Hercules Capital, Inc.

Good day and thank you for standing by. Welcome to the Hercules Capital Q2 2021 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. And please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Michael Herra, Managing Director of Investor Relations. Please go ahead.

Thank you, Laurie. Good afternoon, everyone, and welcome to Hercules' conference call for the second quarter of 2021. With us on the call today from Hercules are Scott Blustein, CEO and Chief Investment Officer, and Seth Meyer, CFO. Hercules' second quarter 2021 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 uncertainties 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 be proved 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 related SEC filings, please visit our website. And with that, I'll turn this call over to Scott.

Thank you, Michael, and thank you all for joining us today. We hope that everyone is well. Q2 2021 was a strong follow-up to our record-setting Q1. We delivered solid operating results, further strengthened and expanded our investment platform, and continued to emphasize credit discipline despite the market frothiness. The momentum we saw in Q1 across our investment portfolio accelerated in Q2 with a record number of year-to-date portfolio company completed or announced exit events. Our investment team continued their momentum in Q2 and delivered record first half 2021 performance for both gross new debt and equity commitments and fundings. We continue to conservatively manage the business by maximizing liquidity staying disciplined on new underwritings, ensuring a strong balance sheet, and maintaining substantial operational flexibility. The public and private equity markets continue to perform exceptionally well, and there continues to be an abundance of liquidity across our core markets. Let me recap some of the key highlights of our strong performance for Q2. We originated over $440 million of gross new debt and equity commitments, and delivered gross fundings of over $278 million. Combined with our record-setting debt and equity commitments and fundings in Q1, we established a new record for the first half of the year with over $970 million in gross new debt and equity commitments and total fundings of $634 million. We again saw strong performance from both our technology and life sciences teams. Being able to have balance between our two core verticals has continued to be a significant competitive advantage for us in the market and a key differentiator of our business. Although an abundance of equity capital and loosely structured debt has continued to create challenges in terms of prudent new business origination, our investment team has continued to deliver while staying true to our historical credit discipline. We continue to believe that a disciplined approach to underwriting will serve us and our stakeholders well over the long term. Our expanding platform scale and brand reputation continue to give us exposure to an active pipeline that currently exceeds 1 billion of potential investments. The quality of the companies in our pipeline remains strong. Since the close of Q2 and as of July 26, 2021, Hercules has closed 27 million of new commitments, and has $402 million of pending commitments. Based on our current closed commitments and the strength of our active pipeline, we expect that 2021 will be a record year for Hercules Capital in terms of annual new debt and equity commitments. During Q2, we continue to see strength in terms of portfolio company exits and portfolio company liquidity events. Year to date, we've had eight M&A events ten companies that completed their public offerings through either traditional IPOs or SPAC mergers, and eight additional companies that have agreed to SPAC transactions. This, combined with continued very strong performance across our broader investment portfolio, again drove high levels of early payoffs. Early loan repayments were at the mid-range of our guidance, of $150 to $200 million, at nearly $170 million. but decreased slightly from 192 million in Q1. For Q3, we expect prepayments to be between 200 million and 250 million, based on the momentum that we are seeing across our investment portfolio, although this number could change materially as we progress in the quarter. Even with the continued elevated levels of early payoffs, our strong fundings during the quarter produced net debt investment portfolio growth of 57 million, after allocating over $30 million of new fundings to the initial private fund that is managed through our wholly owned registered investment advisor. Year to date, we have managed to deliver net debt investment portfolio growth of $139.3 million, which is a credit to our investment team and diversified investment platform. In Q2, we generated total investment income of $69.6 million. and net investment income of 37 million or 32 cents per share. The increase in both total investment income and net investment income was primarily attributable to the higher level of fee income during the quarter as compared to the year before. Our portfolio generated a gap effective yield of 12.7% in Q2 and a core yield of 11.5%, which was at the midpoint of our previous guidance for 2021. With net regulatory leverage at a very conservative 82.4% and continued robust liquidity across our platform, we remain very well positioned. Credit quality on the debt investment portfolio again improved in Q2 with a weighted average internal credit rating of 1.93 as compared to 2.01 in Q1. This was our strongest internal credit rating in our history since our first publicly reported quarter in 2005. Overall, our Grade 1 and 2 credits increased to 81.5% in Q2 versus 79.6% in Q1. Grade 3 credits decreased to 18% in Q2 versus 19.5% in Q1. Our Rated 4 and Rated 5 credits made up 1.4% of the entire debt portfolio fair value. In Q2, we had three debt investments on non-accrual with a cumulative investment cost and fair value of approximately $23 million and $7.7 million, respectively, or 1% and 0.3% as a percentage of the company's total investment portfolio at cost and value, respectively. During Q2, Hercules had net realized losses of $14.3 million, primarily due to the write-off of one legacy equity investment that had a fair value of zero. Excluding the write-off of that fully impaired position, we had record gross realized gains of $47.9 million from the sale of equity and warrant investments during Q2. As a result of continued strong performance across our portfolio, the exceptionally strong equity capital markets, and robust exit and IPO activity, our Q2 net asset value per share increased by over 3% to $11.71. This is the highest net asset value per share that we have reported since Q3 2008. We ended Q2 with strong liquidity of $610 million, which provides us with substantial coverage of our available unfunded commitments of $327 million and the ability to fund our ongoing anticipated business activity. Overall, we believe that our balance sheet is exceptionally strong and well-positioned. As Seth will discuss, we will continue to look for ways to optimize our balance sheet and further drive down our overall costs of debt capital. The venture capital ecosystem continued to exhibit exceptional strength in Q2, after a record Q1. For the first half of 2021, venture capital funds raised a total of $74.1 billion and invested over $150 billion in the U.S., according to data gathered by PitchBook and the National Venture Capital Association. That compares to $81 billion and $164.3 billion respectively for all of 2020. We declared our 10th consecutive quarterly cash distribution of $0.32 per share, as well as a supplemental distribution of $0.07 per share as previously discussed on our Q1 2021 earnings call. Inclusive of Q1, we have declared 78 cents of distributions to our shareholders year-to-date, which is a 22% increase over the same period last year. As of Q2 2021, we have generated record undistributed earnings spillover of approximately $160.2 million, or $1.38 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 platform. Year to date, we have continued to add talent to our team with several new hires. We have also continued to enhance our infrastructure and platform. We will continue to make these investments to best position us for sustained long-term success. In closing, I am grateful and thankful to each of our talented and dedicated employees who continue to demonstrate tremendous strength, commitment, and perseverance during what continues to be a challenging time for many. Being able to deliver record new commitments year to date is a credit to each of them and the great work that they do. I would also like to once again thank each of our portfolio companies and their institutional investors that have chosen to make Hercules Capital their preferred financing partner.