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HCAP > SEC Filings for HCAP > Form 10-Q on 13-Aug-2013All Recent SEC Filings

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Form 10-Q for HARVEST CAPITAL CREDIT CORP


13-Aug-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 for periods prior to the IPO 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 are our historical financial statements as a result of the merger.

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 (earnings before interest, taxes, depreciation and amortization) 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 June 30, 2013, we had $44.9 million (at fair value) invested in 13 companies. As of June 30, 2013, our portfolio included approximately 38.7% of first lien debt, 55.1% of second lien debt and 6.2% 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 June 30, 2013 and December 31, 2012 was as follows:

                         As of June 30, 2013             As of December 31, 2012
                        Cost          Fair Value          Cost           Fair Value
Senior Secured      $ 17,322,379     $ 17,374,759     $ 10,720,959     $ 10,720,959
Junior Secured        24,135,800       24,731,316       27,886,467       28,213,321
Equity                 1,046,288        2,815,125          946,288        2,577,038
Total Investments   $ 42,504,467     $ 44,921,200     $ 39,553,714     $ 41,511,318


At June 30, 2013, our average portfolio company investment at amortized cost and fair value was approximately $3.2 million and $3.2 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 June 30, 2013, 31.9% of our debt investments bore interest based on floating rates (some of which were subject to interest rate floors), such as LIBOR, and 68.1% bore interest at fixed rates. At December 31, 2012, 33.6% of our debt investments bore interest based on floating rates (some of which were 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 June 30, 2013 and December 31, 2012 was approximately 17.5% 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 June 30, 2013, we advanced an additional $0.5 million under a line of credit facility in one of our existing portfolio companies and a $5.0 million investment in one new portfolio company. During the three months ended June 30, 2012, we made $9.0 million of investments in 2 new portfolio companies.

During the six months ended June 30, 2013, we advanced an additional $1.5 million under a line of credit facility in one of our existing portfolio companies and a $5.0 million investment in one new portfolio company. During the six months ended June 30, 2012, we made $15.4 million of investments in 4 new portfolio companies.

During the three months ended June 30, 2013, we received a $4.2 million payoff at par and a $0.1 million exit fee for one portfolio company investment. Additionally, we received $43.1 thousand in principal repayments due to amortization or prepayments. During the three months ended June 30, 2012, we received $0.5 million in principal proceeds from prepayments of one of our investments.

During the six months ended June 30, 2013, we received a $4.2 million payoff at par and a $0.1 million exit fee for one portfolio investment and $0.1 million in principal repayments due to amortization. During the six months ended June 30, 2012, we received $0.5 million in principal proceeds from prepayments of one of our 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 June 30, 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                       $     16.6             39.3 %              4     $     10.2               24.6 %              2
2                             25.5             60.7 %              9           31.3               75.4 %             11
3                                -                -                -              -                  -                -
4                                -                -                -              -                  -                -
5                                -                -                -              -                  -                -
                        $     42.1            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 or for such investments in which interest has not been paid for greater than 90 days. As of June 30, 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 and Six Months Ended June 30, 2013 and 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 June 30, 2013 totaled $1.9 million compared to investment income of $0.9 million for the three months ended June 30, 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 June 30, 2013 is attributable to a larger investment portfolio during the period as compared to the three months ended June 30, 2012.

Investment income for the six months ended June 30, 2013 totaled $3.7 million compared to investment income of $1.5 million for the six months ended June 30, 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 six months ended June 30, 2013 is attributable to a larger investment portfolio during the period as compared to the six months ended June 30, 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 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 $0.6 million for the three months ended June 30, 2013 compared to $0.2 million for the three months ended June 30, 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.

Operating expenses totaled $1.1 million for the six months ended June 30, 2013 compared to $0.4 million for the six months ended June 30, 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 and six months ended June 30, 2013 was $169.7 thousand and $247.1 thousand compared to $53.6 thousand and $78.5 thousand for the three and six months ended June 30, 2012. Incentive management fees for the three and six months ended June 30, 2013 were $66.4 thousand and $386.4 thousand compared to $118.8 thousand and $184.7 thousand for the three and six months ended June 30, 2012. The decrease in incentive fees is due to us not exceeding the incentive fee hurdle for the period of time following our IPO through the end of the quarter. The hurdle was not met due to the large amount of equity capital raised in the IPO but yet to be invested. 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 changed as a result of the completion of our 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.

? Our investment adviser has agreed to permanently waive all or such portion of the incentive fee that it would otherwise collect from us to the extent necessary to support a minimum dividend yield of 9% for the period of time commencing with our IPO through March 31, 2014. The 9% dividend hurdle will be based upon our IPO price of $15 times the number of shares of our common stock currently outstanding plus the number of shares of common stock issued pursuant to our dividend reinvestment plan during the waiver period. Incentive fee expense for the quarter ended June 30, 2013 totaled $66 thousand. All of this, however, related to our performance prior to our May 2, 2013 IPO and, as a result, was not subject to the waiver. If we had not entered into the waiver arrangement, we would have accrued an additional $19 thousand of incentive fee expense in the three and six month periods ended June 30, 2013. If we meet the 9% dividend hurdle at March 31, 2014, then our investment adviser will be entitled to such incentive fee and we will expense such additional amount at that time.

? Only a portion of the 2013 periods (i.e., from May 2, 2013, the date of our IPO, to June 30, 2013) reflect the change in our historical expense structure for the items noted above as well as our operations as a public company. As a result, the full impact of such changes will be more evident in future periods.

Net Investment Income

For the three months and six months ended June 30, 2013, net investment income was $1.1 million and $1.9 million, respectively, compared to $0.4 million and $0.6 million for the three and six months ended June 30, 2012, respectively. For the three and six months ended June 30, 2013, net investment income per share was $0.26 and $0.69 compared to $0.58 and $1.05 for the three months and six months ended June 30, 2012, respectively.

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 recognized $152.1 thousand in realized gains on our investments during the three and six months ended June 30, 2013. We did not recognize any realized gains or losses on our investments in the three and six months ended June 30, 2012.


Net Change in Unrealized Appreciation of Investments

Net change in unrealized appreciation (depreciation) 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 (depreciation) on investments totaled $(56.2) thousand and $459.1 thousand for the three and six months ended June 30, 2013 and $35.8 thousand and $92.8 thousand for the three and six months ended June 30, 2012.

Net Increase in Net Assets Resulting from Operations

The net increase in net assets resulting from operations was $1.2 million and $2.5 million for the three and six months ended June 30, 2013 and $0.5 million and $0.7 million for the three and six months ended June 30, 2012. The increased amount in the three and six months ended June 30, 2013 compared to the three and six months ended June 30, 2012 primarily reflects the increase in net investment income, the realized gains on investments and the increase in unrealized appreciation (depreciation), described above.

Financial Condition, Liquidity and Capital Resources

Cash Flows from Operating and Financing Activities

Our operating activities used cash of $1.4 million and $13.9 million for the six months ended June 30, 2013 and 2012, respectively, primarily in connection with the funding of new investments. Our financing activities provided cash of $39.7 million and $12.3 million, respectively, for six months ended June 30, 2013 and 2012. Our financing activity proceeds for the six months ended June 30, 2013 were primarily in connection with proceeds received from our IPO, partially offset by pay downs on our credit facility with JMP Group LLC. Our financing activity proceeds for the six months ended June 30, 2012 were primarily in connection with proceeds received from our pre-IPO private offering of equity securities.

Our liquidity and capital resources are derived from the credit facility with JMP Group LLC, proceeds received from our IPO, 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 . . .

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