Hercules Capital, Inc.

Thank you for standing by and welcome to Hercules Capital fourth quarter and full year 2023 financial results conference call. At this time, all participants are on a listen-only mode. After the speaker's presentations, there will be a question and answer session. To ask a question, please press star 1-1 on your telephone. Please be advised that today's call is being recorded. I will now turn the conference to your host, Mr. Michael Herrera, Managing Director of Investor Relations. Please go ahead.

Thank you, Valerie. Good afternoon, everyone, and welcome to Hercules' conference call for the fourth quarter and full year of 2023. With us on the call today from Hercules are Scott Blustein, CEO and Chief Investment Officer, and Seth Meyer, CFO. Hercules' financial results were released just after today's market closed and can be accessed from Hercules' investor relations section at investor.htgc.com. Excuse me. An archived webcast replay will be available on the Investor Relations webpage for at least 30 days following the conference call. During this call, we may make forward-looking statements based on our own assumptions and current expectations. These forward-looking statements are not guarantees of future performance and should not be relied upon in making any investment decision. Actual financial results may differ from the forward-looking statements made during this call for a number of reasons, including but not limited to the risks identified in our annual report on Form 10-K and other filings that are publicly available on the SEC's website. Any forward-looking statements made during this call are made only as of today's date, and Hercules assumes no obligation to update any such statements in the future. And with that, I will turn the call over to Scott.

Thank you, Michael, and thank you all for joining the Hercules Capital Q4 and full-year 2023 earnings call. Following our record operating performance in 2022, Hercules Capital once again raised the bar higher and delivered record performance in 2023. 2023 was a banner year for Hercules Capital, where we set several new financial and performance records. And I am incredibly proud of what our talented and growing team accomplished. Our record setting performance in 2023 culminated with the strongest total and net investment income quarter in the company's history. and the recent declaration of a new supplemental distribution program for our shareholders. Our performance in 2023 reflects the benefits of being able to operate an institutional venture and growth stage lending platform at scale, maintain robust liquidity and a strong balance sheet, and working with a best-in-class team with significant experience in this asset class. Thanks to the growth of both the BDC and our private credit funds business, Hercules Capital is now managing approximately 4.2 billion of assets, an increase of over 15% from where we were at year end 2022. Despite ongoing market, macro, and geopolitical volatility, which impacted growth stage companies throughout 2023, the continued strength and expansion of our origination platform, robust liquidity position, and strong balance sheet put us in position to deliver achievements on multiple fronts in 2023, including record full year 2023 total gross fundings of $1.6 billion, an increase of 9.1% year over year. Record full year 2023 total investment income of $460.7 million, an increase of 43.2% year over year. Record full year 2023 net investment income of $304 million, an increase of 61.7% year over year. Four consecutive years of delivering supplemental distributions to our shareholders. And finally, strong net debt portfolio growth of over $240 million, which excludes the portfolio growth of our private fund business. We are pleased that we were able to deliver record operating performance in Q4 and the full year, while at the same time managing the business quite conservatively with very low leverage and excess liquidity. We expect 2024 to be another year with higher than normal volatility and a higher for longer rate environment. But as we discussed on our last call, we expect the market environment for new originations to improve throughout 2024. We are already seeing this come to fruition in Q1, where we are benefiting from the balance sheet decisions that we made in 2023. Going forward, we will continue to take steps to manage our business and balance sheet defensively while maintaining maximum flexibility to shift to offense quickly and aggressively if deal quality warrants it, as we are doing in Q1. This includes continuing to enhance our strong liquidity position, maintaining low leverage, tightening our credit screens for new underwritings, and driving our first lien exposure up, which reached 89% in Q4, our highest level since Q1 2017. let me now recap some of the key highlights of our performance for q4 in q4 we generated record total investment income of 122.6 million up 22 percent year over year and record net investment income of 86 million up over 38 percent year over year or 56 cents per share and providing 140% coverage of our base distribution of 40 cents per share. We were able to achieve 140% coverage of our base distribution despite ending the quarter with very conservative gap leverage of 87.1%. This is our third consecutive quarter of over 100 million of quarterly core income, which excludes the benefit of prepayment fees or fee accelerations from early repayments, and our fifth consecutive quarter of delivering record net investment income. We also generated return on equity in Q4 of over 20% for the third consecutive quarter. Our portfolio generated a gap effective yield of 15.3% in Q4 and a core yield of 14.3%. Our balance sheet remains very well positioned to support our continued growth objectives and serves as a key differentiator of our business relative to others in the asset class. The focus of our origination efforts in Q4 was once again on quality and diversification. Our Q4 originations activity was driven by both our technology and life sciences teams delivering healthy funding performance during the quarter. although new business activity was again intentionally weighted slightly more towards life sciences companies. In Q4, approximately 57% of our fundings were to life sciences companies, while approximately 66% of our commitments during the quarter were to life sciences companies. This reflects our slightly more cautious view on the technology sector through year end. we funded debt capital to 27 different companies in Q4, of which five were new borrower relationships. Consistent with what we have seen throughout the year, we expanded our funding relationship with numerous portfolio companies that continue to show strength and achieve performance milestones during the fourth quarter. In addition, the strong level of fundings to existing companies also helped to maintain our available unfunded commitments at approximately $335 million, which decreased from $400 million in Q3. As anticipated, our origination activity has begun to accelerate in Q1. Since the close of Q4 and as of February 13, 2024, our deal team has closed $551.8 million of new commitments, and we have funded $383.8 million. We have pending commitments of an additional 506.5 million in signed non-binding term sheets. The bar for us on new originations remains very high, and we continue to pass on the vast majority of deals that we are currently seeing in the market. Many of the quality later stage deals, companies, excuse me, that put off debt decisions in 2023 are now back at the table. and that is driving our very strong start to the year on originations. Having a strong balance sheet, staying power, and relationships that run wide and deep in the ecosystem gives us great confidence in our ability to continue to generate and deliver quality asset growth over the coming quarters. We believe that Hercules is best positioned in the asset class for continued and sustained success. Consistent with our historical approach to underwriting credit, we will remain disciplined on new originations and we will prioritize credit quality over chasing higher risk transactions with a yield premium. Given the market backdrop throughout 2023, we are pleased with the exit activity that we saw in our portfolio during the year. In Q4, we had two additional portfolio companies complete acquisitions. For fiscal year 2023, we had one portfolio company complete their IPO and two additional portfolio companies file for IPOs, along with 17 portfolio companies completing M&A transactions. Our solid portfolio activity, despite the challenging broader exit environment, continues to validate the great work and selective underwriting that our investment teams do. As we anticipated, early loan repayments increased in Q4 to approximately $278 million, which came in above our guidance of $150 million to $250 million. For Q1 2024, we expect prepayments to decrease from Q4 levels and be in the range of $125 million to $225 million, although this could change as we progress in the quarter. Credit quality of the debt investment portfolio remains stable. Our weighted average internal credit rating of 2.24 improved slightly from the 2.28 rating in Q3 and remains at the lower end of our normal historical range. Our grade one and two credits improved to 62.6% compared to 62.1% in Q3. Grade three credits were slightly lower at 34% in Q3 versus 34.5% in Q3. Our rated four credits increased moderately to 3.4% from 2.6% in Q3, and we had no rated five credits in Q4. In Q4, the number of loans on non-accrual decreased by one. We have one debt investment on non-accrual with an investment cost and fair value of approximately $30.9 million and $0 million respectively, or 1% and 0% as a percentage of the company's total investment portfolio at cost and value respectively. As of our most recent reporting, 100% of our debt portfolio companies remain current on contractual payments to Hercules. Our workout efforts with regards to convoy remain ongoing, and our recovery efforts will likely wrap up early this year, although that situation remains ongoing and fluid. With respect to our broader credit book and outlook, we generally remain pleased by what we are seeing on a portfolio level, and our monitoring remains enhanced given continued market volatility and uncertainty. Our focus on credit underwriting, and a diversified asset base is continuing to serve us well. We are continuing to see general outperformance and positive momentum in terms of capital raising, M&A activity, and milestone achievement throughout our life sciences book, while things continue to remain more muted on the technology side with respect to the same. During Q4 and throughout the year, we experienced many of the same themes that we have been discussing over the last several quarters. With so much attention paid to what the market has been describing as a VC winter, capital raising across our portfolio remained relatively strong, with over $1.1 billion raised in Q4. In total for the year, we had 58 portfolio companies raise approximately 6 billion in new capital, which was heavily weighted towards our life sciences portfolio. During Q4 2023, Hercules had net realized gains of 2.8 million, comprised of net realized gains of 4.6 million, primarily due to the gain on equity investments, offset by approximately 1.8 million due to the loss on debt and warrant investments. For 2023, we generated $8.4 million of realized gains. Our net asset value per share in Q4 was $11.43, an increase of 4.6% from Q3 2023. We ended Q4 with strong liquidity of nearly $750 million. Inclusive of available liquidity in our private funds, we have more than $1 billion of liquidity as of the end of Q4. Our balance sheet is both strong and stable, and it puts us in a strong position to be able to benefit from a new business environment that we anticipate will get better throughout 2024. Venture capital ecosystem fundraising and investment activity finished 2023 with fundraising activity at approximately 67 billion and investment activity at approximately 171 billion, according to data gathered by PitchBook and VCA. To put that into perspective, investment activity equaled 2020 levels in both dollars invested and number of companies raising capital at over 13,000 companies. Fundraising for the year exceeded 2019 levels. However, we expect fundraising to stay at the current level for the foreseeable future. We do not expect investment activity to reach the levels that we saw during the COVID pandemic near term. But we do expect investment activity to remain at healthy levels with more selectivity in terms of the profile of the companies that are receiving equity funding. With our record operating performance in 2023, we exited Q4 with undistributed earnings spillover of over 125 million, or 80 cents per ending share outstanding. We are also very pleased to announce that our RIA has delivered its first distribution to HTGC shareholders. For Q4, we are maintaining our base distribution of 40 cents, and we declared a new supplemental distribution of 32 cents for 2024, which will be distributed equally over the next four quarters or eight cents per share per quarter for a total of 48 cents of shareholder distributions. This is our fourth consecutive year of being able to provide our shareholders with a supplemental distribution on top of our regular quarterly base distribution. In closing, 2024 marks our 20th year investing in the venture and growth stage asset class, which is another milestone for our company. Our scale, institutionalized lending platform, and our ability to capitalize on a rapidly changing competitive and macro environment continues to drive our business forward and our operating performance to record levels. Our success since inception over 20 years ago is attributable to the tremendous dedication, efforts, and capabilities of our employees and the trust that our venture capital and private equity partners place with us every day. We are thankful to the many companies, management teams, and investors that continue to make Hercules their partner of choice. I will now turn the call over to Seth.