Thank you for standing by and welcome to Hercules Capital Fourth Quarter and Full Year 2023 Financial Results Conference call. At this time, all participants are on a listen-only mode. After the speaker's presentations, there'll be a question-and-answer session. [Operator Instruction] Please be advised that today's call is being recorded. I will now return the conference to your host, Mr. Michael Hara, Managing Director of Investor relations. Please go ahead.

Thank you, Valerie. Good afternoon, everyone, and welcome to Hercules conference call for the fourth quarter and full year 2023. With us on the call today from Hercules are Scott Bluestein, CEO and Chief Investment Officer, and Seth Meyer, CFO. Hercules financial results were released just after today's market close and can be accessed from Hercules' Investor Relations section at investor.htgc.com. An archive webcast replay will be available on the investor relations webpage for at least 30 days following the conference call. During this call, we may make forward-looking statements based on our own assumptions and current expectations. These forward-looking statements are not guarantees of future performance and should not be relied upon in making any investment decision. Actual financial results may differ from the forward-looking statements made during this call for a number of reasons, including but not limited to, the risks identified in our annual report on Form 10-K and other filings that are publicly available on the SEC's website. Any forward-looking statements made during this call are made only as of today's date and Hercules assumes no obligation to update any such statements in the future. And with that, I will turn the call over to Scott.

Thank you, Michael and thank you all for joining the Hercules Capital Q4 and full year 2023 earnings call. Following our record operating performance in 2022, Hercules Capital once again raised the bar higher and delivered record performance in 2023. 2023 was a banner year for Hercules Capital, where we set several new financial and performance records and I am incredibly proud of what our talented and growing team accomplished. Our record-setting performance in 2023 culminated with the strongest total and net investment income quarter in the company's history and the recent declaration of a new supplemental distribution program for our shareholders. Our performance in 2023 reflects the benefits of being able to operate an institutional venture and growth stage lending platform at scale, maintain robust liquidity and a strong balance sheet, and working with a best-in-class team with significant experience in this asset class. Thanks to the growth of both the BDC and our private credit funds business, Hercules Capital is now managing approximately $4.2 billion of assets, an increase of over 15% from where we were at year-end 2022. Despite ongoing market, macro and geopolitical volatility, which impacted growth stage companies throughout 2023, the continued strength and expansion of our origination platform, robust liquidity position and strong balance sheet put us in position to deliver achievements on multiple fronts in 2023, including record full year 2023 total gross fundings of $1.6 billion, an increase of 9.1% year-over-year. Record full year 2023 total investment income of $460.7 million, an increase of 43.2% year-over-year. Record full year 2023 net investment income of $304 million, an increase of 61.7% year-over-year. Four consecutive years of delivering supplemental distributions to our shareholders. And finally, strong net debt portfolio growth of over $240 million, which excludes the portfolio growth of our private fund business.…

Thank you, Scott and good afternoon, ladies and gentlemen. As Scott mentioned, this was another record quarter for Hercules Capital, capping off a record-breaking 2023. In addition to record investment activity in 2023, Hercules broke quarterly and annual records in many dimensions, including total investment income, net investment income, core income and many more, all while managing the balance sheet conservatively with low leverage and strong liquidity. In 2023, we further validated the benefits of operating at scale by demonstrating meaningful operating leverage as we grew assets under management to record levels. This allowed us to deliver NII margin of 70.2% in Q4, the highest that we have ever achieved. In 2023, our weighted average cost of debt remained below 5% and leverage remained conservatively low, putting us in a very strong position relative to others in our asset class. We were able to do this by proactively strengthening our balance sheet and liquidity positions early in the year by renewing our $400 million credit facility led by MUFG and putting in place a new committed letter of credit facility with SMBC to cover $175 million of our available unfunded commitment in a more cost-effective manner. We continued to supplement liquidity by raising net of fees $108 million with the equity offering in August and another $230 million throughout the year via our ATM program. We have started 2024 with nearly $750 million in available liquidity, a net regulatory leverage of approximately 72% in possession of our fourth green light letter from the SBA, which will provide $175 million of additional regulatory exempt leverage and a very small maturing private placement of $105 million in July. This positions us very well to invest in the strong pipeline Scott discussed, and be able to strategically time accessing the market for additional…

[Operator Instructions] Our first question comes from the line of Brian McKenna of Citizen JMP. Your line is open.

Okay, great, thanks. Good evening, everyone. So just a question on the dividend to start. It's clearly a record quarter of results, and as you noted, dividend coverage on a core basis totaled 140%. So, it would seem like the starting point for earnings in 2024 is quite a bit higher than the base dividend you announced yesterday. So, could you just walk us through the rationale about maintaining and not increasing the current base dividend?

Sure. Thanks, Brian. I think we've been pretty consistent over the course of the last several years in terms of how we manage the base distribution. We never want to set the base distribution at a number that we think would jeopardize our ability to maintain it irrespective of market and rate environment conditions. We set the base distribution based on our outlook for core income, where we essentially back out the benefit of any prepayments and accelerations. And right now, we want to continue to take a conservative position. That was the choice that we made with respect to Q4. We are continuing to deliver that out-performance to our shareholders via the supplemental distributions. This is the fourth consecutive year where we've been able to enhance the quarterly base distribution with an additional supplemental distribution. And we think that that's the right way to operate the business in the current environment. It certainly does not mean that that's not going to change on a go-forward basis. But that was the rationale for the decision to maintain $0.40 and declare a $0.32 supplemental distribution payable $0.08 per quarter in 2024.

Got it. Helpful. And then maybe just a bigger picture question for you, Scott. You know, so you noted Hercules has been operating the business for 20 years now. You've clearly seen a lot of evolution across the industry over this time, but when you think about the next five years or ten years plus, how do you see the sector evolving from here? And then what are you doing at Hercules today to make sure you're positioning the firm for this change over time?

Yeah. Thanks for the question, Brian. Yeah, I think when you look back over 20 years, it's a long period of time, and while that performance for us has been incredibly impressive, I think what's most unique about Hercules is how optimistic the team and I are about what the next five years to ten years look like, despite the tremendous success that we've had. Our firm has grown exponentially. We've maintained a very strong culture. We have always, since inception, operated the firm with a focus on serving our clients and the venture ecosystem exclusively. There are a number of opportunities in terms of platform expansion that we expect to continue to play out over the coming years. Over the last two years to three years, you've seen us rapidly build and grow our private funds business, and we really think that this is just the beginning of the next level of evolution for us as an operating company.

All right, great. I'll leave it there. And congrats on another great quarter.

Thanks, Brian.

Thank you. One moment, please. Our next question comes from the line of Crispin Love of Piper Sandler. Your line is open.

Thanks. Good afternoon. Just first, looking at fundings, they were a little softer in the 4Q versus prior quarters, but 1Q '24 commitments are very strong. So, what do you believe the biggest changes are since late 2023 to the fourth -- to the first quarter so far? Is some of that just timing? And then also looking out to the year, do you believe that fundings in 2024 should increase relative to the $1.6 billion you did in '23?

Sure. Thanks, Crispin. A couple of things. The benefit of being an internally managed BDC is that we do not need to chase deals if the quality does not meet our expectations. In Q4, we saw a tremendous amount of deal flow and we thought that a lot of it, frankly, did not meet our underwriting standards. And so, we chose to be a little bit defensive. We still had a very strong quarter in Q4, $413 million of commitments. We funded $307 million. We funded some great new companies and we were able to expand our funding relationship with several companies that are in the current portfolio and are outperforming expectations. Starting in Q3 of last year, we gave some pretty clear guidance that we expected the new deal environment to improve in 2024. That was based on conversations that our teams were having with companies in market. If you think about the way most of our business works where companies raise equity capital every 12 months to 14 months --12 months to 18 months, you can sort of model in the cycle of fundraising for those companies and we expected to see a tremendous increase in later stage quality companies coming to the table in early 2024. And that's exactly what has happened so far. You mentioned the pipeline and it's the strongest that it's ever been, both in terms of closed commitments quarter-to-date and signed commitments quarter-to-date. Our team, through February 13, has already closed $552 million of commitments. We have another $500 million-plus in signed, non-binding commitments. And so, we feel very good about what our funding trajectory will look like. We don't provide full year guidance with respect to funding numbers, but certainly if we continued on the trajectory that we're seeing to start the year, we would expect to exceed that $1.6 billion number that we achieved last year.

Thanks, Scott. That all makes sense. And then just on expenses. Seth, as you said, you came in below the SG&A guide, looks to be primarily driven by lower comp and benefits expenses, I think that line was down over 30% sequentially. You mentioned [in the release] (ph) that it was due to lower variable comp, but what was the reason there just given the strong results? And what does that mean for that line as you start 2024? Should there be a pretty big jump there in the first quarter?

Yeah, and that's why it guided higher Crispin. So, you hit the right punchline that we would expect a reversion back to normal. But it was based on the lower funding volume in Q4 and that's what really drove the variable comp portion of the accrual. It's that simple.

Okay, sounds good. Thank you and appreciate you taking my questions.

Thanks, Crispin.

[Operator instructions] One moment, please. Our next question comes from the line of Christopher Nolan of Ladenburg Thalmann. Your line is open.

Hey, guys. Hey, Seth, the RIA dividend of [1 to 1.5] (ph), is that quarterly or annual?

That's quarterly. Good question. Yeah, I should have emphasized that. Thanks, Chris.

Also, back to the earlier dividend question. Your excise tax seems to be growing a bit year-over-year. Is -- could we see, while you're keeping the base dividend steady, a supplement on top of the one you just announced just to manage the excise tax expense?

Yeah, well, it's two dimensional. One, we keep the base dividend at a level that we believe is sustainable through an entire interest rate cycle. Two, we do distribute an additional supplemental level to make sure that we are keeping the excise tax in check, but also, the requirement as a registered investment company that we need to distribute 90% of our income. So, we're balancing all those dimensions out, making sure that we're returning the income to the shareholders, retaining what we can and should for building out the infrastructure and the structure for future investment, but it is a balancing act between those, and the excise tax would naturally go up as our income levels go up. So, the small amount that we're retaining is certainly going to attract a higher amount of nominal tax at a 4% rate.

Got you. And then I guess a final, broader question. Following the demise of SVB, I presume more of your portfolio companies are banking at a broader array of banks. Given the threat posed to that sector by commercial real estate, how do your investment loans -- did -- what portion of your portfolio companies have a bank facility ahead of your loans?

Hey, Chris, a couple of, a couple of things there. First, I would not characterize it as the demise of SVB. It was certainly the demise of SVB, as we all once knew the firm. But the firm is continuing to operate under the First Citizen's umbrella. We continue to see them in the market from time to time. We've done a handful of transactions with them and so the firm didn't, all of a sudden, in March of last year, just go away. Obviously, they're rebranded and the team has changed quite a bit, but we are still seeing them in the market. We made the comment in the prepared remarks about our first lien exposure. That first lien exposure has been moving up steadily throughout 2023, and we ended the year at about 89%, which is the highest we've had since 2017, that gives you a pretty good indication of a couple of things. Number one, we are managing the business more conservatively, and we're focusing in on first lien exposure. And number two, banks in general are just being a little bit less active. So, we're able to get more deals done alone than historically we have been able to, and so that really speaks to both of those points at the same time.

Okay, thanks, Scott.

Thanks, Chris.

Thank you. One moment, please. Our next question comes from the line of Ryan Lynch of KBW. Your line is open.

Hey, good afternoon. First question, I wanted to kind to circle back around to some of the previous comments you made regarding just the level of activity you're experiencing thus far in 2024 because it's been quite remarkable. If I look at the gross debt and equity commitments you did in all of 2023, it was $2.2 billion. If I look at the investments, you've closed and pending commitments you've done in the first 45 days of 2024, it's $1.1 billion. So, it's half of the amount you did in the entire year of 2023. I'm just curious, I know you said -- you provided some commentary on why there was a pickup. I'm just curious, in addition to what you said, is there any change in the size of average position you were looking at? Are you targeting larger businesses and larger companies in this marketplace? Is that part of the reason that you're seeing such a big uptick in commitments? Or is it purely just that much activity and that much higher quality, favorable activity occurring in 2024?

Sure. Thanks, Ryan. Couple of things there. First, I just want to point out the $1.1 billion is not just through 45 days. Right? $551 million of that has actually closed through the first 45 days, and then that next $500 million is signed as of the 45th day. So, we would expect that that $505 million, which is signed, if it gets through our diligence process to, you know, sort of get to the closing side of things over the next 30 days to 60 days. So, don't think of that $1.1 billion as something that we've done in 45 days. I would think of it as something that we would expect to do over the first 90 days to 115 days of the year. So, still incredibly impressive. But I just wanted to point that out. In terms of the second part of the question, it's primarily just based on activity. There is certainly a component of, we are looking at, as we've signaled the last several quarters, larger, more scaled, more stable businesses. That is an intentional shift that we've made. We continue to be of the view that a lot of the smaller companies that received financing historically are going to struggle to receive equity support on a go-forward basis. So, when we think about things from a risk-adjusted return perspective, we want to focus right now and we're going to continue to focus on larger, more scaled, more stable businesses. And we think that that's the best thing to do for our shareholders long term. If you look at it in terms of average dollars per deal, the numbers are up slightly, but it's not really materially increased from where it was throughout 2023.

Okay, understood. And then on the guidance you gave regarding the advisor, I think you said and correct me if I'm wrong, $2.5 million to $3 million of RAA expense reductions and then $1 million to $1.5 million from the RIA for dividend. So, that's $3 million to $4.5 million of total value that's going to come back to the BDC from either expense reductions or dividends. That's a pretty big jump from certainly what you were doing in kind of the beginning of 2023 and even from the most recent, this fourth quarter, in just total value that the RIA is generating. Can you talk about what's really driving that sizable increase in value coming back to BDC shareholders recently?

Sure. Thanks, Ryan. So, $2.5 million to $3 million is not actually outside of the scope of what we've been doing on a per-quarter basis. We had a little bit lower allocation on the fact that our total SG&A costs went down in the fourth quarter, as discussed previously on the variable comp accruals. And so, there's nothing abnormal about that, although the portfolio does continue to grow, that we're managing in the private funds, and therefore, it absolutely is driven and connected to that. Originations are the biggest portion of our expense allocation on a per-quarter basis. So, the variable comp that is associated with originating new deals is something that also gets tacked and allocated to those deals that are allocated or originated by the RAA managed funds. So, there's a direct relationship there. What comes up and is new is this a $1 million to a $1.5 million per quarter of the dividend flow coming into Hercules capital, the BDC, and then ultimately to our shareholders that we had guided from the very beginning that this would eventually come as soon as the RIA managed to overcome the original establishment costs, as it was getting started and generating enough of a carry and a management fee to start paying the dividend to the BDC. So absolutely in line with what the original guidance is. It just looks like a lot right now because we had a lower allocation in Q4, and these are the initial dividend flows that are occurring.

Okay, makes sense. I appreciate the time this afternoon and really great quarter, guys.

Thanks, Ryan.

Thank you. One moment, please. Our next question comes from the line of John Hecht with Jefferies. Your line is open.

Hey, guys, thanks for taking my questions and congrats. First question is, you've grown a lot. You've got very, very low nonperforming assets. And your leverage is, in the context of your targets, pretty low. I'm just wondering for this year, should we think about some sort of desire to increase leverage, or how do we think about your target leverage ratios as you grow this year?

Thanks for the question, John. No change in terms of our guidance for leverage. You've been following us for a long time, so you'll appreciate the comment. We've always sort of run the balance sheet conservatively. Right now, we're running it conservatively and we're taking a defensive posture. So, we're running it at even lower leverage than we typically do. I think our expectation is, given our funding goals for 2024, that leverage will increase slowly throughout the year, but we would expect to continue to manage the business from a balance sheet perspective, conservatively, with low leverage and long liquidity.

Okay. And then maybe can you talk about LTV and spreads on recent transactions and how that, you know, maybe has changed over the course of the last few months?

Sure. LTV is pretty consistent with our historical underwriting. The range for us, if you look at our publicly reported data over the last several years, has been on the very low end 5%, on the very high end 20%. The majority of deals that we're doing currently are in that sort of low teens from an LTV perspective. And I think that's what we're going to continue to target short to medium term here. And then in terms of spreads, you know, we're not seeing a lot of pressure right now on spreads. Seth just updated our guidance in terms of core yield. We expect to continue to be in that very high 13%, low 14% from a core yield perspective, and we've done a great job or the Seth's done a great job in terms of managing the liability side of the balance sheet to maintain those spreads, which have continued to increase over the last several years as the rate environment has improved in our favor.

Great. Thanks very much, guys. All my other questions have been answered.

Thanks, John.

Thank you. I'm showing no further questions at this time. Let's just turn the call back over to Scott Bluestein, CEO, for any closing remarks.

Thank you, Valerie. And thanks to everyone for joining our call today. As a final note, we will be participating in the UBS Financial Services Conference on February 26 to the February 29 in Miami. If you are interested in meeting with us at this event, please contact UBS directly or Michael Hara. We look forward to reporting our progress on our Q1 2024 earnings call. Thanks, everybody.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.