Hercules Capital, Inc.

Ladies and gentlemen, thank you for standing by. Welcome to the Hercules Capital Third Quarter 2020 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. Please be advised that today's conference is being recorded. After the speaker's presentation, there will be a question and answer session. To ask a question during that time, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I'd now like to hand the conference over to your speaker for today, Mr. Michael Hara. Thank you, sir. Please go ahead.

Thank you, AJ. Good afternoon, everyone, and welcome to Hercules' conference call for the third quarter of 2020. With us on the call today from Hercules are Scott Blustein, CEO and Chief Investment Officer, and Seth Meyer, CFO. Hercules' third quarter 2020 financial results were released just after today's market close and can be accessed from Hercules' investor relations section at htgc.com. We have arranged for a replay of the call at Hercules' webpage or by using the telephone number and passcode provided in today's earnings release. During this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation and final audit results. In addition, the statements contained in this release that are not purely historical are forward-looking statements. These forward-looking statements are not a guarantee of future performance, and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including, and without limitation, the risks and uncertainties, including the uncertainty surrounding the current market turbulence caused by the COVID-19 pandemic, and other factors we identify from time to time in our findings with the SEC. Although we believe that the assumptions on which these forward-looking statements are reasonable, any of those assumptions can prove to be inaccurate, and as a result, The forward-looking statements based on those assumptions also can be incorrect. You should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of SEC-related filings, please visit our website. And with that, I will turn the call over to Scott.

Thank you, Michael, and thank you all for joining us today. We hope that everyone is staying safe and healthy. Continuing with the theme of our Q1 and Q2 2020 earnings calls, I'm going to provide an overview of our performance in Q3 and then discuss key areas of the business that we continue to believe require additional focus. I would like to start by once again acknowledging and thanking our employees, management teams, and financial partners who continue to diligently perform their jobs with commitment and resiliency. despite the challenging operating environment that we are all facing. Being eight months into this pandemic, we continue to manage the business to maximize liquidity, ensure balance sheet strength, and maintain substantial operational flexibility. Q3 was a very strong quarter on multiple fronts for Hercules Capital, particularly origination activity. where we used our balance sheet strength and liquidity position to be aggressive on select high-quality investment opportunities. Our world-class investment team and industry-leading originations platform closed a record level of Q3 commitments and fundings. We were able to maintain our strong liquidity position and balance sheet despite the write-off of two previously impaired loans that were on non-accruals. Overall, our credit performance during the quarter was solid, and we continue to feel good about how our credit book is positioned. Let me recap some of the key highlights of our performance for Q3. We originated more than $514 million of new debt and equity commitments and delivered gross fundings of nearly $266 million. In Q3, our investment-related activity reflected our focus on diversification and controlled growth. Our unique and dual focus on technology and life sciences continues to provide us with a competitive advantage and the ability to deliver strong investment activity in any market environment when we see attractive opportunities. Our third quarter fundings included ten new and five existing portfolio companies. We saw strong performance from both our technology and life sciences teams, with respect to new debt commitments, although our funding and commitment activity was again skewed slightly more towards life sciences companies. We are continuing to see attractive proprietary investment opportunities across our existing portfolio, and we expect to continue to be aggressive in terms of providing additional funding to those companies within our portfolio that are demonstrating strong growth and performance metrics. Despite the fact that we are only through three quarters of 2020, Hercules Capital has managed to deliver over $1 billion of new commitments for the third consecutive year, highlighting the resiliency of our diversified business model and the scale that we have achieved. During the third quarter, we had debt investment portfolio growth of $4.8 million at cost and $48.2 million at fair value. Early loan repayments were $191 million, which was up from $85 million in Q2 and above our guidance of $100 to $150 million. The increase in early loan repayments during Q3 resulted in higher fee income as compared to Q2. In Q3, we generated total investment income of $70.3 million and net investment income of $38.7 million. or 34 cents per share, resulting in 106% coverage of the base cash distribution. Year-to-date, we have generated total investment income of $211.9 million, an increase of 7.4% year-over-year, and net investment income of $115 million, an increase of 11.4% year-over-year. Year to date, we have also grown the debt investment portfolio by $114 million at cost, despite $427 million of early loan repayments and the challenges associated with this pandemic. We believe that this has been driven by the tremendous depth and talent across our investment team and our long-term commitment to the venture and growth stage lending space. On a cumulative basis since inception, we have now committed in excess of $11 billion of capital to venture and growth stage companies, an accomplishment that I would like to congratulate our investment team and all of our employees on achieving. Credit quality on the debt investment portfolio improved nicely in Q3, with a weighted average internal credit rating of 2.22 as compared to 2.30 in Q2. Overall, our grade one and two credits increased to 64.4% in Q3 versus 59.7% in Q2. Grade three credits decreased slightly to 34.1% in Q3 versus 38.3% in Q2. Our rated four and rated five credits made up less than 1.5% of the entire debt portfolio fair value. During the quarter, we wrote off two impaired loans that had been on non-accrual. In Q3, we had five debt investments on non-accrual with a cumulative investment cost and fair value of approximately $23.5 million and $6.2 million, respectively, or 0.9% and 0.3% as a percentage of the company's total investment portfolio at cost and value, respectively. Again, this quarter, I would like to provide an update on three specific areas of our business that we believe are important for our shareholders and stakeholders in this environment and detail specific things that we are doing to best position the company. First, employee well-being and the continuity of our business. Our emphasis remains on the well-being of our employees and the continuity of our business operations while the pandemic continues. To date, we have not experienced any material interruptions to our business or our ability to operate, and we are currently assuming that the majority of our workforce will remain in a work-from-home setting through the rest of the year and perhaps longer. While certain of our offices have been able to reopen with capacity restrictions, we are continuing to prioritize the safety and well-being of our employees and while doing our best to ensure that the business continues to operate in the normal course and without any material interruption. We have also opportunistically continued to make investments in our team and our systems to best position the company long term. Liquidity and balance sheet strength. We are continuing to prioritize liquidity. Despite record Q3 fundings, we ended Q3 with $465.1 million of liquidity, which provides us with substantial coverage of our available unfunded commitments of $243 million and the ability to fund our ongoing anticipated business activity. This continues to give us the ability to be aggressive on new deals and take advantage of any potential market dislocation when we believe that it is prudent to do so. Early payoffs and ordinary course principal payments have always been a source of liquidity for our business, and was again the case in Q3, where we received approximately $211 million of early payoffs and amortization. At this time, we expect early payoffs in Q4 to be between $100 million and $150 million, although this number could change materially. Our balance sheet was strong heading into this crisis, and it remains strong today, with near-record liquidity and no near-term liability maturities in our debt stack. Subsequent to quarter end, we officially received our third SBA license, which provides us with an additional up to $175 million of flexible capital and extends our long-standing relationship with the SBA. Finally, portfolio and credit quality. We continue to believe that it will take time to ascertain the true impact of this crisis and that a diversified balance sheet, both with respect to assets and liabilities, will serve us well. Having ample liquidity remains an important factor for our portfolio companies that we continue to closely monitor. When looking at our entire outstanding debt investment portfolio, we estimate that approximately 81% of the portfolio currently has 12-plus months of liquidity, with another 11% with 6 to 12 months of liquidity currently on the balance sheet. Loans that have three months or less of liquidity make up approximately 4% of our outstanding debt portfolio. Of the loans with 12-plus months of liquidity, over 76%, or approximately 60% of our entire debt portfolio currently has 18 plus months of liquidity on balance sheet. Within our life sciences portfolio, we continue to have 13 debt investments with a cost basis in excess of 25 million. Each of these 13 companies currently have cash on hand to fund their businesses for approximately 12 plus months. In our technology portfolio, nine of our ten largest investments at cost have cash on balance sheet for at least 12 months based on the most recent reporting that we have. Capital raising across our portfolio remains strong. Since our last earnings call, 14 of our debt portfolio companies raised new capital, totaling over $1.7 billion. Since the beginning of COVID-19 in the United States, we have had 43 of our current debt portfolio companies raise a total of approximately $5 billion of new capital. Year-to-date, we have had 10 M&A events, six companies that have completed their initial public offerings, including four in the last 90 days, and three additional companies that are currently in registration. Our top 10 debt investments continue to make up only 27% of our debt portfolio at fair value. While each of these companies will continue to be impacted to a varying degree by the current situation, all currently have at least 12 plus months of liquidity on balance sheet as of the most recent reporting that we have. Our debt portfolio continues to be overweight towards drug discovery and development and software companies. two sectors that we expect to perform better on a relative basis during this period and based on what we know as of today. Approximately 90% of our current life sciences debt investments at cost are in publicly traded companies. These public companies have a weighted average public market capitalization of approximately $1.5 billion as of September 30th. Based on the public market capitalization for these companies, the weighted average ratio of public equity value to our debt at cost equals 39.9 times as of September 30th. In our technology portfolio, approximately 64% of our companies are classified as software or have a software-driven contractual recurring revenue model. Of these companies, our estimated weighted average debt to annual recurring revenue attachment point as of the most recent reporting period continues to be less than one times, which we believe is conservative. The venture capital ecosystem continues to raise funds and make investments selectively as we have seen in the latest reports. Through the first three quarters of the year, venture capital funds raised a total of $56.6 billion and invested over a record $112 billion in the United States, according to data gathered by PitchBook and the National Venture Capital Association. That cash continues to put them in a strong position as the pandemic endures. This data also reflects the many portfolio companies that we work with that have raised capital during their most recent quarter. Our focus continues to be on maintaining an appropriate level of liquidity, actively managing our credit book, and working with our companies and financial partners proactively. Our investment team has continued to be incredibly busy evaluating an active pipeline that currently exceeds $1 billion of potential investments. But our bar for new deals remains high, and we continue to be selective and prudent with capital deployment. Finally, I would like to discuss our shareholder distribution. With our debt investment portfolio at 2.28 billion at cost, our NII per share of 34 cents in Q3 generated 106% coverage of our quarterly base distribution of 32 cents per share. In addition to our seventh consecutive quarterly cash distribution of 32 cents per share, we are also declaring a supplemental distribution of 2 cents per share. In addition to our quarterly net investment income in Q3 covering our base distribution, we are also fortunate to have undistributed earnings spillover of approximately 78.2 million, or 68 cents per share. subject to final tax filings. This provides us with additional flexibility with respect to our variable-based distribution going forward and the ability to continue to invest in our team and in our platform. In closing, these continue to be unique and challenging times for everyone. I would like to acknowledge and thank each of our dedicated and talented employees for maintaining their spirit effort, and focus. We send our most sincere wishes to all of those who are being affected by this unprecedented pandemic, and we hope for the well-being and safety of all. Thank you very much, everyone, and I will now turn the call over to Seth.