Hercules Capital(US:HTGC)2022-02-22 21:31Part I Business Hercules Capital is an internally managed specialty finance company providing senior secured loans to high-growth, venture-backed firms in technology, life sciences, and sustainable technology sectors - Hercules Capital is a specialty finance company providing senior secured loans to high-growth, innovative venture capital-backed companies in technology, life sciences, and sustainable/renewable technology industries21 - The company operates as an internally managed, non-diversified Business Development Company (BDC) and has elected to be treated as a Regulated Investment Company (RIC) for tax purposes2830 - The primary business objectives are to increase net income, net investment income, and NAV by investing in debt with warrants or equity, targeting attractive current yields and potential for equity appreciation22 - Since its inception through December 31, 2021, the company's team has originated structured debt, debt with warrants, and equity investments in over 500 companies, representing more than $13.0 billion in commitments4795 - As of December 31, 2021, the investment portfolio had a weighted average investment grading of 2.10 on a scale of 1 (least risk) to 5 (most risk)89 Portfolio Composition by Industry (Fair Value, Dec 31, 2021) | Industry | Percentage of Portfolio | | :--- | :--- | | Drug Discovery & Development | 39.7% | | Software | 24.1% | | Internet Consumer & Business Services | 16.3% | | All other industries | 19.9% | Risk Factors The company faces significant risks from its internally managed BDC structure, concentrated investments in volatile sectors, substantial leverage, and market factors like interest rate fluctuations and the LIBOR transition - As an internally managed BDC, the company is dependent on key personnel, particularly CEO Scott Bluestein, and faces limitations in offering competitive compensation structures compared to externally managed BDCs, which could impact talent retention183184185 - The company operates in a highly competitive market, competing with larger entities that may have a lower cost of funds, potentially forcing Hercules to accept less attractive investment terms188 - With the minimum asset coverage ratio reduced to 150%, the company can incur additional leverage, which increases the risk of investing by magnifying potential gains and losses197199 - The investment portfolio is concentrated in technology-related sectors, with 80.1% of fair value in three industries as of year-end 2021, making the company vulnerable to downturns in these specific sectors258259 - The COVID-19 pandemic continues to pose a risk by potentially disrupting portfolio companies' operations and their ability to meet debt obligations, which could lead to increased defaults and losses379380 - The discontinuation of LIBOR and transition to alternative rates like SOFR may affect the value of financial obligations and could cause disruptions in credit markets, impacting the company's portfolio245246247 - The company's Notes are unsecured and structurally subordinated to the indebtedness of its subsidiaries, including the secured SBA debentures, meaning holders of secured debt have priority claims on assets in a liquidation367368369 Unresolved SEC Staff Comments The company reports that it has no unresolved staff comments from the SEC - None425 Properties The company does not own any real estate. It leases its corporate headquarters in Palo Alto, CA, and maintains additional leased offices in Boston, New York, Bethesda, Westport, Chicago, San Diego, and London - The company leases approximately 14,500 square feet for its corporate headquarters in Palo Alto, CA, and has 7 other leased offices in the U.S. and the United Kingdom426 Legal Proceedings The company may be involved in litigation in the normal course of business but does not expect any current matters to materially affect its financial condition or results of operations - The company is not currently involved in any legal proceedings that are expected to have a material adverse effect on its financial condition or results of operations427 Mine Safety Disclosures This item is not applicable to the company - Not applicable428 Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Hercules Capital's common stock trades on the NYSE, with a variable distribution policy aiming to distribute 90-100% of taxable income quarterly, and an 'opt-out' dividend reinvestment plan 2021 Quarterly Stock Price and Distribution Data | Quarter | NAV per Share | High Price | Low Price | High Price to NAV | Low Price to NAV | Distribution per Share | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Q1 2021 | $11.36 | $16.60 | $14.21 | 46.1% | 25.1% | $0.37 | | Q2 2021 | $11.71 | $17.66 | $15.98 | 50.8% | 36.5% | $0.39 | | Q3 2021 | $11.54 | $17.56 | $16.50 | 52.2% | 43.0% | $0.39 | | Q4 2021 | $11.22 | $18.07 | $16.14 | 61.1% | 43.9% | $0.40 | - The company's distribution policy aims to distribute 90-100% of its taxable quarterly or potential annual income448 - The company maintains an 'opt-out' dividend reinvestment plan, under which 248,041 shares were issued in 2021438449 - No common stock was repurchased on the open market during 2021, 2020, or 2019. A prior $25.0 million repurchase plan expired in June 2019442553 Management's Discussion and Analysis of Financial Condition and Results of Operations In 2021, total investment income slightly decreased to $281.0 million, while net realized gains significantly reversed prior losses, maintaining a stable $2.4 billion investment portfolio and strong liquidity Portfolio Value Comparison (Fair Value) | Portfolio Component | Dec 31, 2021 (in millions) | Dec 31, 2020 (in millions) | | :--- | :--- | :--- | | Debt Investments | $2,200 | $2,100 | | Equity Investments | $184.7 | $224.7 | | Warrant Investments | $38.4 | $34.6 | | Total Portfolio | $2,400 | $2,400 | Key Operational Metrics (2021 vs 2020) | Metric | 2021 | 2020 | | :--- | :--- | :--- | | Total Investment Income | $281.0M | $287.3M | | Total Net Operating Expenses | $131.0M | $130.1M | | Net Investment Income | $150.0M | $157.1M | | Net Realized Gains (Losses) | $20.9M | ($56.1M) | | Net Change in Unrealized Appreciation | $3.3M | $126.2M | | Net Increase in Net Assets | $174.2M | $227.3M | | Basic EPS | $1.50 | $2.02 | - During 2021, the company received approximately $1,185.0 million in aggregate principal repayments, of which $1,104.1 million were early repayments from 49 portfolio companies478 - As of December 31, 2021, the company had $627.7 million in available liquidity, including $133.1 million in cash and available borrowing capacity under its credit facilities and SBIC license541 - The company's regulatory asset coverage ratio was 218.9% as of December 31, 2021 (excluding SBA debentures), well above the required minimum of 150%542 - The non-GAAP Core Yield on the debt portfolio was 11.4% in 2021, compared to 11.6% in 2020. This metric excludes one-time income events like early payoff accelerations481489491 Quantitative and Qualitative Disclosure About Market Risk The company's primary market risk is interest rate volatility, with 94.0% of its loan portfolio having variable rates, and a 100 basis point increase would raise annual net income by approximately $18.0 million - As of December 31, 2021, approximately 94.0% of the company's loans had variable interest rates, making its income sensitive to changes in Prime and LIBOR rates576 Annualized Impact of Interest Rate Changes on Net Income (as of Dec 31, 2021) | Basis Point Change | Net Income Change (in thousands) | EPS Change | | :--- | :--- | :--- | | +200 | $36,629 | $0.32 | | +100 | $17,936 | $0.16 | | +50 | $8,965 | $0.08 | | -50 | ($44) | $0.00 | | -75 | ($47) | $0.00 | - The company does not currently engage in hedging activities against interest rate or foreign currency fluctuations but may do so in the future578 Financial Statements and Supplementary Data This section presents the audited consolidated financial statements for fiscal year 2021, including key statements and schedules, with an unqualified opinion from PricewaterhouseCoopers LLP on financial statements and internal controls - The independent registered public accounting firm, PricewaterhouseCoopers LLP, provided an unqualified opinion on the consolidated financial statements and the effectiveness of the company's internal control over financial reporting as of December 31, 2021584 - The auditor identified the valuation of Level 3 investments (senior secured debt, unsecured debt, preferred stock, common stock) as a critical audit matter due to the significant management judgment and use of unobservable inputs required593594 Consolidated Statements of Assets and Liabilities As of December 31, 2021, total assets were $2.60 billion, with total investments at fair value increasing to $2.43 billion, and total net assets rising to $1.31 billion Consolidated Balance Sheet Highlights (in thousands) | Account | Dec 31, 2021 | Dec 31, 2020 | | :--- | :--- | :--- | | Total Investments, at fair value | $2,434,522 | $2,354,078 | | Cash and cash equivalents | $133,115 | $198,282 | | Total Assets | $2,600,013 | $2,623,997 | | Total Debt (net) | $1,236,303 | $1,286,638 | | Total Liabilities | $1,291,466 | $1,332,293 | | Total Net Assets | $1,308,547 | $1,291,704 | | Net Asset Value per share | $11.22 | $11.26 | Consolidated Statements of Operations For 2021, total investment income was $281.0 million, with net investment income at $150.0 million, leading to a net increase in net assets from operations of $174.2 million Consolidated Income Statement Highlights (in thousands) | Account | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Total Investment Income | $280,976 | $287,258 | $267,874 | | Total Net Operating Expenses | $131,008 | $130,118 | $124,602 | | Net Investment Income | $149,968 | $157,140 | $143,272 | | Total Net Realized/Unrealized Gain | $24,187 | $70,121 | $30,326 | | Net Increase in Net Assets | $174,155 | $227,261 | $173,598 | | Basic EPS | $1.50 | $2.02 | $1.71 | | Diluted EPS | $1.49 | $2.01 | $1.71 | Notes to Consolidated Financial Statements The notes detail accounting policies, fair value measurements, investment composition, and debt obligations, highlighting that 93.6% of the portfolio is Level 3, and subsequent debt refinancing activities - As of December 31, 2021, approximately 93.6% of the company's total assets were investments valued in good faith by the Board (Level 3 assets), highlighting the subjective nature of the portfolio's valuation702 - The company's debt portfolio is primarily senior secured, with 77.0% of debt investments in a first lien position as of December 31, 2021781 - Subsequent to year-end, in January 2022, the company issued $350.0 million of 3.375% notes due 2027. In February 2022, it used the proceeds to fully redeem its $230.0 million 2022 Convertible Notes and its $150.0 million 2022 Notes899900901 - On February 16, 2022, the Board declared a Q4 cash distribution of $0.33 per share and a supplemental cash distribution of $0.60 per share, to be paid in four quarterly installments of $0.15897 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure This item is not applicable to the company - Not Applicable904 Controls and Procedures Management, including the CEO and CFO, concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2021, a conclusion confirmed by PricewaterhouseCoopers LLP - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of the end of the period covered by the report905 - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2021, based on the COSO Framework909 - The effectiveness of the company's internal control over financial reporting was audited by PricewaterhouseCoopers LLP, which concurred with management's assessment910 Other Information This section provides an updated table of fees and expenses, with total annual expenses at 9.87% of average net assets for 2021, and a detailed 10-year history of senior securities Annual Expenses (as a % of net assets for YE 2021) | Expense Category | Percentage | | :--- | :--- | | Operating expenses | 5.11% | | Interest and fees paid on borrowed funds | 4.75% | | Acquired fund fees and expenses | 0.01% | | Total annual expenses | 9.87% | - The Senior Securities table provides a historical overview of the company's various debt facilities, including credit facilities, SBA debentures, and multiple note issuances, from 2011 through 2021923924 - Total senior securities outstanding were $1.25 billion as of December 31, 2021, with an asset coverage per unit of $2,046926 Part III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the company's 2022 Proxy Statement - This section incorporates information by reference from the company's 2022 Proxy Statement935 Executive Compensation Information regarding executive compensation is incorporated by reference from the company's 2022 Proxy Statement - This section incorporates information by reference from the company's 2022 Proxy Statement936 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information on security ownership of beneficial owners and management is incorporated by reference from the company's 2022 Proxy Statement - This section incorporates information by reference from the company's 2022 Proxy Statement937 Certain Relationships and Related Transactions and Director Independence Information on certain relationships, related transactions, and director independence is incorporated by reference from the company's 2022 Proxy Statement - This section incorporates information by reference from the company's 2022 Proxy Statement938 Principal Accountant Fees and Services Information regarding principal accountant fees and services is incorporated by reference from the company's 2022 Proxy Statement - This section incorporates information by reference from the company's 2022 Proxy Statement939 Part IV Exhibits and Financial Statement Schedules This section lists all financial statements, schedules, and exhibits filed as part of the Form 10-K report, including audited financials and various corporate agreements - This section lists all financial statements, schedules, and exhibits filed with the Form 10-K, including corporate governance documents, debt indentures, credit agreements, and executive certifications941968 Form 10-K Summary This item is not applicable to the company - Not applicable943