UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended September 30, 2014

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from             to

 

Commission File No. 0-54615

 

VII Peaks Co-Optivist Income BDC II, Inc.

(Exact name of Registrant as specified in its charter)

 

Maryland	45-2918121
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

 

4 Orinda Way, Suite 125-A

Orinda, CA 94563

(Address of principal executive offices)

 

(877) 700-0527

(Registrant’s telephone number, including area code)

 

Not applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

  

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨

  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨	Accelerated filer ¨	Non-accelerated filer x	Smaller reporting company ¨
		(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

 

The number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding as of November 12, 2014 was 5,169,473.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2014

 

TABLE OF CONTENTS

 

		Page
PART I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements	3
	Statements of Assets and Liabilities as of September 30, 2014 (unaudited) and December 31, 2013	3
	Statements of Operations for the three and nine months ended September 30, 2014 and 2013 (unaudited)	4
	Statements of Changes in Net Assets for the nine months ended September 30, 2014 and 2013 (unaudited)	5
	Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 (unaudited)	6
	Schedule of Investments as of September 30, 2014 (unaudited)	7
	Schedule of Investments as of December 31, 2013	8
	Notes to Financial Statements (unaudited)	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	33
PART II.	OTHER INFORMATION	33
Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3.	Defaults upon Senior Securities	34
Item 4.	Mine Safety Disclosures	34
Item 5.	Other Information	34
Item 6.	Exhibits	34
Signatures		35

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF ASSETS AND LIABILITIES

(in thousands, except share and per share data) 

(Unaudited)

  

		As of
		September 30, 2014				December 31, 2013 (1)
ASSETS
Investments, at fair value (amortized cost of $37,170 and $23,769)		$	32,899			$	23,154
Investments, money market at fair value (cost of $4,561 and $1,644)			4,561				1,644
Total investments, at fair value		$	37,460			$	24,798
Interest receivable			1,117				579
Prepaid expenses			28				8
Due from related party			98				1,354
Receivable for common stock purchased			676				974
Total assets		$	39,379			$	27,713
LIABILITIES
Payable for unsettled trades		$	601			$	104
Management fees payable			-				8
Accounts payable and accrued liabilities			406				129
Stockholder distributions payable			149				99
Total liabilities		$	1,156			$	340
NET ASSETS
Preferred stock, par value, $.001 per share, 50,000,000 authorized, none issued and outstanding			-				-
Common stock, par value, $.001 per share, 200,000,000 authorized; 4,909,423 and 3,151,376 shares issued and outstanding, respectively			5				3
Paid-in capital in excess of par value			45,339				28,651
Treasury stock at cost, 73,606 and 548 shares, respectively			(716	)			(6	)
Accumulated distribution in excess of net investment income and net realized gain on investments			(2,134	)			(660	)
Net unrealized depreciation on investments			(4,271	)			(615	)
Total net assets			38,223				27,373
Total liabilities and net assets		$	39,379			$	27,713
Net asset value per share		$	7.79			$	8.69

 

The accompanying notes are an integral part of these financial statements. 

 

(1) Derived from the Company’s audited Financial Statements as of December 31, 2013.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

(Unaudited)

 

		For the  Three Months Ended September 30,				For the  Three Months Ended September  30,				For the  Nine Months Ended September  30,				For the  Nine Months Ended September 30,
		2014				2013				2014				2013
Investment income:
Interest from investments		$	744			$	456			$	2,302			$	1,101
Other income			-				-				103				1
Total investment income			744				456				2,405				1,102
Operating expenses:
Professional fees			67				111				203				300
Directors fees			10				12				37				32
Insurance			24				22				71				62
Management fees			193				128				527				291
Incentive fees			-				4				-				4
Administrative Services			89				46				229				130
General and administrative			99				55				479				102
Offering expense			127				124				252				319
Operating expenses before expense reimbursements			609				502				1,798				1,240
Expense reimbursement			-				(201	)			-				(776	)
Total operating expenses net of expense reimbursements			609				301				1,798				464
Net investment income			135				155				607				638
Realized and unrealized gain (loss) on investments:
Net realized gain from investments			28				47				114				137
Net unrealized appreciation (depreciation) on investments			(2,438	)			135				(3,656	)			14
Net realized and unrealized gain (loss) on investments			(2,410	)			182				(3,542	)			151
Net increase (decrease) in net assets resulting from operations		$	(2,275	)		$	337			$	(2,935	)		$	789
Per share information - basic and diluted:
Net investment income		$	0.03			$	0.06			$	0.15			$	0.34
Net increase (decrease) in net assets resulting from operations		$	(0.52	)		$	0.14			$	(0.74	)		$	0.42
Weighted average common shares outstanding			4,365,342				2,443,182				3,962,809				1,887,741

 

The accompanying notes are an integral part of these financial statements.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF CHANGES IN NET ASSETS

(in thousands, except share and per share data)

(Unaudited) 

 

		For the Nine Months Ended September 30, 2014				For the Nine Months Ended September  30, 2013
Operations:
Net investment income		$	607			$	638
Net realized gain from investments			114				137
Net unrealized appreciation (depreciation) on investments			(3,656	)			14
Net increase (decrease) in net assets from operations			(2,935	)			789
Stockholder distributions:
Distributions from net investment income			(607	)			(638	)
Distributions from net realized gain on investments			(114	)			(137	)
Distributions from paid in capital			(1,473	)			(373	)
Net decrease in net assets from stockholder distributions			(2,194	)			(1,148	)
Capital share transactions:
Issuance of common stock, net of issuance costs			15,155				16,771
Reinvestment of stockholder distributions			783				480
Total investment contributions transferred in-kind			757				-
Treasury capital/redemptions			(716	)			-
Net increase in net assets from capital share transactions			15,979				17,251
Total increase in net assets			10,850				16,892
Net assets at beginning of period			27,373				8,336
Net assets at end of period		$	38,223			$	25,228
Net asset value per common share		$	7.79			$	8.88
Common shares outstanding at end of period			4,909,423				2,842,231
Accumulated distribution in excess of net investment income and net realized gain on investments		$	(2,134	)		$	(614	)

 

The accompanying notes are an integral part of these financial statements.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF CASH FLOWS

(in thousands, except share and per share data)

(Unaudited)

  

		For the Nine Months Ended September 30, 2014				For the Nine Months Ended September  30, 2013
Operating activities:
Net increase (decrease) in net assets from operations		$	(2,935	)		$	789
Adjustments to reconcile net increase (decrease) in net assets from operations to net cash used in operating activities:
Paid in-kind interest income			(15	)			-
Net accretion of discount on investments			(61	)			(61	)
Repayments of investments			10,775				7,117
Purchase of investments			(23,250	)			(19,801	)
Repayments of investments - money market			25,048				21,438
Purchase of investments - money market			(27,963	)			(24,981	)
Net realized gain from investments			(114	)			(137	)
Net unrealized depreciation on investments			3,656				(14	)
(Increase) decrease in operating assets:
Interest receivable			(538	)			(455	)
Prepaid expenses			(20	)			(8	)
Due from related party			1,287				(776	)
Receivable for common stock purchased			298				729
Increase (decrease) in operating liabilities:
Payable for unsettled trades			497				15
Management fees payable			(8	)			32
Accounts payable and accrued liabilities			277				65
Net cash used in operating activities			(13,066	)			(16,048	)
Financing activities:
Proceeds from issuance of shares of common stock, net			15,155				16,771
Redemptions of common stock			7				-
Stockholder distributions			(1,380	)			(723	)
Treasury stock			(716	)			-
Net cash provided by financing activities			13,066				16,048
Net increase in cash and cash equivalents			-				-
Cash and cash equivalents, beginning of period			-				-
Cash and cash equivalents, end of period		$	-			$	-
Supplemental non-cash information:
DRIP distribution payable		$	56			$	32
Cash distribution payable		$	93			$	56
DRIP distribution paid		$	766			$	480

 

The accompanying notes are an integral part of these financial statements.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars in thousands)

September 30, 2014

(Unaudited)

 

Portfolio Company (a)		Industry		Investment Coupon Rate, Maturity Date		Principal				Amortized Cost				Fair Value				% of Net Assets
Senior Secured First Lien Debt - 15.1% (b)
Accuride Corp.		Consumer Goods: Durable		9.50%, 8/1/2018		$	825			$	835			$	860				2.2	%
APX Group, Inc.		Services: Consumer		6.375%, 12/1/2019			825				825				798				2.1	%
Caesars Entertainment Operating Co., Inc.		Hotel, Gaming & Leisure		11.25%, 6/1/2017			860				757				668				1.7	%
Cambrium Learning Group, Inc.		Services: Consumer		9.75%, 2/15/2017			1,375				1,394				1,334				3.5	%
Endeavour International Corp. (e)		Energy: Oil & Gas		12.00%, 3/1/2018			525				551				375				1.0	%
EuraMax International, Inc.		Metals & Mining		9.50%, 4/1/2016			1,350				1,346				1,316				3.5	%
Toys R Us Property Co II LLC		Retail		8.50%, 12/1/2017			425				435				428				1.1	%
Sub Total Senior Secured First Lien Debt							6,185				6,143				5,779				15.1	%
Senior Secured Second Lien  Debt - 12.6% (b)
Aspect Software, Inc.		Telecommunications		10.63%, 5/15/2017		$	1,302			$	1,324			$	1,292				3.4	%
Bon-ton Department Stores, Inc.		Retail		10.63%, 7/15/2017			40				41				40				0.1	%
Claire's Stores, Inc.		Retail		8.88%, 3/15/2019			825				804				685				1.8	%
Endeavour International Corp. (e)		Energy: Oil & Gas		12.00%, 6/1/2018			725				708				181				0.5	%
Logan's Roadhouse, Inc.		Beverage, Food & Tobacco		10.75%, 10/15/2017			770				735				577				1.5	%
Radiation Therapy Services, Inc.		Healthcare & Pharmaceuticals		8.88%, 1/15/2017			1,285				1,276				1,324				3.4	%
Saratoga Resources, Inc.		Energy: Oil & Gas		12.50%, 7/1/2016			885				899				708				1.9	%
Sub Total Senior Secured Second Lien Debt							5,832				5,787				4,807				12.6	%
Senior Unsecured Debt - 39.9% (b)
APX Group, Inc.		Services: Consumer		8.75%, 12/1/2020		$	575			$	552			$	523				1.4	%
Armored Autogroup, Inc.		Consumer Goods: Durable		9.25%, 11/1/2018			1,250				1,247				1,281				3.3	%
Caesar's Entertainment Corp.		Hotel, Gaming & Leisure		10.75%, 2/1/2016			495				470				173				0.5	%
Cenveo Corp.		Services: Business		11.50%, 5/15/2017			545				530				549				1.4	%
Clear Channel Communications		Media: Broadcasting & Subscription		10.00%, 1/15/2018			1,400				1,330				1,173				3.1	%
Colt Defense LLC		Aerospace and Defense		8.75%, 11/15/2017			1,253				1,060				735				1.9	%
DynCorp International Inc.		Aerospace and Defense		10.38%, 7/1/2017			1,135				1,149				979				2.6	%
Education Management LLC		Services: Consumer		15.00%, 7/1/2018 (d)			870				889				870				2.3	%
Gentiva Health Services, Inc.		Healthcare & Pharmaceuticals		11.50%, 9/1/2018			925				969				983				2.6	%
Gymboree Corp.		Retail		9.13%, 12/1/2018			810				762				227				0.6	%
Hutchinson Technology, Inc.		High Tech Industries		8.50%, 1/15/2026, puttable on 01/15/2015			858				818				826				2.2	%
NII Capital Corp. (e)		Telecommunications		10.00%, 8/15/2016			960				921				274				0.7	%
Nuverra Environmental Solutions, Inc.		Environmental Industries		9.88%, 4/15/2018			1,325				1,364				1,329				3.5	%
QuickSilver Resources, Inc.		Energy: Oil & Gas		7.13%, 4/1/2016			890				858				360				0.9	%
Seitel, Inc.		Energy: Oil & Gas		9.50%, 4/15/2019			825				845				887				2.3	%
Sitel LLC / Sitel Finance Corp		Media: Advertising, Printing & Publishing		11.50%, 4/1/2018			1,300				1,289				1,235				3.2	%
Suntech Power Holdings Company, Ltd. (c)		Environmental Industries		3.00%, 5/15/13			100				108				7				0.0	%
Travelport LLC		Services: Consumer		11.38% cash; 2% PIK, 3/1/2016			344				321				344				0.9	%
UCI International Inc		Automobile		8.63%, 2/15/2019			1,400				1,356				1,351				3.5	%
Visant Corp.		Media: Advertising, Printing & Publishing		10.00%, 10/1/2017			1,275				1,237				1,138				3.0	%
Sub Total Senior Unsecured Debt							18,535				18,075				15,244				39.9	%
Senior Subordinated Debt -18.5% (b)
Affinion Group, Inc.		Media: Advertising, Printing & Publishing		13.50%, 8/15/2018		$	816			$	702			$	759				2.0	%
American Media, Inc.		Media: Advertising, Printing & Publishing		11.50%, 12/15/2017			995				1,046				1,050				2.7	%
Central Garden and Pet Co.		Retail		8.25%, 3/1/2018			1,400				1,443				1,424				3.7	%
Claires Stores, Inc		Retail		10.50%, 6/1/2017			715				711				687				1.8	%
DJO Finance, LLC.		Healthcare & Pharmaceuticals		9.75%, 10/15/2017			1,265				1,316				1,284				3.4	%
Ryerson Inc./Joseph T Ryerson & Son, Inc.		Metals & Mining		9.00%, 10/15/2017			490				510				517				1.4	%
Toys R Us Inc.		Retail		10.38%, 8/15/2017			860				821				703				1.8	%
Travelport LLC		Services: Consumer		11.88%, 9/1/2016			645				616				645				1.7	%
Sub Total Senior Subordinated Debt							7,186				7,165				7,069				18.5	%
Investments - Money Market -11.9%
Investments - U.S. Bank Money Market				0.03%		$	4,561				4,561				4,561				11.9	%
Sub Total Investments - Money Market											4,561				4,561				11.9	%
TOTAL INVESTMENTS - 98.0% (b)										$	41,731			$	37,460				98.0	%

 

(a) All of our investments are issued by eligible U.S. portfolio companies, as defined in the Investment Company Act of 1940, except for Caesar's Entertainment Corp. and Suntech Power Holdings Company, Ltd.

 

(b) Percentages are based on net assets of $38,223 as of September 30, 2014.

 

(c) Non-U.S. company. The principal place of business for Suntech Power Holdings Company, Ltd. Is China. Non-income producing as of September 30, 2014.

 

(d) The notes pay cash interest at the rate of 15% per annum. For any interest period after March 30, 2014, the notes pay additional PIK interest in the form of additional notes. PIK interest on the notes accrues at the rate of (i) 1.0% per annum for the period from March 30, 2014 through and including March 30, 2015, (ii) 2.0% per annum for the period from March 30, 2015 through and including March 30, 2016, (iii) 3.0% per annum for the period from March 30, 2016 through and including March 30, 2017 and (iv) 4.0% per annum for the period from March 30, 2017 through and including July 1, 2018.

 

(e) Non-income producing as of September 30, 2014.

 

The accompanying notes are an integral part of these financial statements.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars in thousands)

December 31, 2013

Portfolio Company (a)		Industry		Investment Coupon Rate, Maturity Date		Principal				Amortized Cost				Fair Value				% of Net Assets
Senior Secured First Lien Debt - 8.4% (b)
Endeavour International Corp.		Energy: Oil & Gas		12.00%, 3/1/2018		$	525			$	551			$	539				2.0	%
EuraMax International, Inc.		Metals & Mining		9.50%, 4/1/2016			775				779				777				2.8	%
GSX Worldwide, Inc.		Services: Business		9.75%, 6/15/2015			940				965				971				3.6	%
Sub Total Senior Secured First Lien Debt							2,240				2,295				2,287				8.4	%
Senior Secured Second Lien  Debt - 19.3% (b)
Apria Healthcare Group, Inc.		Healthcare & Pharmaceuticals		12.38%, 11/1/2014		$	571			$	581			$	576				2.1	%
Aspect Software, Inc.		Telecommunications		10.63%, 5/15/2017			692				696				697				2.6	%
Bon-ton Department Stores, Inc.		Retail		10.63%, 7/15/2017			40				41				40				0.1	%
Caesar's Entertainment Corp.		Hotel, Gaming & Leisure		10.00%, 12/15/2015			505				481				432				1.6	%
Cenveo Corp.		Services: Business		8.88%, 2/1/2018			585				589				585				2.1	%
Endeavour International Corp.		Energy: Oil & Gas		12.00%, 6/1/2018			700				688				655				2.4	%
Logan's Roadhouse, Inc.		Beverage, Food & Tobacco		10.75%, 10/15/2017			750				715				557				2.0	%
Radiation Therapy Services, Inc.		Healthcare & Pharmaceuticals		8.88%, 1/15/2017			935				922				944				3.5	%
Saratoga Resources, Inc.		Energy: Oil & Gas		12.50%, 7/1/2016			860				888				804				2.9	%
Sub Total Senior Secured Second Lien Debt							5,638				5,601				5,290				19.3	%
Senior Unsecured Debt - 30.6% (b)
Alion Science and Technology Corp.		Aerospace and Defense		10.00% cash; 2% PIK, 11/1/2014		$	1,030			$	1,038			$	1,051				3.9	%
Avaya, Inc.		Telecommunications		9.75%, 11/1/2015			650				633				645				2.4	%
Avaya, Inc.		Telecommunications		10.13%, 11/1/2015			460				442				457				1.7	%
Caesar's Entertainment Corp.		Hotel, Gaming & Leisure		10.75%, 2/1/2016			445				416				358				1.3	%
Cenveo Corp.		Services: Business		11.50%, 5/15/2017			510				492				502				1.8	%
Ceridian Corporation		Services: Business		11.25%, 11/15/15			390				402				393				1.4	%
Ceridian Corporation		Services: Business		12.25%, 11/15/15			560				576				564				2.1	%
Colt Defense LLC		Aerospace and Defense		8.75%, 11/15/2017			853				718				737				2.7	%
DynCorp International, Inc.		Aerospace and Defense		10.38%, 7/1/2017			810				850				828				3.0	%
Education Management LLC (d)		Services: Consumer		15.00%, 6/1/2014			270				232				293				1.1	%
Harland Clarke Corp.		Banking, Finance, Insurance & Real Estate		9.50%, 5/15/5015			691				692				694				2.5	%
Hutchinson Technology, Inc.		High Tech Industries		8.50%, 1/15/2026, puttable on 1/15/2015			443				406				388				1.4	%
NII Cap Corp.		Telecommunications		10.00%, 8/15/2016			925				907				490				1.8	%
QuickSilver Resources, Inc.		Energy: Oil & Gas		7.13%, 4/1/2016			620				594				606				2.2	%
Suntech Power Holdings Company, Ltd.		Environmental Industries		3.00%, 2/28/2014			100				98				8				0.0	%
Travelport LLC		Services: Consumer		11.375% cash; 2.5% PIK, 3/1/2016			340				308				361				1.3	%
Sub Total Senior Unsecured Debt							9,097				8,804				8,375				30.6	%
Senior Subordinated Debt - 26.3% (b)
Accelent, Inc.		Healthcare & Pharmaceuticals		10.00%, 11/1/2017		$	775			$	732			$	800				2.9	%
Affinion Group, Inc.		Media: Advertising, Printing & Publishing		13.50%, 8/15/2018			816				689				812				2.9	%
American Media, Inc.		Media: Advertising, Printing & Publishing		11.50%, 12/15/2017			670				704				729				2.7	%
Claires Stores, Inc		Retail		10.50%, 6/1/2017			215				220				220				0.8	%
DJO Finance, LLC.		Healthcare & Pharmaceuticals		9.75%, 10/15/2017			825				864				840				3.1	%
First Data Corp.		Banking, Finance, Insurance & Real Estate		11.25%, 3/31/2016			374				375				375				1.4	%
Radio One, Inc.		Media: Broadcasting & Subscription		12.50%, 5/24/16			875				889				875				3.2	%
Ryerson Inc./Joseph T Ryerson & Son, Inc.		Metals & Mining		9.00%, 10/15/2017			420				438				445				1.6	%
Serena Software, Inc.		High Tech Industries		10.38%, 3/15/2016			770				786				770				2.8	%
Toys R Us, Inc.		Retail		10.38%, 8/15/2017			825				790				707				2.6	%
Travelport LLC		Services: Consumer		11.88%, 9/1/2016			620				582				629				2.3	%
Sub Total Senior Subordinated Debt							7,185				7,069				7,202				26.3	%
Investments - Money Market - 6.0% (b)
Investments – U.S. Bank Money Market				0.03%		$	1,644				1,644				1,644				6.0	%
Sub Total Investments - Money Market											1,644				1,644				6.0	%
TOTAL INVESTMENTS - 90.6% (b)										$	25,413			$	24,798				90.6	%

 

(a)

All of our investments are issued by eligible U.S. portfolio companies, as defined in the Investment Company Act of 1940, except for Caesar's Entertainment Corp., Education Management LLC, NII Capital Corp., QuickSilver Resources, Inc., and Suntech Power Holdings Company, Ltd.

 

(b)

Percentages are based on net assets of $27,373 as of December 31, 2013.

 

(c)

Non-U.S. company. The principal place of business for Suntech Power Holdings Company, Ltd. is China.

 

(d)

The notes pay cash interest at the rate of 15% per annum. For any interest period after March 30, 2014, the notes pay additional PIK interest in the form of additional notes. PIK interest on the notes accrues at the rate of (i) 1.0% per annum for the period from March 30, 2014 through and including March 30, 2015, (ii) 2.0% per annum for the period from March 30, 2015 through and including March 30, 2016, (iii) 3.0% per annum for the period from March 30, 2016 through and including March 30, 2017 and (iv) 4.0% per annum for the period from March 30, 2017 through and including July 1, 2018.

 

The accompanying notes are an integral part of these financial statements.

 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

NOTES TO FINANCIAL STATEMENTS

September 30, 2014

 

(Unaudited)

 

Note 1.  Nature of Operations  

 

VII Peaks Co-Optivist ^TM Income BDC II, Inc. (the “Fund” or “we”), a Maryland Corporation formed in August 3, 2011 is  an externally managed, non-diversified closed-end management investment company that has elected to be treated as a business development company, under the Investment Company Act of 1940, as amended, or (“1940 Act”). In addition, we have elected to be treated for federal income tax purpose, and intend to qualify annually, as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code of 1986, as amended, or the Code.

 

We are managed by VII Peaks Capital, LLC, or our (“Manager”), which is registered as an investment adviser with the Security Exchange Commission, or (“SEC”). Our Manager is responsible for sourcing potential investments, analyzing investment opportunities, structuring our investments, and monitoring our investments and portfolio companies on an ongoing basis.

 

On August 9, 2011, we filed a registration statement on Form N-2 to sell up to 75,000,000 shares of common stock, $0.001 par value per share, at an initial public offering price of $10.00 per share. The registration statement was declared effective by the SEC on March 1, 2012. We commenced operations when we raised gross offering proceeds of over $1.0 million, all of which was from persons who were not affiliated with us or our manager by one year from the date the registration statement was declared effective by the SEC. Prior to the successful satisfaction of that condition, all subscription payments were placed in an account held by the escrow agent, UMB Bank, N.A., in trust for the benefit of our subscribers, pending release to us. We achieved the minimum offering requirement on July 10, 2012 and commenced operations on such date. As of September 30, 2014, we issued 5.0 million shares of common stock, including 0.2 million shares under our distribution reinvestment plan (“DRIP”) and 0.07 million shares redeemed under our tender offer. Gross proceeds from our common stock issuances total $50.0 million, including $1.5 million under our distribution reinvestment plan (“DRIP”) and $0.7 million in tender offer redemption shares.

 

Note 2.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The financial statements of the Fund included herein were prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements include all adjustments, consisting only of normal recurring adjustments and accruals, necessary for a fair presentation of the results for the interim period. This Form 10-Q should be read in conjunction with the Fund’s annual report on Form 10-K for the year ended December 31, 2013, which was filed with the SEC on March 11, 2014. The current period’s results of operations will not necessarily be indicative of results that ultimately may be achieved for the fiscal year ending December 31, 2014. Certain prior period amounts have been reclassified to conform to the current period presentation.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of the accompanying financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and income, gains (losses) and expenses during the period reported. Actual results could differ materially from those estimates.

 

 

Investments - Money Market

 

The Fund has classified its money market investments as investments carried at fair value.

 

Organizational and Offering Costs

 

The Fund is a closed-end fund with a continuous offering period. Under the investment advisory agreement between the Fund and the Manager, our Manager fronts the cost of the organizational and offering expenses which are reimbursable by the Fund with up to 1.5% of the gross offering proceeds. The Fund expenses organizational and offering costs as they become payable under the investment advisory agreement.

 

U.S. Federal Income Taxes

 

The Fund has elected to be treated for federal income tax purposes as a RIC under subchapter M of the Code and to operate in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify as a RIC, among other things, the Fund is required to annually distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code. So long as the Fund maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as distributions. Rather, any tax liability related to income earned by the Fund represents obligations of the Fund’s investors and will not be reflected in the financial statements of the Fund. The Fund will also be subject to nondeductible federal excise taxes if it does not distribute at least 98% of net ordinary income, 98.2% of capital gain net income, if any, and any recognized and undistributed income from prior years for which it paid no federal income taxes.

 

The Fund has evaluated the implications of ASC Topic 740, for all open tax years and in all major tax jurisdictions, and determined that there is no material impact on the financial statements. The Fund continues to remain subject to examination by U.S. federal and state authorities for the years 2010 through 2013.

 

New Accounting Pronouncements  

 

In June 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-11 "Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures." ASU No. 2014-11 makes limited changes to the accounting for repurchase agreements, clarifies when repurchase agreements and securities lending transactions should be accounted for as secured borrowings, and requires additional disclosures regarding these types of transactions. The guidance is effective for fiscal years beginning on or after December 15, 2014, and for interim periods within those fiscal years. Management is currently evaluating the impact these changes will have on the Fund's financial statement disclosures.

 

In June 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-08, Financial Services – Investment Companies (Accounting Standards Codification (“ASC”) Topic 946), which affects the scope, measurement and disclosure requirements for investment companies under U.S. GAAP.  ASU 2013-08 contains new guidance on assessing whether an entity is an investment company, requiring non-controlling ownership interest in investment companies to be measured at fair value and requiring certain additional disclosures. This guidance became effective for us on January 1, 2014 and did not have a material impact on our financial position or disclosures.

 

Revenue Recognition

 

We generate investment income in the form of interest and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt and collateralized securities in our portfolio. The level of income we receive is directly related to the collectible balance of income producing investments multiplied by the weighted average yield of our investments.

 

 

We record interest income on an accrual basis to the extent that we expect to collect such amounts. Coupon interest income is adjusted for amortization of premiums and accretion of discounts. For loans and debt securities with contractual payment-in-kind (“PIK”) interest, which represents contractual interest accrued and added to the principal balance, we generally will not accrue PIK interest for accounting purposes if the portfolio company valuation indicates that such PIK interest is not collectible. We do not accrue as a receivable interest on loans and debt securities for accounting purposes if we have reason to doubt our ability to collect such interest. Original issue discounts, market discounts or premiums are accreted or amortized using the effective interest method as interest income. We record prepayment premiums on loans and debt securities as interest income. Dividend income, if any, is recognized on an accrual basis to the extent that we expect to collect such amount.

 

Expense Reimbursement Agreement

 

We entered into an expense reimbursement agreement with VII Peaks-KBR BDC Advisor II, LLC (the “prior manager”), under which the prior manager agreed to reimburse us for certain GAAP compliant expenses recognized on our quarterly financial statements for 2012, retroactive to the date of formation on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the prior manager effective as of January 1, 2013. We recognized a receivable on our books for the amount due from the prior manager under the expense reimbursement agreement, and the prior manager recognized a liability on its books in the same amount.

 

On August 20, 2013, we terminated our investment management agreement with our prior manager, and entered into a new investment management agreement with our current Manager. Our current Manager has not entered into an expense reimbursement agreement with us, but has agreed to assume the prior manager’s obligation to pay us the $1.3 million which had accrued under the prior manager’s expense reimbursement agreement. In consideration for such assumption, we have agreed to pay our current Manager any amounts otherwise due our prior manager for organization and offering expenses funded by our prior manager, subject to the limitation that such organization and offering costs may only be reimbursed to the extent of 1.5% of offering proceeds.

 

The Manager paid in full the Due from Affiliate balance of $1.3 million the quarter ended June 30, 2014. Interest on the Due from Affiliate balance was also accrued in the amount of $0.1 million at the rate of 7.35% per annum.

 

Note 3. Valuation of Portfolio Investments

 

The investment portfolio is recorded on a trade date basis. The Fund determines the net asset value of its investment portfolio each quarter. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Forty one of the forty two investments were valued using the closing market price at period end September 30, 2014. The exception was the investment in Education Management LLC, 15% Notes due July 1, 2018. The market did not have a sufficient amount of trades to use the quoted price for this position.

 

Securities that are not publicly-traded are valued at fair value as determined in good faith by the board of directors. In connection with that determination, the Manager will prepare portfolio company valuations using relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, the most recent portfolio company financial statements and forecasts, and valuations prepared by third-party valuation services. With respect to investments for which market quotations are not readily available, the Fund will undertake a multi-step valuation process each quarter, as described below:

 

•

the quarterly valuation process begins with each portfolio company or investment being initially valued by members of the investment committee, with such valuation taking into account information received from an independent valuation firm, if applicable;

 

•

preliminary valuation conclusions are then documented and discussed with the members of the board of directors; and

 

•

the board of directors discusses valuations and determines the fair value of each investment in the portfolio in good faith based on various statistical and other factors, including the input and recommendation of members of the investment committee and any third-party valuation firm, if applicable.

 

 

Investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts.

 

In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, mergers and acquisition comparables, the principal market and enterprise values, among other factors.

 

 The Fund has adopted FASB ASC Topic 820, Fair Value Measurements and Disclosures (formerly Statement of Financial Accounting Standards No. 157, Fair Value Measurements), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.

 

ASC Topic 820 clarifies that the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of market participants. ASC Topic 820 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC Topic 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels of valuation hierarchy established by ASC Topic 820 are defined as follows:

 

Level 1:  Quoted prices in active markets for identical assets or liabilities, accessible by the Fund at the measurement date.

 

Level 2:  Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.

 

Level 3:  Unobservable inputs for the asset or liability.

 

In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement.

 

The following table presents fair value measurements of investments, by major class, as of September 30, 2014, according to the fair value hierarchy (dollars in thousands):

 

		Level 1				Level 2				Level 3				Total
Investments – U.S. Bank money market		$	4,561			$	—			$	—			$	4,561
Senior Secured First Lien Debt			—				5,779				—				5,779
Senior Secured Second Lien Debt			—				4,807				—				4,807
Senior Unsecured Debt			—				14,374				870				15,244
Senior Subordinated Debt			—				7,069				—				7,069
Total		$	4,561			$	32,029			$	870			$	37,460

 

 

 

The following table presents fair value measurements of investments, by major class, as of December 31, 2013, according to the fair value hierarchy (dollars in thousands):

		Level 1				Level 2				Level 3				Total
Investments – U.S. Bank money market		$	1,644			$	—			$	—			$	1,644
Senior Secured First Lien Debt			—				2,287				—				2,287
Senior Secured Second Lien Debt			—				5,290				—				5,290
Senior Unsecured Debt			—				8,375				—				8,375
Senior Subordinated Debt			—				7,202				—				7,202
Total		$	1,644			$	23,154			$	—			$	24,798

 

There was one transfer between levels for the period ending September 30, 2014, Education Management, LLC. 15%, 7/1/2018. There were no transfers between levels for the period ending December 31, 2013.

 

 During the year, the following were the transfers in or out of levels:

 

		Level 1				Level 2				Level 3				Total
Senior Unsecured Debt		$	—			$	(870	)		$	870			$	—
Total		$	—			$	(870	)		$	870			$	—

 

The following table presents additional information about Level 3 assets measured at fair value. Both observable and unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category. As a result, the net unrealized gains and losses for assets within the Level 3 category may include changes in fair value that were attributable to both observable and unobservable inputs.

 

Changes in Level 3 assets measured at fair value for the quarter ended September 30, 2014 are as follows:

 

		Fair Value at June 30, 2014				Purchases (Sales and Settlement s)				Amortization and Accretion of Fixed Income Premiums and Discounts				Realized and Unrealized Gains  (Losses)				Fair Value at September 30, 2014				Change in Unrealized Gains (Losses) for Investments held as of September 30, 2014
Senior Unsecured Debt		$	435			$	—			$	36			$	399			$	870			$	435
Total		$	435			$	—			$	36			$	399			$	870			$	435

 

Realized and unrealized gains and losses are included in net realized gain (loss) on investments and net change in unrealized gain (loss) on investments in the Statement of Operations. The change in unrealized losses for Level 3 investments still held as of September 30, 2014 of $435 is included in net change in net unrealized gain (loss) on investments in the Statement of Changes in Net Assets for the quarter ended September 30, 2014.

 

The following table provides quantitative information regarding Level 3 fair value measurements as of September 30, 2014 (dollars in thousands):

 

														Range
		Fair Value				Valuation Technique		Unobservable Input		Mean				Minimum				Maximum
Senior Unsecured Debt		$	870			Liquidation value		Transaction Value		$	1,143			$	870			$	1,416
Total		$	870

 

 

The primary significant unobservable input used in the fair value measurement of the Company's debt securities (unsecured debt), is the fair value of the debt issuer's equity securities which will be exchanged with the notes. Significant increases (decreases) in the fair values of the issuer's equity securities would result in a significantly lower (higher) fair value measurement.

 

The composition of the Fund’s investments as of September 30, 2014, at amortized cost and fair value were as follows (dollars in thousands):

 

		Investments at Amortized Cost				Investments at Fair Value				Fair Value Percentage of Total Portfolio
Investments – U.S. Bank money market		$	4,561			$	4,561				12.2	%
Senior Secured First Lien Debt			6,143				5,779				15.4
Senior Secured Second Lien Debt			5,787				4,807				12.8
Senior Unsecured Debt			18,075				15,244				40.7
Senior Subordinated Debt			7,165				7,069				18.9
Total		$	41,731			$	37,460				100.0	%

 

The composition of the Fund’s investments as of December 31, 2013, at amortized cost and fair value were as follows (dollars in thousands):

 

		Investments at Amortized Cost				Investments at Fair Value				Fair Value Percentage of Total Portfolio
Investments – U.S. Bank money market		$	1,644			$	1,644				6.6	%
Senior Secured First Lien Debt			2,295				2,287				9.2
Senior Secured Second Lien Debt			5,601				5,290				21.3
Senior Unsecured Debt			8,804				8,375				33.8
Senior Subordinated Debt			7,069				7,202				29.1
Total		$	25,413			$	24,798				100.0	%

 

Note 4.  Related Party Transactions

  

Since August 20, 2013, the Fund has been managed by the Manager. Prior to August 20, 2013 the Fund was managed by VII Peaks-KBR BDC Advisor II, LLC which was wholly-owned by VII Peaks-KBR, LLC which was a joint venture between the Manager and KBR Capital Advisors, LLC (“KBR”).

 

Investment Advisory Agreement

 

The Fund has entered into an investment advisory agreement with the Manager to manage the Fund’s investment activities. Pursuant to the investment advisory agreement, the Manager implements the Fund’s business strategy on a day-to-day basis and performs certain services for us, subject to oversight by our board of directors. The Manager is responsible for, among other duties, determining investment criteria, sourcing, analyzing and executing investment transactions, asset sales, financings and performing asset management duties. Under the investment advisory agreement, the Manager is entitled to a base management and incentive fee as outlined in the investment advisory agreement with the Fund. The base management fee is 2% of net assets below $100 million; 1.75% of net assets between $100 million and $250 million; and 1.5% of net assets over $250 million. For the three and nine months ended September 30, 2014, the Fund incurred $0.2 million and $0.5 million of base management fees, respectively. For the three and nine months ended September 30, 2013, the Fund incurred $0.1 million and $0.3 million of base management fees, respectively.

 

 

The incentive fee has two parts. The first part, the subordinated incentive fee on income, is calculated and payable quarterly in arrears based upon the Fund’s “pre-incentive fee net investment income” for the immediately preceding quarter. The subordinated incentive fee on income is 20% of pre-incentive net investment income subject to a quarterly return to investors, expressed as a rate of return on adjusted capital at the beginning of the most recently completed calendar quarter, of 2.0% (8.0% annualized). The second part of the incentive fee, the incentive fee on capital gains, is an incentive fee on capital gains earned on liquidated investments from the portfolio and is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory agreement). This fee equals 20% of the Fund’s incentive fee capital gains, which will equal the Fund’s realized capital gains on a cumulative basis from inception, calculated as of the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gains incentive fees. For the three and nine months ended September 30, 2014 and 2013, the Fund did not incur any incentive fees related to net investment income or capital gains.

 

 Under U.S. GAAP, the Fund calculates capital gains incentive fees as if the Fund had realized all assets at their fair values and liabilities at their settlement amounts as of the reporting date. U.S. GAAP requires that the capital gains incentive fee accrual assume the cumulative aggregate unrealized capital appreciation is realized, even though such unrealized capital appreciation is not payable under the investment advisory agreement. Accordingly, the Fund accrues a provisional capital gains incentive fee taking into account any unrealized gains or losses. There can be no assurance that such unrealized capital appreciation will be realized in the future and that the provisional capital gains incentive fee will become payable.

 

Under the investment advisory agreement, the Manager bears all offering and organizational expenses. Pursuant to the terms of the investment advisory agreement, the Fund has agreed to reimburse the Manager for any such organizational and offering expenses incurred by the Manager not to exceed 1.5% of the gross subscriptions raised by the Fund over the course of the offering period, which is currently scheduled to terminate two years from the initial offering date, unless extended. From each sale of common stock, the Fund pays the Manager the lesser of 1.5% of the gross offering proceeds or the amount of unreimbursed offering and organizational expenses incurred by the Manager. The Fund expenses organizational and offering costs as they become payable to the Manager under the investment advisory agreement.

 

The Manager agreed to assume and pay the Fund all amounts due the Fund from the prior manager as reflected in the Fund’s books and records as of August 20, 2013, including any amounts due under the Expense Reimbursement Agreement between the Fund and the prior manager. The Fund agreed to pay the Manager any reimbursable organization and offering expenses incurred by the prior manager which the Fund would otherwise be obligated to reimburse the prior manager from future sales of the Company’s securities, beginning with any sales of securities occurring after Augusts 20, 2013, subject to the limitation that such organization and offering costs may only be reimbursed to the extent of 1.5% of offering proceeds.

 

From time to time, the Fund has paid directly certain expenses that were classified as organization or offering expenses that should have been borne by the prior manager and for which the prior manager is obligated to reimburse the Fund. As of September 30, 2014 and December 31, 2013, the unreimbursed amount of organization and offering expenses was $43,000 and $0.1 million, respectively, which amount is included in “Due from related party” on the Fund’s balance sheet as of that date.

 

Expense Reimbursement Agreement

 

We entered into an expense reimbursement agreement with our prior manager under which the prior manager agreed to reimburse us for certain operating expenses recognized on our quarterly financial statements for 2012, retroactive to the date of formation on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the prior manager effective as of January 1, 2013. We recognized a receivable on our books for the amount due from the prior manager under the expense reimbursement agreement, and the prior manager recognized a liability on its books in the same amount.

 

On August 20, 2013, we terminated our investment management agreement with our prior manager, and entered into a new investment management agreement with our current Manager. Our current Manager has not entered into an expense reimbursement agreement with us, but agreed to assume the prior manager’s obligation to pay us the $1.3 million which had accrued under the prior manager’s expense reimbursement agreement. In consideration for such assumption, we have agreed to pay our current Manager any amounts otherwise due our prior manager for organization and offering expenses funded by our prior manager, subject to the limitation that such organization and offering costs may only be reimbursed to the extent of 1.5% of offering proceeds.

 

 

Our Manager paid in full the Due from Affiliate balance of $1.3 million in the prior quarter ending June 30, 2014. In addition, in the same period, we accrued $0.1 million of interest on such amount at the rate of 7.35% per annum.

 

Administration Agreement

 

  We also entered into an administration agreement with the Manager under which the Manager provides us with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities. Under the administration agreement, our Manager also performs, or oversees the performance of, our required administrative services, which include, among other things, transfer agency and other service provider supervision and oversight, preparation and supervision of the financial records for which we are required to maintain for SEC reporting, stockholder reporting and our other needs, implementation and supervision of a robust compliance program and oversight and administration of the quarterly share repurchase program.

 

In addition, our Manager assists us in activities which include among other things, performance and supervision of investor relations, our Board of Director communication and reporting, determining and publishing our net asset value, overseeing the preparation and filing of our tax returns, the communication, printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and other events such as distributions, and the performance of administrative and professional services rendered to us by others.

 

Under the administration agreement, we are obligated to reimburse our Manager for our allocable portion of our Manager’s overhead cost incurred in performing its duties under the administration agreement, including rent, the fees and expenses associated with overseeing and performing the accounting and compliance functions, our allocable portion of the compensation of our chief financial officer, chief compliance officer, compliance program and any administrative support staff; however, to date, the cost of the chief financial officer, fund administration accounting, the chief compliance officer and compliance program are charged directly to us.

 

Under the administration agreement, our Manager will also provide on our behalf managerial assistance to portfolio companies that request such assistance. The amount of reimbursements to our Manager or services charged directly are captured in the Statement of Operations under “Administrative Services”. During the three and nine months ended September 30, 2014, the Fund reimbursed the Manager or was charged directly for $0.1 million and $0.2 million in administration expenses under the administration agreement, respectively. During the three and nine months ended September 30, 2013, the Fund reimbursed the Manager for $0.01 million and $0.02 million in administration expenses under the administration agreement, respectively. 

 

Note 5.  Common Stock

 

Initially, the Manager purchased 111 and 22,222 shares of common stock on August 31, 2011 and December 31, 2011, respectively. These shares were purchased at a price of $9.00 per share, which represents the initial public offering (“IPO”) price of $10.00 per share, net of selling commissions and dealer manager fees.

 

On July 10, 2012, the Fund had raised sufficient proceeds to break escrow on its IPO and through September 30, 2014, the Fund has sold 4.9 million shares of common stock for gross proceeds of $49.2 million, including the purchases made by the Manager.

 

During the nine months ended September 30, 2014, the Fund sold 1,758,046 shares of common stock in its offering for net proceeds of $16.7 million, including shares issued under the distribution reinvestment plan (“DRIP”). The Manager sold its shares during the nine months ending September 30, 2014.

 

Note 6. Earnings (Loss) Per Share

 

In accordance with the provisions of FASB ASC 260, “Earnings per Share” (“ASC 260”), basic earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis.

 

 

The following information sets forth the computation of the weighted average basic and diluted net increase (decrease) in net assets per share from operations for the three and nine months ended September 30, 2014 (dollars in thousands except share and per share amounts): 

		For the three months ended September 30, 2014				For the three months ended September 30, 2013
Basic and diluted
Net increase (decrease) in net assets resulting from operations		$	(2,275	)		$	337
Weighted average common shares outstanding			4,365,342				2,443,182
Net increase (decrease) in net assets resulting from operations per share		$	(0.52	)		$	0.14

 

		For the nine months ended September 30, 2014				For the nine months ended September 30, 2013
Basic and diluted
Net increase (decrease) in net assets resulting from operations		$	(2,935	)		$	789
Weighted average common shares outstanding			3,962,809				1,887,741
Net increase (decrease) in net assets resulting from operations per share		$	(0.74	)		$	0.42

 

The Fund had no potentially dilutive securities as of September 30, 2014 or September 30, 2013, resulting in the same number of shares for basic and diluted.

 

Note 7. Tender Offer Program

 

We do not currently intend to list our shares on any securities exchange and do not expect a public market for them to develop in the foreseeable future. Therefore, shareholders should not expect to be able to sell their shares promptly or at a desired price. Beginning with fourth calendar quarter of 2013 and on a quarterly basis thereafter, we intend to offer to repurchase shares of our common stock at a price equal to 90% of our offering price on the date of repurchase. We currently intend to limit the number of shares to be repurchased during any calendar year to 20% of the weighted average number of shares outstanding in the prior calendar year, or 5.0% in each quarter, though the actual number of shares that we offer to repurchase may be less in light of the limitations noted above. We will offer to repurchase such shares on each date of repurchase at a price equal to 90% of our offering price. For the nine months ended September 30, 2014, the treasury shares were redeemed for $0.05 million less than the aggregate original purchase prices.

 

The following table reflects certain information regarding the tender offers that we have conducted to date:

  

For the Three Months Ended		Repurchase Date		Shares Repurchased				Percent of Shares Tendered that were Repurchased				Repurchase Price Per Share				Aggregate Consideration for Repurchased  Shares ('000s)
December 13, 2013		December 12, 2013			548				100	%		$	9.135			$	6
March 31, 2014		March 14, 2014			550				100	%		$	9.135				5
June 30, 2014		June 27, 2014			34,025				100	%		$	9.135				319
September 30, 2014		September 30, 2014			38,482				100	%		$	9.000				346

 

Our quarterly repurchases will be conducted on such terms as may be determined by our board of directors in its complete and absolute discretion unless, in the judgment of the independent directors of our board of directors, such repurchases would not be in the best interests of our stockholders or would violate applicable law. We will conduct such repurchase offers in accordance with the requirements of Rule 13e-4 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the 1940 Act. In months in which we repurchase shares, we will conduct repurchases on the same date that we hold our first semi-monthly closing for the sale of shares in this offering. Any offer to repurchase shares will be conducted solely through tender offer materials mailed to each stockholder.

 

 

Note 8.  Distributions

 

When we commenced operations, we initiated a policy of declaring semi-monthly distributions at an annual distribution rate of 7.35% per annum of our offering price. We have authorized, declared and paid distributions to our shareholders at that rate on a semi-monthly basis since July 2012. Our distributions historically have not been based on our investment performance. Prior to September 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities.

 

As of September 30, 2014, the Fund has accrued $0.1 million in stockholder distributions that were unpaid. All amounts with record date in September 2014 and paid in October 2014 have been accrued in the September 30, 2014 financial statements. As of December 31, 2013, the Fund has accrued $0.1 million in stockholder distributions that were unpaid. All amounts with record dates in December 2013 and paid in January 2014 have been accrued in the December 31, 2013 financial statements.

 

The following tables reflect the distributions per share paid or payable in cash or with the distribution reinvestment plan (“DRIP”) on the Fund’s common stock to date (dollars in thousands except per share amounts), as well as the source of the distributions:

 

Source of Distribution by Cash vs. DRIP:

 

						Net Investment				Realized Gain From				Return of								Paid in
Period		Per Share				Income				Investments				Capital				Total				Cash				DRIP
July 12, 2012 - September 30, 2012		$	0.183750			$	32			$	-			$	18			$	50			$	34			$	16
October 1, 2012 - December 31, 2012 *			0.260750				118				-				82				200				123				77
January 1, 2013 -March 31. 2013 *			0.262586				247				47				76				370				220				150
April 1, 2013 - June 30, 2013			0.186504				235				43				26				304				185				119
July 1, 2013 - September 30, 2013			0.186504				244				47				183				474				274				200
October 1, 2013 - December 31, 2013			0.186504				20				258				271				549				347				202
January 1, 2014 - March 31, 2014			0.186504				124				85				423				632				405				227
April 1, 2014 - June 30, 2014			0.186504				348				-				406				754				491				263
July 1, 2014 - September 30, 2014			0.184668				135				28				645				808				511				297
TOTAL		$	1.824274			$	1,503			$	508			$	2,130			$	4,141			$	2,590			$	1,551

 

* Includes a special distribution of $0.077 per share.

 

The following table shows the percentage of our distributions which have been funded from net investment income, realized capital gains and paid in capital since the inception of operations:

 

Percentage of Distributions by Source:

 

						Net				Realized
						Investment				Gain From				Return of
Period		Per Share				Income				Investments				Capital
July 12, 2012 - September 30, 2012		$	0.183750				64	%			0	%			36	%
October 1, 2012 - December 31, 2012			0.260750				59	%			0	%			41	%
January 1, 2013 -March 31. 2013			0.262586				67	%			13	%			20	%
April 1, 2013 - June 30, 2013			0.186504				77	%			14	%			9	%
July 1, 2013 - September 30, 2013			0.186504				51	%			10	%			39	%
October 1, 2013 - December 31, 2013			0.186504				4	%			47	%			49	%
January 1, 2014 - March 31, 2014			0.186504				20	%			13	%			67	%
April 1, 2014 - June 30, 2014			0.186504				46	%			0	%			54	%
July 1, 2014  - September 30, 2014			0.184668				17	%			3	%			80	%
TOTAL		$	1.824274

 

The following table reflects the sources of the distributions on a tax basis that the Company has paid on its common stock (dollars in thousands) during the fiscal years ended December 31, 2012 and 2013, and the nine months ended September 30, 2014:

 

		Nine months ended								Year ended								Year ended
Source of Distributions:		September 30, 2014								December 31, 2013								December 31, 2012
Distributions from Net investment income		$	607				27.7	%		$	746				44.0	%		$	150				60.0	%
Distributions from Realized Gains			114				5.2	%			395				23.3	%			-				0.0	%
Distributions from Paid In Capital			1,473				67.1	%			556				32.7	%			100				40.0	%
TOTAL		$	2,194				100.0	%		$	1,697				100.0	%		$	250				100.0	%

 

There were no distributions paid with borrowings, non-capital gain proceeds from sale of assets, distribution on account of preferred and common equity or expense reimbursement from sponsor.

 

We expect to continue paying distributions at the same distribution rate, and that a substantial part of those distributions will constitute a return of capital for the foreseeable future. Our distributions will continue to constitute return of capital until our net investment income is sufficient to support our distribution rate, which will probably not occur until our Manager enters into an expense support agreement with us, or our assets increase enough to lower our expense ratio, which we do not expect to occur until we have more than $100 million in assets.

 

Note 9.  Financial Highlights

 

The following is a schedule of financial highlights for the nine months ended September 30, 2014 and 2013:

 

 

		For the nine months ended  September 30, 2014				For the nine months ended September 30, 2013
Per share data:
Net asset value, beginning of period		$	8.69			$	8.77
Results of operations (1)
Net investment income			0.15				0.34
Net realized gain on investments			0.03				0.07
Net unrealized loss on investments			(0.92	)			0.01
Net increase (decrease) in net assets resulting from operations			(0.74	)			0.42
Stockholder distributions (2)
Distributions from net investment income			(0.15	)			(0.34	)
Distributions from realized gains			(0.03	)			(0.07	)
Distributions from capital			(0.37	)			(0.20	)
Net decrease in net assets resulting from stockholder distributions			(0.55	)			(0.61	)
Capital share transactions
Impact from issuance of common stock (3)			0.40				0.30
Net increase in net assets resulting from capital share transactions			0.40				0.30
Net asset value, end of period		$	7.79			$	8.88
Shares outstanding at end of period			4,909,423				2,842,231
Total return (5)			(4.96	)%			7.76	%
Ratio/Supplemental data:
Net assets, end of period (in thousands)		$	38,223			$	25,228
Average net assets (in thousands)		$	33,274			$	16,600
Ratio of net investment income to average net assets (4)(7)			2.44	%			5.13	%
Ratio of operating expenses to average net assets (4)(7)			7.22	%			9.99	%
Ratio of incentive fees to average net assets (7)			-	%			0.03	%
Ratio of expenses reimbursed to average net assets (7)			-	%			6.25	%
Portfolio turnover ratio (6)			37.10	%			55.10	%

 

(1)	The per share amounts were derived by using the weighted average shares outstanding during the period. There was no expense waiver and reimbursement for the nine months ended September 30, 2014. Net investment income per share excluding the expense reimbursements would have been $0.01 for the nine months ended September 30, 2013.
(2)	The per share data for distributions reflects the actual amount of distributions declared per share during the period.
(3)	The issuance of common stock on a per share basis reflects the incremental net asset value changes as a result of the issuance of shares of common stock in the Fund's continuous offering.
(4)	The ratios are after giving effect to amounts reimbursed by the Manager under an expense reimbursement agreement. See “Note 4 – Related Party Transactions.” For the nine months ended September 30, 2014 there was no expense waiver and reimbursement. For the nine months ended September 30, 2013, excluding the expense reimbursement, the ratio of net investment income and operating expenses to average net assets would have been (1.11%) and 9.99%, respectively.
(5)	Total return is calculated assuming a purchase of shares at the current net asset value on the first day and a sale at the current net asset value on the last day of the periods reported. Distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the DRIP. For the nine months ended September 30, 2014 there was no expense reimbursement. The total return based on net asset value for the nine months ended September 30, 2013, includes the effect of the expense reimbursement which added 4.67% to the return.
(6)	Portfolio turnover rate is calculated using the lesser of year-to-date sales or purchases over the average of the invested assets at fair value. Not annualized.
(7)	Ratios are annualized based on average net assets using current and prior 3 quarters net assets.

 

 

Note 10.  Subsequent Events

 

Management of the Fund has evaluated subsequent events in the preparation of the Fund’s financial statements and has determined that no events require recognition or disclosure in the financial statements except for the following: 

 

From October 1, 2014 to November 12, 2014, the Fund issued 260,000 shares of common stock for gross proceeds of $2.6 million. With the proceeds from the continuous offering, the fund purchased a total of 7 investments for $3.1 million in cash.

 

On September 2, 2014, the Fund was informed by Endeavour International Corporation (NYSE: ENDV) , the “company”, that it had decided not to pay the coupon interest due on the 12% First Priority Notes, 3-1-2018 and 12% Second Priority Notes, 6-1-2018. At September 30, 2014, the Fund held $0.5 million principal amount of 12% First Priority Notes with an amortized cost of $0.6 million, and $0.7 million in 12% Second Priority Notes with an amortized cost of $0.7 million. Under the terms of the indentures, there was a thirty day grace period during which the company had the right to make the interest payment and cure any potential event of default for non-payment. Because the interest payments were not made during the grace period, an event of default occurred.

 

On October 10, 2014, the company announced its restructuring agreement for the notes. In connection therewith, the company and certain of its subsidiaries filed a voluntary petition for relief under Chapter 11 of the Bankruptcy code. Pursuant to the agreement, the company’s debt will be reduced by 43%. In consideration for the cancellation of debt, the Fund will receive 9.75% new notes for its 12% First Priority Notes and new 3.5% convertible preferred shares for its 12% First Priority Notes and 12% Second Priority Notes.

 

On October 20, 2014, the Fund accepted the voluntary corporate action exchange for the Education Management LLC 15.00%, 7/1/2018 multi coupon notes offered at par. Of the options offered, the Fund chose the exchange in preferred shares and warrants for the full 869,582 par value.

 

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

 

The following discussion should be read in conjunction with the accompanying financial statements of VII Peaks Co-Optivist Income BDC II, Inc., and the notes thereto. As used herein, the terms “we,” “our” and “us” refer to VII Peaks Co-Optivist Income BDC II, Inc., a Maryland corporation and, as required by context to VII Peaks Capital, LLC (the “Manager”), which serves as our investment adviser and administrator. We are externally managed by our Manager.

 

Forward-Looking Statements

 

This Form 10-Q includes forward-looking statements that reflect our expectations and projections about our future results, performance, prospects and opportunities. We may, in some cases, use words such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,” “could,” “potentially,” or “may” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements in this Form 10-Q are subject to a number of risks and uncertainties, some of which are beyond our control, including, among other things:

 

•

our ability to invest in discounted corporate debt and equity-linked debt securities of our target companies;

 

 

•

our ability to successfully employ our Co-Optivist TM approach in executing our investment strategy;

 

•

a limited pool of prospective target businesses;

 

•

our ability to pay distributions on our shares of common stock;

 

•

an economic downturn which could impair our target companies’ abilities to continue to operate, which could lead to the loss of some or all of our assets; and

 

•

changes in general economic or business conditions or economic or demographic trends in the United States.

 

Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by our forward-looking statements. In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements. These forward-looking statements are made as of the date of this Form 10-Q. We undertake no obligation to publicly update or revise any forward-looking statements after the date of this Form 10-Q, whether as a result of new information, future events or otherwise, except as required by law. The forward-looking statements and projections contained in this Quarterly Report on Form 10-Q are excluded from the safe harbor protection provided by Section 27A of the Securities Act of 1933.

 

Overview

 

We invest in discounted corporate debt and equity-linked debt securities of public and private companies that trade on the secondary loan market for institutional investors and provide distributions to investors. At the same time, we actively work with the target company’s management to restructure the underlying securities and improve the liquidity position of the target company’s balance sheet. We employ a proprietary “Co-Optivist” ^TM approach (“cooperative activism”, Co-Optivist ^TM is a registered trademark of VII Peaks Capital, LLC and is being used with their permission) in executing our investment strategy, which entails proactively engaging the target company management on average 24 months prior to a redemption event (typically a put or maturity event) to create an opportunity for growth in the investments. Our strategy is not dependent on restructuring to generate distributions. Capital appreciation on securities is generally not realized evenly over the holding period. In some instances market prices for securities may continue to reflect a discount until a relatively short time period prior to a redemption event. The potential capital gain typically occurs during the end of the holding period of a bond in our portfolio when securities are either called by the company or exchanged to new securities during refinance. We have tendered certain debt securities well above the market-traded deep discount.

 

Our investment objectives are to generate current income and capital appreciation. We intend to meet our investment objectives by: (i) realizing income and capital appreciation through the acquisition, management and orderly liquidation of corporate debt securities, (ii) making distributions of available distributable cash to our shareholders, and (iii) preserving the capital investments of our shareholders. There can be no assurance that any of these objectives will be achieved. 

 

Our proprietary “Co-Optivist” ^TM approach entails investment in the corporate debt and equity-linked debt securities of target companies, or Target Investments, in conjunction with proactively engaging the target companies’ management. We acquire Target Investments whose debt securities trade on the over-the-counter market for institutional loans at a discount to their par redemption value, and will be subject to a “redemption event” within (on average) 24 months. We define a “redemption event” as a maturity event or a put event (where investors in the target companies’ debt security can have a redemption right at a pre-determined price). We hold such debt an average of 12 – 18 months, during which time we anticipate working actively with the target companies’ management to effect and/or participate in a restructuring or exchange of the invested securities for new securities.

 

 

We make target companies that meet our investment criteria. The size of an individual investment will vary based on numerous factors. However, assuming we raise the maximum offering amount of $750 million we expect to hold at least 50 investments, and we anticipate that the minimum investment size will be approximately $250,000. We do not anticipate being heavily invested in any one industry, and generally, we do not expect to invest in more than two different classes of debt of the same target company. We invest in debt and equity-linked debt of target company with a minimum enterprise value of $200 million and whose debt and equity-linked debt is actively traded in the secondary loan market. Our portfolio is predominantly composed of fixed-rate high-yield and equity-linked corporate debt securities. However, we may also purchase senior secured corporate debt securities which may have variable interest rates. We currently anticipate that the portion of our portfolio composed of variable rate corporate debt securities, if any, will not exceed 20%, but we may increase that to 33% of our aggregate portfolio at the time of any purchase depending on market opportunities.

 

We offer our stockholders the ability to receive distributions as well as the potential capital appreciation resulting from the restructuring of the debt of our Target Investments. To the extent we have distributable income available we anticipate declaring distributions with a record and payment date on a semi-monthly basis.

 

Between 2001 and 2008, corporate debt levels and the supply of leverage offered by banks and other investors steadily increased. We believe a significant amount of this debt will be subject to a redemption event prior to 2016. Many of the companies that have outstanding issues of such debt have not been able to proactively refinance, creating a “refinancing wall” that we believe will create a liquidity shortfall for many issuers. The value of the debt securities of these companies as reflected in prices quoted in the secondary loan market, may be at a significant discount to par, and represent a premium yield to maturity reflective of these liquidity concerns, creating the opportunity for us to identify and invest in the debt securities of select companies at attractive current market valuations. We believe that our Co-Optivist ^TM approach can help our target companies achieve results that are beneficial to the long-term value of their businesses, which will in turn, result in capital gains through capital appreciation, or the exchange of invested securities into a current security or cash at a premium to its acquisition price. Our principals collectively have experience in principal investing, debt securities and general capital markets, and we believe we are well-positioned to capitalize on these opportunities.

 

Our investment activities are managed by our Manager who is registered as an investment adviser under the Investment Advisers Act of 1940, as amended. Our Manager is responsible for sourcing potential investments, conducting research on prospective investments, analyzing investment opportunities, structuring our investments, and monitoring our investments and portfolio companies on an ongoing basis. Our Manager is led by Gurpreet (Gurprit) S. Chandhoke, who also serves as our Chief Executive Officer, who has extensive experience in underwriting and issuing debt products that include high-yield, bank debt and convertible debt and has acted as financial adviser to private equity funds, venture capital firms and corporations in mergers and acquisitions, recapitalization and corporate finance transactions, and has served as principal investor in private equity and leveraged buyout transactions.

 

Our Manager has an investment committee that is responsible for reviewing, discussing and approving each investment opportunity we seek to pursue. Our investment committee meets routinely to discuss new and existing opportunities and developments on current investments. Our investment committee currently is led by Mr. Chandhoke, our Chief Executive Officer, with Stephen F. Shea, a Managing Partner of VII Peaks Capital, LLC, and Bhavin Shah, Investment Committee Member, VII Peaks Capital, LLC.

 

Critical Accounting Policies

 

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to the valuation of portfolio securities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements.

 

 

Valuation of Portfolio Investments

 

The investment portfolio is recorded on a trade date basis. We determine the net asset value of our investment portfolio each quarter. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Forty one of the forty two investments were valued using the closing market price at period end September 30, 2014. The exception was the investment in Education Management LLC, 15%, July 1, 2018. The market did not have a sufficient amount of trades to use the quoted price for this position.

 

Securities that are not publicly-traded are valued at fair value as determined in good faith by our board of directors. In connection with that determination, our Manager prepares portfolio company valuations using relevant inputs, including, but not limited to, indicative dealer quotes, values of like securities, the most recent portfolio company financial statements and forecasts, and valuations prepared by third-party valuation services.

 

With respect to investments for which market quotations are not readily available, we will undertake a multi-step valuation process each quarter, as described below:

 

•

our quarterly valuation process begins with each portfolio company or investment being initially valued by members of our investment committee, with such valuation taking into account information received from our independent valuation firm, if applicable;

 

•

preliminary valuation conclusions are then documented and discussed with the members of our board of directors; and

 

•

the board of directors discusses valuations and determines the fair value of each investment in our portfolio in good faith based on various statistical and other factors, including the input and recommendation of members of our investment committee and any third-party valuation firm, if applicable.

  

Investments are valued utilizing a market approach, an income approach, or both approaches, as appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business). The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present value amount (discounted) calculated based on an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations about those future amounts. In following these approaches, the types of factors that we may take into account in fair value pricing our investments include, as relevant: available current market data, including relevant and applicable market trading and transaction comparables, applicable market yields and multiples, security covenants, call protection provisions, information rights, the nature and realizable value of any collateral, the portfolio company’s ability to make payments, its earnings and discounted cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, M&A comparables, the principal market and enterprise values, among other factors.

 

We have adopted Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 820, Fair Value Measurements and Disclosures (formerly Statement of Financial Accounting Standards No. 157, Fair Value Measurements ), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.

 

ASC Topic 820 clarifies that the exchange price is the price in an orderly transaction between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of market participants. ASC Topic 820 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, ASC Topic 820 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels of valuation hierarchy established by ASC Topic 820 are defined as follows:

 

Level 1:  Quoted prices in active markets for identical assets or liabilities, accessible by the Fund at the measurement date.

 

 

Level 2:  Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices.

 

Level 3:  Unobservable inputs for the asset or liability.

 

In all cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level of input that is significant to the fair value measurement.

 

Revenue Recognition

 

We generate investment income in the form of interest and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt and collateralized securities in our portfolio. The level of income we receive is directly related to the balance of collectible income producing investments multiplied by the weighted average yield of our investments. Coupon interest income is adjusted for the amortization of premiums and accretion of discounts. We record interest income on an accrual basis to the extent that we expect to collect such amounts.

 

For loans and debt securities with contractual payment-in-kind (“PIK”) interest, which represents contractual interest accrued and added to the principal balance, we generally will not accrue PIK interest for accounting purposes if the portfolio company valuation indicates that such PIK interest is not collectible. We do not accrue as a receivable interest on loans and debt securities for accounting purposes if we have reason to doubt our ability to collect such interest. Original issue discounts, market discounts or premiums are accreted or amortized using the effective interest method as interest income. We record prepayment premiums on loans and debt securities as interest income. Dividend income, if any, is recognized on an accrual basis to the extent that we expect to collect such amount.

 

Our total interest income was $0.7 million and $2.3 million for the three and nine months ended September 30, 2014, as compared to $0.5 million and $1.1 million for the three and nine months ended September 30, 2013, respectively. The increase is due to a larger note portfolio earning interest in 2014 as compared to 2013. At September 30, 2014, the weighted average coupon yield was 10.3%, as compared to 11.1% as of September 30, 2013. For the quarter ending September 30, 2014, four of the investments in the portfolio did not accrue interest as the issuers were in default of the coupon payment for more than the thirty day grace period. These four are Suntech Power Holdings Company, Ltd., 3%, 5/15/13, NII Capital Corp, 10%, 8/15/16, Endeavor International Corporation, 12%, 3/1/18 and Endeavor International Corporation 12%, 6/1/18.

 

Expense Reimbursement

 

We entered into an expense reimbursement agreement with our prior manager under which the prior manager agreed to reimburse us for certain U.S. GAAP compliant expenses recognized on our quarterly financial statements for 2012, retroactive to the date of formation on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the prior manager effective as of January 1, 2013. We recognized a receivable on our books for the amount due from the prior manager under the expense reimbursement agreement, and the prior manager recognized a liability on its books in the same amount.

 

On August 20, 2013, we terminated our investment management agreement with our prior manager, and entered into a new investment management agreement with our current Manager. Our current Manager has not entered into an expense reimbursement agreement with us, but agreed to assume the prior manager’s obligation to pay us the $1.3 million which had accrued under the prior manager’s expense reimbursement agreement. In consideration for such assumption, we have agreed to pay our current Manager any amounts otherwise due our prior manager for organization and offering expenses funded by our prior manager, subject to the limitation that such organization and offering costs may only be reimbursed to the extent of 1.5% of offering proceeds.

 

During the nine months ended September 30, 2014, our Manager paid in full the Due from Affiliate balance of $1.3 million.

 

 

Net Realized Gains or Losses and Net Change in Unrealized Appreciation or Depreciation

 

We measure net realized gains or losses by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees and prepayment penalties. Net change in unrealized appreciation or depreciation will reflect the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation, when gains or losses are realized. Consistent with the high yield bond market, the portfolio experienced a fair value reduction, with a net unrealized depreciation on investments of $2.4 million for the three months ending September 30, 2014, and $3.7 million for the nine months ending September 30, 2014.

 

Payment-in-Kind Interest

 

We may have investments in our portfolio that contain a PIK interest provision. Any PIK interest will be added to the principal balance of such investments and is recorded as income, if the portfolio company valuation indicates that such PIK interest is collectible. In order to maintain our status as a regulated investment company (“RIC”), substantially all of this income must be paid out to stockholders in the form of distributions, even if we have not collected any cash.

 

Organization and Offering Expenses

 

The Fund is a closed-end fund with a continuous offering period. Under the investment advisory agreement between the Fund and the Manager, our Manager fronts the cost of the organizational and offering expenses which are reimbursable by the Fund with up to 1.5% of the gross offering proceeds. The Fund expenses organizational and offering costs as they become payable under the investment advisory agreement.

 

Federal Income Taxes

 

We have elected to be treated for federal income tax purposes as a RIC under Subchapter M of the Code. As a RIC, we generally will not have to pay corporate-level federal income taxes on any ordinary income or capital gains that we distribute to our shareholders from our tax earnings and profits. To obtain and maintain our RIC tax treatment, we must meet, among other things, specified source-of-income and asset diversification requirements and distribute annually at least 90% of our ordinary income and realized net short-term capital gains in excess of realized net long-term capital losses, if any.

 

Portfolio and Investment Activity

 

During the nine months ended September 30, 2014, we made $23.3 million of investments in new portfolio companies and had $10.8 million in aggregate amount of exits and repayments, resulting in net investments of $12.5 million for the period. During the nine months ended September 30, 2013, we made $19.8 million of investments in new portfolio companies and had $7.1 million in aggregate amount of exits and repayments, resulting in net investments of $12.7 million for the period. As of September 30, 2014, we had one portfolio investment in default with a fair value of $0.01 million which represented 0.02% of our portfolio.

 

As of September 30, 2014, we have invested an aggregate of approximately $36.2 million in 42 investment positions in 35 portfolio companies. At September 30, 2014, the fair value of our investment positions was $34 million (excluding cash and including the accrued interest of $1.1 million). As of such date, our estimated gross annual portfolio current yield was 10.29% and gross annual portfolio yield to maturity was 10.52% based on the purchase price of our investments. The average duration of our portfolio was approximately 2.60 years. As of September 30, 2014, we have exited 22 portfolio companies in full and 8 partially for aggregate sales proceeds of $24.0 million. As of September 30, 2014, we had one portfolio investment in default of payment of its par value at maturity date with a fair value of $7,250 which represented 0.02% of our portfolio. As of September 30, 2014, in addition to the investment in maturity date default, three additional investments had not paid coupon interest as due beyond the thirty day grace period. These investments were placed in a nonaccrual status.

  

 

The following table presents our portfolio composition based on fair value as of September 30, 2014:

 

		As of September 30, 2014
		Percentage of Total Portfolio				Weighted Average Current Coupon Yield
Investments – U.S. Bank money market			12.2	%			-	%
Senior Secured First Lien Debt			15.4				9.5
Senior Secured Second Lien Debt			12.8				10.5
Senior Unsecured Debt			40.7				10.0
Senior Subordinated Debt			18.9				10.4
Total			100.0	%			9.0	%

 

 As of September 30, 2014, our investment portfolio had a yield to maturity of 10.82%, and an average duration of 2.61 years.

 

The following table presents our portfolio composition based on fair value as of December 31, 2013:

 

		As of December 31, 2013
		Percentage of Total Portfolio				Weighted Average Current Coupon Yield
Investments – U.S. Bank money market			6.6	%			-	%
Senior Secured First Lien Debt			9.2				10.2
Senior Secured Second Lien Debt			21.3				10.8
Senior Unsecured Debt			33.8				10.4
Senior Subordinated Debt			29.1				11.1
Total			100.0	%			10.7	%

 

 As of December 31, 2013, our investment portfolio had a yield to maturity of 11.16%, and an average duration of 2.36 years.

 

The following table shows the portfolio composition by industry grouping at fair value as of September 30, 2014 (dollars in thousands):

 

		As of September 30, 2014
		Investments at Fair Value				Percentage of Total Portfolio
Investments - Money Market		$	4,561				12.2	%
Services: Consumer			4,514				12.1
Retail			4,194				11.2
Media: Advertising, Printing & Publishing			4,182				11.2
Healthcare and Pharmaceuticals			3,590				9.6
Energy: Oil & Gas			2,512				6.7
Consumer Goods: Durable			2,141				5.7
Metals & Mining			1,833				4.9
Aerospace and Defense			1,713				4.6
Telecommunications			1,566				4.2
Automobile			1,351				3.6
Environmental Industries			1,336				3.6
Media: Broadcasting & Subscription			1,173				3.1
Hotel, Gaming & Leisure			841				2.2
High Tech Industries			826				2.2
Beverage, Food & Tobacco			578				1.5
Services: Business			549				1.4
Total		$	37,460				100.0	%

 

 

The following table shows the portfolio composition by industry grouping at fair value as of December 31, 2013 (dollars in thousands):

 

		As of December 31, 2013
		Investments at Fair Value				Percentage of Total Portfolio
Healthcare & Pharmaceuticals		$	3,160				12.7	%
Services: Business			3,015				12.2
Aerospace and Defense			2,616				10.6
Energy: Oil & Gas			2,604				10.5
Telecommunications			2,289				9.2
Investments – Money Market			1,644				6.6
Media: Advertising, Printing & Publishing			1,541				6.2
Services: Consumer			1,282				5.2
Metals & Mining			1,222				4.9
High Tech Industries			1,158				4.7
Banking, Finance, Insurance & Real Estate			1,069				4.3
Retail			968				3.9
Media: Broadcasting & Subscription			875				3.5
Hotel, Gaming & Leisure			790				3.2
Beverage, Food & Tobacco			557				2.2
Environmental Industries			8				0.1
Total		$	24,798				100.0	%

 

Our fair value of total investments was $37.5 million as of September 30, 2014 as compared to $24.8 million as of December 31, 2013. The portfolio increase in the three and nine months ending September 30, 2014 is mainly due to invested proceeds from continuous investor closings. The additional proceeds from investor closings in the three and nine months ending September 30, 2014 also led to further portfolio diversification by industry, as compared to diversification as of December 31, 2013.

 

Results of Operations

 

The results of operations are based on revenue less expenses, adjusted for the impact of the realized gain/loss and change in unrealized gain/loss on our investment portfolio. To the extent that it is expected to be received, revenue is recognized on an accrual basis. Income is earned as coupon interest adjusted for the amortization of premiums and accretion of discounts is recognized on the high-yield investments. Expenses include professional services, management fees, administrative services, organizational and offering costs and other general and administrative. Realized gains/losses are from investments sold or called at an advantageous price. The unrealized gain/loss is the change in the market price on investments in the portfolio at period end, subject to significant fluctuation.

 

Operating results for the three and nine months ended September 30, 2014 and 2013 are as follows (dollars in thousands):   

 

 

		For the three months ended September 30, 2014				For the three months ended September 30, 2013
Total investment income		$	744			$	456
Total expenses, net			609				301
Net investment income			135				155
Net realized gains			28				47
Net unrealized depreciation			(2,438	)			135
Net increase (decrease) in net assets resulting from operations		$	(2,275	)		$	337

 

		For the nine months ended September 30, 2014				For the nine months ended September 30, 2013
Total investment income		$	2,405			$	1,102
Total expenses, net			1,798				464
Net investment income			607				638
Net realized gains			114				137
Net unrealized depreciation			(3,656	)			14
Net increase (decrease) in net assets resulting from operations		$	(2,935	)		$	789

 

Revenues

 

We generated investment income of $0.7 million and $2.4 million for the three and nine months ended September 30, 2014, as compared to $0.5 million and $1.1 million for the three and nine months ended September 30, 2013. The nine months ended September 30, 2014 included a non-recurring interest receivable in Other Income of $0.1 million. The interest resulted from the Due from Affiliate balance of $1.3 million that was paid in full in during the nine months ended September 30, 2014.

 

Interest from investments is in the form of interest and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt and collateralized securities in our portfolio. The level of income we receive is directly related to the balance of collectible income producing investments multiplied by the weighted average yield of our investments. We expect the dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases. The average balance of the September 30, 2014 note portfolio was significantly higher than the September 30, 2013 balance, resulting in the increase in interest income. For the quarter ending September 30, 2014, four of the investments in our portfolio were on nonaccrual status as a result of the issuers being in default of the coupon payment for more than the thirty day grace period. These four are Suntech Power Holdings Company, Ltd., 3%, 5/15/13; NII Capital Corp, 10%, 8/15/16; Endeavor International Corporation, 12%, 3/1/18; and Endeavor International Corporation 12%, 6/1/18.

 

Since becoming operational in the third quarter of 2012, we generate revenue primarily from the cash interest we collect on our debt investments and, to a lesser extent, from the early termination fees that many of our debt investments require the borrower to pay. Going forward, we may generate revenue in the form of commitment, origination, structuring or diligence fees. Any such fees will be generated in connection with our investments and recognized as earned.

 

Expenses

 

The composition of our operating expenses for the three and nine months ended September 30, 2014 and September 30, 2013 was as follows (dollars in thousands):

 

 

		For the three months ended September 30, 2014				For the three months ended September 30, 2013
Professional fees		$	67			$	111
Director fees			10				12
Insurance			24				22
Management fees			193				128
Incentive fees			—				4
Administrative services			89				46
General and administrative expenses			99				55
Offering expense			127				124
Operating expenses before expense reimbursements			609				502
Expense reimbursement			—				(201	)
Total operating expenses net of expense waivers and reimbursements		$	609			$	301

 

		For the nine months ended September 30, 2014				For the nine months ended September 30, 2013
Professional fees		$	203			$	300
Director fees			37				32
Insurance			71				62
Management fees			527				291
Incentive fees			—				4
Administrative services			229				130
General and administrative expenses			479				102
Offering expense			252				319
Operating expenses before expense reimbursements			1,798				1,240
Expense reimbursement			—				(776	)
Total operating expenses net of expense waivers and reimbursements		$	1,798			$	464

 

For the nine months ended September 30, 2014 and September 30, 2013, our operating expenses before expense reimbursement were $1.8 million and $1.2 million, respectively. The rise in expenses for the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013 was due to higher management fees, administrative services, offering expense and general and administrative in 2014, offset with a reduction in professional fees. Larger assets under management led to the growth in management fees, and an increase in transfer agent expense, captured in the general and administrative category. Travel was also a component of the increase in 2014, as compared to the same period in 2013, as part of general and administrative expense above. Administrative services include the costs outlined in the Administration Agreement, with more allocation and direct charges in 2014 than 2013. The amount of offering costs is directly related to the gross offering price of shares sold in the period. Professional fees were lower in 2014, as less legal and audit support was needed.

 

Expense Reimbursement

 

We entered into an expense reimbursement agreement with our prior manager under which the prior manager agreed to reimburse us for all U.S. GAAP compliant expenses recognized on our quarterly financial statements for 2012, retroactive to the date of formation on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the Manager effective as of January 1, 2013. We recognized a receivable on our books for the amount due from the prior manager under the expense reimbursement agreement, and the prior manager recognized a liability on its books in the same amount. Our prior manager was obligated to reimburse us for $0.8 million in the nine months ended September 30, 2013.

 

On August 20, 2013, we terminated our investment management agreement and expense reimbursement agreement with our prior manager, and entered into a new investment management agreement with our current Manager. Our current Manager has not entered into an expense reimbursement agreement with us, but agreed to assume the prior manager’s obligation to pay us $1.3 million which had accrued under the prior manager’s expense reimbursement agreement. In consideration for such assumption, we have agreed to pay our current Manager any amounts otherwise due our prior manager for organization and offering expenses funded by our prior manager, subject to the limitation that such organization and offering costs may only be reimbursed to the extent of 1.5% of offering proceeds.

 

 

During the nine months ended September 30, 2014, our Manager paid in full the Due from Affiliate balance of $1.3 million. In addition, during the nine months ended September 30, 2014, we accrued $0.1 million of interest on such amount at the rate of 7.35% per annum.

 

Net Investment Income

 

Our net investment income totaled $0.1 million and $0.6 million for the three and nine months ended September 30, 2014, respectively. The balance of our net investment income was attributable to investment income less operating expenses for the period. For the three and nine months ended September 30, 2014, total investment income was $0.7 million and $2.4 million, respectively. For the nine months ended September 30, 2014, the Total Investment Income includes $0.1 million of nonrecurring interest, captured in other income.

 

Our net investment income totaled $0.2 million and $0.6 million for the three and nine months ended September 30, 2013, respectively. Of our net investment income, $0.2 million and $0.8 million for the three and nine months ended September 30, 2013, respectively, was attributable to expense reimbursements by our prior manager, and the balance was attributable to investment income less operating expenses for the period. For the three and nine months ended September 30, 2013, total investment income was $0.5 million and $1.1 million, respectively.

 

The increase in net investment income in the three months ending September 30, 2014 as compared to the three months ending September 30, 2013 is due to a higher earning asset average balance in the investment portfolio. For the three and nine months ended September 30, 2014, total expenses before expense reimbursements were $0.6 million and $1.8 million, respectively. For the three and nine months ended September 30, 2013, total expenses before expense reimbursements were $0.5 million and $1.2 million, respectively.

 

Net Realized Gains or Losses from Investments

 

For the three and nine months ended September 30, 2014, we had $3.5 million and $10.8 million of sales and principal repayments, resulting in $0.03 million and $0.1 million of realized gains, respectively. For the three and nine months ended September 30, 2013, we had $1.0 million and $7.0 million of sales and principal repayments, resulting in $0.05 million and $0.1 million of realized gains.

 

Net Change in Unrealized Appreciation or Depreciation on Investments

 

For the three and nine months ended September 30, 2014, we had $2.4 million and $3.7 million of unrealized depreciation, respectively. For the three and nine months ended September 30, 2013, we had $0.1 million and $0.01 million of unrealized depreciation. The increase in unrealized depreciation during fiscal 2014 was due to two main factors. First, the high yield corporate bond market declined overall due to a variety of macro factors, including the announcement of the end of Quantitative Easing by the Federal Reserve, concerns about the Chinese and European economies, and worries about the economic effect of various global conflicts, particularly in Ukraine and the Middle East. For example, the BofA Merrill Lynch U.S. High Yield Master II Index total return declined 3.34% and 0.93% (including interest and dividends on securities) during the three and nine months ending September 30, 2014, respectively.

 

In addition, we encountered greater than average declines in certain positions that were caused by conditions unique to the company or industry. In particular, we had a number of positions that either initiated a restructuring of their indebtedness (either in Chapter 11 bankruptcy or prepackaged bankruptcy) or announced that they were considering a restructuring. Such announcements generally reduce liquidity in the secondary market creating greater mispricing in underlying bonds. Until the bankruptcy or other restructuring process is complete, it becomes difficult to ascertain whether some of these positions will result in loss of principal or full recovery of principal given their position in the capital structure of the issuer and the underlying asset values. Generally, we expect much higher recoveries or full payment for senior secured first lien type bonds, as compared to senior secured second-lien or unsecured bonds for defaulted bonds.

 

Changes in Net Assets from Operations

 

For the three and nine months ended September 30, 2014, we recorded a net decrease in net assets resulting from operations of $2.3 million and $2.9 million, respectively. This decrease is due to the reduction in fair value of our investment portfolio. Consistent with the high yield bond market, the portfolio experienced a market value reduction, with a net unrealized depreciation on investments of $2.4 million for the three months ending September 30, 2014, and $3.6 million for the nine months ending September 30, 2014. Based on 4,365,342 and 3,962,809 weighted average common shares outstanding for the three and nine months ended September 30, 2014, respectively, our per share net decrease in net assets resulting from operations was $0.52 and $0.74, respectively.

 

  

Liquidity and Capital Resources

 

We generate cash primarily from the net proceeds of our ongoing continuous public offering and from cash flows from interest and dividends earned from our investments as well as principal repayments and proceeds from sales of our investments. On July 10, 2012, we satisfied our minimum offering requirement of raising gross offering proceeds in excess of $1.0 million from persons who are not affiliated with us or our Manager, and commenced operations. As of September 30, 2014, we issued 5.0 million shares of common stock, including 0.2 million shares under our distribution reinvestment plan (“DRIP”) and 0.07 million shares redeemed under our tender offer, Gross proceeds from our issuance total $50.0 million, including $1.5 million under our distribution reinvestment plan (“DRIP”) and $0.7 in tender offer redemption shares.

 

We currently sell our shares on a continuous basis. In the three months ending September 30, 2014, we reduced our current offering price from $10.15 to $10.00. To the extent that our net asset value per share increases, we will sell at a price necessary to ensure that our shares are not sold at a price, after deduction of selling commissions and dealer manager fees, that is below our net asset value per share.

 

Prior to investing in debt securities, we invest the net proceeds from our continuous offering primarily in money market funds that invest in U.S. government securities and high-quality debt instruments maturing in one year or less from the time of investment. As of September 30, 2014 and December 31, 2013, we had $4.6 million and $1.6 million, respectively, invested in money market investments pending investment in debt instruments.

 

For the nine months ended September 30, 2014, we experienced a net increase in money market investments of $3.0 million. For the nine months ended September 30, 2014, approximately $13.1 million was generated from our financing activities, which primarily consisted of $15.2 million in net offering proceeds received, offset by $1.4 million in distributions. We used approximately $13.1 million of cash in our operating activities. Also, we received proceeds from the sale of, repayment of and principal payments on portfolio debt investments of $10.8 million, offset by the purchase of new portfolio debt investments of $23.2 million.

 

We do not expect to borrow funds during the following four quarters to make investments. In the future, however, if the market for debt financing presents attractively priced debt financing opportunities, or if our board of directors determines that leveraging our portfolio would be in our best interests and the best interests of our shareholders, we may decide to borrow funds to make investments. We do not currently anticipate issuing any preferred shares. 

 

Distributions

 

When we commenced operations, we initiated a policy of declaring semi-monthly distributions at an annual distribution rate of 7.35% per annum of our offering price. We have authorized, declared and paid distributions to our shareholders at that rate on a semi-monthly basis since July 2012. Our distributions historically have not been based on our investment performance. Prior to September 30, 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 30, 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities.

 

 Any distributions to our shareholders are declared out of assets legally available for distribution. We expect to continue making distributions unless our results of operations, our general financial condition, general economic conditions, or other factors prohibit us from doing so. There can be no assurance that we will be able to sustain distributions at any particular level.

 

Each year a statement on Internal Revenue Service Form 1099-DIV (or such successor form) identifying the source of the distribution (i.e., paid from ordinary income, paid from net capital gain on the sale of securities, or a return of capital) will be mailed to our shareholders. We expect that our distributions will continue to constitute a return of capital until our net investment income is sufficient to support our distribution rate, which will probably not occur until our Manager enters into an expense support agreement with us, or our assets increase enough to lower our expense ratio, which we do not expect to occur until we have more than $100 million in assets, neither of which may ever occur. As a result, for the foreseeable future, a portion of the distributions we make will represent a return of capital for tax purposes. The tax basis of shares must be reduced by the amount of any return of capital distributions, which will result in an increase in the amount of any taxable gain (or a reduction in any deductible loss) on the sale of shares. 

 

Distribution Reinvestment Plan

 

We have adopted an “opt-in” distribution reinvestment plan (“DRIP”) pursuant to which shareholders may elect to have the full amount of their cash distributions reinvested in additional shares of our common stock. If shareholders wish to receive their distribution in cash, no action will be required on their part to do so. There will be no selling commissions, dealer manager fees or other sales charges to shareholders, if they elect to participate in the DRIP. We will pay the plan administrator’s fees under the plan. Shareholders distribution amount will purchase shares at 95% of the price that the shares are offered pursuant to the effective registration statement of the public offering. Shares issued pursuant to our DRIP will have the same voting rights as our shares of common stock offered pursuant to our prospectus.

  

Election as a RIC

 

We elected to be treated as a RIC under Subchapter M of the Code beginning with the taxable year ended December 31, 2012. As a RIC, we generally will not have to pay corporate-level U.S. federal income taxes on any income that we distribute to our stockholders from our tax earnings and profits. To qualify as a RIC, we must, among other things, meet certain source-of-income and asset diversification requirements. In addition, in order to obtain RIC tax treatment, we must distribute to our stockholders, for each taxable year, at least 90% of our “investment company taxable income,” which is generally our net ordinary income plus the excess, if any, of realized net short-term capital gain over realized net long-term capital loss, or the annual distribution requirement. Even if we qualify as a RIC, we generally will be subject to corporate-level U.S. federal income tax on our undistributed taxable income and could be subject to U.S. federal excise, state, local and foreign taxes.

 

Related-Party Transactions and Agreements

 

We have entered into agreements with the Manager, whereby we pay certain fees and reimbursements. These include payments to our Manager for reimbursement of organization and 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 Manager, pursuant to various agreements that we have entered into. See Note 4 to the financial statements included elsewhere in this quarterly report on Form 10-Q for additional information regarding such contractual obligations.

 

Conflicts of interest between us and the various roles, activities and duties of the Manager and its affiliates may occur from time to time. The Manager, its officers and other affiliates may act as a manager or general partner of other private or public entities, some of whom may have the same or a similar investment objective as us. As a result, conflicts of interest between us and the other activities of the Manager and its affiliates may occur from time to time. None of the agreements or arrangements, including those relating to compensation, between us, the Manager or their affiliates, is the result of arm’s-length negotiations. As a result, there may be conflicts between us, on the one hand, and our Manager, including members of its management team, on the other, regarding the allocation of resources to the management of our day-to-day activities.

 

The compensation we pay to our Manager was not entered into on an arm’s-length basis with unaffiliated third parties. As a result, the form and amount of such compensation may be less favorable to us than they might have been had they been entered into through arm’s-length transactions with unaffiliated parties. See “Contractual Obligations” for a discussion of the investment advisory agreement we have with the Manager.

 

Further, our officers are involved in other ventures, some of which may compete with us for investment opportunities, including certain affiliated funds or managed accounts, and may be incentivized to offer investment opportunities to such other ventures rather than to us which would make it more difficult to achieve our investment objectives. In addition, the officers of VII Peaks may also be involved in other ventures, some of which may compete with us for investment opportunities.

 

 

As a BDC, we are subject to certain regulatory restrictions in making our investments. For example, we generally are not permitted to co-invest with certain entities affiliated with our Manager in transactions originated by our Manager or its affiliates unless we obtain an exemptive order from the SEC or co-invest alongside our Manager or its affiliates in accordance with existing regulatory guidance and our allocation policy. Under existing regulatory guidance, we are permitted to, and may co-invest in syndicated deals and secondary loan market transactions where price is the only negotiated point. We may seek exemptive relief from the SEC to engage in co-investment transactions with our Manager and/or its affiliates. However, there can be no assurance that we will obtain such exemptive relief, if requested. Even if we receive exemptive relief, neither our Manager nor its affiliates are obligated to offer us the right to participate in any transactions originated by them. Prior to obtaining exemptive relief, we may co-invest alongside our Manager or its affiliates only in accordance with existing regulatory guidance and our allocation policy.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

We are subject to financial market risks, and experienced a substantial unrealized depreciation in our portfolio values for the period ending September 30, 2014. We are also subject to interest rate and other market risks. Any investments we make that are denominated in a foreign currency will be subject to risks associated with changes in currency exchange rates. These risks include the possibility of significant fluctuations in the foreign currency markets, the imposition or modification of foreign exchange controls and potential illiquidity in the secondary market. These risks will vary depending upon the currency or currencies involved.

 

We may hedge against interest rate and currency exchange rate fluctuations by using standard hedging instruments such as futures, options and forward contracts subject to the requirements of the 1940 Act. While hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in benefits of lower interest rates with respect to our portfolio of investments with fixed interest rates.

 

Assuming that our current balance sheet was to remain constant and no actions were taken to alter our existing interest rate sensitivity, a 100 basis point move in interest rates up or down from their September 30, 2014 levels would result in an increase or decrease in net asset value of $0.4 million or 0.99%.

  

Item 4. Controls and Procedures

 

Disclosure Controls

 

In accordance with Rules 13a-15(b) and 15d-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q and determined that the disclosure controls and procedures are effective.

 

Change in Internal Control over Financial Reporting

 

No change occurred in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

  

PART II

 

OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Neither we nor our Manager are currently subject to any material legal proceedings.

 

Item 1A. Risk Factors

 

There have been no material changes from the risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2013.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Not applicable.

 

Item 3. Defaults upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable.

 

Item 6. Exhibits

 

Listed below are the exhibits which are filed as part of this report (according to the number assigned to them in Item 601 of Regulation S-K):

 

Exhibit Number		Description of Document
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended.
31.2*		Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended.
32.1*		Certification of Chief Executive Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certification of Chief Financial Officer pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*    Filed herewith.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	VII Peaks Co-Optivist Income BDC II, Inc.
Date: November 13, 2014	By	/s/ Gurpreet S. Chandhoke
		Gurpreet S. Chandhoke
		Chairman of the Board of Directors,
		Chief Executive Officer and President
		(Principal Executive Officer)

  

	VII Peaks Co-Optivist Income BDC II, Inc.
Date: November 13, 2014	By	/s/ Cecilia Shea
		Cecilia Shea
		Chief Financial Officer,
		Treasurer and Secretary
		(Principal Financial Officer and Principal Accounting Officer)