Q4 2019 Earnings Call
Ladies and gentlemen. This is the operators today's conference is scheduled to begin momentarily until that time, Charlie will again be placed on hold thank you very patient.
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Listen only mode. Later, we'll conduct a question answer session and instructions will follow at the time, if anyone should driver assistance during the conference piece, that's our view on your touched on telephone.
As a reminder, this conference call is being recorded.
Don't like to turn the conference over to your host Mr. Maki Mr., Michael Hara managing director of Investor Relations. Please go ahead Sir.
Thank you great. Good afternoon, everyone and welcome to Hercules Conference call for the fourth quarter and for your 2019.
On the call today from Hercules as Scott Hussein's, Chief Executive Officer, Chief Investment Officer, <unk> Myers, Chief Financial Officer first of these fourth quarter and full year 2019 financial results released just after market close I can be accessed for Hercules Investor Relations section that age TGC Dot com.
We've arranged for a replay of the call adversities web page or by using the telephone number and passcode.
Provided in todays earnings release.
During this call we may make forward looking statements based on current expectations.
Actual financial results filed with Securities Exchange Commission may differ from those contained herein due to timing delays between the date of this release and the NIM in the confirmation quite a lot of result.
In addition, the statements contained in this way so that are not purely historical are forward looking statements.
These forward looking statements are not guarantees of future performance and are subject to uncertainties and other factors that could cause actual results could differ materially from those expressed in forward looking statements including.
Limitations, the risks and uncertainties, including the uncertainties try to current market turbulence and other factors that identified from time to time in a hard with you ask you see.
Although we believed that the assumptions I wish. These forward looking statements are reasonable any of those assumptions can prove to be inaccurate and as a result before looking statements based on those functions assumptions also can be a correct.
You should not place undue reliance upon these forward looking statements forward looking statements contained in this space are made until the day hero Hercules assumes no obligation to update the forward looking statements or subsequent events to obtain copies of related houses you farms. Please visit our website with that I'll turn the call over to Scott.
Thank you Michael and thank you all for joining us today.
Our strong finish in Q4 capped off a record year, where our key competitive advantages and our differentiated lending model were once again reflected in our results.
We delivered strong new debt and equity commitments and total gross fundings, while continuing to deliver superior and consistent credit performance and operating results.
Our overall performance throughout 2019 put us in a strong position to declare a record shareholder distributions for 2019 and more importantly, we continue to believe that we are well positioned at this particular juncture of the credit and economic cycle.
The continued strength of our originations platform.
Robust liquidity and strong balance sheet delivered another year of outstanding growth profitability and credit quality with records on multiple fronts, including.
Total investment income of 267.9 million.
29%.
Net investment income of 143.3 million.
Up 32%.
New debt and equity commitments of 1.47 billion up 22%.
Total gross fundings of 1.03 billion up 7%.
Debt investment portfolio 2.17 billion at cost.
24%.
Total portfolio investments of 2.4 billion at cost up 21%.
Total assets of 2.46 billion up 24%.
Total declared shareholder distributions of one dollar and 42 cents per share.
And undistributed earnings spillover of 68 million were 67 cents per share based on weighted average shares outstanding.
In Q4, we originated new debt and equity commitments of 283.9 million in.
An increase of nearly 14% from the same period last year.
Our strong performance in Q4 allowed us to achieve record new debt and equity commitments in 2019 of 1.47 billion.
In addition, our current pipeline remains strong with approximately $1 billion in potential transactions.
In Q4, our investment related activity continued to reflect our focus on three key themes first diversification, where our objectives are centered on building and maintaining a broadly diversified portfolio and avoiding concentrated or binary risk.
Second delivering controlled growth without sacrificing our credit underwriting standards and discipline.
And third positioning the portfolio best for where we believe we are in the credit cycle.
During the quarter, we were successful in each of these three areas of focus and I'm incredibly proud of the entire Hercules investment team and broader organization for our achievements in 2019.
We have chosen to build and grow our business with an emphasis on diversification and risk management.
During the fourth quarter, we funded 10, new and 11 existing portfolio companies.
Consistent with what we saw throughout 2019, the majority of the 11 existing portfolio companies that we funded during Q4 were situations, where our portfolio companies achieved specific performance milestones or growth targets that unlock additional capital availability.
As our debt portfolio has continued to grow in our portfolio companies have continued to perform we're seeing more opportunities to expand and enhance our funding relationships with existing borrowers who chose Hercules capital impart because of our unique ability to growing scale with them as their funding needs increase.
We ended the year with a total of 97 debt portfolio companies.
The profile of the 10, new companies that we made debt commitments to was consistent with our focus on quality diversification and the differentiation.
We saw strong performance from both our technology and life Sciences teams with respect to new debt commitments to both new and existing companies.
Our total fundings in Q4 were split nearly evenly between technology and life Sciences companies as we continue to emphasize diversification across our investment portfolio.
At the end of Q4, our top five and top 10 debt positions made up 17% and 29% of our total debt portfolio at cost respectively.
We funded 240.9 million in Q4, and a record 1.03 billion for the year.
The first time in our history that we have managed to fund in excess of $1 billion in a here.
As noted in our earnings release early payoffs remained at a higher level, but did not produce a commensurate level of accelerated fee income due to the vintage of some of the pay downs.
So we'll provide more detail in his comments.
In Q4, we had 161 million of early payoffs, which was up from 140 million in Q3.
Consistent with what we have seen in each of the last three years in 2019, we had 527 million in early pay offs compared to 487 million in 2018 and 506 million in 2017.
As we continue to emphasize prudent risk management and portfolio quality approximately 50% of the Q4 payoffs were attributable to either M&A related events or prudent credit management.
With the growth of our debt investment portfolio and an increase in the average size of our loans, we expect quarterly payoffs throughout 2020 to remain elevated and lumpy.
Our focus will remain on sustainable long term performance and total shareholder returns.
Net debt portfolio growth of 68.8 million in Q4 drove our debt investment portfolio to a record 2.17 billion at cost.
We had a record net debt investment growth for 2019, a 417.2 million, which exceeded the high end of our debt investment portfolio growth targets for 2019.
Credit quality on the debt investment portfolio improved slightly in Q4 with a weighted average internal credit rating of 2.15 as compared to 2.17 in Q3.
Our rated one credits as a percentage of our overall investment portfolio increased to 18% in Q4 from 11.4% in Q3.
Largely driven by a handful of companies continuing to perform above our initial expectations.
Our rated two credits as a percentage of our investment portfolio decreased to 55% in Q4 from 64% in Q3 and are rated four and rated five credits continue to make up less than 3.5% of our entire debt debt portfolio.
Nonaccruals remained low with three debt investments on nonaccrual with a cumulative investment cost and fair value of approximately 9 million and 1 million, respectively, or <unk>, 0.4% and zero percent as a percentage of the company's total investment portfolio at cost and value respect.
Thirdly.
During 2019, we had 16.5 million of net realized gains across our investment portfolio.
Largely driven by M&A activity and several public market dispositions.
Our diverse and well structured balance sheet is designed to provide a long term focused and sustainable investment platform and give us the flexibility to drive growth when we feel prudent.
We ended Q4 with over 235 million of liquidity.
Which was further strengthened by EUR 120 million private placement of unsecured bonds in early February.
Our Q1 quarter to date, ATM issuances of 35 million as well as the 400 million expanded and enhanced credit facility that we announced earlier today.
Seth will provide greater details in his remarks.
We have made substantial progress in Q1 towards our goals of reducing our cost of capital strengthening our liquidity position and improving our balance sheet flexibility.
We continue to see strong loan demand and transaction deal flow driven partly by the continued strong pace of us venture capital investment activities, which ended the year with more than 103 billion invested in over 46 billion raised according to Dow Jones and pitch books Q4.
Venture monitor respectively.
Assuming market conditions remain favorable we are anticipating all exit activity to continue at a steady pace.
In 2019, 882 exits represented over 256 billion in exit value According to venture monitor.
Evidencing, our team's ability to pick the right companies to partner with in 2019 Hercules capital had 12 companies complete their ipos and 13 companies complete M&A events.
Although we are very early in 2020, and we expect election year market volatility as we approach November we remain optimistic by what we believe lies ahead.
Our focus in the first half of this year will be centered on three specific items.
First enhancing and strengthening our balance sheet and liquidity position both of which we believe differentiate Hercules from others in this space and provide us with the unique ability to fund our companies across numerous value inflection points.
[noise] out the need for them to seek debt capital elsewhere.
We have taken several steps to not only enhance our liquidity position, but also drive dark drive down our cost of capital and these steps remain active and ongoing.
Being long liquidity is something that we believe will position us well to be aggressive and opportunistic moving forward.
Second remaining disciplined underwriters of credit, where we underwrite each deal based on its specific credit attributes and not on what others may be doing to gain market share or a portfolio of assets.
The competitive landscape remains heated and in certain instances, we would rather slow growth than chase deals, where we do not believe the underwriting is warranted from a credit perspective.
We have recently been passing on a higher number of the opportunities we are evaluating largely based on our credit screens.
Using our scaling plot, sorry third using our scale on platform more aggressively for the right opportunities and to expand our product set.
I would now like to spend a few minutes discussing our shareholder distributions.
With our debt investment portfolio at 2.17 billion net cost.
Our eni per share in Q4 generated 119% coverage above our quarterly based distribution of 32 cents per share.
In addition to our quarterly based distribution of 32 cents per share in Q4, we also declared a supplemental distribution of eight cents per share.
In the aggregate. This brings our total declared distributions to shareholders for 2019 to one dollar and 42 cents, representing an increase of nearly 13% compared to 2018.
This also represents the fourth consecutive quarter, where the company's strong performance has allowed us to deliver an increased distribution to our shareholders.
In addition to our quarterly income exceeding our base distribution. We are also fortunate to have been able to grow our undistributed spillover to an estimated 68 million or 67 cents per share based on weighted average shares outstanding subject to final tax filings for 2019.
This provides us with tremendous flexibility with respect to our variable based dividend going forward and the ability to continue to invest in our team and platform as we discussed during 2019.
While at the same time optimizing total shareholder return.
In closing.
Our performance in Q4, and the full year 2019 was impressive on many fronts, but would it would not have been possible without the tremendous work and effort demonstrated by each of our talented employees across this organization.
In January of this year, we announced another record breaking milestone when we crossed $10 billion in cumulative debt commitments since inception.
I would like to close by acknowledging and thanking the nearly 500 different companies and management teams that have been a part of the Hercules story since 2004.
And they are incredible VC and sponsor investors, who have all contributed to our success by choosing to make Hercules capital their preferred partner of choice.
Thank you very much and I will now turn the call over December.
Thanks, Scott and good afternoon, ladies and gentlemen, this was another strong quarter for Hercules capping off a record year with over 1 billion in fundings credit remains strong in Q4 with non accruals remaining below a half percent of total investments on a cost basis.
To support our growth in 2019, we successfully raised more than 130 million in equity and 350 million in debt ending the year with a stronger and more diversified balance sheet.
Subsequent to year end, we've made further substantial progress on both of these fronts.
We have continued prudently using leverage to improve our returns to shareholders.
Our Aro AG or Eni over average equity increased to 15.4%.
For the fourth quarter, and our Aro AA or Eni over average total assets was 7.3% above our average is 7% for the full year.
The year was a testament to the strength of our franchise.
Related to scale the platform and access the capital markets on an as needed basis.
And grow where and when we saw the right opportunities today, we announced a further increase to our amnio AFG syndicated credit facility capacity to 400 million inline with the growth of our balance sheet.
The facility is larger in size has improved pricing and offers include prove flexibility.
Every lender in our existing and new AFG facility participated in the expanded facility.
In addition to several new lenders being added.
We are grateful for their partnership and support the further strengthening of our capital and liquidity position will ensure that we're well positioned in 2020.
Today I'll focus on the following areas income statement performance in highlights any the unrealized and realized activity.
Leverage and finally outlook.
With that let's turn our attention to the income statement performance and highlights.
Net investment income was a record 40.1 million or 38 cents per share in Q4.
Quarter over quarter increased from 37 cents per share in Q3.
Total investment income increased by 1.9% to 70.6 million compared to the prior quarter supported by a 2.9% increase in total investor interest income due to portfolio growth in the fourth quarter.
Fee income decreased in the quarter, despite higher pay offs largely due to the vintage in size at the one time and unamortized fees associated with the loans that paid off.
I would emphasize again this quarter that the growth we have in the portfolio over the full year has created a baseline at which we can cover the base dividend without depending on nonreoccurring or non core income.
For context compared to the full year 2018 core in in that interest investment income has increased 30.2%.
Our effective in core yields in the fourth quarter were 13% and 12.3%, respectively compared to 13.4% and 12.4% in the third quarter.
The primary driver for the decrease in the effective yield was again related to the size of the onetime and unamortized fees associated with the loans that paid off.
The core yield reduced slightly due to the fed rate cut in October however, the average coupon rate across our debt portfolio remained above 10% in Q4.
Net investment income margin further increased to 56.8% in the fourth quarter compared to 56.1% in the prior quarter.
The reason for the increase was primarily due to the higher levels of core income.
Due to the portfolio growth, while maintaining our operating expenses.
Turning to expenses, our total operating expenses for the fourth quarter remained flat at 30.5 million compared to 30.4 million in the third quarter.
Interest expense and fees increased to 16 million from 15 million in the prior quarter commensurate with the increased fundings.
SGN a expenses decreased to 14, and a half million from 15.4 million in the prior quarter.
The main driver for the decrease was lower legal costs compared to the third quarter, which was partially offset by increased discretion, but discretionary and variable compensation as a result of the company's increased debt fundings and strong performance in the quarter.
As a reminder, our discretionary and variable compensation will fluctuate on a quarterly basis, depending on our funding and related activity as well as our overall performance against key corporate goals and objectives.
Finally, our weighted average cost the debt was 5% a small reduction compared to 5.1% in the prior quarter.
Now, let's switch to focus to the navy unrealized and realized activity.
During the quarter are any of the increased by 47.4 million.
Or 17 cents per share to $10.55 per share. The main drivers for the increase were 37.4 million of new equity raised at an average premium of 33% to the year end and event the through our ATM program and earnings in the quarter exceeding the.
Dividend paid.
Our 1.7 million of unrealized gains were largely driven by improvements in the biotech sector. The key drivers of unrealized gains were approximately 1.8 million of mark to market appreciation in the equity and warrant portfolio.
Offset by approximately <unk> point 1 million of depreciation on the loan portfolio.
The 2.9 million of realized gains were comprised of 3.2 million of gains from the disposal of three publicly traded equity positions offset by losses from the expiration of certain legacy warrants.
Next I'd like to discuss our leverage.
At the end of the quarter, our GAAP and regulatory leverage was 115% and 101.8% respectively.
Which increased compared to the third quarter due to the funding.
Growth in the quarter, partially with the credit facilities.
We continue to manage the business to ensure that we remain below our communicated leverage point of approximately 125%.
Consistent with this we've raised an additional 35.2 million of new equity capital App under the ATM program.
Quarter to date in Q1 and at the current time, we do not see a need to raise equity capital in the short to medium term above and beyond what we are able to raise using our ATM.
Earlier this month, we announced the successful issuance of 50 million a five year dated notes and a private placement with a fixed coupon of 4.28%, which is well below our current cost of debt.
At the same time, we announced the commitment to draw an additional $70 million for a total of 120 million in June with a fixed coupon of 4.31% on the later tranche.
This offering done with institutional investors together with the increase in the credit facility announced today further strengthened strengthens our balance sheet and liquidity position and demonstrates our ability to attractively tap the capital markets. When we feel if Britain to do so.
As a reminder, our early payoffs in normal amortization provide us with significant monthly inflows that we can use to de lever when and as needed.
We will closely monitor macro political and market conditions in determining future potential debt and equity capital timing.
Finally, let's.
Address our expectations on outlet points as a result of the multiple rate reductions by the fed in 2019, we are updating our core yield guidance to 11.5% to 12.5% for 2020.
As a reminder, the majority of our loans are issued with a floor, which mitigates some of the potential downside as a result, the impact of rate decreases is not linear when compared to the impact of rate increases as of yearend approximately 63% of our portfolio.
Is that the contractual floor.
For the first quarter, we expect SGN, a expenses of 15, and a half to 16 and half million.
We expect our borrowing costs to increase slightly due to the increased activity in the quarter and greater use of our credit facilities.
Finally, although always predicts a difficult to predict we expect a 100 to 150 million in prepayment activity for the quarter.
In closing as we put our record breaking year behind US we believe Hercules capital is well positioned to prudently grow and further scale our platform and deliver strong shareholder returns in 2020.
I will now turn the call over to the operator to begin the Q in a part of our call creates over to you.
All right, ladies and gentlemen, you have a question at this time. Please press Star then the number one key essential telephone if your question how.
Are you wish to remove yourself from the Q. Please press the pound game.
Your first question comes from the line esteem Hayes from B. Riley FBR. Your line is open.
Hey, good afternoon, guys and congrats on a really strong quarter end year.
My first question and I'm going to start with the dividend here as they did last quarter.
It's the third consecutive quarter of covering the dividend with Eni and this quarter was especially healthy I understand that there is some pressure on core yields.
But it sounds like your outlook is fairly positive you have a very strong liquidity position and I spillover buffer. So can you just explain your decision or the I know, it's a board decision, but maybe give us some context around why the quarterly dividend is being held flat at 32 cents right now and if either the impact from the code.
Grown a virus outbreak and or the uncertainty around the November election played into that.
Sure. So thanks for the comments, Tim with respect to the to the dividends specifically I think we're in a very fortunate position you referenced a couple of points. There we have $68 million spillover roughly 67 cents per share on a weighted average shares outstanding basis, we had eni in the quarter that covered that based distribution.
119% and we have a fairly optimistic outlook per our comments.
When we think about the dividend, we're really focused on total shareholder distributions were very proud of the fact that our total distribution declared distributions in 2019 were $1.42 up over 13% from where they were in the year prior period, our base dividend. We look at as we always have on a variable basis and that's something that we.
We evaluate together with our board on a quarterly basis.
We are very grateful for the fact that we're in a unique position, where we have tremendous flexibility on a go forward basis. Once we get a little bit more visibility into Q1 will sit down with our board and we'll discuss what we believe makes the most sense for our business going forward, we will obviously evaluate whether or not we think can increase to the based distribution is appropriate we all.
So have the flexibility to the extent, we think it's prudent to do so to continue to deliver supplemental distributions on a quarterly basis and we're going to look at both of those things in conjunction with market conditions and then make the determination in Q1 that we think is most prudent with respect to our business.
Okay got it yes, that's helpful. I appreciate the context around that and I guess, just the latter part of that question was.
Two.
I guess it was more relating to the dividend by whether the impact from the krona virus outbreak or the uncertainty around the November election played into that.
Are you with the election less than nine months away and and obviously the Kona virus outbreak still very much President you know have you ship did I mean do you expect any direct impact on your portfolio companies from from Krona virus or are you shifting your behavior at all.
Tim I guess reflect these events.
So specifically with respect to krona virus. The answer is no. We have very little if any exposure outside of one portfolio company directly to the Asian and Hong Kong markets. So we really don't expect to see any direct impact with respect to the virus specifically, we do see a scenario where the virus will create some increased overall.
Our mark to market or macro volatility over the next quarter or so and that's something that we're certainly watching but that really doesn't play into our thinking at the current time with respect to the dividend I think the thing that I would probably focused on a little bit more so would be and we've talked about this on the last few calls when we think about our base dividend, we're really focused on our business.
It is core income so the the income that our portfolio generates excluding any impact from nonrecurring or onetime events. So when we look at what we think is the most prudent based distribution. We are excluding for internal purposes any impact from prepayment penalties, which is sort of reflected on our income.
Segment in the fee income line.
And that number if you look at it with respect to Q4 is in that sort of 30 334 cents, so still exceeding the base distribution, but thats. The number that we're more focused on relative to the 38 cents of overall eni in the quarter.
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Okay.
Got it that's helpful.
And one more for me.
I guess the third.
Point of focus you mentioned for 2020 was using Scott your scale and your platform to more aggressively I guess expand the product set and please correct me if I.
Mitch Misquoted you there but.
I know that you've talked about some new lending initiatives to help expand the pipeline.
Maybe in the context of that third point of view going to expand on that and how thats helped your pipeline over the past three to six months.
Sure. So I think a couple of things there so one.
As an organization, we've done a great job at enhancing and strengthening our balance sheet. We've taken several steps to lower our cost of capital. We've taken several steps to increase the overall flexibility that we have with respect to the funding of our loans and you saw that throughout 2019 in our growth over 415 million.
$1 of growth on the debt investment portfolio, our asset base now is approaching $2.5 billion, our debt portfolio is approaching $2.2 billion and we're going to use the fact that we've achieved scale a little bit more aggressively on a go forward basis in the market. There are a number of deals historic.
Really that we saw that we thought were very strong credits and largely driven on pricing concerns. We chose to let those go we now have the ability given that we've achieved scale and given that we've significantly lowered our overall cost of capital to go after those deals a little bit more aggressively and thats something that I think you're going to see from us.
In both Q1 and in Q2.
The second thing is now that we have again achieved that sort of point of scale. There are some things that we're going to continue to do on the product side that we think will add to our growth objectives for 2020, we talked throughout 2019 about some of the tweaks that we made from a product perspective that enhanced and accelerated our growth. There are some continued ongoing.
Going efforts that were going to continue to roll out in the market in Q1 in Q2 that we think we'll have a similar effect with respect to growth on a go forward basis.
Understood and.
Probably are limited in what you can say, but can you just elaborate on those efforts a little bit.
Yes.
Fortunately, we're not because when we tend to talk about things publicly others start to.
And then make us so we're going to we're going to stay away from that but once we once we get through a couple of quarters I think it will be fairly clear.
What we're doing in how we're trying to take advantage of that in the market. Okay understood well, Congrats again and thanks for taking my questions. Thanks, Tim.
And your second question comes from the line of Avon from Piper farmland, Sir Your line is open.
Good afternoon, everyone.
Aaron.
Just curious I might audio cut out briefly so I might've missed this in your growth or your outlook commentary, but any specific guidance in terms of your expectations for growth this year.
So we're going to what we're going to give some guidance with respect to growth expectations on the Q1 call still relatively early in Q1, we're off to a very strong start if you look at the release that we put out we gave some disclosure in the subsequent events section through the middle of February we've already closed 172 million.
New commitments, we have another 72 million or so of signed commitments. So about 250 million of commitments through the February 14th date, So off to a tour fairly strong start and we're continuing to be optimistic with respect to what we're seeing in the market. What we're going to wait to see how Q1 plays out and that will provide some overall growth.
Targets on the Q1 call.
Okay and then.
It sounds like you're doing more with your existing customers maybe that plays into the to the growth outlook. I think you mentioned that your top five and 10 customers represented 17 and 29% of the portfolio I.
I guess it suggests.
Larger credits sizes can you maybe give us offensive.
Hi, how large you are willing to.
Let some of these bigger relationships become.
Sure. So the average funded loan for us in 2019 was approximately $20 million, that's up slightly but not materially from where it was a year ago. So I think it was about 18 Enap 19 million in 2018, it was a little bit north of 20 million on an average basis in two.
2019, so you've seen the average size creep up a little bit.
The largest deal that we did in 2019 was $150 million commitment we believed that our platform in our balance sheet today gives us the ability to do that on a more frequent basis subject to the underlying credit warranting that size of commitment.
When we've gone that aggressive without large in the past its largely been a tranche or milestone based facility and we've seen and we are continuing to see a number of opportunities across our portfolio for the better performing credits that have achieved scale or achieved significant value inflection points to structure larger more custom tailored longer term financing solution.
And that would allow us to stay long those credits longer than we historically were able to do so.
Okay and then.
Maybe one for for SaaS, given it sounds like you're continuing to make investments in the platform and people I guess when you look at your non interest expenses.
Theres percentage of investment income or assets.
How do you think about operating leverage going forward do with given the investments that you might still be looking to make can you give you extract better operating leverage as we head into 220 20 or how should we think about that yeah as a great question. So.
We actually approved as we move throughout the year, we did have the spike in the middle of the year at 3.3%.
And we ended the year down around two and a half 2.6%. So we would expect that we'll be at that level for the three year 2020 and.
We.
Our continuing to invest if you look at our long term average back to 2016 were 2.6%. So we're operating a little bit below that.
And.
The investment in the platform that we flagged at the end of Q3 and expect to continue to get ready for a 3 billion.
That certainly will be impacting that it will keep it up.
But I would say that you should expect it to be around where we ended for the year.
Okay, and just a reminder, any separation costs coming here in the and the next quarter too.
So we fully disclosed the separation agreement there was a delayed.
Payment.
Two of them, we're amortizing that in but they're not material to our expense.
Okay. Good stuff. Thank you for taking my questions I appreciate it.
Thanks Aaron.
Your next question comes from the line of Chris York from JMP Securities. Your line is open.
Okay.
Hey, guys. Thanks for taking my questions.
Only have two of them Scott it's been about maybe a year since were named interim CEO I think close to seven months. Since you are named CEO. So now that you are cemented here is a leader of Hercules and your stock is close to an all time high you maybe in a position to be more offensive. So could you update us on any growth priorities for the company's.
Strategically over say the next 12 months.
Sure. So look I think youre going to can continue to see us be aggressive when and where it makes sense, but our focus with respect to our investment business on a standalone basis is really going to be on those three things that I mentioned number one we are going to continue to do things to enhance and strengthen our liquidity position.
The entire management tier team here is very focused on being long liquidity, given what we expect to be some increased market volatility in turbulence in the second half of the year.
The second thing that we're going to continue to be laser focused on will be maintaining our disciplined underwriting standards. We think that we are.
Unique given that we are singularly focused on underwriting and structural integrity versus sort of a growth at all costs mentality and we're going to continue to make sure that that's a priority for us with respect to the base business.
And then third we're going to continue to use I think a little bit more aggressively the scale that we've been able to achieve I would add to that that we're now in a fortunate position, where we do have obviously some advantages and I think you will see us look a little bit more aggressively as some strategic initiatives and strategic alternatives. We're currently looking on a couple of things in the market we're going to.
Be very picky, and choosy and selective with respect to what we will do in that regard, but we are as you pointed out in a little bit of a unique position given our stock position given the performance of our business and given our liquidity position, where if we see something that we think makes sense. We are in a position to take advantage of it and I think will be a little bit more willing to do that on a.
Go for basis than we were last year.
That's great color no you're limited from what you can kind of say there.
But just trying to get a sense we are willing to so thank you.
And then second question is.
Looking back in the rear view mirror again, it's been two years since you acquired Gibraltar and notice that the preferred equity investment continues to gradually grow. So could you just update us on the growth at Gibraltar and then any expectations for income potential on that preferred investment maybe in 2020 or in 2020 month sure I'll hand.
Well the first part and then Seth can speak to the second part on the first part it's a portfolio company of ours. So we don't disclose any specific information about their performance that they don't disclose specifically on their own but I can tell you at a high level that business has continued to perform very well and it is certainly meeting our expectations across the board that company.
Announced on their own that in 2019, they crossed the 100 million dollar Mark from a portfolio perspective for the first time and Thats something that was a significant achievement and milestone that we're very proud of and we're proud to be UN partnered with that team.
Both historically and on a go forward basis. The company continues to perform well we have no intention at the current time to do anything in terms of the monetization of that investment and then I'll mill assets provide color on any potential.
Dividend or distribution discussions yen. So currently there aren't any.
Distribution discussions where certainly.
Glad that they continue to grow generate income and are able to reinvest that into their platform.
We do have the loan arrangement that we disclosed in the supply related to that so there is income that comes into Hercules related to that.
But no dividend plan at the moment.
Very helpful. That's it for me congratulations on very successful year.
Thanks, Chris.
Your next question comes from the line of Casey Alexander from Compass Point. Your line is open.
Hi, good afternoon.
A couple of questions. One the you converted a pretty high percentage in the quarter of your gross.
Of your commitments into fundings around 84%.
Generally that has been running you know in this 70% area is are we working towards a new norm on that in the way that your structuring investments.
No. So great point with respect to Q4, but that's really just specific to the quarter of if you look at our business historically over the last several years on a quarterly basis on the low end, we've been at about 60% on the high end, we've been at about 85%. This quarter, we happen to be at the higher end of that largely driven by the number of investments that we had to exist.
Being portfolio companies.
Overall from a a per annum perspective in 2019 $1.5 billion of commitments $1 billion. A funding. So that ratio is very consistent with what it was in each of the last two years.
Okay, great. Thank you very much for for that clarification. Secondly, you did call out in some let's call it less than rational competitive behavior as it relates to deals are there new pockets of capital a new competitors that have entered the market that are crew.
Creating so some of this.
Less than stellar behavior.
We're not going to mention or discuss names, but the answer. The question is largely yes, I think you've seen a little bit of a bifurcation in the market over the last quarter or so the the legacy players in both the venture space and the growth cap space I think of continue to be fairly prudent given that most of us that had been in the space for some time.
Im understand what it takes to run the portfolio of cash flow negative growth stage investments and so you havent seen sort of the same irrationality with respect to the legacy or incumbent players. There are some newer players in the market who have raised some some pools of capital that are being incredibly aggressive with respect to the structure.
During both deals.
We're seeing every one of those deals and what we've told our investment team as if the deal doesn't make sense for us on a credit perspective, we're happy to let someone else do it we've been through that story before we know how that story ends and we've got a strong enough portfolio. When we've got strong enough demand that makes sense for us where we don't need to chase those types of deals at this time.
Alright, great.
Thank you and one last question.
For those of us have been covering the company for a while we remember that.
At the last election, essentially Hercules sort of you shut down for a short period of time around the election and you discussed your expectations for volatility later in the year would you think that that perhaps a deal opportunities might pull forward to the first half of the first half might be more active than the second half.
Simply because.
BCS and sponsors want to get things done before the election, all period arises, yes, I think based on what we're seeing now we expect.
We expect more opportunities in the first half than we do in the second half, but it's early in the here so it's difficult to predict in sort of.
Foreshadow, how thats going to play out we do expect as a company there to be increased market volatility as we get towards the second half of the year. How it plays out I don't think anybody here on this call can tell you, but we do expect it to be fairly volatile. So it would be would make sense from our perspective for demand and interest degree decrease so.
Lightly I would counterbalance that though with and you've been following us for a while so you know this one of the bigger competitive threats that we tend to lose deal two deals to happens to be right. The equity markets. So when the equity markets either on the public side or the private side, our strong that's something that we compete with with respect to the deployment of capital.
So if the market gets more volatile towards the second half of the year the equity markets become a little bit more turbulent public capital raises particularly on the biotech side become a little bit more difficult, we actually could see a case where demand.
For our product actually increases so we're going to wait and see how it plays out but I think intuitively, we would expect the first have to be a little bit stronger than the second half just given what we're looking at today.
Alright, great. Thanks for taking my question Scott I appreciate it sure. Thanks Casey.
Your next question comes from the lineup Brian car from Jefferies. Your line is helpful.
Hi, Good afternoon, guys. This is Ryan car on for John Hecht, Congratulations on the great quarter.
Thanks Ryan.
Yes. So my first questions related to your balance sheet, obviously, you've done a very good job at optimizing that over the past several quarters and we saw the renewal of the facility up by up to 400 million and new ABS debt and very very enhanced use of your ATM program Im just curious in the context of all of that were.
Where do you see here near term leverage goals going over the next several quarters. They eat. This this quarter you saw in debt to equity above one 100% and.
What do the immediate impacts that and.
Any any additional capital raises or debt raise the near term.
No not in the near term thanks to the question Ryan but.
I think for.
Our balance sheet, we will continue to try to optimize liquidity.
Manage the overall leverage position, we've communicated that our leverage point that we're trying to be approximately below is 125.
We'll continue to do that so that's why you're going to continue to see a balanced strategy of a little bit equity a little bit of.
That when we need it but what we really wanted to do by announcing and working with union on the and the announced a credit facility expansion today was really.
Make it so that we don't need to Russia. The market every time that we need additional capital.
Our core activity is obviously.
The business activity on the front side, and we want to have enough liquidity and capital available to conduct the business when we want to do it and so what we're trying to do is make sure that we're focused on that core activity. We're not racing to market every moment and we have the ability to draw a deeper with the size of our balance sheet Scott mentioned large.
Our loan.
Average that continues to go up.
And so thats what are our strategy is about is one managing it to stay at a reasonable level of leverage to having superior liquidity compared to our competitors.
And three tapping the equity markets, when we need to but on a very deliberate basis and opportunistically.
Thank you for that and my second question is related to the two of your rate sensitivity.
Especially given the impending rate outlook that you noted that about 63% of your loans now at LIBOR floors incorporated.
Moving forward or you are all of your loans being originated with those LIBOR floors, and then can you maybe quantify the upwards and downwards effect to NIM when when those rates move.
Sure So Ryan, but 85 plus percent of our investment book on the debt side, it's actually prime based it's not LIBOR based so LIBOR based sensitivity is is a fairly insignificant immaterial part of our business.
With respect to the prime based portion of our business, which again is about 85% of our 2.2 billion dollar debt investment portfolio 97, plus percent of those loans are structured with a contractual floor in place and Thats why if you look at our press release, you'll see the downside that we had with respect.
To further rate cuts is not linear with respect to what we would see it to the extent the rates moved in a different direction.
63% on or about of our current debt investment portfolio book is now at its contractual floor every time, we do and amendment or restructuring we're looking for ways to continue to increase that and Thats something that we'll continue to do want to go for basis.
Thank you for that and then last question for me.
We've been consistently out old out, earning the distribution definitely saw great performance than that in this quarter. You noted earlier that you look every you look quarter to quarter of what you're going to do at winter weather with respect to paying out a special or potentially raising the quarterly distribution mean, what what's what are the characteristics for what your decisions are going.
To be either.
On either side and what would make you ultimately raise that the quarter to quarter distribution and it's a combination of the two things that we hope that we spoke about a little bit earlier number one it's just our outlook on both macro and our specific.
Investment business and secondly, we tend to really focus on the portfolio his ability to generate core income. That's sustainably covers that base distribution. If you look at our business throughout 2018 and in the early parts of 2019 and you isolate.
And I per share to core versus non core there were periods during those times, where core income was not at the 32 cents or the 31 cent historical based distribution. This is really the first time in the last two quarters, where our core income on a per share basis is either meeting or exceeding that base distribution.
Brian and Thats something that we're going to spend a lot of time looking out in Q1, and when you look at that combined with the fact that we have the $68 million of spillover. It really puts us in a great position with respect to driving total shareholder returns. This year, because we have the flexibility to look at both the base distribution as well as the supplemental quarterly distribution.
Thanks, very much guys for answering my question.
Sure.
Your next question comes from the line of Ryan Lynch from KBW. Your line is open.
Hey, Good afternoon, guys first question I wanted to follow up on a question regarding the dividend that was that was helpful color around your guys thoughts around the core dividend, but I wanted to talk about that the supplemental dividend a little bit. It's the fourth quarter on the road grow did you guys have paid a supplemental dividend out theres. Some other bdcs out there we have a little bit more.
For me a formula based approach will double Pat X percentage of earnings.
We have kind of their core dividend I'm trying to get a sense of your guys last for Supplementals about one cents two cents three cents to now eight cents can you talk about what framework you into board used to decide whether to pay a supplemental dividend and really more particularly the size of the supplement a dividended you got.
These are paying on a quarterly basis sure. So we've certainly looked at you know, there's obviously a bunch of different ways to to deal with distributions with respect to the spillover you can distribute all of it you can distribute some of it it can be formulaic. It can be variable you can use it once you pay the excise tax to reinvest in the business and in the platform and those are all things that we've looked at.
And thought about we are going to think about potentially a more formulaic approach, but our view historically in our view currently is that maintaining a variable policy, both with respect to the base distribution and any potential supplemental distribution.
Gives us the maximum flexibility with respect to the growth prudent growth of our business.
Our focus is on driving total shareholder returns and Thats Whats the board and the management team and all of our 78 employees will continue to be focused on throughout 2020 and once we get through Q1 will have the discussions with our board to figure out what we think makes the most sense with respect to driving total shareholder distributions in 2020.
But also maintaining maximum flexibility to be able to continue to invest in our platform and take care take advantage of market opportunities that we think we'll be out there.
Yes.
Okay. That's helpful color and then.
Your investment into for alter the fair value has increased by about $10 million in the past year.
Can you provide some context of what drove that increases it because its retaining earnings is the profitability of the business. I know you mentioned it to had grown meaningfully as the profitability of the business increasing as such were warrants a better valuation can you just kind of walk through the puts and takes of what drove that $10 million increased in the fair value.
The last year churn, so I'd point to two things one.
As I mentioned, we continually see them reinvesting the profits that they are generating into their business and that drives up the valuation in itself and then of course, there's the market comparative so.
Operations like Gibraltar, the valuations are going up comparatively so we continually look at the overall benchmark in that market.
Due in evaluation send it externally for a second opinion on what the valuation would be and we see that industry that sector.
Improving over time, and I'll, just add to that Ryan without giving anything that we can't disclose in terms of the specific numbers in each of the key metrics that we evaluate for Gibraltar and that that management team evaluates for their own business.
Each metric was a record results for that company in 2019, so substantial growth in all key areas of that business F. Why 19, O'brecht why 18 and that certainly contributed to the growth of our.
Our valuation.
Okay.
That makes sense those are all my questions I appreciate the time this afternoon.
Thanks Ryan.
Your next question comes from the line of seen Alicia from Wells Fargo like your line is open.
Hi, guys. Good afternoon, Thanks for taking my question.
Most of that asked and answered one.
Comment.
On the Q in a Scott.
You mentioned lower cost debt.
Affording you the ability to lean in a little more on something that's you know lower priced lower.
Lower risk lower priced.
Just thinking about that you know it's been.
Over time, a little bit of a trend for you, but you've generally.
You know the platforms maintained its core yields.
And.
No.
Beyond that.
The lower cost debt that allows you to do this.
I can stick a bigger things like lower DNA or a higher stock price. So you probably has the ability to do this anyway.
If you really wanted to go lower in core yields. So I'll just leave it there for you to comment am I thinking too much here or does it should we see a late cycle more defensive but markets push.
For the Hercules platform.
Sure so far but if we gave the impression that were materially driving down core yields were certainly not.
You're correct that historically, we have always maintained a core yield somewhere between 11, and a half and 13% obviously prior to the fed rate increases throughout 2017 2018.
We were on the lower end of that and then as the fed increase them. We drove our core yields up to 12 812, nine and then with the three fed cuts in 2019. The core yield has now come back to 12.3, we're very confident but on a portfolio level. We can continue to maintain core yields inside of our target range, which is 11 and a half to 12 and.
5% based on what we're seeing right now in the first half of the year, we expect to be pretty close to the midpoint of that range. Both in both with respect to Q1 in Q2.
We've done a lot of things as you pointed out and as we highlighted on the call to really drive down our overall cost to capital and the operating efficiency of our business. The unsecured bond offering that we did in February was done at 50 million. If it was done at 4.28% $70 million. It was done at 4.31% the four.
Hundred million dollar credit facility that we announced this morning is a reduction from a cost perspective. This is being Donna at L 250 versus the the legacy.
And facility that we had that was at the 270. So we've made a lot of progress with respect to driving down our cost of capital and we're going to use that reduction in the cost of capital to be a little bit more aggressive on select higher profile later stage a more stable credits.
We don't think thats going to have a material impact on our ability on a portfolio level to continue to deliver core yields inside of that range of 11.5% to 12.5%.
Thank you appreciate that context, and then just.
More higher level, one on the venture capital ecosystem, that's obviously been very strong and you've been well positioned for that.
But seeing the money coming in there.
I think toward on on the core middle market private equity side, where there's.
More money being raise then then good deal flow.
Would you say that.
No that applies as much due to our Vcs is is there all the money they want to be raised and and scarcity and deal flow out there or do you think they have is still a good.
Return proposition still abundant investment opportunities.
You were pretty optimistic about the overall ecosystem, particularly the way 2019 wrapped up 2019 was the second consecutive year, where when you exclude strategic investments. So just looking at pure BC from invested equity dollars.
The number exceeded $100 billion for the second year in a row fundraising activity also continued to be very strong in 2018 VC firms within our addressable market raised about $56 billion. The final 2019 numbers have the have the amount raised that at right around $50 billion, so continuing to see.
We have very healthy robust ecosystem, we've seen no slowdown with respect to the number of deals that we are looking at and evaluating our current pipeline is sitting at about $1 billion as I mentioned, the one thing that we have seen as we noted is that on certain of the deals. There are certain lenders that are doing some things structurally that we don't think our defense.
Couple or sustainable and with respect to those specific opportunities, we're going to let them go and continue to pick and choose the deals that we think makes sense for our shareholders and stakeholders.
Very well that's all for me at all congratulate you all as well for the quarter in here. Thank you.
Thanks.
I'm showing no further questions at this time I would now like to turn the conference back our presenters for any closing remarks.
Thank you operator, and thanks to everyone for joining our call today, we look forward to reporting our progress on our Q1 2020 earnings call.
Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank all for joining from an all disconnect.
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