News Column

HMS INCOME FUND, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 12, 2014

The information contained in this section should be read in conjunction with our unaudited financial statements and related notes thereto appearing elsewhere in this quarterly report on Form 10-Q (this "Report"). In this Report, "we," "us," and "our" refer to HMS Income Fund, Inc.



Forward-Looking Statements

Some of the statements in this Report constitute forward-looking statements because they relate to future events or our future performance or financial condition. The forward-looking statements contained in this Report may include statements as to:

our future operating results;

our business prospects and the prospects of our portfolio companies;

the impact of the investments that we expect to make;

the ability of our portfolio companies to achieve their objectives;

our expected financings and investments;

the adequacy of our cash resources and working capital; and

the timing of cash flows, if any, from the operations of our portfolio

companies. In addition, words such as "anticipate," "believe," "expect" and "intend" indicate a forward-looking statement, although not all forward-looking statements include these words. The forward-looking statements contained in this Report involve risks and uncertainties. Our actual results could differ materially from those implied or expressed in the forward-looking statements for any reason, including the factors set forth in "Risk Factors" and elsewhere in this Report. Other factors that could cause actual results to differ materially include: changes in the economy; risks associated with possible disruption in our operations or the economy generally due to terrorism or natural disasters; and



future changes in laws or regulations and conditions in our operating areas.

We have based the forward-looking statements included in this Report on information available to us on the date of this Report, and we assume no obligation to update any such forward-looking statements. Except as required by the federal securities laws, we undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise. 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 forward-looking statements and projections contained in this Report are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933, as amended.



ORGANIZATION

We were formed as a Maryland corporation on November 28, 2011 under the General Corporation Law of the State of Maryland. We are an externally managed, non-diversified closed-end investment company that has elected to be treated as a business development company ("BDC"), under the Investment Company Act of 1940, as amended (the "1940 Act"). We have elected to be treated for U.S. federal income tax purposes as a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). Our primary investment objective is to generate current income through debt and equity investments. A secondary objective is to generate long-term capital appreciation through such investments. On December 16, 2011, we filed a registration statement on Form N-2, as amended (File No. 333-178548) (the "Registration Statement") with the Securities and Exchange Commission (the "SEC") to register for sale, on an ongoing basis, of up to $1.5 billion of shares of common stock (150 million shares at an initial offering price of $10.00 per share) (the "Offering"). Except as with respect to minimum offering requirements set by securities regulators of certain states, there is no minimum number of shares of common stock required to be sold in the Offering. As of June 30, 2014, we have raised approximately $133.5 million in the public offering, including proceeds from the distribution reinvestment plan of approximately $1.7 million. Our business is managed by HMS Adviser LP (the "Adviser"), a Texas limited partnership and affiliate of Hines Interests Limited Partnership ("Hines"), pursuant to an Investment Advisory and Administrative Services Agreement dated May 31, 2012, as amended (the "Advisory Agreement"). On May 31, 2012, we and the Adviser also retained Main Street Capital Corporation ("Main Street"), a New York Stock Exchange listed BDC, as the Company's investment sub-adviser under the Investment Advisers Act of 1940, as amended (the "Advisers Act"), pursuant to an Investment Sub-Advisory Agreement (the 30 -------------------------------------------------------------------------------- "Sub-Advisory Agreement") to identify, evaluate, negotiate and structure prospective investments, make investment and portfolio management recommendations for approval by the Adviser, monitor the our investment portfolio and provide certain ongoing administrative services to the Adviser. Main Street obtained a no-action letter from the SEC in November 2013 that permitted it to assign investment sub-adviser duties under the Sub-Advisory Agreement to MSC Adviser I, LLC ("MSC Adviser"), a wholly owned subsidiary of Main Street, and Main Street assigned such duties, and the Sub-Advisory Agreement was amended to reflect such change on December 31, 2013. The term "Sub-Adviser," as used herein, refers to Main Street until December 31, 2013 and MSC Adviser thereafter. The Adviser and Sub-Adviser are collectively referred to herein as the "Advisers." Upon the execution of the Sub-Advisory Agreement, Main Street became our affiliate. The Company has engaged Hines Securities, Inc. (the "Dealer Manager"), an affiliate of the Adviser, to serve as the dealer manager for the Offering. The Dealer Manager is responsible for marketing the our shares of common stock being offered pursuant to the Offering. We refer to HMS Income Fund, Inc. as the "Company," and the use of "we," "our," "us" or similar pronouns in this quarterly report refers to HMS Income Fund, Inc. or the Company as required by the context in which such pronoun is used.



OVERVIEW

We are a specialty finance company sponsored by Hines that makes debt and equity investments in middle market companies which we define as companies with annual revenues generally between $10 million and $3 billion. We are an externally managed, non-diversified closed-end investment company that has elected to be treated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. We are, therefore, required to comply with certain regulatory requirements. We have elected to be treated for U.S. federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code. Our primary investment objective is to generate current income through debt and equity investments and a secondary objective is to generate long-term capital appreciation through such investments. We anticipate that we will primarily invest in senior secured and second lien debt securities issued by middle market companies in private placements and negotiated transactions, which are traded in private over-the-counter markets for institutional investors. We will also invest in, and ultimately intend to have a significant portion of our assets invested in, customized direct secured and unsecured loans to and equity securities of lower middle market companies, which we define as companies with annual revenues generally between $10 million and $150 million, referred to as customized lower middle market securities. Typically, our investments in lower middle market companies will require us to co-invest with Main Street and/or its affiliates. As a BDC, we are subject to certain regulatory restrictions in making our investments, including limitations on our ability to co-invest with certain affiliates, including Main Street. However, on April 15, 2014, we received an order from the SEC, that permits us, subject to certain conditions, to co-invest with Main Street in certain transactions originated by Main Street and/or our Advisers. The exemptive relief permits us, and certain of our directly or indirectly wholly-owned subsidiaries on one hand, and Main Street, and or/certain of its affiliates on the other hand, to co-invest in the same investment opportunities where such investment would otherwise be prohibited under Section 57(a)(4) of the 1940 Act. In addition, we may continue to co-invest with Main Street and/or its affiliates in syndicated deals and secondary loan market purchases where price is the only negotiated point. Prior to obtaining exemptive relief, we have co-invested alongside Main Street and/or its affiliates only in accordance with existing regulatory guidance. These co-investments were in syndicated deals and secondary loan market transactions where price is the only negotiated point. As of June 30, 2014, we had debt investments in 81 private placement investments, 4 LMM debt investments, and 1 LMM equity investment with an aggregate fair value of approximately $248.7 million, a cost basis of approximately $247.9 million, and a weighted average effective annual yield of approximately 7.1%. The weighted average annual yield was calculated using the effective interest rates for all debt investments at June 30, 2014, including accretion of original issue discount and amortization of the premium to par value. Approximately 90.3% of our total portfolio investments (at fair value) were secured by first priority liens with the remainder secured by second priority liens. The level of new portfolio investment activity will fluctuate from period to period based upon the status of our capital raising efforts under the Offering, our view of the current economic fundamentals, our ability to identify new investment opportunities that meet our investment criteria, and our ability to close on the identified transactions. The level of new investment activity, and associated interest and fee income will directly impact future investment income. While we intend to grow our portfolio and our investment income over the long-term, our growth and our operating results may be more limited during depressed economic periods. However, we intend to appropriately manage our cost structure and liquidity position based on applicable economic conditions and our investment outlook. The level of realized gains or losses and unrealized appreciation or depreciation will also fluctuate depending upon portfolio activity and the performance of our individual portfolio companies. 31 --------------------------------------------------------------------------------



The changes in realized gains and losses and unrealized appreciation or depreciation could have a material impact on our operating results.

Investment Income

We have generated and plan to continue to generate investment income primarily in the form of interest on the debt securities that we hold, dividends and other distributions with respect to any equity interests that we hold and capital gains, if any, on convertible debt or other equity interests that we acquire in portfolio companies. In addition, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees, performance-based fees, and director fees for equity investments for which we, or our Sub-Adviser, holds a director position. All such fees will be generated in connection with our investments and recognized as earned or as additional yield over the life of the debt investment. To date our investment income has been interest income on debt investments, accretion of original issue discounts, amortization of premiums and net realized/unrealized appreciation/depreciation.



Expenses

On both a short-term and long-term basis, our primary use of funds will be investments in portfolio companies and cash distributions to our stockholders. Our primary operating expenses will be debt service payments, general and administrative expenses, and payment of advisory fees under the Advisory Agreement. The investment advisory fees paid to our Adviser (and the fees paid by our Adviser to our Sub-Adviser pursuant to the Sub-Advisory Agreement) will compensate our Advisers for their work in identifying, evaluating, negotiating, executing, monitoring and servicing our investments. We expect our expenses to fluctuate based upon the amount of assets under management. 32 --------------------------------------------------------------------------------



We bear all other expenses of our operations and transactions, including (without limitation) fees and expenses relating to:

ÿ corporate and organizational expenses relating to offerings of our

common stock, subject to limitations included in the Advisory Agreement;

ÿ the cost of calculating our net asset value, including the cost of any

third-party valuation services;

ÿ the cost of effecting sales and repurchase of shares of our common stock

and other securities; ÿ fees payable to third parties relating to, or associated with, monitoring our financial and legal affairs, making investments, and valuing investments, including fees and expenses associated with performing due diligence reviews of prospective investments;



ÿ interest payable on debt, if any, incurred to finance our investments;

ÿ investment advisory fees; ÿ transfer agent and custodial fees; ÿ fees and expenses associated with marketing efforts; ÿ federal and state registration fees; ÿ federal, state and local taxes;



ÿ independent directors' fees and expenses, including travel expenses;

ÿ costs of director and stockholder meetings, proxy statements,

stockholders' reports and notices;

ÿ cost of fidelity bond, directors and officers/errors and omissions

liability insurance and other insurance premiums;

ÿ direct costs such as printing of stockholder reports and advertising or

sales materials, mailing, long distance telephone, and staff; ÿ fees and expenses associated with independent audits and outside legal costs, including compliance with the Sarbanes-Oxley Act of 2002, amended, the 1940 Act, and applicable federal and state securities laws;



ÿ costs associated with our reporting and compliance obligations under the

1940 Act and applicable federal and state securities laws; ÿ brokerage commissions for our investments; ÿ all other expenses incurred by our Advisers, in performing their obligations subject to the limitations included in the Advisory Agreement and Sub-Advisory Agreement; and



ÿ all other expenses incurred by us or any administrator in connection

with administering our business, including payments under any administration agreement that will be based upon our allocable portion of overhead and other expenses incurred by any administrator in



performing its obligations under any proposed administration agreement,

including rent and our allocable portion of the costs of compensation

and related expenses of our chief compliance officer and chief financial

officer and their respective staffs.

Base Management Fee, Incentive Fee, Administrative Expense Waiver and Expense Support and Conditional Reimbursement Agreement

On May 31, 2012, we and the Advisers entered into a conditional fee waiver agreement and subsequent amendments, pursuant to which, for a period from June 4, 2012 to December 31, 2013, the Advisers can waive all fees upon the occurrence of any event, that in the Advisers' sole discretion is deemed necessary, including, but neither limited to nor automatically triggered by our estimate that a distribution declared and payable to our stockholders during the fee waiver period represents, or would represent when paid, a return of capital for U.S. federal income tax purposes. We refer to this conditional fee waiver agreement, as amended from time to time, as the "Conditional Fee Waiver Agreement." Further, the agreement contains a clause which states that at the sole and absolute discretion of our board of directors, in future periods, previously waived fees may be paid to the Advisers if and only to the extent that our cumulative net increase in net assets resulting from operations exceeds the amount of cumulative distributions paid to stockholders. The previously waived fees are potentially subject to repayment by us, if at all, within a period not to exceed three years from the date of each respective fee waiver. On December 30, 2013, we and our Advisers agreed to an amendment, or Fee Waiver Amendment, to the Conditional Fee Waiver Agreement. Under the Fee Waiver Amendment, our Adviser has agreed to extend the term of the fee waiver, with respect to our Adviser (but not with respect to the Sub-Adviser, whose waiver expired on December 31, 2013), through December 31, 2014. Our Adviser has no obligation to waive fees pursuant to the Fee Waiver Agreement after December 31, 2014, unless the fee waiver period is further extended. 33 -------------------------------------------------------------------------------- Reimbursement of previously waived fees will only be permitted with the approval of the our board of directors and if the operating expense ratio is equal to or less than our operating expense ratio at the time the corresponding fees were waived and if the annualized rate of regular cash distributions to stockholders is equal to or greater than the annualized rate of the regular cash distributions at the time the corresponding fees were waived. For the three months ended June 30, 2014 and 2013,the Company incurred base management fees of approximately $1.1 million and $118,000, respectively, and zero capital gains and subordinated incentive fees. For the six months ended June 30, 2014 and 2013, the Company incurred base management fees of approximately $1.7 million and $201,000, respectively, capital gains incentive fees of zero and $1,000, respectively, and subordinated incentive fees of zero and zero, respectively. For the three months ended June 30, 2014 and 2013 the Advisers waived base management fees of $551,000 and $118,000, respectively. For the six months ended June 30, 2014 and 2013 the Advisers waived base management fees of $854,000 and $201,000, respectively, and capital gains incentive fees of zero and $1,000, respectively. For the three and six months ended June 30, 2014 and 2013 the Company did not record an accrual for any previously waived fees. Reimbursement of previously waived fees to the Advisers will not be accrued until the reimbursement of the waived fees become probable and estimable, which will be upon approval by our board of directors. To date none of the previously waived fees have been approved by the board of directors for reimbursement. Pursuant to the Advisory Agreement and Sub-Advisory Agreement, the we are required to pay or reimburse the Advisers for administrative services expenses, which include all costs and expenses related to the day-to-day administration and management not related to advisory services. For the three months ended June 30, 2014 and 2013, we incurred, and the Advisers waived the reimbursement of, administrative services expenses of approximately, $385,000 and $222,000, respectively. For the six months ended June 30, 2014 and 2013 we incurred, and the Advisers waived the reimbursement of, administrative services expenses of approximately $714,000 and $455,000, respectively. The Advisers have agreed to waive the reimbursement of administrative services expenses through December 31, 2014. On November 11, 2013, we entered into an Expense Support and Conditional Reimbursement Agreement (the "Reimbursement Agreement") with the Adviser. Under the Reimbursement Agreement, until December 31, 2013 or a prior date mutually agreed to by both parties, the Adviser will pay us up to 100% of the Company's operating expenses (the "Expense Support Payment"). Operating expenses are defined as 2013 third party operating costs and expenses incurred by us under generally accepted accounting principles for investment management companies. Any Expense Support Payments paid by the Adviser are subject to conditional reimbursement by us upon a determination by our board of directors that we have achieved a reasonable level of expenses relative to our investment income. Any repayment of Expense Support Payments will be made within a period not to exceed three years from the date each respective Expense Support Payment is determined. The Reimbursement Agreement may be terminated by us at any time, and shall automatically terminate upon termination of the Advisory Agreement, or upon our liquidation or dissolution. For the year ended December 31, 2013, the Adviser made an Expense Support Payment of $153,000 to us. On December 30, 2013, we and the Adviser agreed to an Expense Support and Conditional Reimbursement Agreement (the "Expense Reimbursement Agreement"). Under the Expense Reimbursement Agreement, until March 31, 2014 or a prior date mutually agreed to by both parties, the Adviser, at its sole discretion, will pay to us up to 100% of the Company's operating expenses (the "Expense Support Payment") in order for us to achieve a reasonable level of expenses relative to its investment income (the "Operating Expense Objective"). Under the Expense Reimbursement Agreement, operating expenses are defined as third party operating costs and expenses incurred by the Company between January 1, 2014 and March 31, 2014 under generally accepted accounting principles for investment management companies. The Expense Reimbursement Agreement requires a mandatory reimbursement of any Expense Support Payment to the extent that our results exceed the Operating Expense Objective during the year ending December 31, 2014 (a "Mandatory Reimbursement Payment"). Any Mandatory Reimbursement Payment under the Expense Reimbursement Agreement will be determined by the Adviser and us and will not be subject to Board approval. To the extent that any portion of the Expense Support Payments remains unreimbursed after the Company has made any Mandatory Reimbursement Payments, the Board, in its discretion, may approve the repayment of such unreimbursed outstanding Expense Support Payments upon a determination by the Board that the Company has achieved the Operating Expense Objective during any calendar quarter (a "Conditional Reimbursement Payment"). Under the Expense Reimbursement Agreement, any unreimbursed Expense Support Payments may be reimbursed by us within a period not to exceed three years from the date each respective Expense Support Payment is determined, but only after any outstanding Expense Support Payment amounts have been reimbursed under that certain Expense Support and Conditional Reimbursement Agreement, dated as of November 11, 2013, by and between us and the Adviser. Any Expense Support Payments that remain unreimbursed three years after such payment is determined will be considered permanently waived. The Expense Reimbursement Agreement may be terminated by us at any time, and shall automatically terminate upon termination of the Advisory Agreement or upon liquidation or dissolution of the Company. On March 31, 2014, the Expense Reimbursement Agreement was extended through June 30, 2014. and further extended on June 30, 2014 through September 30, 2014. 34 -------------------------------------------------------------------------------- Due to the Mandatory Reimbursement Payments under the Expense Reimbursement Agreement being based on whether the Company exceeds the Operating Expense Objective for the year ended December 31, 2014, any Expense Support Payment from the Adviser for the three and six months ended June 30, 2014 is not fixed or determinable and accordingly has not been recognized in our financial statements for the three and six months ended June 30, 2014. Upon this determination, the unreimbursed Expense Support Payment will be recognized in the Statement of Operations as a reduction to expenses.



CRITICAL ACCOUNTING POLICIES

Basis of Presentation

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and include our accounts and the accounts of our wholly-owned, consolidated subsidiaries. Under the investment company rules and regulations pursuant to Article 6 of Regulation S-X, we are precluded from consolidating portfolio company investments, including those in which we have a controlling interest, unless the portfolio company is another investment company. An exception to this general principle occurs if we own a controlled operating company whose purpose is to provide services to us such as an investment adviser or transfer agent. None of the investments we have made qualify for this exception. Therefore, our portfolio investments are carried on the balance sheet at fair value, as discussed below, with changes to fair value recognized as "Net Unrealized Appreciation (Depreciation)" on the Statement of Operations until the investment is realized, usually upon exit, resulting in any gain or loss on exit being recognized as a "Net Realized Gain (Loss) from Investments."



Valuation of Portfolio Investments

The most significant determination inherent in the preparation of our financial statements is the valuation of our portfolio investments and the related amounts of unrealized appreciation or depreciation. As of June 30, 2014, 92% of our total assets represented investments in portfolio companies valued at fair value. We are required to report our investments at fair value. We follow the provisions of ASC 820, Fair Value Measurements and Disclosures ("ASC 820"). ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. Our portfolio strategy calls for us to invest in illiquid securities issued by private companies with annual revenues generally between $10 million and $150 million. These portfolio investments may be subject to restrictions on resale and will generally have either no established trading market or established markets that are inactive; therefore, market quotations are generally not readily available. Generally, following the origination of a LMM debt investment, the cost basis of the investment, which is the principal less fees received, is considered to be representative of fair value. The fair value of these investments will continue to be equal to the cost basis to the extent that the investment company continues to perform in accordance with expectations and there is no indication of a decline in fair value. To the extent that the investment is out performing or under performing relative to expectations, we determine the fair value primarily using a yield to maturity approach that analyzes the discounted cash flows of interest and principal for the debt security, as set forth in the associated loan agreements, as well as the financial position and credit risk of each of these portfolio investments at each reporting date. Our estimate of the expected repayment date of a debt security is generally the legal repayment date of the instrument. The yield to maturity analysis considers changes in leverage levels, credit quality, portfolio company performance and other factors. We will use the value determined by the yield analysis as the fair value for that security. However, it is our position that assuming a borrower is outperforming underwriting expectations and because these respective investments do not contain pre-payment penalties, the borrower would most likely prepay or refinance the borrowing if the market interest rate, given the borrower's current credit quality, is lower than the stated loan interest rate. Therefore, we do not believe that a market participant would pay a premium for the investment, and because of our general intent to hold its loans to repayment, we generally do not believe that the fair value of the investment should be adjusted in excess of the face amount. However, adjustments to investment values will be made for declines in fair value due to market changes or borrower specific credit deterioration. As of June 30, 2014 and December 31, 2013, the Company owned four and two LMM debt investments which had a total estimated fair value of $2.8 million and $1.5 million which is approximately 1.1% and 2.2% of the Company's portfolio investments at fair value, respectively. We generally will review external events, including private mergers, sales and acquisitions involving comparable companies, and includes these events in the valuation process by using an enterprise value waterfall ("Waterfall") for our LMM equity investments. For two quarters following an acquisition of a LMM equity investment, the investment's fair value is deemed to be at cost, unless there are external events indicative of a change in fair value. After holding an equity investment for two quarters, the Waterfall valuation method will be performed by our Advisers to determine fair value. Under the Waterfall 35 -------------------------------------------------------------------------------- valuation method, we estimate the enterprise value of a portfolio company using a combination of market and income approaches or other appropriate valuation methods, such as considering recent transactions in the equity securities of the portfolio company or third-party valuations of the portfolio company, and then perform a waterfall calculation by using the enterprise value over the portfolio company's securities in order of their preference relative to one another. The Waterfall method assumes the loans and equity securities are sold to the same market participant, which we believe is consistent with its past transaction history and standard industry practices. The enterprise value is the fair value at which an enterprise could be sold in a transaction between two willing parties, other than through a forced or liquidation sale. Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization ("EBITDA"), cash flows, net income, revenues, or in limited cases, book value. There is no single methodology for estimating enterprise value. For any one portfolio company, enterprise value is generally described as a range of values from which a single estimate of enterprise value is derived. In estimating the enterprise value of a portfolio company, we analyze various factors including the portfolio company's historical and projected financial results. The operating results of a portfolio company may include unaudited, projected, budgeted or pro forma financial information and may require adjustments for non-recurring items or to normalize the operating results that may require significant judgment in its determination. In addition, projecting future financial results requires significant judgment regarding future growth assumptions. In evaluating the operating results, we also analyze the impact of exposure to litigation, loss of customers or other contingencies. After determining the appropriate enterprise value, we allocate the enterprise value to investments in order of the legal priority of the various components of the portfolio company's capital structure. In applying the Waterfall valuation method, it is assumed that the loans are paid off at the principal amount in a change in control transaction and are not assumed by the buyer. As of June 30, 2014 and December 31, 2013, the Company had one and zero LMM equity investments, which had estimated fair value of $670,000 and zero, respectively. Given the recent acquisition of the LMM equity investment during the three months ended June 30, 2014, the investment is valued as of June 30, 2014, at cost, which the Company determined to be the best indicator of fair value. The fair value determination for the private placement investments was based upon quotes obtained through a third party pricing service. If available and determined to be reliable, we use the third party quotes to estimate the fair value of our private placement investments owned. The inputs for determining the third party quotes are often unobservable to us. These valuations consist of a combination of observable inputs in non-active markets for which sufficient observable inputs were available to determine the fair value of these investments, observable inputs in the non-active market for which sufficient observable inputs were not available to determine the fair value of these investments and unobservable inputs. The third party quotes are reviewed and discussed with our Sub-Adviser. As a result, a portion of our private placement investments was categorized as Level 2 as of December 31, 2013, and none of our private placement investments was categorized as Level 2 as of June 30, 2014 . For the private placement investments for which sufficient observable inputs were not available to determine the fair value of the investments, we categorized such investments as Level 3 as of June 30, 2014 and December 31, 2013. For valuation purposes, "non-control" portfolio investments are composed of debt securities for which we do not have a controlling interest in the portfolio company or the ability to nominate a majority of the portfolio company's board of directors. For those non-control portfolio investments in which market quotations are generally readily available, we use observable inputs, such as third party quotes or other independent pricing, to determine the fair value of those investments. The fair value of these investments on the reporting date is determined by taking the midpoint between the bid-ask spread obtained from a third party pricing service. Securities under contract to sell have been valued at the contract price, which approximates the pricing noted by the independent pricing service. Securities under contract to purchase have been valued at the pricing noted by the independent pricing service. As of June 30, 2014 and December 31, 2013, all of our investments were classified as non-control investments. Due to the inherent uncertainty in the valuation process, our estimate of fair value may differ materially from the values that would have been used had an active market for the securities existed. In addition, changes in the market environment, portfolio company performance and other events that may occur over the lives of the investments may cause the gains or losses ultimately realized on these investments to be materially different than the valuations currently assigned. We estimate the fair value of each individual investment and record changes in fair value as unrealized appreciation or depreciation in the Statements of Operations.



Interest Income

Interest income is recorded on the accrual basis to the extent amounts are expected to be collected. Prepayment penalties received by us are recorded as income upon receipt. Accrued interest is evaluated for collectability. When a debt security becomes 90 days or more past due and we do not expect the debtor to be able to service all of its debt or other obligations, the debt security will generally be placed on non-accrual status, and the Company will cease recognizing interest income on that debt security until the borrower has demonstrated the ability and intent to pay contractual amounts due. If a debt security's status significantly improves with respect to the debtor's ability to service the debt or other obligations, or if a debt security is 36 -------------------------------------------------------------------------------- fully impaired, sold or written off, it will be removed from non-accrual status. As of June 30, 2014 and December 31, 2013, we did not have any investments that were more than 90 days past due or on non-accrual status. Additionally, we currently are not aware of any material changes to the creditworthiness of the borrowers underlying our debt investments. From time to time, we may hold debt instruments in our investment portfolio that contain a payment-in-kind ("PIK") interest provision. If these borrowers elect to pay or are obligated to pay interest under the optional PIK provision, and if deemed collectible in our judgment, then the interest would be computed at the contractual rate specified in the investment's credit agreement, added to the principal balance of the investment, and recorded as interest income. Thus, the actual collection of this interest would be deferred until the time of debt principal repayment. As of June 30, 2014, and December 31, 2013, we held one and zero investments, which contained a PIK provision. For the the three months ended June 30, 2014 and 2013, we recognized $44,000 and $59,000, respectively of PIK interest income. For the six months ended June 30, 2014 and 2013, we recognized $44,000 and $59,000, respectively PIK interest income.



Unearned Income - Original Issue Discount / Premium to Par Value

We purchased some of our debt investments for an amount different than their respective principal values. For purchases at less than par value a discount is recorded at acquisition, which is accreted into interest income based on the effective interest method over the life of the debt investment. For investments purchased at greater than par value, a premium is recorded at acquisition, which is amortized as a reduction to interest income based on the effective interest method over the life of the investment. Upon repayment or sale, any unamortized discount or premium is also recognized into interest income. For the three months ended June 30, 2014 and 2013, we accreted approximately a net $197,000 and $24,000, respectively, which was net of premiums. For the six months ended June 30, 2014 and 2013 we accreted approximately a net $412,000 and $21,000, respectively, into interest income which was net of premiums.



Organizational and Offering Costs

In accordance with the Advisory Agreement and the Sub-Advisory Agreement, we will reimburse the Adviser and Sub-Adviser for any organizational expenses and Offering costs that are paid on our behalf, which consist of, among other costs, expenses of our organization, actual legal, accounting, bona fide out-of-pocket itemized and detailed due diligence costs, printing, filing fees, transfer agent costs, postage, escrow fees, data processing fees, advertising and sales literature and other Offering-related costs. Pursuant to the terms of the Advisory Agreement and Sub-Advisory Agreement, the Advisers are responsible for the payment of Offering costs to the extent they exceed 1.5% of the aggregate gross proceeds from the Offering. As of June 30, 2014 and December 31, 2013, the Adviser and Sub-Adviser incurred approximately $5.5 million and $4.3 million, respectively, of Offering costs on our behalf. Upon the execution of the Advisory Agreement and Sub-Advisory Agreement, on May 31, 2012, we recorded a due to affiliates liability and capitalized the deferred Offering costs as it is expected that aggregate gross proceeds from the Offering will be at a level which will require us to reimburse the Advisers for these costs. As of June 30, 2014, the balance of the due to affiliate liability related to organizational and Offering costs was $3.5 million. Based on the $5.5 million of offering costs incurred by the Adviser through June 30, 2014, we would have to raise approximately $366.5 million to be obligated to reimburse the Adviser for all of these costs. Commencing with our initial closing, which occurred on September 17, 2012, and continuing with every closing thereafter, 1.5% of the proceeds of such closings will be amortized as a charge to additional paid in capital and a reduction of deferred Offering costs, until such asset is fully amortized. As of June 30, 2014, approximately $2.0 million has been amortized. We expect to reimburse the Advisers for such costs incurred on our behalf on a monthly basis up to a maximum aggregate amount of 1.5% of the gross Offering proceeds. Pursuant to the terms of the Advisory Agreement and Sub-Advisory Agreement, the Adviser and Sub-Adviser will be responsible for the payment of organizational and Offering expenses to the extent they exceed 1.5% of gross proceeds from the Offering.



PORTFOLIO INVESTMENT COMPOSITION

Our private placement portfolio investments primarily consist of direct or secondary purchases of interest-bearing debt securities in companies that are generally larger in size than the LMM companies included in our LMM portfolio. While our privately placed portfolio debt investments are generally secured by a first priority lien, seven investments are secured by second priority liens. Our current LMM portfolio investments consist of secured debt and one equity investment, in privately held, LMM companies. The LMM debt investments are secured by first liens on the assets of the portfolio companies, generally bear interest at fixed rates and generally mature between five and seven years from the original investment date. However, since we purchased these 37 -------------------------------------------------------------------------------- investments subsequent to their original investment dates, the maturities range from approximately one to five years. The LMM equity investment represents an equity position with a liquidity preference. During the six months ended June 30, 2014, we funded investment purchases of approximately $170.5 million and had 21 investments under contract to purchase as of June 30, 2014, for approximately $49.1 million, which settled or are scheduled to settle after June 30, 2014. We also received proceeds from sales and repayments of existing portfolio investments of approximately $26.8 million including $3.4 million in full prepayment and $10.7 million in sales. Additionally, we had two investments under contract to sell as of June 30, 2014, for approximately $3.0 million, which represents the contract sales price. The combined result of which increased our portfolio, on a cost basis, by approximately $181.5 million, or 273%, and the number of portfolio investments by 20, or 30% compared to the portfolio as of December 31, 2013. The largest investment in an individual portfolio company represented approximately 2.8% the portfolio's fair value with the remaining investments ranging from 0.02% to 2.6%. The average investment in our portfolio is approximately $2.9 million or 1.2% of the total portfolio. As a result of the aforementioned transactions our portfolio has become increasingly diversified across individual portfolio investments, geographic regions, and industries. Further, our portfolio investment composition is comprised of 90.3% first lien debt securities, 9.4% second lien debt securities, and 0.3% equity. First lien debt securities have priority over subordinated or other unsecured debt owed by the issuer with respect to the collateral pledged as security for the loan. Due to the priority of first lien investments, these generally have lower yields than lower priority, less secured investments. During the six months ended June 30, 2013, we made investment purchases of approximately $19.8 million and had no investments under contract to purchase as of June 30, 2013. We also received proceeds from sales and repayments of existing portfolio investments of approximately $6.4 million including $3.4 million in full repayment $2.5 million in sales and had no investments under contract to purchase or sell as of June 30, 2013. The result of the aforementioned transactions further diversified our geographic and industry concentrations and based upon our investment rating system, the weighted average rating of our LMM was as of June 30, 2014 and December 31, 2013 was 2.5 and 1.5, respectively. See "- Portfolio Asset Quality" for further discussion of the investment rating system. Lastly, the overall weighted average effective yield on our investment portfolio has decreased from 7.5% as of December 31, 2013 to 7.1% at June 30, 2014.



Summaries of the composition of our total investment portfolio at cost and fair value are shown in the following table:

June 30, 2014 December 31, 2013 Private Private Cost: LMM Placement Total LMM Placement Total First lien secured debt 80.4 % 90.5 % 90.3 % 100.0 % 96.2 % 96.3 % Second lien secured debt - % 9.5 % 9.4 % - % 3.8 % 3.7 % Equity 19.6 % - % 0.3 % - % - % - % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % June 30, 2014 December 31, 2013 Private Private Fair Value: LMM Placement Total LMM Placement Total First lien secured debt 80.4 % 90.5 % 90.3 % 100.0 % 96.2 % 96.3 % Second lien secured debt - % 9.5 % 9.4 % - % 3.8 % 3.7 % Equity 19.6 % - % 0.3 % - % - % - % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 38

-------------------------------------------------------------------------------- The following tables show our total investment portfolio composition by geographic region of the Unites States at cost and fair value as a percentage of the total portfolio. The geographic composition is determined by the location of the corporate headquarters of the portfolio company (dollars in thousands). June 30, 2014 Fair Value Investments at Cost Percentage of Investments at Percentage of Cost Total Portfolio Fair Value Total Portfolio Northeast $ 67,258 27.1 % $ 67,543 27.2 % Southeast 51,003 20.6 % 51,208 20.6 % Southwest 42,549 17.2 % 42,721 17.2 % West 40,269 16.2 % 40,347 16.2 % Midwest 34,801 14.0 % 34,866 14.0 % Non-United States 12,063 4.9 % 12,002 4.8 % Total $ 247,943 100.0 % $ 248,687 100.0 % December 31, 2013 Fair Value Investments at Cost Percentage of Investments at Percentage of Cost Total Portfolio Fair Value Total Portfolio Northeast $ 20,459 30.8 % $ 20,611 30.8 % Southwest 9,545 14.4 % 9,645 14.4 % West 9,254 13.9 % 9,358 14.0 % Southeast 11,674 17.6 % 11,771 17.6 % Midwest 11,569 17.4 % 11,575 17.3 % Non-United States 3,909 5.9 % 3,922 5.9 % Total $ 66,410 100.0 % $ 66,882 100.0 % 39

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The following tables show our total investment portfolio composition of portfolio investments by industry at cost and fair value:

Cost: June 30, 2014 December



31, 2013

Media 8.9 % 6.7 % Electronic Equipment, Instruments & Components 8.5 %



3.0 %

IT Services 7.5 % 11.2 % Hotels, Restaurants, and Leisure 7.1 %



5.4 %

Health Care Providers and Services 6.7 %



5.6 %

Internet Software and Services 5.2 % 5.9 % Chemicals 4.2 % 1.9 % Specialty Retail 3.3 % 6.6 % Textiles, Apparel, & Luxury Goods 3.1 % 4.0 % Diversified Consumer Services 3.0 % 4.1 % Commercial Services and Supplies 3.0 %



2.9 %

Oil, Gas, and Consumable Fuels 3.0 % 4.7 % Application Software 2.8 % - % Software 2.8 % 3.7 % Energy Equipment and Services 2.5 % 3.7 % Data Processing and Outsourced Services 2.4 % 2.2 % Automobiles 2.4 % - % Food Products 2.1 % 1.5 % Healthcare Technology 2.0 % - % Marine 2.0 % - % Aerospace and Defense 1.8 % 1.7 % Health Care Equipment and Supplies 1.8 % 1.5 % Household Products 1.7 % - % Advertising 1.5 % 1.0 % Auto Components 1.4 % 2.2 % Oil and Gas Exploration and Production 1.2 % - % Professional Services 1.1 % 2.8 % Containers and Packaging 1.0 % - % Diversified Telecommunicaton Services 0.8 % - % Internet and Catalog Retail 0.7 % 2.2 % Electric Utilities 0.6 % 1.3 % Tobacco 0.6 % - % Restaurants 0.6 % 2.3 % Electrical Equipment 0.6 % 2.2 % Life Sciences Tools and Services 0.6 %



2.2 %

Leisure Equipment and Products 0.5 % 2.2 % Food & Staples Retailing 0.4 % 1.5 % Metals and Mining 0.3 % 1.4 % Thrifts & Mortgage Finance 0.3 % 1.1 % Communications Equipment - % 1.3 % Total 100.0 % 100.0 % 40

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Fair Value: June 30, 2014 December 31, 2013 Media 8.9 % 6.7 % Electronic Equipment, Instruments & Components 8.5 %



3.0 %

IT Services 7.5 % 11.3 % Hotels, Restaurants, and Leisure 7.0 %



5.4 %

Health Care Providers and Services 6.7 %



5.6 %

Internet Software and Services 5.2 % 5.9 % Chemicals 4.3 % 1.9 % Specialty Retail 3.3 % 6.6 % Textiles, Apparel, & Luxury Goods 3.1 % 4.0 % Diversified Consumer Services 3.0 % 4.1 % Commercial Services and Supplies 3.0 %



2.9 %

Oil, Gas, and Consumable Fuels 3.0 % 4.7 % Application Software 2.8 % - % Software 2.8 % 3.7 % Energy Equipment and Services 2.5 % 3.8 % Data Processing and Outsourced Services 2.4 % 2.2 % Automobiles 2.4 % - % Food Products 2.1 % 1.4 % Healthcare Technology 2.0 % - % Marine 2.0 % - % Aerospace and Defense 1.8 % 1.7 % Health Care Equipment and Supplies 1.8 % 1.5 % Household Products 1.7 % - % Advertising 1.5 % 1.1 % Auto Components 1.4 % 2.2 % Oil and Gas Exploration and Production 1.2 % - % Professional Services 1.1 % 2.7 % Containers and Packaging 1.0 % - % Diversified Telecommunicaton Services 0.8 % - % Internet and Catalog Retail 0.7 % 2.2 % Electric Utilities 0.6 % 1.3 % Tobacco 0.6 % - % Restaurants 0.6 % 2.3 % Electrical Equipment 0.6 % 2.2 % Life Sciences Tools and Services 0.6 %



2.2 %

Leisure Equipment and Products 0.5 % 2.2 % Food & Staples Retailing 0.4 % 1.5 % Metals and Mining 0.3 % 1.3 % Thrifts & Mortgage Finance 0.3 % 1.1 % Communications Equipment - % 1.3 % Total 100.0 % 100.0 % Our portfolio investments carry a number of risks including, but not limited to: (1) investing in companies which may have limited operating histories and financial resources; (2) holding investments that generally are not publicly traded and which may be subject to legal and other restrictions on resale; and (3) other risks common to investing in below investment grade debt in LMM and middle market companies. 41

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PORTFOLIO ASSET QUALITY

As of June 30, 2014, we owned a diversified portfolio of 86 investments in 80 companies representing a wide range of industries. We believe that this diversity adds to the structural protection of the portfolio, revenue sources, income, cash flows and dividends. The portfolio included the following:



? 81 debt investments in 77 private-placement portfolio companies with an

aggregate fair value of approximately $245.3 million and a cost basis of

approximately $244.5 million. The private placement portfolio had a

weighted average annual effective yield of approximately 7.0% and 90.5% of

the investments were secured by first priority liens. Further, 93.7% of

the private placement investments contain variable rates though a majority

of the investments with variable rates are subject to contractual minimum

LIBOR interest rates between 100 and 150 basis points. ? 4 debt investments in 3 LMM portfolio companies with an aggregate fair



value and cost basis of approximately $2.8 million. The LMM investments

had a weighted average annual effective yield of approximately 12.1%, and

the investments were secured by first priority liens.



? 1 equity investment in 1 LMM portfolio company with an aggregate fair

value and cost basis of $670,000.



? Overall, our investment portfolio had a weighted average effective yield

of approximately 7.1%, and 90.3% of the investments were secured by first-priority liens. As of June 30, 2014, the portfolio was generally performing at or above our expectations and none of our investments were in default. For those investments in which S&P credit ratings are available, approximately 58% of the portfolio at fair value, the portfolio had a weighted average effective credit rating of B. We utilize a rating system developed by our Sub-Adviser to rate the performance of each LMM portfolio company. The investment rating system takes into consideration various factors, including, but not limited to, each investment's expected level of returns, collectability, comparisons to competitors and other industry participants, and the portfolio company's future outlook. Investment Rating 1 represents a LMM portfolio company that



is

performing in a manner which significantly exceeds



expectations.

Investment Rating 2 represents a LMM portfolio company that, in general, is performing above expectations. Investment Rating 3 represents a LMM portfolio company that is generally performing in accordance with expectations and for which there is no indication of a decline in value. Investment Rating 4 represents a LMM portfolio company that is underperforming expectations, requiring increased monitoring and scrutiny by us. Investment Rating 5 represents a LMM portfolio company that is significantly underperforming, requiring heightened levels of monitoring and scrutiny by us and involves the recognition of significant unrealized depreciation on such investment.



For investments with a 4 or 5 rating, there is significant doubt regarding our ability to fully recover the principal amount due. All new LMM portfolio investments receive an initial Investment Rating 3, and the cost of the investment is generally considered to be the fair value.

The following table shows the distribution of our LMM portfolio investments on the 1 to 5 investment rating scale at fair value as of June 30, 2014 and December 31, 2013 (dollars in thousands):

June 30, 2014December 31, 2013 Investments at Percentage of



Investments at Fair Percentage of

Investment Rating Fair Value Total Portfolio Value Total Portfolio 1 $ - - $ 750 50.0 % 2 1,500 54.3 % 750 50.0 % 3 1,260 45.7 % - - 4 - - - - 5 - - - - Totals $ 2,760 100.0 % $ 1,500 100.0 % 42

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Based upon our investment rating system, the weighted average rating of our LMM portfolio at fair value as of June 30, 2014 and December 31, 2013, was approximately 2.5 and 1.5, respectively.

DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS

RESULTS COMPARISONS FOR THE THREE MONTHS ENDED JUNE 30, 2014 AND JUNE 30, 2013

Total Investment Income, Operating Expenses, Net Assets

For the three months ended June 30, 2014 and 2013, our total investment income was approximately $3.2 million and $559,000, respectively, consisting predominately of interest income. As of June 30, 2014, the portfolio had a weighted average annual effective yield on investments of approximately 7.1% compared to 8.1% as of June 30, 2013 and our average investment portfolio for the three months ended June 30, 2014 was $195.0 million compared to $23.5 million for the three months ended June 30, 2013. The increase in interest income is primarily due to the growth in our total portfolio resulting from the investment of additional equity capital raised and borrowings under our Syndicated Credit Facility and HMS Funding Facility offset by the decline in the effective yield on investments. The decline in yield is largely due to the repayment of four LMM investments during 2013, which were held during the three months ended June 30, 2013, and were not held during the three months ended June 30, 2014. These investments have higher yields than the private placement portfolio investments. There has also been a general decline in the yields on the private placement portfolio investments, compressing the portfolio yield. We expect further increases in investment income in future periods due to (i) a growing base of portfolio company investments, and (ii) investments being held for the entire period relative to incremental net investment activity during each quarter. For the three months ended June 30, 2014, expenses, net of base management fee, incentive fee and administrative services expenses waivers, were approximately $1.4 million as compared to expenses of approximately $262,000 for the three months ended June 30, 2013. The increase in expenses is primarily due to an increase in interest expense of $444,000, of which $65,000 is related to the increase in the amortization of deferred financing fees, increase in base management and incentive fees, net of waivers, of $550,000, and an increase in other general and administrative expense of $104,000. Interest expense increased due to an increase in the average borrowings during the period. Average borrowings were $55.3 million for the three months June 30, 2014 compared to $8.0 million for the three months ended June 30, 2013. Additionally, interest expense was higher for the three months ended June 30, 2014, due to the increase in amortization of deferred financing fees as a result of fees paid in connection with the Syndicated Credit Facility and the HMS Funding Facility. As of June 30, 2014 and June 30, 2013, the stated interest rate on borrowings was approximately 3%. Other general and administrative expenses increased due to additional banking costs, trade costs and other costs associated with the increase in the overall portfolio size. During the three months ended June 30, 2013, all management and incentive fees were waived. Beginning January 1, 2014, our Sub-Adviser no longer waived its fees, resulting in a management fee of $550,000 for the three months ended June 30, 2014, compared to a fee of zero in the same period in 2013. As described above, we have entered into an agreement with our Adviser to provide support in order for us to achieve the Operating Expense Objective. Due to the nature of the Mandatory Reimbursement Payments under the Expense Reimbursement Agreement, the amount of the Expense Support Payment from the Adviser for the three months ended June 30, 2014, is not fixed or determinable and accordingly has not been recognized by us as of June 30, 2014. We expect the Expense Support Payment will become fixed and determinable at the end of the year, once we have been able to evaluate if the Operating Expense Objective was exceeded during the year, requiring a Mandatory Reimbursement Payment. Upon this determination, the unreimbursed Expense Support Payment will be recognized in the Statement of Operations, as a reduction to expenses. For the three months ended June 30, 2014, the net increase in net assets resulting from operations was approximately $2.0 million. The increase was attributable to net investment income of approximately $1.8 million, realized gains of approximately $82,000, and unrealized appreciation on investments of approximately $44,000. For the three months ended June 30, 2013, the net increase in net assets was approximately $232,000. The increase was primarily attributable to net investment income of approximately $297,000, realized gains of approximately $4,000, and net unrealized depreciation of $69,000.



RESULTS COMPARISONS FOR THE SIX MONTHS ENDED JUNE 30, 2014 AND JUNE 30, 2013

Total Investment Income, Operating Expenses, Net Assets

43 -------------------------------------------------------------------------------- For the six months ended June 30, 2014 and 2013, our total investment income was approximately $4.9 million and $951,000, respectively, consisting predominately of interest income. As of June 30, 2014, the portfolio had a weighted average annual effective yield on investments of approximately 7.1% compared to 8.1% as of June 30, 2013 and our average investment portfolio for the six months ended June 30, 2014 was $152.3 million compared to $21.1 million for the six months ended June 30, 2013. The increase in interest income is primarily due to the growth in our total portfolio resulting from the investment of additional equity capital raised and borrowings under our Syndicated Credit Facility offset by the decline in the effective yield on investments. The decline in yield is largely due to the repayment of four LMM investments during 2013, which were held during the three months ended June 30, 2013, and were not held during the three months ended June 30, 2014. These investments have higher yields than the private placement portfolio investments. There has also been a general decline in the yields on the private placement portfolio investments, compressing the portfolio yield. We expect further increases in investment income in future periods due to (i) a growing base of portfolio company investments, and (ii) investments being held for the entire period relative to incremental net investment activity during each quarter. For the six months ended June 30, 2014, expenses, net of base management fee, incentive fee and administrative services expenses waivers and expense support payment, were approximately $2.2 million as compared to expenses of approximately $553,000 for the six months ended June 30, 2013. The increase in expenses is primarily due to an increase in interest expense of $567,000, of which $84,000 is related to the increase in the amortization of deferred financing fees, increase in base management and incentive fees of $853,000, increase in professional fees expense of $99,000, and an increase in other general and administrative expense of $129,000. Interest expense increased due to an increase in the average borrowings during the period. Average borrowings were $41.5 million for the six months ended June 30, 2014 compared to $7.7 million for the six months ended June 30, 2013. Additionally, interest expense was higher for the six months ended June 30, 2014, due to the increase in amortization of deferred financing fees as a result of fees paid in connection with the Syndicated Credit Facility and the HMS Funding Facility. As of June 30, 2014 and June 30, 2013, the stated interest rate on borrowings was approximately 3%. Professional fees increased largely due to additional legal costs related to the application for exemptive relief and higher audit fees associated with the significant growth of the Company. Other general and administrative expenses increased due to additional banking costs, trade costs and other costs associated with the increase in the overall portfolio size. During the six months ended June 30, 2013, all management and incentive fees were waived. Beginning January 1, 2014, our Sub-Adviser no longer waived its fees, resulting in a management fee of $853,000 for the six months ended June 30, 2014, compared to a fee of zero in the same period in 2013. As described above, we have entered into an agreement with our Adviser to provide support in order for us to achieve the Operating Expense Objective. Due to the nature of the Mandatory Reimbursement Payments under the Expense Reimbursement Agreement, the amount of the Expense Support Payment from the Adviser for the quarter ended June 30, 2014, is not fixed or determinable and accordingly has not been recognized by us as of June 30, 2014. We expect the Expense Support Payment will become fixed and determinable at the end of the year, once we have been able to evaluate if the Operating Expense Objective was exceeded during the year, requiring a Mandatory Reimbursement Payment. Upon this determination, the unreimbursed Expense Support Payment will be recognized in the Statement of Operations, as a reduction to expenses. For the six months ended June 30, 2014, the net increase in net assets resulting from operations was approximately $3.1 million. The increase was attributable to net investment income of approximately $2.7 million, realized gains of approximately $151,000, and unrealized appreciation on investments of approximately $272,000.



For the six months ended June 30, 2013, the net increase in net assets was approximately $540,000. The increase was primarily attributable to net investment income of approximately $398,000, realized gains of $4,000 and unrealized appreciation on investments of approximately $138,000.

Liquidity and Capital Resources

Cash Flows

For the six months ended June 30, 2014, we experienced a net increase in cash and cash equivalents of approximately $6.0 million. During that period, we used approximately $139.5 million of cash in our operating activities from a net increase in net assets resulting from operations of approximately $3.1 million and the repayment of portfolio debt investments of $26.8 million, offset by the funding of new portfolio debt and equity investments of $170.5 million. During the six months ended June 30, 2014, approximately $145.5 million was generated from financing activities, which principally consisted of a net $69 million increase in borrowings under the Syndicated Credit Facility and HMS Funding Facility, $79.7 million in net Offering 44 -------------------------------------------------------------------------------- proceeds received, reduced by $1.6 million in cash distributions paid to stockholders and $1.6 million paid for fees related to the Syndicated Credit Facility amendment and HMS Funding Facility entered into during the six months ended June 30, 2014. For the six months ended June 30, 2013, we experienced a net increase in cash and cash equivalents of approximately $520,000. During that period, we used approximately $11.6 million of our cash in our operating activities from a net increase in net assets resulting from operations of approximately $540,000 and the repayment of portfolio debt investments of $6.4 million, offset by the purchase of new portfolio debt investments of $19.8 million. During the six months ended June 30, 2013, approximately $12.2 million was provided by financing activities, which principally consisted of $9.6 million in net Offering proceeds received, and $458,000 in cash distributions paid to stockholders.



Initial Offering

During the six months ended June 30, 2014, we raised proceeds of $91.4 million from the Offering, including proceeds from the distribution reinvestment plan, and made payments of $7.7 million for selling commissions and dealer manager fees. We also incurred an obligation for $1.4 million of Offering costs related to the Offering, which represents 1.5% of the proceeds raised during the quarter. During the six months ended June 30, 2013, we raised proceeds of $11.0 million from the Offering, including proceeds from the distribution reinvestment plan, and made payments of $947,000 for selling commissions and dealer manager fees. We also incurred an obligation for $165,000 of Offering costs related to the Offering, which represents 1.5% of the proceeds raised during the quarter.



Distributions

The following table reflects the cash distributions per share that we have declared on our common stock during the six months ended June 30, 2014 (in thousands except per share amounts).

Distributions For the Period Ended Per Share Amount



Three months ended June 30, 2014$ 0.18$ 2,049 Three months ended March 31, 2014$ 0.17$ 1,276

The following table reflects the cash distributions per share that we have declared on our common stock during the six months ended June 30, 2013 (in thousands except per share amounts).

Distributions For the Period Ended Per Share Amount



Three months ended June 30, 2013$ 0.18$ 356 Three months ended March 31, 2013$ 0.17$ 243

On June 24, 2014, with the authorization of our board of directors, we declared distributions to our stockholders for the period of July 2014 through September 2014. These distributions have been, or will be, calculated based on stockholders of record each day from July 1, 2014 through September 30, 2014 in an amount equal to $0.00191781 per share, per day (which represents an annualized distribution yield of 7% based on our current public offering price of $10.00 per share, if it were maintained every day for a twelve-month period). Distributions are paid on the first business day following the completion of each month to which they relate.



We have adopted an "opt in" distribution reinvestment plan for our stockholders. As a result, if we make a distribution, our stockholders will receive distributions in cash unless they specifically "opt in" to the distribution reinvestment plan so as to have their cash distributions reinvested in additional shares of our common stock.

We may fund our cash distributions from any sources of funds available, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, dividends or other distributions paid to it on account of preferred and common equity investments in portfolio companies and fee waivers from our Advisers. We have not established any limit on the extent to which we may use borrowings or proceeds from the Offering to fund distributions. Our distributions may exceed our earnings, especially during 45 -------------------------------------------------------------------------------- the period before we have substantially invested the proceeds from the Offering. As a result, a portion of the distributions we make may represent a return of capital for U.S. federal income tax purposes.



The timing and amount of any future distributions to stockholders are subject to applicable legal restrictions and the sole discretion of our board of directors.

In order to satisfy the Code requirements applicable to a RIC, we must distribute to our stockholders substantially all of our taxable income on an annual basis; however, we may elect to spillover certain excess undistributed taxable income from one tax year into the next tax year, which would require us to pay a 4% non-deductible excise tax on such excess undistributed taxable income. In 2012, we estimated approximately $117,000, or $0.09 per share, of our taxable income for 2012 which was distributed in 2013 prior to the filing of our federal income tax return for the 2012 taxable year, would be subject to the 4% nondeductible excise tax. In 2013, we estimate that approximately $7,000, or $0.001 per share, of our taxable income for 2013 will be distributed in 2014, prior to the filing of our federal income tax return for our 2013 taxable year. We anticipate that none of this will be subject to the 4% nondeductible excise tax as the Company has distributed enough to eliminate an excise tax liability. In order to avoid excise tax, we need to distribute, during each calendar year an amount at least equal to the sum of (1) 98.0% of our net ordinary income for the calendar year, (2) 98.2% of our capital gain in excess of capital loss for the calendar year and (3) any net ordinary income and net capital gain for preceding years that were not distributed during such years and on which we paid no U.S. federal income tax.



Capital Resources

As of June 30, 2014, we had approximately $12.3 million in cash and our net asset value totaled approximately $129.7 million, equating to $8.85 per share. We believe our current cash flows from operations, future availability under our Syndicated Credit Facility, HMS Funding Facility and the proceeds from the Offering are sufficient to allow us to meet our liquidity needs for both the near and longer term, to continue operations, satisfy our contractual obligations and pay distributions to our stockholders. On May 24, 2012, we entered into a $15 million senior secured revolving credit facility (the "Credit Facility") with Capital One, National Association ("Capital One"). The Credit Facility had an accordion provision allowing increases in borrowing of up to $60 million, for a total facility of up to $75 million, subject to certain conditions. On August 16, 2013, the Company expanded the available capacity under the Credit Facility from $15 million to $25 million. The Credit Facility was further amended on November 25, 2013, increasing the capacity of the Credit Facility from $25 million to $30 million. On March 11, 2014, we entered into the Syndicated Credit Facility, a $70 million senior secured credit facility with Capital One, as the administrative agent, and with Capital One and the other banks, (the "Lenders"), in the Syndicated Credit Facility. On May 30, 2014, we entered into the First Amendment (the "First Amendment") to the Syndicated Credit Facility. The First Amendment provides for, among other things, the creation of certain of our structured subsidiaries (the "Structured Subsidiaries"), which will not be guarantors under the Syndicated Credit Facility and which will be permitted to incur debt outside of the Syndicated Credit Facility, subject to certain conditions. The assets of the Structured Subsidiaries will not be considered collateral under the Syndicated Credit Facility. The First Amendment contains additional covenants such as the our minimum consolidated tangible net worth, excluding Structured Subsidiaries, will be no less than $50.0 million, calculated quarterly, limitations regarding industry concentration and an anti-hoarding provision to protect the collateral under the Syndicated Credit Facility. This Syndicated Credit Facility amends and restates in its entirety the Credit Facility. Borrowings under the Syndicated Credit Facility bear interest, subject to the Company's election, on a per annum basis equal to (i) the adjusted LIBOR rate plus 2.75% or (ii) the base rate plus 1.75%. The base rate is defined as the higher of (a) the prime rate or (b) the Federal Funds Rate (as defined in the credit agreement) plus 0.5%. The adjusted LIBOR rate is defined in the credit agreement for the Syndicated Credit Facility as the LIBOR rate plus such amount as adjusted for statutory reserve requirements for Eurocurrency liabilities. We pay unused commitment fees of 0.25% per annum on the unused lender commitment under the Syndicated Credit Facility if more than 50% of the Syndicated Credit Facility is being used and a commitment fee of 0.375% per annum on the unused lender commitments under the Syndicated Credit Facility if less than 50% of the Syndicated Credit Facility is being used. The Syndicated Credit Facility has a three year term, with two one-year extension options, subject to approval of the Lenders. Additionally, the Syndicated Credit Facility has an accordion provision allowing borrowing capacity to increase to $150 million. Borrowings under the Syndicated Credit Facility are secured by all of the our assets, except the assets of Structured Subsidiaries, as well as all of the assets, and a pledge of equity ownership interests, of any of our future subsidiaries, which would be joined as guarantors. The credit agreement for the Syndicated Credit Facility contains affirmative and negative covenants usual and customary for credit facilities of this nature, including, but not limited to: (i) maintaining an interest coverage ratio of at least 2.0 to 1.0, which was 5.1 to 1 for the three months ended June 30, 2014, (ii) maintaining an asset coverage ratio of at least 2.25 to 1.0, which was 2.9 to 1 as of June 30, 2014, and (iii) maintaining minimum consolidated tangible net worth, excluding the Structured Subsidiaries, of at least $50 million, which was approximately $100.3 million as of 46 -------------------------------------------------------------------------------- June 30, 2014. Additionally, we must provide information to Capital One on a regular basis, preserve the Company's corporate existence, comply with applicable laws, including the 1940 Act, pay obligations when they become due, and invest the proceeds of the Offering in accordance with its investment objectives and strategies (as set forth in the Syndicated Credit Facility). Further, the credit agreement contains usual and customary default provisions including, without limitation: (i) a default in the payment of interest and principal; (ii) insolvency or bankruptcy; (iii) a material adverse change in our business; or (iv) breach of any covenant, representation or warranty in the loan agreement or other credit documents and failure to cure such breach within defined periods. Additionally, the Syndicated Credit Facility requires us to obtain written approval from the administrative agent prior to entering into any material amendment, waiver or other modification of any provision of the Advisory Agreement. As of June 30, 2014, the Company was not aware of any instances of noncompliance with covenants related to the Syndicated Credit Facility. The maturity date of the Syndicated Credit Facility is March 11, 2017, and the Company has two, one-year extension options subject to Lender approval. On June 2, 2014, our wholly-owned Structured Subsidiary, HMS Funding I, LLC, a Maryland limited liability company ("HMS Funding"), entered into a credit agreement (the "HMS Funding Facility") among HMS Funding, HMS, as equityholder and as servicer, Deutsche Bank AG, New York Branch ("Deutsche Bank"), and the financial institutions party thereto as lenders (together with Deutsche Bank, the "HMS Funding Lenders"). The HMS Funding Facility provides for an initial borrowing capacity of $50.0 million, subject to certain limitations, including limitations with respect to HMS Funding's investments, as more fully described in the HMS Funding Facility. In addition, at HMS Funding's request and approval by HMS Funding Lenders, the maximum borrowings under the HMS Funding Facility can be increased by up to an additional $200.0 million, in the aggregate, subject to certain limitations contained in the HMS Funding Facility, for a total maximum capacity of $250.0 million. In connection with the entry into the HMS Funding Facility, we contributed certain assets to HMS Funding, as permitted under the Syndicated Credit Facility, as collateral to secure the HMS Funding Facility. The HMS Funding Facility matures on June 3, 2019. Under the HMS Funding Facility, interest is calculated as the sum of the index plus the applicable margin of 2.75%. If the HMS Funding Facility is funded via an asset backed commercial paper conduit, the index will be the related commercial paper rate; otherwise, the index will be equal to one-month LIBOR. HMS Funding also pays a commitment fee on the undrawn amount of commitments of 0.65% per annum, depending on the utilization of the loan commitment amount. Additionally, HMS Funding will pay a utilization fee equal to 2.75% of the undrawn amount of the Required Utilization, as defined in the HMS Funding Facility. The HMS Funding Facility provides for a revolving period until December 3, 2016, unless otherwise extended with the consent of the HMS Funding Lenders. The amortization period begins the day after the last day of the revolving period and ends on the maturity date. During the amortization period, the applicable margin will increase by 0.25%. HMS Funding's obligations under the HMS Funding Facility are secured by a first priority security interest in its assets, including all of the present and future property and assets of HMS Funding. The HMS Funding Facility contains affirmative and negative covenants usual and customary for credit facilities of this nature, including, but not limited to maintaining a positive tangible net worth, limitations on industry concentration and complying with all applicable laws. The HMS Funding Facility contains usual and customary default provisions including, without limitation: (i) a default in the payment of interest and principal; (ii) insolvency or bankruptcy of the Company; (iii) the occurrence of a change of control; or (iv) any uncured breach of a covenant, representation or warranty in the HMS Funding Facility. On July 22, 2014, we entered into an amendment to the HMS Funding Facility increasing the capacity of the facility to $100 million. No other terms or conditions were modified as a result of this agreement. As of June 30, 2014, we had borrowings of $52.0 million outstanding on the Syndicated Credit Facility, and had borrowings of $31.0 million outstanding on the HMS Funding Facility, both of which the Company estimated approximated fair value.



During the six months ended June 30, 2014, we raised gross proceeds of approximately $91.4 million from the Offering including proceeds from the distribution reinvestment plan of $1.2 million, and we made payments of approximately $7.7 million for selling commissions and dealer manager fees. We also paid $1.4 million of Offering costs related to the Offering.

We anticipate that we will continue to fund our investment activities through existing cash, capital raised from our Offering, and borrowings on our Syndicated Credit Facility and HMS Funding Facility. Our primary uses of funds in both the short-term and long-term will be investments in portfolio companies, operating expenses and cash distributions to holders of our common stock. In addition, as a BDC, we generally are required to meet a coverage ratio of total assets to total senior securities, which include borrowings and any preferred stock we may issue in the future, of at least 200%. As of June 30, 2014 and December 31, 2013 our asset coverage ratio under BDC regulations was 256% and 443% respectively. This requirement limits the amount that we may borrow. As of June 30, 2014, due to these limitations, we had capacity under our Syndicated Credit Facility and HMS Funding Facility to borrow up to $37 million. 47 -------------------------------------------------------------------------------- Although we have been able to secure access to potential additional liquidity, through proceeds from the Offering and also by entering into the Syndicated Credit Facility and HMS Funding Facility, there is no assurance that equity or debt capital will be available to us in the future on favorable terms, or at all.



Related-Party Transactions and Agreements

We have entered into agreements with the Adviser, the Sub-Adviser, and the Dealer Manager, whereby we pay certain fees and reimbursements to these entities. These include payments to the Dealer Manager for selling commissions and the Dealer Manager fees and payments to our Adviser and Sub-Adviser for reimbursement of Offering costs. In addition, we make payments for certain services that include, but are not limited to, the identification, execution, and management of our investments and also the management of our day-to-day operations provided to us by our Adviser and Sub-Adviser, pursuant to various agreements that we have entered into, including the Advisory Agreement, the Sub-Advisory Agreement and the Conditional Fee Waiver Agreement. See Note 9 - Related Party Transactions and Arrangements to the financial statements included elsewhere in this Report for additional information regarding related party transactions



Contractual Obligations

As of June 30, 2014, we had $83.0 million in borrowings outstanding under the Syndicated Credit Facility and HMS Funding Facility. Unless extended, the Syndicated Credit Facility will mature on March 11, 2017, and the HMS Funding Facility will mature on June 3, 2019. The Syndicated Credit Facility has two, one-year extension options, with Lender approval that, if approved and exercised, would permit us to extend the maturity to March 11, 2019. See above for a description of the Syndicated Credit Facility.



A summary of our significant contractual payment obligations for the repayment of outstanding borrowings at June 30, 2014 is as follows:

Payments Due By Period



(dollars in thousands)

Less than 1 Total year 1-3 years 3-5 years After 5 years Syndicated Credit Facility(1) $ 52,000 $ - $ 52,000 $ - $ - HMS Funding Facility(2) $ 31,000 $ - $ - $ 31,000 $ -



(1) At June 30, 2014, $18 million remained available under our Syndicated Credit

Facility.

(2) At June 30, 2014, $19 million remained available under our HMS Funding

Facility.

Off-Balance Sheet Arrangements

As of June 30, 2014, we had no off-balance sheet arrangements.

Recent Developments and Subsequent Events

From July 1, 2014 through July 31, 2014, the Company has raised $25.8 million in capital in the public offering. During this period, the Company has funded approximately $67.3 million in private placement investments and has received proceeds from repayments and dispositions of approximately $15.2 million.



On July 22, 2014, the Company entered into an amendment to the HMS Funding Facility increasing the capacity to $100 million. No other terms or conditions were modified as a result of this agreement.


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Source: Edgar Glimpses


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