Hercules Capital, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the Hercules Capital Q3 2021 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask the question during this session, you will need to press star then 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then 0. I would now like to turn the conference over to your speaker for today. Michael Herr, you may begin.

Thank you, Tawanda. Good afternoon, everyone, and welcome to Hercules' conference call for the third quarter of 2021. With us on the call today from Hercules are Scott Blustein, CEO and Chief Investment Officer, and Seth Meyer, CFO. Hercules' third quarter 2021 financial results were released just after today's market. 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 do not guarantee the 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 be proved to be inaccurate, and as a result, the forward-looking statements based on those assumptions can also 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 STD 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. 2021 continues to produce unprecedented levels of opportunity on multiple fronts for Hercules. Q3 2021 was no exception. Commitments, fundings, liquidity, credit quality, and portfolio company exits and liquidity events all continue to set records. The momentum that we saw in the first half across our investment portfolio accelerated even more in Q3. Our investment team delivered record Q3 2021 and year-to-date performance for both gross new debt and equity commitments and fundings. As a result of our record-breaking origination efforts through the first three quarters of 2021 and the strength of our pipeline, we now expect to comfortably exceed $2 billion of total gross new debt and equity commitments for 2021. During Q3, we continue to focus on the key themes that we have highlighted throughout the course of 2021. Maximizing liquidity, staying disciplined on new underwritings, expanding our platform capabilities through our new private funds, and driving down our cost of debt capital while strengthening our balance sheet. There continues to be an abundance of liquidity across our core markets, and we did not see any material change in this regard during the course of Q3. Let me recap some of the key highlights of our record performance for the quarter. We originated a record of over $719 million of gross new debt and equity commitments, an increase of over 35% from our previous quarterly record. and delivered record gross fundings of over $431 million, an increase of 17% from our previous quarterly funding record. With three consecutive quarters of strong origination activity, we have already established a new annual record with over $1.69 billion in gross new debt and equity commitments and total fundings of $1.07 billion, with one quarter remaining in the year. Our technology and life sciences teams both turned in exceptional performance in Q3, and our funding activity was once again balanced between our two core verticals. In addition to strong funding activity for new portfolio companies, we were also able to expand our funding relationship with numerous portfolio companies that continued to show strength during the quarter. Being able to have this type of balance between our technology and life sciences teams and our expanded ability to support existing portfolio companies through multiple value inflection points continues to give us a significant competitive advantage and remains a key differentiator of our business. Despite the general frothiness in the market, our investment team has continued to deliver strong results while staying true to our historical credit discipline. While we continue to see a large number of deals get done in the market, that do not fit our investment standards or credit screens, we believe that a disciplined approach to underwriting will serve us and our stakeholders well long term. Our expanding platform scale, brand reputation, and consistency of being in the market over the last 17 years 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 and we are seeing strong deal flow across our areas of focus. Since the close of Q3 and as of October 25th, 2021, Hercules has closed 125 million of new commitments and has 377 million of pending commitments. Based on our current closed commitments and the strength of our active pipeline, we are well on our way to comfortably break the $2 billion mark in annual debt and equity commitments for the first time in our history. During Q3, we continue to see strength in terms of portfolio company exits and liquidity events. Year to date, we've had 13 M&A events, 13 companies that have completed their public offerings through either traditional IPOs or SPAC mergers, and seven additional companies that are in registration or have agreed to SPAC transactions for a total of 33 exit and liquidity events as of today, breaking our previous annual record of 22. This, combined with continued very strong performance across our broader portfolio, again drove high levels of early payoffs. We expect this trend to continue in Q4. Early loan repayments were nearly 319 million. above our guidance of 200 to 250 million, and a significant increase from 168 million in Q2. Year to date, we have had 678 million in early payoffs, and at this pace we will exceed 2020's record of 709 million in early payoffs. For Q4, we expect prepayments to be between 200 million and 300 million, based on the momentum that we are seeing across our investment portfolio. although this 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 nearly 24 million after allocating or funding directly over 59 million of new fundings to our advisor funds that are managed through our wholly owned registered investment advisor. Year to date, we have managed to deliver net debt investment portfolio growth of over 163 million, which is a credit to our investment team and the strength of our platform. Although the elevated prepayments that we are seeing create short-term headwinds in terms of driving net debt portfolio growth, we believe that this is clear validation of our business model and our team's ability to select and partner with the right companies. The vast majority of our year to date prepayments are directly attributable to M&A events and enhanced liquidity for many of our borrowers as a result of the strong capital markets for the best performing companies. As an internally managed BDC, our focus is and has always been on maximizing total shareholder returns and not growing our asset base to drive incremental fees. In Q3, we generated total investment income of 70.2 million and net investment income of 38.1 million or 33 cents per share. Our portfolio generated a gap effective yield of 12.7% in Q3 and a core yield of 11.4%, which was at the midpoint of our previous guidance for 2021. With net regulatory leverage at a very conservative 84%, and continued robust liquidity across our platform, we remain very well positioned. Credit quality on the debt investment portfolio again improved in Q3, with a weighted average internal credit rating of 1.92 as compared to 1.93 in Q2, again setting another historical record. Overall, our grade one and two credits decreased slightly to 79.4% in Q3, versus 81.5% in Q2. However, Grade 1 credits increased and reached the 30% level. Grade 3 credits increased slightly to 20.2% in Q3 versus 18% in Q2. Our rated 4 and 5 credits made up 0.4% of the entire debt portfolio fair value. In Q3, non-accruals remained relatively the same. with three debt investments with a cumulative investment cost and fair value of approximately 24 million and 9 million respectively, or 1% and 0.3% as a percentage of the company's total investment portfolio at cost and value respectively. During Q3, Hercules had net realized gains of 21.1 million, comprised of gross realized gains of 25 million, offset by $3.9 million of gross realized losses, primarily due to the write-off of one legacy debt investment and the early retirement of our borrowings as previously disclosed. We ended Q3 with strong liquidity of $818 million, which provides us with substantial coverage of our available unfunded commitments of $310 million and the ability to fund our ongoing anticipated business activity. Overall, we continue to believe that our balance sheet is exceptionally strong and well positioned. Seth will discuss our recent institutional bond raise and the pay downs of the securitizations and how it will further drive down our cost of debt capital moving forward. We have made substantial progress in terms of lowering our cost of debt capital over the course of the last several years, and these efforts are ongoing. venture capital ecosystem continued to exhibit unprecedented strength in q3 after a record first half for the first three quarters of 2021 venture capital funds raised a total of 96 billion dollars and invested over 238 billion dollars in the u.s according to data gathered by pitchbook and the national venture capital association that already eclipses the 86 billion and 165 billion respectively for all of 2020. Given the positive outlook that we have on our business, in combination with our healthy level of undistributed earnings spillover, our board of directors has elected to raise our base distribution this quarter to 33 cents per share, as well as maintaining the supplemental distribution of 7 cents per share. Inclusive of Q3, we have declared $1.18 of distributions to our shareholders year-to-date, which is a 20% increase over the same period last year. Once we finalize Q4 and fiscal year 2021 numbers early next year, we anticipate announcing a new supplemental distribution policy for 2022, as we did in 2021. As of Q3 2021, we have generated record undistributed earnings spillover of approximately 181.7 million. or $1.57 per share, subject to final tax filings. This provides us with additional flexibility with respect to our shareholder distributions going forward and the ability to continue to invest in our team and platform. Throughout the course of 2021, we have continued to add talent to all levels of our organization and make investments in our infrastructure and platform. These investments are designed to best position us to source, service, and support our growing and diversified investment portfolio. As of the end of Q3, we had 89 full-time employees, which is our highest full-time employee count in our history. In closing, Q3 was another very strong quarter in what we expect to be another record year for Hercules Capital. Our record-breaking year-to-date funding and commitment numbers speak to the great work that our dedicated employees perform each day and the quality of our investment platform. We are incredibly thankful to the many companies, management teams, and investors that continue to make Hercules their partner of choice. With our expanded platform, diversified business model, and scale, we look forward to being able to support these companies over the years to come. I will now turn the call over to Seth.