Business Context and Reporting Period
Hercules Capital, Inc. (Hercules) is a specialty finance company and Business Development Company (BDC) focused on providing senior secured loans to high-growth, venture capital-backed companies in technology, life sciences, and sustainable/renewable technology sectors. This Form 10-Q covers the quarterly period ended September 30, 2016.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2016 | Nine Months Ended Sep 30, 2016 | Net Assets (Sep 30, 2016) |
|---|---|---|---|
| Total Investment Income | $45.1 million | $127.6 million | $753.6 million |
| Net Investment Income | $23.8 million | $67.2 million | |
| Net Realized Gain | $7.9 million | $3.4 million | |
| Net Unrealized Depreciation | ($0.8 million) | ($16.1 million) | |
| Net Increase in Net Assets from Operations | $30.8 million | $54.6 million | $9.86 per share (NAV) |
| Dividends Declared per Share | $0.31 | $0.93 |
Liquidity and Debt: As of September 30, 2016, total debt principal outstanding was approximately $662.5 million. Cash and cash equivalents totaled $69.0 million, with an additional $8.9 million in restricted cash. Available liquidity, including undrawn credit facilities, was approximately $264.0 million.
Material Changes vs. Prior Period
- Investment Income: For the nine months ended September 30, 2016, total investment income increased to $127.6 million from $117.8 million in the prior year period, driven by portfolio growth and higher weighted average principal outstanding.
- Realized Gains: Net realized gains for the nine months decreased to $3.4 million from $8.4 million in the prior year. This was due to gross realized losses of $10.2 million (including a $6.2 million settlement loss on The Neat Company) offsetting gross gains of $13.6 million.
- Unrealized Depreciation: Net unrealized depreciation for the nine months was $16.1 million, a significant improvement from $33.0 million in the prior year period. This improvement was driven by reversals of prior period impairments and market yield adjustments.
- Debt Structure: The company settled its Convertible Senior Notes in April 2016. It significantly increased its long-term debt load by issuing an additional $141.9 million in aggregate principal of 2024 Notes during the period.
- Portfolio Grading: The weighted average investment grading of the debt portfolio declined slightly to 2.32 from 2.16 at year-end 2015, primarily due to downgrades of companies requiring near-term funding.
Guidance, Outlook, and Risks
- Outlook: Management continues to focus on originating new investments and managing the portfolio to maximize total return. The company maintains a strong liquidity position with $264.0 million available.
- Dividend Policy: The Board declared a quarterly dividend of $0.31 per share, payable November 21, 2016. The company intends to distribute taxable income to maintain its Regulated Investment Company (RIC) status.
- Risks and Contingencies:
- Credit Risk: Six debt investments were on non-accrual status as of September 30, 2016, with a fair value of $9.3 million.
- Valuation Risk: Approximately 93% of the portfolio consists of Level 3 assets (private companies) valued in good faith by the Board, which may differ from values in a liquid market.
- Concentration: The top five industries (Drug Discovery, Sustainable Tech, Software, Drug Delivery, Medical Devices) comprised 73.6% of the portfolio.
- Unfunded Commitments: The company had $73.9 million in unfunded contractual commitments available at the request of portfolio companies.
Key Facts for Investor Verification
- NAV vs. Market Price: Verify the discount/premium of the stock price ($13.56 market value at period end) relative to the Net Asset Value ($9.86).
- Debt Maturity Profile: Review the maturity schedule of the $662.5 million in debt, noting the significant issuance of 2024 Notes and the absence of Convertible Notes.
- Non-Accrual Assets: Monitor the status of the six non-accrual loans and the potential for further write-downs or recoveries.
- Realized Losses: Investigate the specific details of the $6.2 million realized loss on The Neat Company settlement and other write-offs contributing to the $10.2 million in gross losses.
- Dividend Coverage: Confirm that the declared dividends are fully covered by taxable income to ensure RIC status is maintained without return of capital implications.