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HCAP > SEC Filings for HCAP > Form 10-Q on 11-Jun-2013All Recent SEC Filings

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Form 10-Q for HARVEST CAPITAL CREDIT CORP


11-Jun-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Forward-Looking Statements

Some of the statements in this quarterly report on Form 10-Q constitute forward-looking statements, which relate to future events or our future performance or financial condition. The forward-looking statements contained in this quarterly report on Form 10-Q involve risks and uncertainties, including statements as to:

? our future operating results, including the performance of our existing investments;
? the introduction, withdrawal, success and timing of business initiatives and strategies;
? changes in political, economic or industry conditions, the interest rate environment or financial and capital markets, which could result in changes in the value of our assets;
? the relative and absolute investment performance and operations of our investment adviser;
? the impact of increased competition; ? the impact of investments we intend to make and future acquisitions and divestitures;
? our ability to turn potential investment opportunities into transactions and thereafter into completed and successful investments; ? the unfavorable resolution of any future legal proceedings; ? our business prospects and the prospects of our portfolio companies; ? our regulatory structure and tax status; ? the adequacy of our cash resources and working capital; ? the timing of cash flows, if any, from the operations of our portfolio companies;
? the impact of interest rate volatility on our results, particularly because we use leverage as part of our investment strategy; ? the ability of our portfolio companies to achieve their objective; ? the impact of legislative and regulatory actions and reforms and regulatory, supervisory or enforcement actions of government agencies relating to us or our investment adviser;
? our contractual arrangements and relationships with third parties; ? our ability to access capital and any future financings by us; ? the ability of our investment adviser to attract and retain highly talented professionals; and
? the impact of changes to tax legislation and, generally, our tax position.

Such forward-looking statements may include statements preceded by, followed by or that otherwise include the words "may," "might," "will," "intend," "should," "could," "can," "would," "expect," "believe," "estimate," "anticipate," "predict," "potential," "plan" or similar words.

We have based the forward-looking statements included in this quarterly report on Form 10-Q on information available to us on the date of this quarterly report on Form 10-Q, and we assume no obligation to update any such forward-looking statements. Actual results could differ materially from those anticipated in our forward-looking statements, and future results could differ materially from historical performance. We undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law or SEC rule or regulation. You are advised to consult any additional disclosures that we may make directly to you or through reports that we in the future may file with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

The following analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto contained elsewhere in this quarterly report on Form 10-Q.

Overview

We were formed as a Delaware corporation on November 14, 2012. We completed our initial public offering ("IPO") on May 7, 2013 raising $51.0 million in gross proceeds. On May 17, 2013 we raised another $6.5 million in gross proceeds from the closing of the IPO underwriters' overallotment option. Immediately prior to the IPO, we acquired Harvest Capital Credit LLC in a merger whereby the outstanding limited liability company membership interests were converted into shares of our common stock and we assumed and succeeded to all of Harvest Capital Credit LLC's assets and liabilities, including its entire portfolio of investments. We issued 2,246,699 shares of our common stock for all of its 2,266,974 outstanding membership interests in connection with the Merger. Harvest Capital Credit LLC is considered to be our predecessor for accounting purposes and, as such, its financial statements are our historical financial statements. Accordingly, the financial statements presented in this Form 10-Q and this "Management's Discussion and Analysis of Financial Condition and Results of Operations" are in reference to the historical financial statements of Harvest Capital Credit LLC which will be our historical financial statements.

As used herein, the terms "we", "us" and the "Company" refer to HCC LLC for the periods prior to the IPO and refer to HCAP for the periods after the IPO.


Our investment objective is to generate both current income and capital appreciation primarily by making direct investments in the form of subordinated debt and, to a lesser extent, senior debt and minority equity investments. We plan to accomplish our investment objective by targeting investments in small and mid-sized U.S. private companies with annual revenues between $10 million and $100 million and EBITDA between $2 million and $15 million. We believe that transactions involving these size companies offer higher yielding investment opportunities, lower leverage levels and other terms more favorable than transactions involving larger companies.

We are an externally managed, non-diversified, closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. As a BDC, we are required to comply with certain regulatory requirements. For instance, we generally have to invest at least 70% of our total assets in "qualifying assets," including securities of private or thinly traded public U.S. companies, cash, cash equivalents, U.S. government securities and high-quality debt investments that mature in one year or less.

As a BDC, we must not acquire any assets other than "qualifying assets" specified in the 1940 Act unless, at the time the acquisition is made, at least 70% of our total assets are qualifying assets (with certain limited exceptions). Qualifying assets include investments in "eligible portfolio companies." Under the relevant SEC rules, the term "eligible portfolio company" includes all private companies, companies whose securities are not listed on a national securities exchange, and certain public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million, in each case organized in the United States.

We intend to elect to be treated for tax purposes as a RIC under Subchapter M of the Code. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. As a RIC, we generally will not have to pay corporate-level taxes on any income we distribute to our stockholders.

Portfolio

Portfolio Composition

As of March 31, 2013, we had $43.5 million (at fair value) invested in 13 companies. As of March 31, 2013, our portfolio included approximately 27.3% of first lien debt, 65.6% of second lien debt and 7.1% of equity investments at fair value.

We completed 2012 with $41.5 million (at fair value) invested in 13 companies. As of December 31, 2012, our portfolio included approximately 25.8% of first lien debt, 68.0% of second lien debt, and 6.2% of equity investments at fair value.

We originate and invest primarily in privately-held middle-market companies (typically those with $2.0 million to $15.0 million of EBITDA) through first lien and second lien debt, often times with a corresponding equity investment component. The composition of our investments as of March 31, 2013 and December 31, 2012 was as follows:

                                   As of March 31, 2013          As of December 31, 2012
                                   Cost         Fair Value         Cost         Fair Value
Senior Secured - First Lien    $ 11,822,981    $ 11,859,269    $ 10,720,959    $ 10,720,959
Senior Secured - Second Lien     28,135,622      28,516,155      27,886,467      28,213,321
Equity                            1,046,288       3,102,384         946,288       2,577,038
Total Investments              $ 41,004,891    $ 43,477,808    $ 39,553,714    $ 41,511,318


At March 31, 2013, our average portfolio company investment at amortized cost and fair value was approximately $3.1 million and $3.1 million, respectively, and our largest portfolio company investment by amortized cost and fair value was approximately $5.4 million and $5.5 million, respectively. At December 31, 2012, our average portfolio company investment at amortized cost and fair value was approximately $3.0 million and $3.0 million, respectively, and our largest portfolio company investment by amortized cost and fair value was approximately $5.4 million and $5.4 million, respectively.

At March 31, 2013, 32.8% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 67.2% bore interest at fixed rates. At December 31, 2012, 33.6% of our debt investments bore interest based on floating rates (subject to interest rate floors), such as LIBOR, and 66.4% bore interest at fixed rates.

The weighted average yield on all of our debt investments as of March 31, 2013 and December 31, 2012 was approximately 18.0% and 17.6%, respectively. The weighted average yield was computed using the effective interest rates for all of our debt investments, including cash and PIK interest as well as the accretion of original issue discount.

Investment Activity

During the three months ended March 31, 2013, we made a $1.0 million add-on investment in one of our existing portfolio companies and no investments in new portfolio companies. During the three months ended December 31, 2012, we made $18.6 million of investments in 7 new portfolio companies and a $1.0 million add-on investment in one of our existing portfolio companies.

During the three months ended March 31, 2013, we did not receive principal repayments due to amortization or prepayments. During the three months ended December 31, 2012, we received $5.6 million in principal proceeds from prepayments of our investments and the pay down and amortization of certain other investments.

Our level of investment activity can vary substantially from period to period depending on many factors, including the level of merger and acquisition activity in our target market, the general economic environment and the competitive environment for the types of investments we make.

Asset Quality

In addition to various risk management and monitoring tools, we use an investment rating system to characterize and monitor the credit profile and expected level of returns on each investment in our portfolio. This investment rating system uses a five-level numeric scale. The following is a description of the conditions associated with each investment rating:

? Investment Rating 1 is used for investments that are performing above expectations, and whose risks remain favorable compared to the expected risk at the time of the original investment.

? Investment Rating 2 is used for investments that are performing within expectations and whose risks remain neutral compared to the expected risk at the time of the original investment. All new loans are initially rated 2.

? Investment Rating 3 is used for investments that are performing below expectations and that require closer monitoring, but where no loss of return or principal is expected. Portfolio companies with a rating of 3 may be out of compliance with financial covenants.

? Investment Rating 4 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are often in work out. Investments with a rating of 4 are those for which some loss of return but no loss of principal is expected.

? Investment Rating 5 is used for investments that are performing substantially below expectations and whose risks have increased substantially since the original investment. These investments are almost always in work out. Investments with a rating of 5 are those for which some loss of return and principal is expected.


The following table shows the investment rankings of our investments at fair value:

                                   As of March 31, 2013                           As of December 31, 2012
                                          % of          Number of                           % of          Number of
                           Fair           Total         Portfolio         Fair             Total          Portfolio
Investment Rating         Value         Portfolio       Companies        Value           Portfolio        Companies

1                       $     10.9            25.1 %             2     $     10.2               24.6 %             2
2                       $     32.6            74.9 %            11     $     31.3               75.4 %            11
3                                -               -               -              -                  -               -
4                                -               -               -              -                  -               -
5                                -               -               -              -                  -               -
                        $     43.5           100.0 %            13     $     41.5                100 %            13

Loans and Debt Securities on Non-Accrual Status

We will not accrue interest on loans and debt securities if we have reason to doubt our ability to collect such interest. As of March 31, 2013 and December 31, 2012, we had no loans on non-accrual.

Results of Operations

An important measure of our financial performance is net increase (decrease) in net assets resulting from operations, which includes net investment income
(loss), net realized gain (loss) and net unrealized appreciation (depreciation). Net investment income (loss) is the difference between our income from interest, dividends, fees and other investment income and our operating expenses including interest on borrowed funds. Net realized gain (loss) on investments is the difference between the proceeds received from dispositions of portfolio investments and their amortized cost. Net unrealized appreciation (depreciation) on investments is the net change in the fair value of our investment portfolio.

Comparison of the Three Months Ended March 31, 2013 and the Three Months Ended March 31, 2012

Revenues

We generate revenue in the form of interest income on debt investments and capital gains and distributions, if any, on investment securities that we may acquire in portfolio companies. Our debt investments typically have a term of five to seven years and bear interest at a fixed or floating rate. Interest on our debt securities is generally payable quarterly. Payments of principal on our debt investments may be amortized over the stated term of the investment, deferred for several years or due entirely at maturity. In some cases, our debt investments may pay interest in-kind, or PIK. Any outstanding principal amount of our debt securities and any accrued but unpaid interest will generally become due at the maturity date. The level of interest income we receive is directly related to the balance of interest-bearing investments multiplied by the weighted average yield of our investments. We expect that the dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases. In addition, we may generate revenue in the form of prepayment fees, commitment, loan origination, structuring or due diligence fees, fees for providing significant managerial assistance and consulting fees.

Investment income for the three months ended March 31, 2013 totaled $1.8 million compared to investment income of $0.5 million for the three months ended March 31, 2012. Investment income in both periods is comprised of interest income and fees earned on the investment portfolio. The increase in investment income in the three months ended March 31, 2013 is attributable to a larger investment portfolio over the period as compared to the three months ended March 31, 2012.


Expenses

Our primary operating expenses include the payment of fees to HCAP Advisors LLC under the investment advisory and management agreement, our allocable portion of overhead expenses under the administration agreement and other operating costs described below. We bear all other out-of-pocket costs and expenses of our operations and transactions, which may include:

? the cost of calculating our net asset value, including the cost of any third-party valuation services;

? the cost of effecting sales and repurchases of shares of our common stock and other securities;

? fees payable to third parties relating to making investments, including out-of-pocket fees and expenses associated with performing due diligence and reviews of prospective investments;

? transfer agent and custodial fees;

? out-of-pocket fees and expenses associated with marketing efforts;

? federal and state registration fees and any stock exchange listing fees;

? U.S. federal, state and local taxes;

? independent directors' fees and expenses;

? brokerage commissions;

? fidelity bond, directors' and officers' liability insurance and other insurance premiums;

? direct costs, such as printing, mailing, long distance telephone and staff;

? fees and expenses associated with independent audits and outside legal costs;

? costs associated with our reporting and compliance obligations under the 1940 Act and other applicable U.S. federal and state securities laws; and

? other expenses incurred by JMP Credit Advisors LLC or us in connection with administering our business, including payments under the administration agreement that are based upon our allocable portion of overhead (subject to the review of our board of directors).

Operating expenses totaled $0.5 million for the three months ended March 31, 2013 compared to $0.1 million for the three months ended March 31, 2012. Operating expenses in both periods consisted of base and incentive management fees, administrator expenses, fees related to the credit facility with JMP Group LLC, professional fees, valuation fees, insurance expenses, directors' fees, and other general and administrative expenses.

The base management fee for the three months ended March 31, 2013 was $77 thousand compared to $25 thousand for three months ended March 31, 2012. Incentive management fees for the three months ended March 31, 2013 were $320 thousand compared to $66 thousand for the three months ended March 31, 2012. The increase in incentive fees is attributable to higher pre-incentive fee net investment income and higher unrealized appreciation in the portfolio during the three months ended March 31, 2013. Other operating expenses included reimbursement under the administrative services agreement and general and administrative expenses such as legal, accounting and valuation expenses.

Our historical expense structure will change as a result of our completion of the IPO as follows:

? The base management fee payable to our investment adviser prior to the IPO was calculated at an annual rate of 2.0% of our gross assets, including assets acquired with the use of borrowings. However, our investment adviser had agreed to waive the base management fee payable to it prior to the IPO with respect to any assets acquired by us through the use of borrowings under the Credit Facility until such time that the Credit Facility has been repaid in full and terminated. Moreover, our investment adviser received a base management fee prior to the IPO with respect to cash and cash equivalents held by us. Subsequent to the IPO, the base management fee is calculated based on our gross assets (which includes assets acquired with the use of leverage, but excludes cash and cash equivalents) at an annual rate of 2.0% on gross assets up to and including $350 million, 1.75% on gross assets above $350 million and up to and including $1 billion, and 1.5% on gross assets above $1 billion. Moreover, the waiver agreement described above with respect to assets acquired by us through the use of borrowings under the Credit Facility was terminated in connection with our IPO. As a result, a base management fee will be payable to our investment adviser on all assets acquired by us through the use of borrowings, including under the Credit Facility.

? Subsequent to the IPO, we expect to experience an increase in our operating expenses due to the regulatory and other costs associated with being a publicly traded BDC.

Net Investment Income

For the three months ended March 31, 2013, net investment income was $765 thousand, or $0.65 per common share, compared to $206 thousand, or $0.43 per common share, for the three months ended March 31, 2012.

Net Realized Gains and Losses

We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, using the specific identification method, without regard to unrealized appreciation or depreciation previously recognized.

We did not recognize any realized gains or losses on our investments during the three months ended March 31, 2013 or 2012.


Net Change in Unrealized Appreciation of Investments

Net change in unrealized appreciation primarily reflects the change in portfolio investment values during the reporting period, including the reversal of previously recorded appreciation or depreciation when gains or losses are realized.

Net change in unrealized appreciation on investments totaled $515 thousand for the three months ended March 31, 2013 and $57 thousand for the three months ended March 31, 2012.

Net Increase in Net Assets Resulting from Operations

The net increase in net assets resulting from operations was $1.3 million and $0.3 million for the three months ended March 31, 2013 and 2012 respectively. The increased amount in the three months ended March 31, 2013 compared to the three months ended March 31, 2012 primarily reflects the increase in net investment income and the increase in unrealized appreciation due to the larger investment portfolio.

Financial Condition, Liquidity and Capital Resources

Cash Flows from Operating and Financing Activities

Our operating activities used cash of $0.3 million and $5.9 million for the three months ended March 31, 2013 and 2012, respectively, primarily in connection with the funding of new investments. Our financing activities for the three months ended March 31, 2013 used cash of $6.8 million primarily in connection with paying down the outstanding balance under our credit facility with JMP Group LLC. For the three months ended March 31, 2012, our financing activities provided us with $7.6 million primarily attributable to borrowings under the credit facility with JMP Group LLC and draws on commitments from equity investors.

Our liquidity and capital resources are derived from the credit facility with JMP Group LLC, draws on unfunded equity capital commitments and cash flows from operations, including investment sales and repayments, and income earned. Our primary use of funds from operations includes investments in portfolio companies and other operating expenses we incur, as well as the payment of dividends to the holders of our common stock. We used, and expect to continue to use, these capital resources as well as proceeds from turnover within our portfolio and from public and private offerings of securities to finance our investment activities.

Although we expect to fund the growth of our investment portfolio through the net proceeds from future equity offerings and issuances of senior securities or future borrowings to the extent permitted by the 1940 Act, our plans to raise capital may not be successful. In this regard, if our common stock trades at a price below our then-current net asset value per share, we may be limited in our ability to raise equity capital given that we cannot sell our common stock at a price below net asset value per share unless our stockholders approve such a sale and our board of directors makes certain determinations in connection therewith.

In addition, we intend to distribute between 90% and 100% of our taxable income to our stockholders in order to satisfy the requirements applicable to RICs under Subchapter M of the Code. Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. In addition, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.

Also, as a BDC, we generally will be required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200%. This requirement limits the amount that we may borrow. As of March 31, 2013 and December 31, 2012, we would not have been in compliance with this requirement if we were a BDC on those dates. We used the proceeds from the IPO to pay down the outstanding balance under the credit facility with JMP Group LLC and, as of the date of this filing, there was $0 outstanding under the credit facility with JMP Group
LLC. The amount of leverage that we employ as a BDC will depend on our assessment of market conditions and other factors at the time of any proposed borrowing, such as the maturity, covenant package and rate structure of the proposed borrowings, our ability to raise funds through the issuance of shares of our common stock and the risks of such borrowings within the context of our investment outlook. Ultimately, we only intend to use leverage if the expected returns from borrowing to make investments will exceed the cost of such borrowing.


As of March 31, 2013 and December 31, 2012, we had cash of $0.5 million and $7.6 million, respectively.

Credit Facility

Effective August 24, 2011, Harvest Capital Credit LLC entered into its senior secured revolving credit facility with JMP Group LLC. The credit facility had a total size of $30 million, a maximum term of six years and revolving period of two years. The maximum amount outstanding was also limited by a covenant which restricted borrowings to no more than 2.0 times the Net Tangible Asset Value ("NTAV") of Harvest Capital Credit LLC. At the end of the two year revolving period, the outstanding balance was set to amortize evenly at 5% per quarter over the following 16 consecutive quarters with the final 20% due at maturity on August 24, 2017. The credit facility carried an interest rate of either (i) LIBOR + 7.0%, with a LIBOR floor of 1.5%, or (ii) the Prime Rate + 4.75%. The . . .

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