Hercules Capital, Inc. (HCX) - Q1 2018 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended March 31, 2018. Hercules Capital, Inc. is an internally managed, non-diversified closed-end management investment company regulated as a Business Development Company (BDC) under the Investment Company Act of 1940. The Company focuses on providing senior secured loans to high-growth, venture capital-backed companies in technology, life sciences, and sustainable/renewable technology sectors. It also operates two Small Business Investment Companies (SBICs), Hercules Technology II, L.P. and Hercules Technology III, L.P.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net Investment Income | $26.1 million | $22.7 million |
| Net Increase in Net Assets from Operations | $5.9 million | $(5.6) million |
| Net Asset Value (NAV) per Share | $9.72 | $9.76 |
| Total Investments (at Value) | $1.48 billion | $1.54 billion |
| Cash and Cash Equivalents | $118.2 million | $148.1 million |
| Total Liabilities | $791.0 million | $813.7 million |
| Weighted Average Debt Outstanding | $795.1 million | $785.9 million |
| Effective Yield on Debt Investments | 14.3% | 13.4% |
| Distributions Declared per Share | $0.31 | $0.31 |
Material Changes vs. Prior Period
- Investment Income: Total investment income increased to $48.7 million from $46.4 million year-over-year. This was driven by higher one-time fee income ($3.2 million vs. $0.6 million) and interest accelerations from early loan repayments, partially offset by a decrease in recurring interest income.
- Realized Gains/Losses: The Company recorded a net realized loss of $4.9 million, compared to a net realized gain of $3.2 million in Q1 2017. The loss was primarily due to the liquidation or write-off of warrant and equity investments in six portfolio companies and debt investments in two companies.
- Unrealized Depreciation: Net unrealized depreciation on investments was $15.2 million, a significant improvement from the $31.5 million depreciation recorded in Q1 2017. This included $8.3 million of depreciation on debt investments, largely due to collateral-based impairments on seven portfolio companies.
- Portfolio Composition: The portfolio value decreased by approximately $58.6 million from the prior year-end, primarily due to early payoffs ($243.5 million) and write-offs ($6.5 million), partially offset by new fundings ($236.3 million).
- Debt Structure: The Company redeemed $100.0 million of its 2024 Notes in April 2018 (subsequent to period end). As of March 31, 2018, the Company had no borrowings outstanding under its Wells or Union Bank credit facilities.
Guidance, Outlook, and Risks
- Outlook: Management expects to continue generating current income from debt investments and capital appreciation from warrants. The Company maintains a variable distribution policy targeting 90-100% of taxable quarterly income.
- Subsequent Events:
- On April 25, 2018, the Board declared a distribution of $0.31 per share.
- On April 26, 2018, the Company issued $75.0 million of 5.25% Notes due 2025.
- Portfolio company DocuSign, Inc. completed its IPO in April 2018.
- Portfolio company IntegenX, Inc. was acquired by Thermo Fisher Scientific in March 2018.
- Risks and Contingencies:
- Concentration Risk: Five portfolio companies represented greater than 5% of net assets as of March 31, 2018 (Paratek Pharmaceuticals, Axovant Sciences, Fuze, Emma, and Snagajob).
- Valuation Risk: Approximately 91.6% of total assets are Level 3 investments valued in good faith by the Board, which may differ from values in a liquid market.
- Interest Rate Risk: 96.5% of the debt portfolio has floating rates. A 100 basis point increase in rates would increase net income by approximately $12.6 million annually.
- Regulatory Changes: The Small Business Credit Availability Act (signed March 2018) allows BDCs to increase leverage from 50% to 66.7% of assets, potentially increasing risk exposure.
Key Facts for Investor Verification
- NAV Decline: Verify the impact of the $15.2 million unrealized depreciation on the decline in NAV per share from $9.96 to $9.72.
- Realized Losses: Review the specific portfolio companies written off or liquidated that contributed to the $4.9 million net realized loss.
- Debt Redemption: Confirm the execution and pricing of the $100 million 2024 Notes redemption announced in February and executed in April 2018.
- Concentration: Assess the credit quality and performance of the top five holdings (Paratek, Axovant, Fuze, Emma, Snagajob) which collectively represent ~31% of net assets.
- Unfunded Commitments: Note the $51.9 million in unfunded contractual commitments available at the request of portfolio companies.