Hercules Capital, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Hercules Capital Q4 2020 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. Please be advised that today's conference call is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Michael Hara. Thank you. Please go ahead.

Thank you, Sherry. Good afternoon, everyone, and welcome to Hercules' conference call for the fourth quarter and full year 2020. With us on the call today from Hercules is Scott Blustein, CEO and Chief Investment Officer, and Seth Meyer, CFO. Hercules' fourth quarter and full year 2020 financial results were released just after today's market closed, 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 guarantees of future performance and are subject to uncertainties and other factors that could cause actual results to differ materially from those expressed in the forward-looking statements, including, without limitation, the risks and uncertainties, including the uncertainty surrounding the current market turbulence caused by the COVID-19 pandemic and other factors we identified 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. These forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, just please visit our website. And with that, I'll 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. I am incredibly proud of what our team was able to achieve in 2020. Despite the challenges associated with the COVID-19 pandemic, Hercules Capital was able to deliver yet another strong year of solid execution, outstanding financial results, and solid credit performance. We were also able to demonstrate to our 100 plus borrowers the importance of having a partner with a strong and stable balance sheet and our ability to grow with the companies as they scale. In 2020, the health and vibrancy of the VC ecosystem, continued strength of our origination platform, robust liquidity position, and strong balance sheet put us in position to deliver achievements on multiple fronts, including Record total investment income of $287.3 million, up 7.2%. Record net investment income of $157.1 million, up 9.7%. Record undistributed earnings spillover of $107.7 million, or 94 cents per share, based on ending shares outstanding. Record available liquidity of $673.3 million. Record total assets of $2.6 billion, up 6.6%. Over $1 billion of new debt and equity commitments for the third consecutive year. 22 IPO and M&A events. And finally, formation of Hercules Advisor as a wholly owned subsidiary of Hercules Capital. We continue to manage the business to maximize liquidity, ensure balance sheet strength, and maintain substantial operational flexibility in the current environment. Continuing with the theme throughout 2020, I'm going to provide an overview of our performance in Q4 and then discuss key areas of the business that we feel are important. I will also be providing an update on some of the work that we did in 2020 to further strengthen our platform and position us for future growth. Let me recap some of the key highlights of our performance for Q4. We originated more than $151 million of new debt and equity commitments and delivered gross fundings of nearly $130 million. Our fourth quarter debt and equity fundings were weighted towards existing portfolio company relationships, largely driven by continued strong performance and the achievement of milestones across the current portfolio. During Q4, we chose to stay disciplined and true to our focus on strong underwriting parameters as an abundance of equity capital and loosely structured debt created challenges in terms of prudent new business origination. Being at scale affords us the opportunity to be aggressive when we believe deal quality warrants it, but also pull back when warranted. Our debt and equity commitments in Q4 were to a mix of technology and life sciences companies, although they were weighted more towards technology companies after a record Q3 performance from our life sciences team. Our investment team has hit the ground running in 2021, and we are very pleased by our performance on Originations quarter to date, despite continued frothiness in the capital markets. Since the close of Q4 and as of February 18, 2021, Hercules has already closed 294 million of new commitments, and we have pending commitments of an additional 248 million in signed non-binding term sheets. Q4 was unusually strong with regards to portfolio company exits. and an abundance of liquidity and capital availability across our ecosystem. This, combined with continued very strong performance across our portfolio, drove record early payoffs and strong effective yields during the fourth quarter. While prepayments are always difficult to predict, the strong activity that we saw in Q4 validates our model of being a disciplined underwriter of credit in this asset class and being able to identify and partner with some of the leading companies in our core verticals. The velocity of capital in our ecosystem makes achieving and sustaining scale difficult, but we have proven the ability to do this over the last 16 plus years. Early loan repayments were over 282 million, which was up from 191 million in Q3, and above our guidance of 100 million to 150 million. Nearly 50% of the Q4 prepayments were attributable to M&A exits or strong equity capital market activity. Given the strength that we are seeing across our portfolio, we expect prepayments to remain elevated near term before reverting back to a more normal cadence in the second half of 2021. For Q1, we expect prepayments to be between $150 million and $200 million. although this could change materially as we progress in the quarter. The increase in early loan repayments during Q4 resulted in higher fee income as compared to Q3 and stronger GAAP effective yields. In Q4, we generated total investment income of $75.3 million, net investment income of $42.2 million, or 37 cents per share. resulting in 116% coverage of the base cash distribution and a 13.3% GAAP effective yield. While the heavy Q4 prepayment activity and resulting portfolio decline will reduce our NII short term, we are confident and remain focused on building the portfolio the right way with an emphasis on quality and positioning the credit book for the long term. Credit quality on the debt investment portfolio again improved in Q4 with a weighted average internal credit rating of 2.16 as compared to 2.22 in Q3. Overall, our grade one and two credits increased to 68.7% in Q4 versus 64.4% in Q3. Grade three credits decreased to 29.7% in Q4 versus 34.1% in Q3. Our rated four and five credits made up 1.6% of the entire debt portfolio fair value. In Q4, we had seven debt investments on non-accrual with a cumulative investment cost and fair value of approximately 31 million and 11.9 million respectively. or 1.3% and 0.5% as a percentage of the company's total investment portfolio at cost and value, respectively. Subsequent to quarter end, we have exited one of our non-accrual loans with a full recovery of all principal, interest, and fees, and we have received net cash proceeds from a second non-accrual loan that fully covers our Q4 fair value on that position. As a result of continued strong performance across our portfolio, the exceptionally strong equity capital markets, and robust exit and IPO activity, our Q4 NAV per share increased by nearly 10% to $11.26, the highest net asset value per share mark that we have seen since Q4 of 2008. At the onset of the COVID-19 pandemic, we spoke about our focus on liquidity and balance sheet strength and maintaining strong credit quality. In 2020, we were successful in both areas. We ended Q4 with record liquidity of $673 million, which provides us with substantial coverage of our available unfunded commitments of $180 million and the ability to fund our ongoing anticipated business activities. 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. With net regulatory leverage of 77.6% and no near-term material liability maturities in 2021, our balance sheet is exceptionally strong and well positioned. In terms of how our portfolio companies are managing through the current environment, and their ability to continue to raise capital to fund growth, we are very pleased by what we have seen to date. When looking at our entire outstanding debt investment portfolio, we currently estimate that nearly 80% of the portfolio currently has 12 plus months of liquidity on balance sheet, with another 16% with 6 to 12 months of liquidity currently on balance sheet. Loans that have three months or less of liquidity make up less than 3% of the outstanding debt portfolio. Of the loans with 12 plus months of liquidity, over 76% or approximately 61% of our entire debt portfolio currently has 18 plus months of liquidity on balance sheet. Capital raising across our portfolio also remains strong. Since our last earnings call, 16 of our debt portfolio companies have raised new capital, totaling over $1.8 billion. Since the beginning of the COVID-19 outbreak in the United States, we have now had 49 of our current debt portfolio companies raise a total of nearly $7 billion of new capital. For the year, we had 14 M&A events, and eight companies complete their initial public offerings. The venture capital ecosystem continued to exhibit strength and finished the year in record territory for the third consecutive year. For 2020, venture capital funds raised a record of $73.6 billion compared to $58.7 billion in 2019 and invested over a record $156 billion compared to $103.3 billion in 2019 in the U.S. 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. 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 been 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 very selective and prudent with capital deployment. I would also like to discuss our shareholder distribution. Our NII per share of 37 cents in Q4 generated 116% coverage of our quarterly base distribution of 32 cents per share. In addition to our eighth consecutive quarterly cash distribution of 32 cents per share, we are also declaring a supplemental distribution of 5 cents per share. Our warrant and equity portfolio is designed to provide potential upside returns to our shareholders above and beyond our net investment income. as well as mitigate potential debt losses that may occur. As of Q4 2020, we have generated undistributed earnings spillover of approximately $107.7 million, or $0.94 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 platforms. Finally, I would like to briefly touch on some of the progress that we made in 2020 in terms of strengthening and expanding our platform. We made significant investments throughout 2020 in our team, infrastructure, and systems. We added talent to all levels of the organization and made a series of investments in our technology and systems that we believe will best position us for future growth. After extensive dialogue with our shareholders over the last 18 months or so, we made the decision to seek SEC no action relief in order to be able to create a registered investment advisor as a wholly owned subsidiary of HTGC. We received that approval in May of 2020 and subsequently established Hercules Advisor. Having this in place puts us in a position to be able to expand and diversify the platform with the potential of raising and managing new funds down the road. Because of the unique structure of having the BDC wholly own the registered investment advisor, all new potential future activity under the RIA would be done for the benefit of our shareholders. In closing, I would like to acknowledge and thank each of our dedicated and talented employees for their contributions to our strong performance in 2020. This past year was a challenging year for many, and despite that, our employees maintained their commitment to the company and their focus on ensuring our continued success. I would also like to once again thank our portfolio companies and their financial sponsors, our shareholders and stakeholders, for their unwavering support of our company. Our unique business model and asset class proved its resiliency in 2020, and we believe that the innovation economy will continue to demonstrate its strength as we eventually return to a new normal. Thank you very much, everyone. I will now turn the call over to Seth.