declared a cash distribution of $0.31 per share to be paid on August 20, 2018 to stockholders of record as of August 13, 2018. This distribution represents our fifty-second consecutive distribution since our initial public offering, bringing the total cumulative distribution to date to $14.64 per share.
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Our Board of Directors maintains a variable distribution policy with the objective of distributing four quarterly distributions in an amount that approximates 90 - 100% of our taxable quarterly income or potential annual income for a particular taxable year. In addition, at the end of our taxable year, our Board of Directors may choose to pay an additional special distribution, or fifth distribution, so that we may distribute approximately all of our annual taxable income in the taxable year in which it was earned, or may elect to maintain the option to spill over our excess taxable income into the following taxable year as part of any future distribution payments.
Distributions from our taxable income (including gains) to a stockholder generally will be treated as a dividend for U.S. federal income tax purposes to the extent of such stockholder’s allocable share of our current or accumulated earnings and profits. Distributions in excess of our current and accumulated earnings and profits would generally be treated first as a return of capital to the extent of a stockholder’s tax basis in our shares, and any remaining distributions would be treated as a capital gain. The determination of the tax attributes of our distributions is made annually as of the end of our taxable year based upon our taxable income for the full taxable year and distributions paid for the full taxable year. As a result, any determination of the tax attributes of our distributions made on a quarterly basis may not be representative of the actual tax attributes of the Company’s distributions for a full taxable year. Of the distributions declared during the year ended December 31, 2017, 100% were distributions derived from our current and accumulated earnings and profits.
During the three months ended June 30, 2018, we declared a distribution of $0.31 per share. If we had determined the tax attributes of our distributions year-to-date as of June 30, 2018, 100% would be from our current and accumulated earnings and profits. However, there can be no certainty to stockholders that this determination is representative of what the tax attributes of our 2018 distributions to stockholders will actually be.
We maintain an “opt out” dividend reinvestment plan that provides for reinvestment of our distribution on behalf of our stockholders, unless a stockholder elects to receive cash. As a result, if our Board of Directors authorizes, and we declare a cash distribution, then our stockholders who have not “opted out” of our dividend reinvestment plan will have their cash distribution automatically reinvested in additional shares of our common stock, rather than receiving the cash distributions.
Shortly after the close of each calendar year information identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gains on the sale of securities, and/or a return of paid-in-capital surplus which is a nontaxable distribution, if any) will be provided to our stockholders subject to information reporting. To the extent our taxable earnings fall below the total amount of our distributions for any taxable year, a portion of those distributions may be deemed a tax return of capital to our stockholders.
We expect to qualify to be subject to tax as a RIC under Subchapter M of the Code. In order to be subject to tax as a RIC, we are required to satisfy certain annual gross income and quarterly asset composition tests, as well as make distributions to our stockholders each taxable year treated as dividends for federal income tax purposes of an amount at least equal to 90% of the sum of our investment company taxable income, determined without regard to any deduction for dividends paid, plus our net tax-exempt income, if any. Upon being eligible to be subject to tax as a RIC, we would be entitled to deduct such distributions we pay to our stockholders in determining the overall components of our “taxable income.” Components of our taxable income include our taxable interest, dividend and fee income, reduced by certain deductions, as well as taxable net realized securities gains. Taxable income generally differs from net income for financial reporting purposes due to temporary and permanent differences in the recognition of income and expenses and generally excludes net unrealized appreciation or depreciation as such gains or losses are not included in taxable income until they are realized. In connection with maintaining our ability to be subject to tax as a RIC, among other things, we have made and intend to continue to make the requisite distributions to our stockholders each taxable year, which generally should relieve us from corporate-level U.S. federal income taxes.
As a RIC, we will be subject to a 4% nondeductible U.S. federal excise tax on certain undistributed income and gains unless we make distributions treated as dividends for U.S. federal income tax purposes in a timely manner to our stockholders in respect of each calendar year of an amount at least equal to the Excise Tax Avoidance Requirement. We will not be subject to this excise tax on any amount on which we incurred U.S. federal corporate income tax (such as the tax imposed on a RIC’s retained net capital gains).
Depending on the level of taxable income earned in a taxable year, we may choose to carry over taxable income in excess of current taxable year distributions treated as dividends for U.S. federal income tax purposes from such taxable income into the next taxable year and incur a 4% excise tax on such taxable income, as required. The maximum amount of excess taxable income that may be carried over for distribution in the next taxable year under the Code is the total amount of distributions treated as dividends for U.S. federal income tax purposes paid in the following taxable year, subject to certain declaration and payment guidelines. To the extent we choose to carry over taxable income into the next taxable year, distributions declared and paid by us in a taxable year may differ from our taxable income for that taxable year as such distributions may include the distribution of current taxable year taxable income, the distribution of prior taxable year taxable income carried over into and distributed in the current taxable year, or returns of capital.
We can offer no assurance that we will achieve results that will permit the payment of any cash distributions and, if we issue senior securities, we will be prohibited from making distributions if doing so causes us to fail to maintain the asset coverage ratios stipulated by the 1940 Act or if distributions are limited by the terms of any of our borrowings. Our ability to make distributions will be limited by the asset coverage requirements under the 1940 Act.
We intend to distribute 100% of our spillover earnings, which consists of ordinary income, from the year ended December 31, 2017 to our stockholders during 2018.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and revenues and expenses during the period reported. On an ongoing basis, our management evaluates its estimates and assumptions, which are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates. Changes in our estimates and assumptions could materially impact our results of operations and financial condition.
The most significant estimate inherent in the preparation of our consolidated financial statements is the valuation of investments and the related amounts of unrealized appreciation and depreciation of investments recorded.
At June 30, 2018, approximately 94.9% of our total assets represented investments in portfolio companies whose fair value is determined in good faith by the Board of Directors. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Our investments are carried at fair value in accordance with the 1940 Act and ASC Topic 946 and measured in accordance with ASC Topic 820. Our debt securities are primarily invested in venture capital-backed companies in technology-related industries including technology, drug discovery and development, biotechnology, life sciences, healthcare and sustainable and renewable technology at all stages of development. Given the nature of lending to these types of businesses, substantially all of our investments in these portfolio companies are considered Level 3 assets under ASC Topic 820 because there is no known or accessible market or market indexes for these investment securities to be traded or exchanged. As such, we value substantially all of our investments at fair value as determined in good faith pursuant to a consistent valuation policy by our Board of Directors in accordance with the provisions of ASC Topic 820 and the 1940 Act. Due to the inherent uncertainty in determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by our Board of Directors may differ significantly from the value that would have been used had a readily available market existed for such investments, and the differences could be material.
We may from time to time engage an independent valuation firm to provide us with valuation assistance with respect to certain of our portfolio investments. We engage independent valuation firms on a discretionary basis. Specifically, on a quarterly basis, we will identify portfolio investments with respect to which an independent valuation firm will assist in valuing. We select these portfolio investments based on a number of factors, including, but not limited to, the potential for material fluctuations in valuation results, credit quality and the time lapse since the last valuation of the portfolio investment by an independent valuation firm.
We intend to continue to engage an independent valuation firm to provide us with assistance regarding our determination of the fair value of selected portfolio investments each quarter unless directed by the Board of Directors to cancel such valuation services. The scope of the services rendered by an independent valuation firm is at the discretion of the Board of Directors. Our Board of Directors is ultimately, and solely, responsible for determining the fair value of our investments in good faith.
Refer to “Note 2 – Summary of Significant Accounting Policies” included in the notes to our consolidated financial statements appearing elsewhere in this report for a discussion of our valuation policies for the three and six months ended June 30, 2018.
See “— Changes in Portfolio” for a discussion of our income recognition policies and results during the three and six months ended June 30, 2018. See “— Results of Operations” for a comparison of investment income for the three and six months ended June 30, 2018 and 2017.
Stock Based Compensation
We have issued and may, from time to time, issue stock options and restricted stock to employees under the 2018 Equity Incentive Plan and the Director Plan. We follow the guidelines set forth under ASC Topic 718, (“Compensation – Stock Compensation”) to account for stock options granted. Under ASC Topic 718, compensation expense associated with stock-based compensation is measured at the grant date based on the fair value of the award and is recognized over the vesting period. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rate and expected option life.
Recent Accounting Pronouncements
In January 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which, among other things, requires that (i) all equity investments, other than equity-method investments, in unconsolidated entities generally be measured at fair value through earnings and (ii) an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. Additionally, the ASU changes the disclosure requirements for financial instruments. ASU 2016-01 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. We have adopted this standard, which did not have a material impact, on our consolidated financial statements and related disclosures for the periods presented.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which, among other things, requires recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous U.S. GAAP. Additionally, the ASU requires the classification of all cash payments on leases within operating activities in the Consolidated Statement of Cash Flows. ASU 2016-02 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2018. Early adoption is permitted. We anticipate an increase in the recognition of right-of-use assets and lease liabilities, however, we do not believe that ASU 2016-02 will have a material impact on our consolidated financial statements and disclosures.
In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which addresses eight specific cash flow issues including, among other things, the classification of debt prepayment or debt extinguishment costs. ASU 2016-15 is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2017. We have adopted this standard, which did not have a material impact, on our consolidated financial statements and related disclosures for the periods presented.
In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230),” which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new guidance is effective for interim and annual periods beginning after December 15, 2017. We have adopted this standard, which did not have a material impact, on our consolidated financial statements and related disclosures for the periods presented.
In June 2018, the FASB issued ASU 2018-07, “Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting”. This amendment expands the scope of Topic 718, Compensation—Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees and is effective for annual reporting periods, and the interim periods within those periods, beginning after December 15, 2018. We do not believe that ASU 2018-07 will have a material impact on our consolidated financial statements and disclosures.
Subsequent Events
On July 25, 2018 the Board of Directors declared a cash distribution of $0.31 per share to be paid on August 20, 2018 to stockholders of record as of August 13, 2018. This distribution represents our fifty-second consecutive distribution since our initial public offering, bringing the total cumulative distribution to date to $14.64 per share.
Subsequent to June 30, 2018 and as of July 30, 2018, we sold 1.6 million shares of common stock for total accumulated net proceeds of approximately $19.8 million, including $150,000 of offering expenses, under the Equity Distribution Agreement with JMP. As of July 30, 2018, approximately 6.2 million shares remain available for issuance and sale under the Equity Distribution Agreement.
On July 13, 2018, we completed repayment of the $41.2 million of outstanding HT II debentures.
On July 31, 2018, we entered into a further amendment to the Wells Facility to extend the maturity date and fully repay the pro-rata portion of outstanding balances of Alostar Bank of Commerce and Everbank Commercial Finance Inc., thereby resigning both as lenders and terminating their commitments thereunder.
As of July 30, 2018, we held warrants or equity positions in two companies that have filed registration statements on Form S-1 with the SEC in contemplation of potential initial public offerings. Both companies filed confidentially under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. There can be no assurance that companies that have yet to complete their initial public offerings will do so in a timely manner or at all. Subsequent to June 30, 2018 and as of July 30, 2018, there were no companies that announced or completed liquidity events.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to financial market risks, including changes in interest rates. Interest rate risk is defined as the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows. Changes in interest rates may affect both our cost of funding and our interest income from portfolio investments, cash and cash equivalents and idle fund investments. Our investment income will be affected by changes in various interest rates, including LIBOR and Prime rates, to the extent our debt investments include variable interest rates. As of June 30, 2018, approximately 97.2% of the loans in our portfolio had variable rates based on floating Prime or LIBOR rates with a floor. Changes in interest rates can also affect, among other things, our ability to acquire and originate loans and securities and the value of our investment portfolio.
Based on our Consolidated Statement of Assets and Liabilities as of June 30, 2018, the following table shows the approximate annualized increase (decrease) in components of net assets resulting from operations of hypothetical base rate changes in interest rates, assuming no changes in our investments and borrowings.
Basis Point Change
Expense
EPS(1)
3,489
3,453
0.04
7,061
6,990
0.08
10,632
10,525
0.12
14,353
143
14,210
0.16
28,988
286
28,702
43,172
42,743
0.49
Earnings per share impact calculated based on basic weighted average shares outstanding of 87,125.
We do not currently engage in any hedging activities. However, we may, in the future, hedge against interest rate fluctuations (and foreign currency) by using standard hedging instruments such as futures, options, and forward contracts. While hedging activities may insulate us against changes in interest rates (and foreign currency), they may also limit our ability to participate in the benefits of lower interest rates with respect to our borrowed funds and higher interest rates with respect to our portfolio of investments. During the six months ended June 30, 2018 we did not engage in interest rate (or foreign currency) hedging activities.
Although we believe that the foregoing analysis is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in the credit market, credit quality, size and composition of the assets in our portfolio. It also does not adjust for other business developments, including borrowings under our SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes and Credit Facilities that could affect the net increase in net assets resulting from operations, or net income. It also does not assume any repayments from borrowers. Accordingly, no assurances can be given that actual results would not differ materially from the statement above.
Because we currently borrow, and plan to borrow in the future, money to make investments, our net investment income is dependent upon the difference between the rate at which we borrow funds and the rate at which we invest the funds borrowed. Accordingly, there can be no assurance that a significant change in market interest rates will not have a material adverse effect on our net investment income. In periods of rising interest rates, our cost of funds would increase, which could reduce our net investment income if there is not a corresponding increase in interest income generated by variable rate assets in our investment portfolio.
For additional information regarding the interest rate associated with each of our, SBA debentures, 2022 Notes, 2024 Notes, 2025 Notes, 2021 Asset-Backed Notes, 2022 Convertible Notes, and Credit Facilities, please refer to “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition, Liquidity and Capital Resources - Outstanding Borrowings” in this quarterly report on Form 10-Q and “Note 4 – Borrowings” included in the notes to our consolidated financial statements appearing elsewhere in this report.
ITEM 4.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our chief executive and chief financial officers, under the supervision and with the participation of our management, conducted an evaluation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. As of the end of the period covered by this quarterly report on Form 10-Q, our chief executive and chief financial officers have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive and chief financial officers, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financing reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act that occurred during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
LEGAL PROCEEDINGS
We may, from time to time, be involved in litigation arising out of our operations in the normal course of business or otherwise. Furthermore, third parties may try to seek to impose liability on us in connection with the activities of our portfolio companies. While the outcome of any current legal proceedings cannot at this time be predicted with certainty, we do not expect any current matters will materially affect our financial condition or results of operations; however, there can be no assurance whether any pending legal proceedings will have a material adverse effect on our financial condition or results of operations in any future reporting period.
ITEM 1A.
RISK FACTORS
In addition to the risks discussed below, important risk factors that could cause results or events to differ from current expectations are described in Part I, Item 1A “Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission on February 22, 2018.
Our financial results could be negatively affected if a significant portfolio investment fails to perform as expected.
Our total investment in companies may be significant individually or in the aggregate. As a result, if a significant investment in one or more companies fails to perform as expected, our financial results could be more negatively affected and the magnitude of the loss could be more significant than if we had made smaller investments in more companies. The following table shows the fair value of the totals of investments held in portfolio companies June 30, 2018 that represent greater than 5% of our net assets:
Percentage of Net Assets
Paratek Pharmaceuticals, Inc. (p.k.a. Transcept Pharmaceuticals, Inc.)
60,908
6.3
Axovant Sciences Ltd.
54,251
5.6
Fuze, Inc.
5.3
EverFi, Inc.
5.2
Paratek Pharmaceuticals, Inc. is a biopharmaceutical company focused on the development and commercialization of innovative therapies based upon its expertise in novel tetracycline chemistry
Axovant Sciences Ltd. is a clinical-stage biopharmaceutical company focused on acquiring, developing and commercializing novel therapeutics for the treatment of dementia.
Fuze, Inc. is a technology company that provides a cloud-based unified communications-as-a-service platform to server message block, mid-market, and small enterprise customers worldwide.
EverFi, Inc. is a technology company that offers a web-based media platform to teach and certify students in the core concepts of financial literacy, from student loan defaults and sub-prime mortgages to credit card debt and rising bankruptcy rates.
Businessolver.com, Inc. is a technology company that provides a cloud-based SaaS platform for employee benefit administration designed to manage and monitor enrollment and payroll dashboards with real-time data.
Our financial results could be materially adversely affected if these portfolio companies or any of our other significant portfolio companies encounter financial difficulty and fail to repay their obligations or to perform as expected.
Recently passed legislation may allow us to incur additional leverage.
Historically, as a business development company, under the 1940 Act generally we are not permitted to incur indebtedness unless immediately after such borrowing we have an asset coverage for total borrowings of at least 200% (i.e., the amount of debt may not exceed 50% of the value of our assets). The Small Business Credit Availability Act, which was signed into law in March 2018, modifies this section of the 1940 Act and decreases this percentage from 200% to 150% (subject to either stockholder approval or approval of both a majority of the board of directors and a majority of directors who are not interested persons). As a result of this new law, we may be able to incur additional indebtedness subject to relevant approval and disclosure requirements and, therefore, your risk of an investment in us may increase. Rating agencies may also decide to review our credit ratings and those of other business development companies in light of this new law as well as any corresponding changes to asset coverage ratios and consider downgrading such ratings, including a downgrade from an investment grade rating to a non-investment grade rating. Such a downgrade in our credit ratings may adversely affect our other securities.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Dividend Reinvestment Plan
During the six months ended June 30, 2018, we issued 69,231 shares of common stock to stockholders in connection with the dividend reinvestment plan. These issuances were not subject to the registration requirements of the Securities Act. The aggregate value of the shares of our common stock issued under our dividend reinvestment plan was approximately $854,000.
DEFAULTS UPON SENIOR SECURITIES
Not Applicable
MINE SAFETY DISCLOSURES
ITEM 5.
OTHER INFORMATION
None.
ITEM 6.
EXHIBITS
ExhibitNumber
4.1
Fifth Supplemental Indenture, dated as of April 26, 2018, between the Registrant and U.S. Bank, National Association.(1)
4.2
Form of 5.25% Note due 2025, dated April 26, 2018 (included as part of Exhibit 4.1).(1)
10.1
Form of Retention Performance Stock Unit Award Agreement.(2)
10.2
Form of Cash Retention Bonus Award Agreement.(2)
10.3
Second Amendment to the Loan and Security Agreement, dated as of May 25, 2018, by and among Hercules Funding III, LLC, as borrower, MUFG Union Bank, N.A., as the arranger and administrative agent, and the lenders party thereto.(3)
Computation of Per Share Earnings (included in Note 8 to the Consolidated Financial Statements included in this report).
31.1*
Chief Executive Officer Certification Pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Chief Accounting Officer Certification Pursuant to Exchange Act Rule 13a-14 (a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Chief Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*
Chief Accounting Officer Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Filed herewith.
Previously filed as part of Post-Effective Amendment No. 4, as filed on April 26, 2018 (File No. 333-214767), to the Registration Statement on Form N-2 of the Company.
Previously filed as part of the Quarterly Report on Form 10-Q of the Company, as filed on May 3, 2018.
Previously filed as part of the Current Report on Form 8-K of the Company, as filed on June 1, 2018.
Schedule 12 – 14
SCHEDULE OF INVESTMENTS IN AND ADVANCES TO AFFILIATES
Amount of
As of
Credited to
Appreciation/
Income (2)
Gain (Loss)
Additions (3)
Reductions (4)
Majority Owned Control Investments
(3,100
Gibraltar Business Capital, LLC (8)
Total Majority Owned Control Investments
Other Control Investments
Second Time Around (Simplify Holdings, LLC) (7)
(1,781
Tectura Corporation(5)
645
(335
(402
(900
Total Other Control Investments
(1,408
1,545
(2,116
479
39,134
(5,216
Preferred Warrants
1,301
(412
Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.)(6)
364
(3,500
(86
(404
1,665
(5,558
Total Control and Affiliate Investments
50,756
40,799
(10,774
Stock and warrants are generally non-income producing and restricted.
Represents the total amount of interest or dividends credited to income for the period an investment was an affiliate or control investment.
Gross additions include increases in the cost basis of investments resulting from new portfolio investments, paid-in-kind interest or dividends, the amortization of discounts and closing fees and the exchange of one or more existing securities for one or more new securities.
Gross reductions include decreases in the cost basis of investments resulting from principal repayments or sales and the exchange of one or more existing securities for one or more new securities. Gross reductions also include previously recognized depreciation on investments that become control or affiliate investments during the period.
As of March 31, 2017, the Company's investment in Tectura Corporation became classified as a control investment as of result of obtaining more than 50% representation on the portfolio company's board. In May 2018, the Company purchased common shares, thereby obtaining greater than 25% of voting securities of Tectura as of June 30, 2018.
As of September 30, 2017, the Company's investment in Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.) became classified as an affiliate investment due to a reduction in equity ownership. Note that this investment was classified as a control investment as of June 30, 2017 after the Company obtained a controlling financial interest.
As of February 2018, the Company’s investments in Second Time Around (Simplify Holdings, LLC) were deemed wholly worthless and written off for a realized loss.
As of March 31, 2018, the Company's investment in Gibraltar Business Capital, LLC became classified as a control investment as a result of obtaining a controlling financial interest
As of June 30, 2018
Industry
Type of Investment (1)
Interest Rate and Floor
or Shares
Cost
Value (2)
Total Gibraltar Business Capital, LLC
Total Majority Owned Control Investments (3.90%)*
Preferred Series BB Equity
21,748
Total Other Control Investments (1.98%)*
Total Control Investments (5.89%)*
59,337
Preferred Series B Equity
Preferred Series C Equity
Preferred Series D Equity
Preferred Series E Equity
Preferred Series E Warrants
Total Optiscan BioMedical, Corp.
12,093
Total Solar Spectrum Holdings LLC (p.k.a. Sungevity, Inc.)
71,970
Total Affiliate Investments (2.98%)*
84,063
Total Control and Affiliate Investments (8.86%)*
143,400
All of the Company’s control and affiliate investments are Level 3 investments valued using significant unobservable inputs.
Pursuant to the requirements of the Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HERCULES CAPITAL, INC. (Registrant)
Dated: August 2, 2018
/S/ MANUEL A. HENRIQUEZ
Manuel A. Henriquez
Chairman, President, and Chief Executive Officer
/S/ GERARD R. WALDT, JR.
Gerard R. Waldt, Jr.
Interim Chief Accounting Officer