Hercules Capital, Inc. — Q1 2023 Form 10-Q
Business context and period. Hercules Capital is an internally managed business development company (BDC) focused on lending to venture- and institutionally backed companies, principally in technology, life sciences and healthcare. This unaudited report covers the three months ended March 31, 2023; balance-sheet figures are compared with December 31, 2022, and operating results with Q1 2022.
Key financial metrics
| Metric | Q1 2023 / March 31, 2023 | Comparable period / prior year-end |
|---|---|---|
| Total investment income | $105.1 million | $65.2 million in Q1 2022 |
| Net investment income | $65.5 million; $0.48 per share | $35.8 million; $0.30 per share in Q1 2022 |
| Net change in unrealized value | $21.1 million appreciation | $36.7 million depreciation in Q1 2022 |
| Net realized gain (loss) | $8.0 million gain | $2.4 million loss in Q1 2022 |
| Increase (decrease) in net assets from operations | $94.6 million; $0.69 basic and $0.68 diluted per share | $3.3 million decrease; $0.03 loss per share in Q1 2022 |
| Net investment income margin | 62.3% of investment income | 54.9% in Q1 2022 |
| Investment portfolio at fair value | $3.13 billion | $2.96 billion at December 31, 2022 |
| Net asset value (NAV) | $1.50 billion; $10.82 per share | $1.40 billion; $10.53 per share at December 31, 2022 |
| Debt | $1.733 billion principal; $1.714 billion carrying value | $1.594 billion principal at December 31, 2022 |
| Cash and liquidity | $71.1 million cash and cash equivalents; $78.9 million including restricted cash. Management reported $553.1 million available liquidity. | $15.8 million cash and cash equivalents at December 31, 2022 |
| Operating cash flow | $80.9 million used | $188.6 million used in Q1 2022 |
| Distributions | $0.47 per share declared for Q1 | $0.48 per share paid in Q1 2022 |
Material changes and portfolio developments
- Investment income rose 61% year over year, with interest income increasing to $99.9 million from $62.3 million. Management attributed the increase mainly to higher average loan principal and benchmark rates. Fee income increased to $5.2 million from $2.9 million, including higher accelerated fees from early repayments.
- Net operating expenses increased to $39.6 million from $29.4 million. Debt interest and fees rose to $19.0 million from $13.5 million; employee compensation and benefits increased to $14.6 million from $8.3 million, mainly due to variable compensation.
- Positive unrealized appreciation and realized gains contrasted with Q1 2022 depreciation and realized losses. The 2023 realized gain included proceeds from sales of Sprinklr and Zeta Global equity; losses included write-offs of Concert Pharmaceuticals and Fungible investments. Q1 2022 included a $3.7 million loss on extinguishment of debt.
- Fair value of debt investments increased to $2.97 billion from $2.80 billion at year-end; equity investments declined to $124.4 million from $134.0 million, while warrants increased to $33.2 million from $30.6 million. The portfolio remained concentrated in drug discovery and development (39.0%), software (26.5%), and consumer and business services (15.2%).
- About 95.6% of debt investments carried floating rates. Weighted-average core yield increased to 14.0% from 11.1% in Q1 2022; effective yield rose to 15.1% from 11.5%. The core yield is a company-defined non-GAAP measure.
- ATM equity issuance generated $65.3 million net proceeds from 4.7 million shares, versus $85.2 million from 4.9 million shares in Q1 2022. Total shares outstanding rose to 138.6 million from 133.0 million at year-end.
Liquidity, debt and risk considerations
- Of $1.733 billion principal debt, $318 million was outstanding under floating-rate credit facilities; the remaining $1.415 billion was fixed-rate term debt. Debt principal was not due within one year; $375 million was scheduled within one to three years. Hercules reported compliance with borrowing arrangements.
- Reported BDC asset coverage was 196.0% excluding SBA debentures and 186.3% including them. The company has elected the 150% minimum asset coverage framework; SBA leverage may be excluded under SEC exemptive relief.
- Available unfunded portfolio commitments were $562.1 million, down from $628.9 million at year-end. These commitments may be drawn on request, but some may expire unused; further commitments are subject to contractual terms and, in some cases, milestones.
- Portfolio credit grading weakened modestly: the weighted-average grade moved to 2.26 from 2.23 at year-end (1 is highest quality). Non-accrual investments were 0.6% of portfolio cost, unchanged from year-end. Tectura’s PIK portion was on non-accrual; the filing identifies $18 million of total non-accrual investments at cost.
- Most investments are Level 3 and valued using significant unobservable inputs; management states that actual realizations may differ materially from those valuations. The ten largest portfolio companies represented 29.5% of portfolio fair value. The largest disclosed exposures included Corium (9.1% of net assets) and Axsome (8.7%).
- Management cited ongoing inflation, geopolitical events, lingering pandemic effects, supply-chain disruption and banking-sector volatility. These may pressure portfolio-company liquidity and performance; borrowers could draw substantial portions of available commitments. Management said it could not predict the full financial impact and believed liquidity was adequate for near-term needs.
- Interest-rate sensitivity is material: the filing estimates a 100-basis-point increase would add approximately $24.4 million to annualized net investment income, while a 100-basis-point decrease would reduce it by approximately $25.2 million, assuming no other changes. Hercules reported no hedging activity in the quarter.
- The company reported no expected material impact from current legal matters, while noting outcomes cannot be assured. It reported effective disclosure controls and no material changes in internal control over financial reporting.
Outlook and unusual items
The filing provides no specific earnings or portfolio-growth guidance. Management’s forward-looking discussion emphasizes continued monitoring of macroeconomic conditions, portfolio-company credit quality, liquidity, funding access, interest rates and fair values. On April 27, 2023, the Board declared a $0.39-per-share base distribution and a $0.08-per-share supplemental distribution, payable May 23, 2023. The company estimated $0.96 per share of undistributed taxable earnings spillover at March 31.
Important facts for investors to verify
- Whether portfolio-company repayment capacity and credit grades hold up amid tighter capital markets, particularly for the largest exposures and non-accrual investments.
- How much of the $562.1 million in available commitments is drawn, and whether those funding needs can be met without additional borrowing or equity issuance.
- Whether interest income gains from floating-rate assets continue to exceed the rising cost of floating-rate credit facilities.
- Whether Level 3 portfolio marks, including unrealized appreciation, are supported by subsequent company performance and realized transactions.
- Whether distributions remain covered by taxable income and cash collections, including the effect of PIK income that is recorded before cash is received.
- How liquidity, debt maturities, asset coverage and share issuance evolve, and whether the reported $553.1 million of available liquidity remains accessible under facility terms.