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Edited Transcript of HTGC earnings conference call or presentation 2-May-19 9:00pm GMT

Q1 2019 Hercules Capital Inc Earnings Call

PALO ALTO May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Hercules Capital Inc earnings conference call or presentation Thursday, May 2, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael W. Hara

Hercules Capital, Inc. - MD of IR & Corporate Communications

* Scott Bluestein

Hercules Capital, Inc. - Interim CEO & CIO

* Seth Hardy Meyer

Hercules Capital, Inc. - CFO

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Conference Call Participants

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* Christopher Whitbread Patrick Nolan

Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research

* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* John Hecht

Stephens Inc., Research Division - MD

* Ryan Patrick Lynch

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Timothy Paul Hayes

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Hercules Capital First Quarter 2019 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Michael Hara, Managing Director of Investor Relations. You may begin, sir.

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Michael W. Hara, Hercules Capital, Inc. - MD of IR & Corporate Communications [2]

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Thank you, Nicole. Good afternoon, everyone, and welcome to Hercules conference call for the first quarter of 2019. With us on the call today from Hercules are Scott Bluestein, our Interim Chief Executive Officer and Chief Investment Officer; and Seth Meyer, our Chief Financial Officer. Hercules first quarter 2019 financial results were released just after today's market close and can be accessed from Hercules Investor Relations section at htgc.com. We have arranged for a replay of the call at Hercules web page or by using the telephone number and passcode provided in today's earnings release.

During this call, we may make forward-looking statements based on current expectations. Actual financial results filed with the Securities and Exchange Commission may differ from those contained herein due to timing delays between the date of this release and in the confirmation of the final audit results. In addition, the statements contained in this release that are purely historical -- 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 to differ materially from those expressed in the forward-looking statements including, without limitation, the risks and uncertainties, including the uncertainty surrounding the current market turbulence and other factors we've identified from time to time in our filings with the SEC.

Although we believe that the assumptions on which these forward-looking statements are reasonable, any of those assumptions can prove to be inaccurate, and as a result, forward-looking statements based on those assumptions also could be incorrect. You should not place undue reliance upon these forward-looking statements. The forward-looking statements contained in this release are made as of the date hereof, and Hercules assumes no obligation to update the forward-looking statements or subsequent events. To obtain copies of related SEC filings, please visit our website at hgtc.com.

With that, I will turn the call over to Scott.

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [3]

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Thank you, Michael, and good afternoon, everyone, and thank you all for joining us today. Q1 was a standout quarter on multiple fronts for Hercules. As our leading position in the venture lending market continues to grow and strengthen, it affords us optionality that no other venture lender possesses. Our unique and proprietary origination platform combined with our internally managed structure is designed to deliver long-term industry-leading shareholder returns. There are many approaches to venture lending, but none of them possess the proven ability to scale and deliver the level of sustained and consistent credit quality that Hercules has been able to demonstrate. The breadth, depth and diversity of our investment portfolio, which crossed $2 billion in Q1, is unmatched. In addition, the constant and diligent monitoring and communication with our 93 portfolio companies provides us with key leading economic visibility that helps us to navigate and mitigate risk on a forward-looking basis.

In Q1, our deep and experienced team of best-in-class investment professionals delivered new debt and equity commitments of $414.8 million, our second highest in history. We funded $239.6 million during the quarter while maintaining a modest level of available unfunded commitments of $154.2 million or only 7.2% of total assets. We carefully monitor and manage our unfunded commitments to ensure that we will always be in position to meet our borrowers' needs as and when they arise. Net debt portfolio growth of $160.5 million drove our debt investment portfolio to a record $1.9 billion at cost.

Our total investment portfolio grew by approximately 9% quarter-over-quarter and is up 40% from where it was in Q1 of 2018. This strong growth was achieved with the same underwriting discipline and credit focus that we have demonstrated on a consistent basis. As an internally managed BDC we are simply not incentivized to grow our asset base at the expense of credit quality.

Of the $414.8 million of Q1 commitments, $210 million was closed in the second half of March clearly demonstrating the tremendous commitment, dedication and resilience of our investment team and platform. Since the close of Q1 and as of April 30, 2019, Hercules has closed new debt and equity commitments of $153.5 million and has pending commitments of $150.7 million in signed nonbinding term sheets. Year-to-date through April 30, 2019 our closed and pending new debt and equity commitments are at $719 million. As you can see, our deal pipeline remains healthy and robust and our ability to close deals that meet or exceed our historical standards for quality remains unabated.

We remain optimistic by what we're seeing so far in Q2 2019 as we continue to be selective in our valuation of and the potential conversion of our new deal pipeline currently at over $1.2 billion. While the top of our deal funnel has expanded, I will reiterate that we remain committed to the same underwriting discipline and credits focus that we have always maintained. We continue to pass on the vast majority of the deal opportunities that our investment team screens and evaluates despite the continued strong competitive environment in our core markets.

To support our optimistic growth outlook for 2019, we added 2 new investment professionals in Q1. We will continue to be both opportunistic and selective as we add to the investment team and other areas of the organization throughout the year with a focus on ensuring that we are positioning the company for continued strength and managed growth. With our total investment portfolio now at $2.1 billion at cost and our debt investment portfolio at $1.9 billion at cost combined with the size and quality of our pipeline and our current earnings spillover at $0.38 per share, we made the decision to increase our quarterly base distribution to $0.32 per share. In addition, we also announced a supplemental distribution of $0.01 per share. As a reminder, our board maintains a variable distribution policy. So we will continue to evaluate the distribution as we move further into 2019. As we anticipate adding further to our scale, we have begun to modestly increase the use of leverage as previously stated with Q1 coming in at 114.9% on a GAAP basis and regulatory leverage, excluding our SBA debentures, coming in at 99.9%.

However, consistent with our previous guidance and conservative historical approach to leverage, we intend to be prudent as we manage leverage in 2019 to our desired target of 1.25x and gradually step up above that level thereafter, if market conditions and deal quality remain favorable in 2020 and beyond. Credit quality remained consistent in Q1 with the weighted average internal credit rating of the debt investment portfolio at 2.19 as compared to 2.18 in Q4 2018.

Our rated one credits as a percentage of our overall investment portfolio went down slightly to 15.8% in Q1 from 18% in Q4 largely driven by payoffs of several rated one credits that we were anticipating. Our rated 2 credits as a percentage of our overall investment portfolio increased to 55.7% in Q1 from 51.1% in Q4 and our rated 4 and rated 5 credits continue to make up less than 4% of our investment portfolio at fair value.

Nonaccruals remained at historic lows. With 2 debt investments on nonaccrual with a cumulative investment cost and fair value of approximately 2.4 and $0.5 million respectively or 0.1% and 0.02% as a percentage of the company's total investment portfolio and value respectively. We will continue to be vigilant and focused on credit, both from a macro and portfolio perspective as we move into the second half of 2019.

We remain focused on delivering an investment portfolio that is intentionally diversified by stage, sector, geography and sponsor. After 15 years and over $8.9 billion of cumulative commitments, we believe that this is the best way to drive long-term sustainable shareholder and franchise value. During the first quarter, we closed new debt and equity commitments with 10 and 8 existing portfolio companies. The scale that we have now achieved and the size of our investment portfolio provides us with the unique ability to fund our borrowers through multiple value inflection points as they continue to grow and expand our own businesses. The profile of the 10 new companies that we made debt and equity commitments to during Q1 reflect our focus on delivering an investment portfolio that is highly diversified. We do not ascribe to the model of focusing singularly or exclusively on any one or group of sectors or sponsors. We continue to see and realize very strong loan demand and transaction deal flow volumes driven in no small part by the robust U.S. venture capital only investment activities, which invested $24.6 billion and raised $15.5 billion during the first quarter of 2019.

In addition, with many of the highly anticipated unicorn IPOs taking place as VCs monetize their investments in these companies, it will provide another influx of future funding for investments in the next 2 to 3 years. Year-to-date 2019 we have had 7 of our own portfolio companies, Stealth BioTherapeutics, Avedro, X4, Lightspeed, Lyft, Pinterest, and TransMedics complete their IPO debuts. Fastly has publicly filed and we have 3 additional confidential filers.

Assuming market conditions remain favorable, we are anticipating a very healthy pipeline of portfolio company IPOs for the remainder of 2019 and M&A exit activity in our portfolio to continue at a steady pace. M&A transactions continue to make up the majority of liquidity events for venture-backed companies. Historically 90% of all exits are M&A related with Q1 '19 being at 95%. 173 companies were acquired for $30.7 billion in total versus 10 IPOs, raising 3.3 billion in Q1.

Given our strong start to 2019, we anticipate seeing continued NII growth in 2019 along with sustained portfolio growth and stable yields assuming, of course, market conditions remain favorable. Our performance in Q1 truly underscores the amazing depth and level of talent, discipline, and diligence that our origination team has put forward and further all of our employees' contributions towards our continued growth and increasing shareholder returns. We take enormous pride in our human capital and advancing shareholder value. I would like to conclude by acknowledging and thanking each and every one of our 75 employees, 93 active borrowers and key VC and sponsor partners for the tremendous support that we have received. Being able to partner with some of the most dynamic companies and with some of the most creative and leading entrepreneurs while remaining focused on building shareholder value is what drives this team each and every day.

Thank you very much, everyone. I will now turn the call over to Seth.

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Seth Hardy Meyer, Hercules Capital, Inc. - CFO [4]

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Thank you, Scott, and good afternoon, ladies and gentlemen. As Scott mentioned, this has been a very strong quarter for Hercules. We delivered record investment income totaling $58.8 million and had meaningful NAV appreciation per share. Our early payoff levels reduced to $47.5 million, which is the lowest Hercules has experienced on a quarterly basis since 2015. This combined with a healthy loan growth helped our debt investments grow $160 million to $1.9 billion at cost. Today I want to focus on the following areas. Number one, the income statement performance and highlights, number 2, NAV unrealized and realized activities, number 3 liquidity and number 4, expenses and related outlook points.

With that, let's turn our attention to the income statement performance and highlights. Adjusted net investment income per share on a pro forma basis, excluding the onetime effect of the early repayment of the 2024 notes, was $0.32 a share. Total investment income increased by 3.4% to $58.8 million in the first quarter compared to $56.9 million in the previous quarter. Lower early payoffs resulted in noncore income declining from $2.8 million in the prior quarter to $1.6 million in the first quarter. This was more than offset by the effect of the increase in the weighted average principal balance of our debt portfolio quarter-on-quarter resulting in a 5.8 increase in reoccurring core income.

Our effective and core yields in the first quarter were 13% and 12.7% respectively compared to 13.5% and 12.9% in the fourth quarter of 2018. The primary reason for the decrease in the effective yield was due to the lower early payoffs that I mentioned. The reason for the decrease in the core yield was due to a reduction of the expired commitment income of approximately 22 basis points. The fourth quarter of 2018 had a higher than normal level of expired commitment income. Removing this effect, the core yields in the underlying portfolio were nearly identical in the current and the prior quarter. While the competitive landscape has driven down yields broadly, we expect core yields for 2019 to remain between 12.5% and 13%.

Net income margin reduced to 49.4% in the first quarter compared to 53.8% in the prior quarter. A large portion of that decrease was related to the early repayment of the 2024 notes. Excluding that impact of $1.6 million in expense, the pro forma net income margin for Q1 was 52%.

Our return on average equity was 12.8% for the first quarter compared to 13.6% in the prior quarter. Adjusting for the same impact of the early repayment of the 2024 notes, the pro forma return on average equity was 13.5%.

Turning to expenses. Our total operating expenses for the first quarter were $29.8 million compared to $26.3 million in the fourth quarter of 2018. The entire increase of the expense is related to interest and loan fees. The increase in interest and loan fees is related to the onetime noncash acceleration of the early repayment of the 2024 notes of $1.6 million along with a full quarter of the interest on the November 2018 securitization and the partial quarter of interest from the January 2019 securitization.

Our weighted average cost of debt was 5.8% for the quarter, which when the -- when you remove the onetime cash acceleration is 5.2% comparing favorably with the prior quarter's weighted average cost of debt at 5.3%.

Let's now switch to the focus on the NAV unrealized and realized activity. We saw our NAV increase by approximately $35 million or $0.36 per share to $10.26 per share principally related to the unrealized depreciation of the portfolio of $28 million. We also saw realized gains of $4.6 million. Our $28 million unrealized gain appreciation was driven by improvements in both the technology and life sectors, with the late 2018 market disruption largely being reversed along with increased market optimism in these sectors at the end of the quarter. To highlight this market movement the S&P Biotech Index, which declined 22.6% in Q4, increased by 25.7% in the first quarter of 2019. And similarly, the S&P Technology Index which declined 18.1% in Q4, increased by 19.4% in the first quarter of 2019. The increase of the $28 million can further be broken down into the components of $24.8 million of mark to market appreciation in the equity and warrant portfolio, and $3.1 million of appreciation in the loan portfolio. The $4.6 million of realized gains were comprised of $8.8 million of gains driven mainly by 2 significant excess and $4.2 million of losses driven in part by a loss on one debt position that was being carried at 0 and was on nonaccrual and the write-off of certain equity and warrant positions.

Next I'd like to discuss our liquidity position. We finished the quarter with $247 million in available liquidity, up from $156 million in the prior quarter. The first quarter liquidity was comprised of $16 million in cash, and $231 million of undrawn availability under our revolving credit facilities, which are subject to borrowing base, leverage, and other restrictions.

During the quarter, we announced the renewal of our $75 million credit facility with Wells Fargo that can accordion up to $125 million. And we entered a new Union Bank credit facility, which includes a syndicate of 4 new lenders for $200 million that can accordion up to $300 million.

Both facilities have enhanced terms from the prior facilities, and we have actively utilized the facilities throughout the quarter. Additionally, in January, we closed our fourth securitization of $250 million at 4.703%, which was partially used to repay $83.5 million of our 2024 notes that I've referenced several times. This was the repayment of the $1.6 million cash -- noncash acceleration expense.

Our strong liquidity position and consistent inflows from amortization and prepayments afford us flexibility in terms of when and how we access the capital markets. As mentioned by Scott, we've begun to modestly increase our GAAP and regulatory leverage at 114.9% and 99.9% respectively as of the end of the first quarter. With the expectation that early prepayments and normal amortization will increase for the remainder of year, and combined with the utilization of our ATM program, we can effectively manage leverage within our communicated target of 125% for 2019.

Finally, I'd like to address our expectations on expenses and related outlook points. For the remainder of the year, we expect our expenses to increase in line with the growth of the business that we've communicated. We will scale our borrowing and human capital costs with the market as it develops. For the second quarter, we expect SG&A expenses of $16 million to $16.5 million commensurate with the business growth we've seen year-to-date.

As mentioned previously, we expect our core yield to remain in the 12.5% to 13% range for Q2. Finally, although very difficult to predict, we expect $75 million to $100 million in pre-payment activity during Q2, followed by approximately $100 million in each of the remaining quarters of 2019. In closing, I see us very well positioned for 2019.

I will now turn the call over to the operator to begin the Q&A part of our call. Operator, over to you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from John Hecht from Jefferies.

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John Hecht, Stephens Inc., Research Division - MD [2]

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First one, just I guess, forgive me if you addressed this on the call. The loan fee expense moved up and I'm wondering is that a new base because of the increased size of the bank facilities or was there some incremental expenses because of those renewals this quarter?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [3]

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So the loan fee expense you said, John?

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John Hecht, Stephens Inc., Research Division - MD [4]

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Yes.

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [5]

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Yes. So it was 2 things there was one -- we had that one-off $1.6 million impact related to the repayment of the 2024 notes. And then the second dimension was that we had really the full quarter of the November 2018 securitization as well as a partial quarter of the January securitization that we did. And those were not in a full quarter at all for the 2018 November securitization wasn't in all of Q4 and certainly nothing related to the January securitization was in Q4.

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John Hecht, Stephens Inc., Research Division - MD [6]

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Okay, very helpful. And Seth, you guys have been using a more secure -- well, securitizations more frequently over the past several quarters. You've now got a lot of dry powder in bank facilities. I am wondering do you expect to pursue the same kind of mix of financing or would you modify things based on rates and how do we think about your strategy with liability management?

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Seth Hardy Meyer, Hercules Capital, Inc. - CFO [7]

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Sure. I think the set-up that we have is really good in using the credit facilities to warehouse, our new underwriting in the new positions, securitizing them into the market and then using the unsecured debt for positions that don't fit in any of those instruments, as well as although a smaller part of our business in our asset base, the equity and the warrant positions that we have. So I don't really think the strategy needs to change, but certainly the elements around us continue to evolve. And that may cause us to decide to lengthen the duration that we're looking for in the market on the unsecured side. We may take advantage of the lower interest rates that we see on the horizon now compared to even just Q4 when we are looking at things, not me, because I wasn't here, but as an organization when we are looking at the balance sheet. So I think that there is no wholesale plan to change anything, to answer your question, John. But we may makes slight different utilization of the buckets that we have available, based on the market conditions.

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John Hecht, Stephens Inc., Research Division - MD [8]

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Okay. And Scott, you referred to the top of the deal funnel expanding. And I'm wondering, when you mentioned that, is that just you're getting more looks at more opportunities as an organization? Or is it mean there is more I guess subsegments of technology and biotech that you're able to look at now?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [9]

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I think it's a combination of the 2, John. The DC market, broadly speaking, remains quite robust and strong which is partly what's driving our optimism and outlook for the remainder of 2019. The number of deals that the team is canvassing and screening and that we're looking at has increased substantially. Part of that is also driven by the fact that over the years our firm has significantly expanded the breadth of our platform and the capabilities that we have in terms of the types of companies and profiles that we can go after. So by virtue of that continued platform expansion, we're able to look at an increasing pool of available opportunities with it being very clear that the discipline and underwriting focused on the bottom end of that funnel remains as tight and as strong as it's been.

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Operator [10]

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And our next question comes from Tim Hayes from B. Riley FBR.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [11]

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First one just kind of a follow-up on capital. How do you think about prioritizing capital sources, while keeping your leverage target in mind and your expectations for growth? Do you think you have enough available liquidity between cash on hand, capacity on the credit facilities in the ATM programs to fund the pipeline you see in front of you today or do you anticipate needing to raise capital outside of the ATM program to support growth, whether it be an equity offering unsecured debt or doing another securitization?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [12]

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Yeah, Tim, I think that the only thing that you leave out in your list of what we have available is the reality that we expect paydowns to pick up for the remainder of the year. So we have that opportunity to recycle the capital that we already have deployed and is already part of our 114.9% leverage as of the quarter-end. So combined with that recycling, the normal amortization that we think that will pick up for the remainder of the year, the fact that we will continue to utilize our ATM program to kind of act as a governor on that leverage position and the continued borrowing that we do have available, even under the $125 million ceiling that we've self-imposed, we do think that we have the right mix to continue to write the business for the year. And we're not going to communicate our intentions as far as going to the market at any time but we'll continue to evaluate those positions as we move forward.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [13]

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Got it. Makes sense. Okay. And then you gave some guidance around repayments for the remainder of the year. I believe on the last quarter's call, you might have talked about kind of $300 million of net growth for the year and obviously this is a really strong quarter for you guys. I don't know if it's -- should we still be keeping that kind of loose target or just guideline, the $300 million as a guideline for the year or do you have any kind of updated expectations around that and sorry if I missed any guidance that was given on the call?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [14]

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No problem. So Tim, on the February call, we guided to $300 million to $400 million of net portfolio growth in 2019. Based on what we did in Q1, what we're seeing in Q2 and our outlook for 2019, we're very comfortable reiterating that guidance of anticipated portfolio growth of between 300 and $400 million in 2019.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [15]

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Got it. Appreciate it, Scott. And then one more for me. Just on the dividend increase, can you touch on exactly what factors went into that decision and -- to set it at $0.32. Does that let -- $0.32, does it reflect where earnings power is today and you expect to continue growing it as the portfolio and NII grow or is it set at a level that assumes you will continue to grow the portfolio and is kind of just stable for the foreseeable future?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [16]

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Yes, so I would remind you and we reiterate this on virtually all of our calls, right, we maintain a variable distribution policy. So on a quarterly basis obviously management is making recommendations to the board, but ultimately the board will determine what makes the most sense. Based on what we did in Q1, based on what we've already seen on a quarter-to-date basis in Q2, and based on our optimistic outlook for the remainder of the year, combined with where our spillover is, we were comfortable increasing the base distribution to $0.32. If you look at what the business did in terms of NII and the DNOI in Q1, that's a number that we obviously felt comfortable with increasing the base to. And in addition to that, we obviously issued the $0.01 of additional supplemental distribution. And we will, as we've always done on a quarterly basis, continue to evaluate what we think makes the most sense based on the market as it develops and ultimately the board will make that decision on a quarterly basis.

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Operator [17]

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And our next question comes from Ryan Lynch from KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [18]

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First one, Scott, there is substantial responsibilities and time commitments that really come with taking over as the CEO role. And that, given that you are still the CIO, you just can't commit the same amount of time to both of those functions. So can you just talk about how are you dividing your responsibilities and time today and then really particularly how are you making sure you're devoting enough time to the CIO function to ensure the investment process is really running as strong as it has in the past.

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [19]

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Sure. Thanks for the question, Ryan. So I'll reiterate something that I've said quite frequently over the last 45 or 60 days. The investment team at Hercules is incredibly deep, is incredibly experienced and is incredibly talented. And if you look at the growth and the trajectory of this business over the last 10 years that's been driven not by any one individual, but by the quality and the depth of that investment team. And that investment team today remains with the addition of 2 -- additions that we made in Q1, the same team that has helped drive the growth of this firm over the last several years. There are some senior members on that team who will obviously be asked to step up and take on some additional responsibility, and we'll evaluate those things and we'll make announcements about those things in the ordinary course when we are ready to do so.

But I'm very confident and comfortable that the depth and talent that we have on this investment team is capable of ensuring the same level of trajectory that we've had on a historical basis, continues on a go-forward basis. I am clearly now in a position where I'm allocating a significant amount of my time to a different role, but I can assure you that we will make sure that the investment team continues to function with that same level of discipline, focus and integrity that it's done so on a historical basis.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [20]

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Okay. And kind of on that point, you guys are off to a very strong start so far in the second quarter. Can you just provide a little feedback on -- or some color around what has been the feedback from existing and potential borrowers given the significant changes in management that occurred?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [21]

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Yes, as I said, tremendous support, tremendously positive feedback. I don't think that we would be as optimistic as we are if that weren't the case. You can see what we did in Q1 in terms of commitments, $414 million of commitments, north of $200 million of commitments closing in the last 2 weeks of March. We are off to an incredibly strong start in Q2 per my comments and remarks. And if you look at where we are on a year-to-date basis through April, we're north of $700 million of new debt and equity commitments. You can compare that to what we did in all of fiscal year 2018 where we delivered $1.2 billion of commitments, which was a record year for us.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [22]

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Okay, that's helpful. And then I wanted to follow up on the discussion around the dividend. I just want to make sure I am understanding that correctly, the variable dividend policy. Is your intention to kind of have a core dividend that you said and then the variable portion will come via the supplemental dividend that you guys are paying or when you say variable dividend policy do you expect the core dividend to kind of jump around, because you guys have historically kept the core dividend pretty solid and you guys have raised it recently? But I'm just trying to understand where the variable rate comes in as well as how you guys anticipate paying supplemental dividends in the future.

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [23]

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Sure. The base distribution has been $0.31 for several years. Despite the fact that it's been a consistent $0.31 per our public disclosure, we've always maintained a variable distribution policy. So the board reserves the right on a quarterly basis to evaluate the market, the strength of the firm, the trajectory of the firm and make a decision on the base distribution that they feel is in the best interest of the company and of course our shareholders. The decision was made to increase the base distribution to $0.32 based on the trajectory of the business, based on the confidence that we have in the base -- in the business and based on where we are today from an earnings perspective. The supplemental dividend is obviously -- distribution is driven by what our perspective is as it relates to the spillover. The spillover at the end of Q1 is now $0.38 per share. On that basis, we made a decision to issue an additional $0.01 supplemental distribution and that's the part that we will obviously continue to evaluate as we head further into 2019.

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Operator [24]

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And our next question comes from Christopher Nolan from Ladenburg Thalmann.

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Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [25]

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Scott, given Manuel was a pretty strong leader from my observation, how do you anticipate your management style to change? And do you anticipate that as a CEO, you would be more of a consensus builder going forward?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [26]

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Yes. So appreciate the question. My focus is on managing this business to the best of my abilities. I've been at this firm for 10 years. I've been named the executive officer and I've served the company in 2 different capacities initially Chief Credit Officer and then from 2014 through today as Chief Investment Officer. I've been involved in driving the investment side of this business since 2014. I've been responsible for hiring a lot of the talent that we have, particularly on the investment team side. Everybody has their own personality and way of doing things and I'm not going to talk about anyone's style or what those differences are. I believe in this company, I believe in this team and I am quite -- quite confident that we will continue on the same trajectory and level of success that we've been fortunate enough to have historically.

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Christopher Whitbread Patrick Nolan, Ladenburg Thalmann & Co. Inc., Research Division - EVP of Equity Research [27]

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And then as a follow-up question, given the change in CEO role to yourself, do you anticipate that the Hercules business can scale at a faster pace than before?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [28]

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Yes, I think our growth trajectory over the last several years has been pretty impressive. We highlighted a couple of those key points in our prepared remarks today. Our investment portfolio from a cost perspective is now $2.1 billion. Our debt portfolio at the end of Q1 now $1.9 billion. So if you think about that just in terms of year-over-year growth, if you look at where the business is today versus where it was 2, 3, 4 years ago, I think our ability to scale has been proven out. We will continue to focus on managed growth. We're not incentivized to grow this business just for the sake of doing so. We are an internally managed BDC. We are focused on shareholder returns, we are focused on capital efficiency, and that's the way that we're going to continue to grow the business. We will continue to look selectively at strategic initiatives. We will look at further ways to expand the platform to diversify our product offering. And I think that you will see us take a pretty consistent view to the go-forward strategic direction that we talk historically.

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Operator [29]

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(Operator Instructions) And our next question comes from Fin O'Shea, Wells Finance Security (sic) [Wells Fargo Securities].

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [30]

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Just to continue off of the previous final question from Mr. Nolan. Can you talk about the outlooks 2019 versus 2018 for your expense ratio? And then if you plan on the growth side to look at any more innovative, or structural changes on ways to grow the asset manager ex balance sheet from a HTGC so any organic or external growth plans going forward? Thank you.

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Seth Hardy Meyer, Hercules Capital, Inc. - CFO [31]

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So on the expense side, I mentioned that we expect $16 million to $16.5 million on our SG&A expenses for Q2. Looking out further we'll kind of hold our projection on that based on how we see the growth. So if we see that we stabilize and growth at that time, then we would hold it, but it's really subject to the market development. Beyond that, I probably wouldn't comment at this time. But Scott, maybe you want to take the second question?

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [32]

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Yes, Finian, I would just say a couple of things. One, we're going to continue invest in the platform and in the franchise. We always want to make sure that we're ahead of the game with respect to making sure we've got talent, making sure that we've got expertise and making sure that we are positioned well with respect to ensuring the same investment philosophy and success that we've had historically. So you will see us as you did in Q1 continue to make investments, not just in the investment team, but in other areas of the organization in some of our infrastructure. And now that we've crossed the $2.1 billion investment portfolio mark, we'll obviously look to make sure that we've got the appropriate headcount and team in place to manage that appropriately.

With respect to the other question which I think is a little bit of a broader question, we are going to continue to look for ways to enhance shareholder value. And we've learned over the last couple of years that there are certainly a bunch of options that are available to us in terms of partnerships and product enhancements and other things that we can do to help grow shareholder value, enhance the breadth of our platform and significantly develop our product capabilities. And you will see us make a pretty concerted effort to focus on those things through the remainder of 2019.

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Operator [33]

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Thank you. And there are no further questions at this time. I would now like to turn the call back to Scott Bluestein, CEO, for any further remarks.

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Scott Bluestein, Hercules Capital, Inc. - Interim CEO & CIO [34]

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Thank you, operator. And thanks to all of you for joining our call today. We will be attending the B. Riley FBR Annual Investor Conference in Beverly Hills on May 22 as well as numerous nondeal roadshows through May and June. We will also be holding our Annual Shareholders' Meeting as announced on May 30. So we encourage you to please vote your share. If you are interested in meeting with us at any of these events, please contact B. Riley FBR for their conference or Michael Hara for our nondeal roadshows and Annual Shareholder Meeting.

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Operator [35]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.