Hercules Capital, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Hercules is a business development company (BDC) and specialty finance lender focused on senior secured and structured loans to venture-backed and institutional-backed companies, principally in technology and life sciences.
Key financial results
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Total investment income | $116.2 million | $72.1 million | $221.3 million | $137.3 million |
| Net investment income (NII) | $75.7 million | $40.1 million | $141.2 million | $75.9 million |
| Net realized gains (losses) | $0.2 million | $(2.1) million | $8.2 million | $(4.5) million |
| Net unrealized appreciation (depreciation) | $18.9 million | $(48.3) million | $40.0 million | $(85.1) million |
| Net increase (decrease) from operations | $94.8 million | $(10.3) million | $189.3 million | $(13.7) million |
| Operations per common share, diluted | $0.66 | $(0.09) | $1.34 | $(0.12) |
Q2 NII per share was $0.53, compared with $0.32 a year earlier. Distributions paid were $0.47 per share in Q2 and $0.94 for the first half. The filing reports Q2 total, effective, and core debt yields of 15.3%, 16.0%, and 14.1%, respectively, versus 10.8%, 11.5%, and 11.3% in Q2 2022. Core yield is a non-GAAP measure; management excludes certain one-time and accelerated income items.
Portfolio, balance sheet, and liquidity
- Investments at fair value totaled $3.113 billion at June 30, up from $2.964 billion at year-end 2022. Senior secured debt was 92.5% of the portfolio; 95.5% of debt investments carried floating rates.
- Net assets were $1.586 billion and NAV was $10.96 per share, compared with $1.401 billion and $10.53 at December 31, 2022.
- Debt principal outstanding was $1.606 billion ($1.589 billion carrying value), versus $1.594 billion principal at year-end. Cash and cash equivalents were $61.7 million, with an additional $12.3 million restricted.
- Management reported $670.7 million of available liquidity, including $61.7 million cash, $175 million available under the letter-of-credit facility, and borrowing capacity of $95 million under SMBC and $339 million under MUFG. Asset coverage was 210.6% excluding SBA debentures and 198.5% including them.
- For the first half, operating activities provided $52.8 million cash, compared with $306.7 million used in the prior-year period. Financing activities used $4.2 million, versus $289.2 million provided in 2022. Cash, cash equivalents, and restricted cash ended the period at $74.0 million.
Material changes and notable items
- Income and NII increased materially year over year, reflecting higher average investment principal and benchmark rates. Debt interest and fees also rose, to $38.6 million for the first half from $27.7 million, amid higher borrowing costs and greater use of floating-rate credit facilities.
- Portfolio fair value increased despite substantial turnover: first-half fundings were $834.8 million, while principal repayments and debt-sale proceeds were $516.5 million. Early repayments totaled approximately $499.4 million across 25 portfolio companies; accelerated fees and interest contributed to income.
- First-half investment commitments originated by Hercules and its adviser funds were $1.067 billion, down from $1.659 billion in 2022. Available unfunded commitments fell to $381.1 million from $628.9 million at year-end; commitments may expire undrawn and some depend on milestones.
- Portfolio credit grades were broadly stable: weighted-average grade was 2.24 versus 2.23 at year-end (lower numbers indicate higher quality). Non-accrual investments were 0.4% of portfolio amortized cost, down from 0.6%; the filing notes Tectura’s PIK portion was on non-accrual.
- Realized gains included sales of equity and warrants, while write-offs included equity/warrant positions and debt investments. First-half net realized gains were $8.2 million. Net unrealized appreciation was $40.0 million, reversing the prior-year first-half depreciation of $85.1 million.
- Hercules issued 9.7 million shares through its equity distribution program in the first half, raising $130.7 million net, versus $147.1 million in 2022. Stockholders authorized below-NAV common share issuance through July 20, 2024, subject to conditions; such sales could dilute NAV per share.
Outlook, risks, and contingencies
The filing gives no quantified earnings or portfolio guidance. Management said it believes near-term liquidity is ample, while continuing to monitor inflation, rising rates, geopolitical and supply-chain disruption, banking-sector volatility, and effects on portfolio-company liquidity and valuations. The company warns that higher rates can increase income on floating-rate assets but also raise funding costs; its sensitivity analysis estimates a 25-basis-point rate increase would raise annualized net investment income by about $6.0 million, while a decrease would reduce it by about $5.9 million, assuming no other changes.
Investment valuation is a key risk: approximately 96.5% of total assets were investments, and substantially all private-company debt and equity positions use Level 3 inputs. Management notes that actual realizations may differ materially from reported fair values. The portfolio is concentrated in drug discovery and development (36.5%), software (28.6%), and consumer and business services (14.8%). Six portfolio companies individually represented at least 5% of net assets; the largest was Axsome Therapeutics at 9.7%. PIK interest is non-cash income that may nevertheless contribute to distributions. Available unfunded commitments total $381.1 million, creating potential funding needs. The filing says ordinary-course legal matters are not expected to materially affect results, but outcomes cannot be assured.
After quarter-end, the board declared a $0.40 per-share base distribution and a $0.08 supplemental distribution, payable August 25, 2023. Controls and procedures were reported effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether elevated investment income and yields are sustainable after excluding early-payoff accelerations and other non-recurring fees.
- Credit performance, non-accrual status, PIK accruals, and repayment capacity at large exposures, particularly Axsome, Corium, Phathom, Worldremit, Rocket Lab Global Services, and SeatGeek.
- How Level 3 valuation assumptions and portfolio-company financing conditions affect NAV and future realized losses.
- Liquidity and borrowing-base availability relative to $381.1 million of unfunded commitments, distributions, and debt maturities.
- Potential dilution from ATM issuance or any below-NAV share sales, and the coverage of distributions by taxable and cash income.