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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 814-01108

 

 

Corporate Capital Trust II

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   47-1595504

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

CNL Center at City Commons

450 South Orange Avenue

Orlando, Florida

  32801
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (866) 745-3797

 

 

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  ☒    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 (§232.405 of this chapter) 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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

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

The number of shares of common stock of the registrant outstanding as of November 10, 2016 was 4,864,756.

 

 

 


Table of Contents

CORPORATE CAPITAL TRUST II

INDEX

 

         PAGE  
PART I. FINANCIAL INFORMATION   
Item 1.  

Financial Statements:

  
 

Condensed Statements of Assets and Liabilities as of September 30, 2016 (unaudited) and December 31, 2015

     2   
 

Condensed Statements of Operations for the three and nine months ended September 30, 2016 (unaudited)

     3   
 

Condensed Statement of Changes in Net Assets for the nine months ended September 30, 2016 (unaudited)

     4   
 

Condensed Statement of Cash Flows for the nine months ended September 30, 2016 (unaudited)

     5   
 

Condensed Schedule of Investments as of September 30, 2016 (unaudited)

     6   
 

Notes to Condensed Financial Statements (unaudited)

     10   
Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     23   
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     36   
Item 4.  

Controls and Procedures

     36   
PART II. OTHER INFORMATION   
Item 1.  

Legal Proceedings

     37   
Item 1A.  

Risk Factors

     37   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     39   
Item 3.  

Defaults Upon Senior Securities

     39   
Item 4.  

Mine Safety Disclosures

     39   
Item 5.  

Other Information

     39   
Item 6.  

Exhibits

     39   
Signatures      40   
Exhibit Index      41   


Table of Contents

Corporate Capital Trust II

Condensed Statements of Assets and Liabilities

 

     September 30,
2016
    December 31,
2015
 
     (unaudited)        

Assets

    

Investment at fair value:

    

Non-controlled, non-affiliated investments (amortized cost of $31,361,399 and $0, respectively)

   $ 31,841,824      $ —     

Cash

     19,219,208        202,000   

Interest receivable

     114,657        —     

Receivable for investments sold

     755,873        —     

Principal receivable

     18,634        —     

Receivable from advisors

     225,073        —     

Prepaid expenses

     95,577        —     
  

 

 

   

 

 

 

Total assets

     52,270,846        202,000   
  

 

 

   

 

 

 

Liabilities

    

Payable for investments purchased

     16,484,777        —     

Accrued performance-based incentive fees

     110,906        —     

Accrued trustees’ fees

     5,284        —     

Accrued distribution and shareholder servicing fees

     32,578        —     

Other accrued expenses and liabilities

     562,568        —     
  

 

 

   

 

 

 

Total liabilities

     17,196,113        —     
  

 

 

   

 

 

 

Commitments and contingencies (Note 10)

    

Net Assets

   $ 35,074,733      $ 202,000   
  

 

 

   

 

 

 

Components of Net Assets

    

Preferred stock, $0.001 par value per share, 100,000,000 and 1,000,000 shares authorized and unissued at September 30, 2016 and December 31, 2015, respectively.

   $ —        $ —     

Common stock, $0.001 par value per share, 1,000,000,000 shares authorized, 3,823,466 and 22,444 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively

     3,823        22   

Paid-in capital in excess of par value

     34,833,732        201,978   

Distributions in excess of net investment income

     (245,521     —     

Accumulated net unrealized appreciation on investments

     482,699        —     
  

 

 

   

 

 

 

Net assets

   $ 35,074,733      $ 202,000   
  

 

 

   

 

 

 

Net asset value per share

   $ 9.17      $ 9.00   
  

 

 

   

 

 

 

See notes to condensed financial statements.

 

2


Table of Contents

Corporate Capital Trust II

Condensed Statements of Operations (unaudited)

 

     Three Months
Ended September 30,
2016
    Nine Months
Ended September 30,
2016
 

Investment income

    

Interest income

   $ 326,873      $ 438,244   

Fee income

     4,770        5,917   
  

 

 

   

 

 

 

Total investment income

     331,643        444,161   
  

 

 

   

 

 

 

Operating expenses

    

Professional services

     129,162        600,304   

Administrative services

     127,974        268,582   

Investment advisory fees

     165,183        225,666   

Trustee fees and expenses

     49,017        114,017   

Custodian and accounting fees

     48,977        113,568   

Performance-based incentive fees

     96,726        110,906   

Distribution and shareholder servicing fee

     79,074        109,816   

Insurance

     40,191        64,498   

Other

     43,080        60,954   
  

 

 

   

 

 

 

Total operating expenses

     779,384        1,668,311   

Expense support

     (603,584     (1,447,589
  

 

 

   

 

 

 

Net operating expenses

     175,800        220,722   
  

 

 

   

 

 

 

Net investment income

     155,843        223,439   
  

 

 

   

 

 

 

Net realized and unrealized gains

    

Net realized gains on investments

     71,463        71,831   

Net change in unrealized appreciation on:

    

Non-controlled, non-affiliated investments

     410,639        480,425   

Foreign currency translation

     2,274        2,274   
  

 

 

   

 

 

 

Net change in unrealized appreciation

     412,913        482,699   
  

 

 

   

 

 

 

Net realized and unrealized gains

     484,376        554,530   
  

 

 

   

 

 

 

Net increase in net assets resulting from operations

   $ 640,219      $ 777,969   
  

 

 

   

 

 

 

Net investment income per share

   $ 0.06      $ 0.14   
  

 

 

   

 

 

 

Diluted and basic earnings per share

   $ 0.23      $ 0.47   
  

 

 

   

 

 

 

Weighted average shares outstanding

     2,756,657        1,646,189   
  

 

 

   

 

 

 

Distributions declared per share

   $ 0.14      $ 0.34   
  

 

 

   

 

 

 

See notes to condensed financial statements.

 

3


Table of Contents

Corporate Capital Trust II

Condensed Statement of Changes in Net Assets

 

     Nine Months
Ended

September 30,
2016
 
     (unaudited)  

Operations

  

Net investment income

   $ 223,439   

Net realized gains on investments

     71,831   

Net change in unrealized appreciation on investments and foreign currency translation

     482,699   
  

 

 

 

Net increase in net assets resulting from operations

     777,969   
  

 

 

 

Distributions to shareholders from

  

Net investment income

     (223,439

Net realized gains

     (71,831

Distributions in excess of net investment income (Note 6)

     (245,521
  

 

 

 

Net decrease in net assets resulting from shareholders’ distributions

     (540,791
  

 

 

 

Capital share transactions

  

Issuance of shares of common stock

     34,451,942   

Reinvestment of shareholders distributions

     183,613   
  

 

 

 

Net increase in net assets resulting from capital share transactions

     34,635,555   
  

 

 

 

Total increase in net assets

     34,872,733   

Net assets at beginning of period

     202,000   
  

 

 

 

Net assets at end of period

   $ 35,074,733   
  

 

 

 

Capital share activity

  

Shares issued from subscriptions

     3,781,001   

Shares issued from reinvestment of distributions

     20,021   
  

 

 

 

Net increase in shares outstanding

     3,801,022   
  

 

 

 

Distributions in excess of net investment income at end of period

   $ (245,521
  

 

 

 

See notes to condensed financial statements

 

4


Table of Contents

Corporate Capital Trust II

Condensed Statement of Cash Flows

 

     For the Nine
Months Ended
September 30,
2016

(unaudited)
 

Operating Activities:

  

Net increase in net assets resulting from operations

   $ 777,969   

Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operating activities:

  

Purchases of investments

     (32,768,960

Increase in payable for investments purchased

     16,480,488   

Proceeds from sales of investments

     1,470,350   

Proceeds from principal payments

     113,571   

Net realized gain on investments

     (71,831

Net change in unrealized appreciation on investments

     (480,425

Net change in unrealized appreciation on foreign currency translation

     (2,274

Amortization of premium/discount – net

     (104,529

Increase in receivable for investments sold

     (749,310

Increase in principal receivable

     (18,634

Increase in receivable from advisors

     (225,073

Increase in interest receivable

     (114,657

Increase in prepaid expenses

     (95,577

Increase in accrued performance-based incentive fees

     110,906   

Increase in accrued distribution and shareholder servicing fees

     32,578   

Increase in accrued trustees’ fees

     5,284   

Increase in other accrued expenses and liabilities

     562,568   
  

 

 

 

Net cash used in operating activities

     (15,077,556
  

 

 

 

Financing Activities:

  

Proceeds from issuance of shares of common stock

     34,451,942   

Distributions paid

     (357,178
  

 

 

 

Net cash provided by financing activities

     34,094,764   
  

 

 

 

Net increase in cash

     19,017,208   

Cash, beginning of period

     202,000   
  

 

 

 

Cash, end of period

   $ 19,219,208   
  

 

 

 

Supplemental disclosure of cash flow information and non-cash financing activities:

  

Distributions reinvested

   $ 183,613   

See notes to condensed financial statements.

 

5


Table of Contents

Corporate Capital Trust II

Condensed Schedule of Investments (unaudited) (continued)

As of September 30, 2016

 

Company (a)(b)

  Footnotes    

Industry

   Interest
Rate
     Base
Rate
Floor
    Maturity
Date
     No. Shares/
Principal
Amount (c)
     Cost (d)      Fair Value  

Senior Secured Loans – First Lien – 74.2%

  

ABB CONCISE Optical Group, LLC

    (1 )    Retailing      L+500         1.00     6/1/2023       $ 516,170       $ 514,539       $ 521,977   

ABILITY Network, Inc.

    (e )(1)    Health Care Equipment & Services      L+500         1.00     5/14/2021         202,785         198,932         201,687   

Bay Club Co.

    (1 )    Consumer Services      L+650         1.00     8/31/2022         1,229,339         1,205,003         1,210,899   

Belk, Inc.

    (e )(1)    Retailing      L+475         1.00     12/12/2022         1,232,749         1,113,989         1,120,149   

Brock Holdings III, Inc.

    (e )(1)    Capital Goods      L+450         1.50     3/16/2017         838,296         832,008         831,225   

Commercial Barge Line, Co.

    (1 )    Transportation      L+875         1.00     11/12/2020         563,701         532,757         550,313   

CSM Bakery Products

    (e )(1)    Food, Beverage & Tobacco      L+400         1.00     7/3/2020         1,000,000         970,000         957,500   

David’s Bridal, Inc.

    (1 )    Retailing      L+375         1.25     10/11/2019         854,141         789,476         805,566   

Distribution International, Inc.

    (1 )    Retailing      L+500         1.00     12/15/2021         203,636         163,326         174,109   

FleetPride Corp.

    (e )(1)    Capital Goods      L+400         1.25     11/19/2019         1,548,219         1,324,285         1,405,008   

Hanson Building Products North America

    (f )(1)    Capital Goods      L+550         1.00     3/13/2022         74,979         68,296         74,745   

Heartland Dental Care, Inc.

    (1 )    Pharmaceuticals, Biotechnology & Life Sciences      L+450         1.00     12/21/2018         262,504         259,888         262,941   

Integra Telecom Holdings, Inc.

    (e )(1)    Telecommunication Services      L+425         1.00     8/14/2020         1,585,975         1,589,940         1,583,992   

Koosharem, LLC

    (1 )    Commercial & Professional Services      L+650         1.00     5/15/2020         1,292,965         1,125,052         1,114,109   

MedAssets, Inc.

    (e )(2)    Health Care Equipment & Services      L+550         1.00     10/19/2022         1,568,509         1,578,698         1,582,233   

Netsmart Technologies, Inc.

    (f )(2)    Health Care Equipment & Services      L+475         1.00     4/19/2023         81,835         81,638         82,321   

NewWave Communications, Inc.

    (1 )    Media      L+375         1.00     4/30/2020         75,596         70,005         75,502   

Paradigm Acquisition Corp.

    (e )(1)    Health Care Equipment & Services      L+500         1.00     6/2/2022         1,496,212         1,496,212         1,490,609   

Polyconcept North America, Inc.

    (2 )    Consumer Durables & Apparel      L+525         1.00     8/10/2023         335,870         332,556         338,809   

 

6


Table of Contents

Corporate Capital Trust II

Condensed Schedule of Investments (unaudited) (continued)

As of September 30, 2016

 

Company (a)(b)

  Footnotes    

Industry

   Interest
Rate
     Base
Rate
Floor
    Maturity
Date
     No. Shares/
Principal
Amount (c)
     Cost (d)      Fair Value  

RedPrairie Corp.

    (2 )    Software & Services      L+500         1.00     12/21/2018       $ 273,374       $ 253,718       $ 273,651   
    (e )(1)         L+350         1.00     9/22/2023         1,000,000         1,003,750         1,002,500   

Riverbed Technology, Inc.

    (1 )    Technology Hardware & Equipment      L+400         1.00     4/25/2022         34,550         34,550         34,927   

Safway Group Holding, LLC

    (e )(1)    Capital Goods      L+475         1.00     8/21/2023         1,500,000         1,515,000         1,512,188   

Savers, Inc.

    (1 )    Retailing      L+375         1.25     7/9/2019         1,246,647         1,092,297         1,146,291   

Scientific Games International, Inc.

    (f )(1)    Consumer Services      L+500         1.00     10/1/2021         238,182         232,248         238,943   

Sequa Corp.

    (e )(1)    Capital Goods      L+400         1.25     6/19/2017         1,757,337         1,471,340         1,547,828   

SI Organization, Inc.

    (1 )    Capital Goods      L+475         1.00     11/23/2019         605,195         605,238         608,981   

TIBCO Software, Inc.

    (e )(2)    Software & Services      L+550         1.00     12/4/2020         1,419,802         1,356,100         1,402,686   

TruGreen, LP

    (e )(3)    Consumer Services      L+550         1.00     4/13/2023         1,589,207         1,605,404         1,606,092   

Vertafore, Inc.

    (3 )    Software & Services      L+375         1.00     6/30/2023         140,940         140,257         141,700   

Vertiv Co.

    (e )(f)    Technology Hardware & Equipment      L+500         1.00     9/29/2023         1,760,260         1,707,452         1,725,055   

WireCo WorldGroup, Inc.

    (e )    Capital Goods      L+600         1.00     7/21/2023         395,810         392,947         397,872   

Total Senior Secured Loans – First Lien

  

   $ 25,656,901       $ 26,022,408   
                 

 

 

    

 

 

 

Senior Secured Loans – Second Lien – 16.3%

  

Applied Systems, Inc.

    (1 )    Software & Services      L+650         1.00     1/24/2022       $ 218,057       $ 204,769       $ 220,443   

CTI Foods Holding Co., LLC

    (1 )    Food, Beverage & Tobacco      L+725         1.00     6/28/2021         222,222         203,910         200,000   

Formula One (LUX)

    (e )(f)(g)(1)    Media      L+675         1.00     7/29/2022         422,630         421,574         424,849   

Genoa, a QoL Healthcare Co., LLC

    (1 )    Health Care Equipment & Services      L+775         1.00     4/28/2023         513,066         506,524         516,914   

Grocery Outlet, Inc.

    (1 )    Food & Staples Retailing      L+825         1.00     10/21/2022         198,393         183,517         198,393   

iParadigms Holdings, LLC

    (1 )    Software & Services      L+725         1.00     7/29/2022         204,082         198,551         200,510   

 

7


Table of Contents

Corporate Capital Trust II

Condensed Schedule of Investments (unaudited) (continued)

As of September 30, 2016

 

Company (a)(b)

  Footnotes    

Industry

   Interest
Rate
    Base
Rate
Floor
    Maturity
Date
     No. Shares/
Principal
Amount (c)
     Cost (d)      Fair Value  

Lightower Fiber, LLC

    (1 )    Telecommunication Services      L+675        1.25     4/12/2021       $ 225,000       $ 219,228       $ 225,984   

NEP Group, Inc.

    (1 )    Media      L+875        1.25     7/22/2020         215,054         202,146         216,667   

NewWave Communications, Inc.

    (1 )    Media      L+800        1.00     10/30/2020         206,718         201,999         203,101   

Polyconcept North America, Inc.

    (2 )(i)    Consumer Durables & Apparel      L+1000        1.00     12/31/2023         624,235         608,861         611,920   

Press Ganey Holdings, Inc.

    (e )    Health Care Equipment & Services      L+800        1.00     9/30/2024         390,260         386,357         393,187   

RedPrairie Corp.

    (2 )    Software & Services      L+1000        1.25     12/21/2019         30,060         24,198         30,314   

SI Organization, Inc.

    (1 )    Capital Goods      L+875        1.00     5/23/2020         460,504         453,552         462,806   

SRS Distribution, Inc.

    (1 )    Capital Goods      L+875        1.00     2/24/2023         444,840         436,180         450,122   

WireCo WorldGroup, Inc.

    (e )(1)    Capital Goods      L+950        1.00     7/12/2024         1,353,870         1,345,923         1,357,255   

Total Senior Secured Loans – Second Lien

  

   $ 5,597,289       $ 5,712,465   
                

 

 

    

 

 

 

Total Senior Debt

  

   $ 31,254,190       $ 31,734,873   
                

 

 

    

 

 

 

Subordinated Debt – 0.1%

  

  

GCI, Inc.

    Telecommunication Services      6.88       4/15/2025       $ 45,000       $ 44,785       $ 46,125   

Total Subordinated Debt

  

   $ 44,785       $ 46,125   
                

 

 

    

 

 

 

Equity – 0.2%

  

  

Polyconcept North America Holdings, Inc.

    (i )    Consumer Durables & Apparel           624       $ 62,424       $ 60,826   
                

 

 

    

 

 

 

Total Equity

  

   $ 62,424       $ 60,826   
                

 

 

    

 

 

 

TOTAL INVESTMENTS (h) – 90.8%

  

   $ 31,361,399       $ 31,841,824   
                

 

 

    

 

 

 

OTHER ASSETS IN EXCESS OF LIABILITIES – 9.2%

  

        3,232,909   
                   

 

 

 

NET ASSETS – 100.0%

  

      $ 35,074,733   
                   

 

 

 

 

8


Table of Contents
(a) Security may be an obligation of one or more entities affiliated with the named company.
(b) Non-controlled/non-affiliated investments as defined by the Investment Company Act of 1940, as amended (“1940 Act”), unless otherwise indicated. Non-controlled/non-affiliated investments are investments that are neither controlled investments nor affiliated investments.
(c) Denominated in U.S. dollars unless otherwise noted.
(d) Represents amortized cost for debt securities and cost for equity investments translated to U.S. dollars.
(e) Position or portion thereof unsettled as of September 30, 2016.
(f) The investment is not a qualifying asset as defined in Section 55(a) under the 1940 Act. A business development company may not acquire any asset other than qualifying assets, unless, at the time the acquisition is made, qualifying assets represent at least 70% of the company’s total assets. The Company calculates its compliance with the qualifying assets test on a “look through” basis by disregarding the value of the Company’s total return swaps and treating each loan underlying the total return swaps as either a qualifying asset or non-qualifying asset based on whether the obligor is an eligible portfolio company. On this basis, 95.0% of the Company’s total assets represented qualifying assets as of September 30, 2016.
(g) A portfolio company domiciled in a foreign country. The jurisdiction of the security issuer may be a different country than the domicile of the portfolio company.
(h) As of September 30, 2016, the aggregate gross unrealized appreciation for all securities in which there was an excess of value over tax cost was $525,773; the aggregate gross unrealized depreciation for all securities in which there was an excess of tax cost over value was $45,348; the net unrealized appreciation was $480,425; the aggregate cost of securities for Federal income tax purposes was $31,361,399.
(i) Investments classified as Level 3 whereby fair value was determined by the Company’s Board of Trustees (Note 2).
(1) The interest rate on these investments is subject to a base rate of 3-Month LIBOR, which at September 30, 2016 was 0.85%. The current base rate for each investment may be different from the reference rate on September 30, 2016.
(2) The interest rate on these investments is subject to a base rate of 1-Month LIBOR, which at September 30, 2016 was 0.53%. The current base rate for each investment may be different from the reference rate on September 30, 2016.
(3) The interest rate on these investments is subject to a base rate of 6-Month LIBOR, which at September 30, 2016 was 1.24%. The current base rate for each investment may be different from the reference rate on September 30, 2016.

Abbreviations:

LUX – Luxembourg

L = LIBOR – London Interbank Offered Rate, typically 3-Month

See notes to condensed financial statements.

 

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CORPORATE CAPITAL TRUST II

Notes to Condensed Financial Statements (Unaudited)

1. Principal Business and Organization

Corporate Capital Trust II (the “Company”) was formed as a Delaware statutory trust on August 12, 2014. The Company is a non-diversified closed-end management investment company and has elected to be regulated as a business development company under the Investment Company Act of 1940 (the “1940 Act”). The Company’s investment objective is to provide its shareholders with current income and, to a lesser extent, long-term capital appreciation, by investing primarily in the debt of privately owned U.S. companies with a focus on originated transactions sourced through the networks of its advisors. The Company intends to elect to be taxed as a regulated investment company (“RIC”) under the Internal Revenue Code of 1986, as amended (the “Code”) and operate in a manner so as to qualify for the tax treatment applicable to RICs.

The Company is externally managed by CNL Fund Advisors II, LLC (“CNL”) and KKR Credit Advisors (US) LLC (“KKR”) (collectively the “Advisors”), which are collectively responsible for sourcing potential investments, conducting due diligence on prospective investments, analyzing investment opportunities, structuring investments, determining the securities and other assets that the Company will purchase, retain or sell and monitoring the Company’s portfolio on an ongoing basis. Both of the Advisors are registered as investment advisers with the Securities and Exchange Commission (“SEC”). CNL also provides the administrative services necessary for the Company to operate.

On September 29, 2014, the Company filed a registration statement on Form N-2 (the “Registration Statement”) with the SEC to register its common stock. The Registration Statement, as amended, provides for the sale on a continuous basis of up to $2.6 billion of shares of common stock (275 million shares at $9.45 per share) (the “Offering”). The Registration Statement was declared effective on October 9, 2015, at which time the Company’s Offering commenced.

On March 1, 2016 the Company satisfied its minimum offering requirement to accumulate in excess of $2.25 million in subscriptions in an escrow account. On March 1, 2016, the Company issued shares of common stock in exchange for the subscription capital in the escrow account. The Company commenced principal and investment operations on March 1, 2016.

2. Significant Accounting Policies

Basis of Presentation – The accompanying condensed financial statements of the Company are prepared in accordance with the instructions to Form 10-Q and accounting principles generally accepted in the United States of America (“GAAP”). The Company is an investment company following accounting and reporting guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 946, Financial Services—Investment Companies (“ASC Topic 946”). The unaudited condensed financial statements reflect all normal recurring adjustments, which are, in the opinion of management, necessary for the fair presentation of the Company’s results for the interim periods presented. The results of operations for interim periods are not indicative of results to be expected for the full year.

Certain financial information that is normally included in annual financial statements, including certain financial statement footnotes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted herein. These financial statements should be read in conjunction with the Company’s financial statements and notes related thereto included in the Company’s Annual Report on Form 10-K for the period ended December 31, 2015, which was filed with the SEC on March 14, 2016.

Use of Estimates – The preparation of the condensed financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities at the date of the condensed financial statements, (ii) the reported amounts of income and expenses during the reporting periods presented and (iii) disclosure of contingent assets and liabilities at the date of the condensed financial statements. Actual results could differ from those estimates.

Cash – Cash consists of demand deposits.

Valuation of Investments – The Company measures the value of its investments in accordance with ASC Topic 820, Fair Value Measurements and Disclosure (“ASC Topic 820”), issued by the FASB. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are defined as buyers and sellers in the principal or most advantageous market (which may be a hypothetical market) that are independent, knowledgeable, and willing and able to transact. In accordance with ASC Topic 820, the Company considers its principal market to be the market that has the greatest volume and level of activity.

 

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ASC Topic 820 defines hierarchical levels directly related to the amount of subjectivity associated with the inputs used to determine fair values of assets and liabilities. The hierarchical levels and types of inputs used to measure fair value for each level are described as follows:

Level 1 – Quoted prices are available in active markets for identical investments as of the reporting date. Publicly listed equities and debt securities, publicly listed derivatives, money market/short-term investment funds and foreign currency are generally included in Level 1. The Company does not adjust the quoted price for these investments.

Level 2 – Valuation inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value is determined through the use of models or other valuation methodologies. In certain cases, debt and equity securities are valued on the basis of prices from orderly transactions for similar investments in active markets between market participants and provided by reputable dealers or independent pricing services. In determining the value of a particular investment, independent pricing services may use certain information with respect to transactions in such investments, quotations from dealers, pricing matrices, market transactions in comparable investments, and various relationships between investments. Investments generally included in this category are corporate bonds and loans that are priced based on observable inputs.

Level 3 – Valuation inputs are unobservable for the investment and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require significant judgment or estimation. Investments generally included in this category are illiquid corporate bonds and loans, unlisted common and preferred stock investments, and equity options that lack observable market pricing.

In certain cases, the inputs used to measure fair value may fall within different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Depending on the relative liquidity in the markets for certain investments, the Company may transfer assets to Level 3 if it determines that observable quoted prices, obtained directly or indirectly, are not available or reliable. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and the consideration of factors specific to the investment.

Investments for which market quotations are readily available are valued using market quotations, which are generally obtained from independent pricing services, broker-dealers or market makers. With respect to the Company’s portfolio investments for which market quotations are not readily available, the Company’s board of trustees is responsible for determining in good faith the fair value of the Company’s portfolio investments in accordance with the valuation policy and procedures approved by the board of trustees based on, among other things, the input of the Company’s Advisors and management, its audit committee, and independent third-party valuation firms.

The Company and the board of trustees conduct their fair value determination process on a monthly basis and any other time when a decision regarding the fair value of the portfolio investments is required. A determination of fair value involves subjective judgments and estimates. Due to the inherent uncertainty of determining the fair value of portfolio investments that do not have a readily available market value, the fair value of the investments may differ significantly from the values that would have been determined had a readily available market value existed for such investments, and the differences could be material. Further, such investments are generally less liquid than publicly traded securities. If the Company was required to liquidate a portfolio investment that does not have a readily available market value in a forced or liquidation sale, the Company could realize significantly less than the value recorded by the Company.

The Company and its Advisors undertake a multi-step valuation process each quarter for determining the fair value of the Company’s investments, the market prices of which are not readily available, as described below:

 

    Each portfolio company or investment is initially valued by KKR (internal valuation) and/or the Company’s independent third party valuation firm (external valuation), which provides a valuation range.

 

    Valuation recommendations are formulated and documented by KKR and reviewed by KKR’s valuation committee. The KKR valuation committee then provides its valuation recommendation for each portfolio investment, along with supporting documentation, to CNL and the Company.

 

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    After the Company’s management has substantially completed its review, it forwards the valuation recommendations and supporting documentation for audit committee review.

 

    The Company’s board of trustees then discusses the investment valuation recommendations with the Advisors and management and, based on those discussions and the related review process conducted by the Company’s audit committee, determines the fair value of the investments in good faith.

The valuation techniques used by the Company for the assets and liabilities that are classified as Level 3 in the fair value hierarchy are described below.

Senior Debt and Subordinated Debt: Senior debt and subordinated debt investments are initially valued at transaction price and are subsequently valued using (i) market data for similar instruments (e.g., recent transactions or indicative broker quotes), (ii) comparisons to benchmark derivative indices or (iii) valuation models. Valuation models are generally based on yield analysis and discounted cash flow techniques, where the key inputs are based on relative value analyses and the assignment of risk-adjusted discounted rates, based on the analysis of similar instruments from similar issuers. In addition, an illiquidity discount is applied where appropriate.

Equity Investments: Equity investments are initially valued at transaction price and are subsequently valued using valuation models in the absence of readily observable market prices. Valuation models are generally based on (i) market and income (discounted cash flow) approaches, in which various internal and external factors are considered, and (ii) earnings before interest, taxes, depreciation and amortization (“EBITDA”) valuation multiples analysis. Factors include key financial inputs and recent public and private transactions for comparable investments. Key inputs used for the discounted cash flow approach include the weighted average cost of capital and assumed inputs used to calculate terminal values, such as EBITDA exit multiples. The fair value for a particular investment will generally be within the value range conclusions derived by the two approaches. Upon completion of the valuations conducted, an illiquidity discount is applied where appropriate.

The Company utilizes several valuation techniques that use unobservable pricing inputs and assumptions in determining the fair value of its Level 3 investments. The unobservable pricing inputs and assumptions may differ by asset and in the application of the Company’s valuation methodologies. The reported fair value estimates could vary materially if the Company had chosen to incorporate different unobservable pricing inputs and other assumptions.

Security Transactions, Realized/Unrealized Gains or Losses, and Income Recognition – Investments purchased on a secondary basis are recorded on the trade date. Loan originations are recorded on the funding date. The Company measures realized gains or losses from the sale of investments using the specific identification method. Realized gains or losses are measured by the difference between the net proceeds from the sale and the amortized cost basis of the investment without regard to unrealized gains or losses previously recognized, and include investments charged off during the period, net of recoveries. Unrealized gains or losses primarily reflect the change in investment values, including the reversal of previously recorded unrealized gains or losses when gains or losses are realized. The amortized cost basis of investments includes (i) the original cost and (ii) adjustments for the accretion/amortization of market discounts and premiums, original issue discount and loan origination fees. The Company reports changes in fair value of investments as a component of net change in unrealized appreciation (depreciation) on investments in the condensed statements of operations.

Interest Income – Interest income is recorded on an accrual basis and includes amortization of premiums to par value and accretion of discounts to par value. Discounts and premiums to par value on securities purchased are accreted/amortized into interest income over the life of the respective security using the effective interest method. Upon prepayment of a debt investment, any prepayment penalties and unamortized loan fees and discounts are recorded as interest income.

Debt securities are placed on nonaccrual status when principal or interest payments are at least 90 days past due or when there is reasonable doubt that principal or interest will be collected. Generally, accrued interest is reversed against interest income when a debt security is placed on nonaccrual status. Interest payments received on debt securities on nonaccrual status may be recognized as interest income or applied to principal based on management’s judgment. Debt securities on nonaccrual status are restored to accrual status when past due principal and interest are paid and, in management’s judgment, such investments are likely to remain current on interest payment obligations. The Company may make exceptions to this treatment if the debt security has sufficient collateral value and is in the process of collection.

Fee Income – The Company receives fees for commitments, amendments and other services related to portfolio companies. Such fees are recognized as fee income when earned or the services are rendered.

 

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Paid In Capital – The Company records the proceeds from the sale of its common stock on a net basis to (i) capital stock and (ii) paid-in capital in excess of par value, excluding up-front selling commissions and dealer manager fees.

Foreign Currency Translation, Transactions and Gains/Losses – Foreign currency amounts are translated into U.S. dollars on the following basis: (i) at the exchange rate on the last business day of the reporting period for the fair value of investment securities, other assets and liabilities; and (ii) at the prevailing exchange rate on the respective recording dates for the purchase and sale of investment securities, income, expenses, gains and losses.

Net assets and fair values are presented based on the applicable foreign exchange rates described above and the Company does not isolate that portion of the results of operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in fair values of investments held; therefore, fluctuations related to foreign exchange rate conversions are included with the net realized gains (losses) and unrealized appreciation (depreciation) on investments.

Net realized gains or losses on foreign currency transactions arise from sales of foreign currency, currency gains or losses realized between the trade and settlement dates on securities transactions, and the difference between the amounts of dividends, interest, and foreign withholding taxes recorded by the Company and the U.S. dollar equivalent of the amounts actually received or paid by the Company.

Unrealized appreciation (depreciation) from foreign currency translation for other receivables or payables is presented as net change in unrealized appreciation (depreciation) in foreign currency translation in the condensed statements of operations.

Management Fees – The Company incurs a base management fee (recorded as investment advisory fees) and performance-based incentive fees, including (i) a subordinated incentive fee on income and (ii) an incentive fee on capital gains, due to its Advisors pursuant to an investment advisory agreement described in Note 5 “Related Party Transactions.” The two components of performance-based incentive fees are combined and expensed in the condensed statements of operations and accrued as accrued performance-based incentive fees in the condensed statements of assets and liabilities. Pursuant to the terms of the investment advisory agreement, the incentive fee on capital gains is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory agreement) based on the Company’s realized capital gains on a cumulative basis from inception, net of all realized capital losses on a cumulative basis and unrealized depreciation at year end, less the aggregate amount of any previously paid capital gains incentive fees. Although the terms of the investment advisory agreement do not provide for the inclusion of unrealized gains in the calculation of the incentive fee on capital gains, pursuant to relevant authoritative guidance for investment companies, the Company includes unrealized gains in the calculation of the incentive fee on capital gains expense and related accrued incentive fee on capital gains. This accrual reflects the incentive fees that would be payable to the Advisors if the Company’s entire portfolio was liquidated at its fair value as of the balance sheet date even though the Advisors are not entitled to an incentive fee with respect to unrealized gains unless and until such gains are actually realized.

Organization and Offering Expenses – Organization expenses will be expensed on the Company’s statement of operations. Continuous offering expenses, excluding sales load and distribution and shareholder servicing fees, will be capitalized on the Company’s statement of assets and liabilities as deferred offering expenses and expensed to the Company’s statement of operations over a 12-month period.

Earnings per Share – Earnings per share is calculated based upon the weighted average number of shares of common stock outstanding during the reporting period.

Distributions – Weekly distributions are generally declared quarterly by the Company’s board of trustees and recognized as a liability on the applicable record date. Distributions are paid monthly. The Company has adopted a distribution reinvestment plan that provides for reinvestment of distributions on behalf of shareholders. Shareholders who have elected to participate in the distribution reinvestment plan will have their cash distribution automatically reinvested in additional shares of common stock at a price per share equivalent to the then current public offering price, net of up-front selling commissions and dealer manager fees.

 

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Federal Income Taxes – The Company intends to elect to be treated for federal income tax purposes, and intends to maintain its qualification, as a RIC under Subchapter M of the Code. Generally, a RIC is not subject to federal income taxes on distributed income and gains if it distributes at least 90% of its “Investment Company Taxable Income,” as defined in the Code. The Company intends to distribute sufficient dividends to maintain its RIC status each year.

The Company is generally subject to nondeductible federal excise taxes if it does not distribute to its shareholders an amount at least equal to the sum of (i) 98% of its net ordinary income for the calendar year, (ii) 98.2% of its capital gains in excess of capital losses for the one-year period generally ending on October 31 of the calendar year and (iii) any ordinary income and net capital gains for preceding years that were not distributed during such years and on which the Company paid no federal income tax. The Company may, at its discretion, pay a 4% nondeductible federal excise tax on under-distribution of capital gains and taxable income.

The Company recognizes in its condensed financial statements the effect of a tax position when it is deemed more likely than not, based on the technical merits, that the position will be sustained upon examination. Tax benefits of positions not deemed to meet the more-likely-than-not threshold are recorded as tax expenses in the current year. The Company did not have any uncertain tax positions that met the recognition or measurement criteria of ASC 740-10-25, Income Taxes – Overall –Recognition, nor did it have any unrecognized tax benefits for the periods presented herein. Although the Company files federal and state tax returns, its major tax jurisdiction is federal.

Permanent book and tax basis differences are reclassified among the Company’s capital accounts, as appropriate. Additionally, the tax character and amount of distributions is determined in accordance with the Code which differs from GAAP.

Recent Accounting Pronouncements – In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments,” which will make eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU further clarifies how the predominance principle should be applied to cash receipts and payments relating to more than one class of cash flows. The ASU is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017. The ASU is to be applied retrospectively for each period presented. The Company is currently evaluating the impact this ASU will have on the Company’s consolidated statement of cash flows.

3. Investments

The Company is engaged in a strategy to invest primarily in the debt of privately owned and thinly traded U.S. companies. The primary investment concentrations include (i) senior debt securities and (ii) subordinated debt securities. The Company’s investments may, in some cases, be accompanied by warrants, options or other forms of equity participation. The Company may separately purchase common or preferred equity interests, including non-controlling equity investments. Additionally, the Company may invest in convertible securities, derivatives and private investment funds. The fair value of the Company’s investments will generally fluctuate with, among other things, changes in prevailing interest rates, the general supply of, and demand for, debt capital among private and public companies, general domestic and global economic conditions, the condition of certain financial markets, developments or trends in any particular industry and changes in the financial condition and credit quality of each security’s issuer.

As of September 30, 2016, the Company’s investment portfolio (the “Investment Portfolio”) consisted of the following:

 

     As of September 30, 2016  

Asset Category

   Amortized
Cost
     Fair
Value
     Percentage of
Investment
Portfolio
    Percentage of
Net Assets
 

Senior debt

          

Senior secured loans – first lien

   $ 25,656,901       $ 26,022,408         81.7     74.2

Senior secured loans – second lien

     5,597,289         5,712,465         18.0        16.3   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total senior debt

     31,254,190         31,734,873         99.7        90.5   

Subordinated debt

     44,785         46,125         0.1        0.1   

Equity

     62,424         60,826         0.2        0.2   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments

   $ 31,361,399       $ 31,841,824         100.0     90.8
  

 

 

    

 

 

    

 

 

   

 

 

 

As of September 30, 2016, none of the Company’s debt investments were on nonaccrual status.

 

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The industry composition and geographic dispersion of the Company’s investment portfolio as a percentage of total fair value of the Company’s investments as of September 30, 2016 is as follows:

 

Industry Composition

   September 30,
2016
 

Capital Goods

     27.3

Health Care Equipment & Services

     13.4   

Retailing

     11.8   

Software & Services

     10.3   

Consumer Services

     9.6   

Telecommunication Services

     5.8   

Technology Hardware & Equipment

     5.5   

Food, Beverage & Tobacco

     3.6   

Commercial & Professional Services

     3.5   

Consumer Durables & Apparel

     3.2   

Media

     2.9   

Transportation

     1.7   

Pharmaceuticals, Biotechnology & Life Sciences

     0.8   

Food & Staples Retailing

     0.6   
  

 

 

 

Total

     100.0
  

 

 

 

Geographic Dispersion(1)

      

United States

     98.7

Luxembourg

     1.3   
  

 

 

 

Total

     100.0
  

 

 

 

 

(1) The geographic dispersion is determined by the portfolio company’s country of domicile or the jurisdiction of the security’s issuer.

As of September 30, 2016, all of the Company’s investments were denominated in U.S. dollars.

4. Fair Value of Financial Instruments

The Company’s investments were categorized in the fair value hierarchy described in Note 2. “Significant Accounting Policies”, as follows as of September 30, 2016:

 

     September 30, 2016  

Description

   Level 1      Level 2      Level 3      Total  

Senior debt

   $ —         $ 31,122,953       $ 611,920       $ 31,734,873   

Subordinated debt

     —           46,125         —           46,125   

Equity

     —           —           60,826         60,826   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ —         $ 31,169,078       $ 672,746       $ 31,841,824   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no transfers between Level 1 and Level 2 during the nine months ended September 30, 2016. The carrying value of cash is classified as Level 1 with respect to the fair value hierarchy. At September 30, 2016, the Company held two distinct investment positions classified as Level 3, representing an aggregate fair value of $672,746 and 2.1% of the total investment portfolio. The ranges of unobservable inputs used in the fair value measurement of the Company’s Level 3 investments as of September 30, 2016 were as follows:

 

Asset Group

   Fair
Value (1)
    

Valuation Techniques

  

Unobservable Inputs

   Range
(Weighted
Average) (2)
   

Impact to Valuation from an
Increase in Input (3)

Senior Debt

   $ 611,920       Discounted Cash Flow    Discount Rate      12.54   Decrease
         EBITDA Multiple      8.8   Increase
     

 

  

 

  

 

 

   

 

Equity

     60,826       Waterfall    Illiquidity Discounts      10   Decrease
         EBITDA Multiple      8.8   Increase
  

 

 

    

 

  

 

  

 

 

   

 

Total

   $ 672,746              
  

 

 

            

 

(1) Certain investments may be valued at cost for a period of time after an acquisition as the best indicator of fair value.
(2) Weighted average amounts are based on the estimated fair values.
(3) This column represents the directional change in the fair value of the Level 3 investments that would result from an increase to the corresponding unobservable input. A decrease to the input would have the opposite effect. Significant changes in these inputs in isolation could result in significantly higher or lower fair value measurements.

 

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The preceding table represents the significant unobservable inputs as they relate to the Company’s determination of fair values for the majority of its investments categorized within Level 3 as of September 30, 2016. In addition to the techniques and inputs noted in the table above, according to the Company’s valuation policy, it may also use other valuation techniques and methodologies when determining the fair value estimates for the Company’s investments. Any significant increases or decreases in the unobservable inputs would result in significant increases or decreases in the fair value of the Company’s investments.

Investments that do not have a readily available market value are valued utilizing a market approach, an income approach (i.e. discounted cash flow approach), or both approaches, as appropriate. The market comparables approach uses prices, including third party indicative broker quotes, 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) that are discounted based on a required or expected discount rate to derive a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts. In following these approaches, the types of factors the Company may take into account to determine the fair value of its investments include, as relevant: available current market data, including an assessment of the credit quality of the security’s issuer, relevant and applicable market trading and transaction comparables, applicable market yields and multiples, illiquidity discounts, 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 cash flows, the markets in which the portfolio company does business, comparisons of financial ratios of peer companies that are public, data derived from merger and acquisition activities for comparable companies, and enterprise values, among other factors.

The following table provides reconciliations for the period ended September 30, 2016 of investments for which Level 3 inputs were used in determining fair value:

 

     Nine Months Ended September 30, 2016  
     Senior
Debt
     Subordinated
Debt
     Equity      Total  

Fair value balance as of January 1, 2016

   $ —         $ —         $ —         $ —     

Additions (1)

     608,629         —           62,424         671,053   

Net change in unrealized appreciation (depreciation) (2)

     3,059         —           (1,598      1,461   

Net discount accretion

     232         —           —           232   
  

 

 

    

 

 

    

 

 

    

 

 

 

Fair value balance as of September 30, 2016

   $ 611,920       $ —         $ 60,826       $ 672,746   
  

 

 

    

 

 

    

 

 

    

 

 

 

Change in net unrealized appreciation

(depreciation) in investments still held

as of September 30, 2016 (2)

   $ 3,059       $ —         $ (1,598    $ 1,461   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Includes increases in the cost basis of investments resulting from new and add-on portfolio investments.
(2) Included in net change in unrealized appreciation (depreciation) in the condensed statements of operations.

No securities were transferred into or out of the Level 3 hierarchy during the nine months ended September 30, 2016. All realized and unrealized gains and losses are included in earnings and are reported as separate line items within the Company’s condensed statements of operations.

5. Related Party Transactions

As of September 30, 2016 and December 31, 2015, the Advisors owned 15% and 100%, respectively, of the Company’s outstanding shares. CNL is an affiliate of CNL Financial Group, Inc. (“CFG”). All of the Company’s executive officers also serve as executive officers of either KKR or CNL and other CFG affiliates.

The Company is a party to an investment advisory agreement with CNL (the “Investment Advisory Agreement”) for the overall management of the Company’s activities. CNL is a party to a sub-advisory agreement with KKR (the “Sub-Advisory Agreement”), under which KKR is responsible for the day-to-day management of the Company’s investment portfolio. Pursuant to the Investment Advisory Agreement, CNL earns (i) a management fee equal to an annual rate of 2% of the Company’s average gross assets, and (ii) an incentive fee based on the Company’s performance. The incentive fee consists of (i) an incentive fee on income and (ii) an incentive fee on capital gains. CNL compensates KKR for advisory services that it provides to the Company with 50% of the fees that CNL receives under the Investment Advisory Agreement.

 

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A subordinated incentive fee on income is payable to the Advisors each calendar quarter if the Company’s pre-incentive fee net investment fee income (as defined in the Investment Advisory Agreement and approved by the Company’s board of trustees) exceeds the 1.75% quarterly preference return to the Company’s shareholders (the ratio of pre-incentive fee net investment income divided by average adjusted capital). The Company did not incur any subordinated incentive fee on income during the nine months ended September 30, 2016.

The annual incentive fees on capital gains recorded for GAAP purposes are equal to (i) 20% of our realized and unrealized capital gains on a cumulative basis since inception, net of all realized capital losses and unrealized depreciation on a cumulative basis from inception, less (ii) the aggregate amount of any previously paid incentive fees on capital gains. For financial reporting purposes, in accordance with GAAP, the Company includes unrealized appreciation on the Investment Portfolio in the calculation of incentive fees on capital gains; however, such amounts are not payable by the Company unless and until the net unrealized appreciation is actually realized. The actual amount of incentive fees on capital gains that are due and payable to the Advisors is determined at the end of the calendar year. The Company accrued $110,906 for incentive fees on capital gains as of September 30, 2016.

Under the terms of the Investment Advisory Agreement, CNL (and indirectly KKR) is entitled to receive up to 1.5% of gross offering proceeds as reimbursement for organization and offering expenses incurred by the Advisors on behalf of the Company. CFG and its affiliates have incurred organization and offering costs of approximately $3.7 million as of September 30, 2016. The Advisors have waived the reimbursement of organization and offering expenses in connection with the Company’s gross capital raise from the Offering from March 1, 2016 (the period beginning at the time the Company satisfied the minimum offering requirement) through December 31, 2016 (the “O&O Reimbursement Waiver”). Had the O&O Reimbursement Waiver not been in effect as of September 30, 2016, the Company would have been required to reimburse the Advisors approximately $0.47 million. The O&O Reimbursement Waiver does not reduce the amount of organization and offering expenses incurred by the Advisors that are eligible for reimbursement in future periods. After the O&O Reimbursement Waiver period ends, subsequent gross capital raised by the Company will be subject to the maximum organization and offering cost reimbursement of 1.5%.

The Company is a party to a managing dealer agreement with CNL Securities Corp., an affiliate of CNL. CNL Securities Corp. serves as the managing dealer of the Company’s Offering and in connection therewith will receive up-front selling commissions of up to 2.00% of gross offering proceeds, up-front dealer manager fees of up to 2.75% of gross offering proceeds and distribution and shareholder servicing fees at an annualized rate of 1.25% of the Company’s most recently published net asset value per share, excluding shares issued through the distribution reinvestment plan. Shares may also be subject to a contingent deferred sales charge in the event that a stockholder tenders his or her shares of common stock prior to the fourth anniversary of the date such shares were purchased. All or any portion of these fees may be re-allowed to participating brokers. Financial Industry Regulatory Authority (“FINRA”) Rule 2310 provides that the maximum underwriting compensation payable from any source to FINRA members participating in an offering may not exceed 10% of gross offering proceeds, excluding proceeds from a distribution reinvestment plan.

In addition, under the terms of the Investment Advisory Agreement, the Advisors are entitled to reimbursement of certain expenses incurred on behalf of the Company including expenses incurred in connection with its investment operations and investment transactions.

The Company is a party to an administrative services agreement with CNL, under which CNL performs, or oversees the performance of, various administrative services on behalf of the Company. Administrative services include investor services, general ledger accounting, fund accounting, maintaining required financial records, calculating the Company’s net asset value, filing tax returns, preparing and filing SEC reports, preparing, printing, and disseminating shareholder reports and generally overseeing the payment of the Company’s expenses and the performance of administrative and professional services rendered to the Company by others. The Company reimburses CNL for administrative expenses it incurs in performing its obligations.

The Company is a party to an Expense Support and Conditional Reimbursement Agreement, as amended (the “Expense Support Agreement”) with the Advisors pursuant to which the Advisors jointly and severally agree to pay to the Company some or all operating expenses (an “Expense Support Payment”) for each month during the Expense Support Payment Period (as defined below) in which the Company’s board of trustees declares a distribution to its shareholders. The “Expense Support Payment Period” commenced on March 1, 2016 and ends on December 31, 2016. The Advisors are entitled to be reimbursed promptly by the Company (a “Reimbursement Payment”) for Expense Support Payments made with respect to any class of common stock, subject to the limitation that no Reimbursement Payment may be made by the Company to the extent that it would cause the Company’s other operating expenses (as defined in the Expense Support Agreement) for such class of common stock to exceed the lesser of (A) 1.75% of average net assets attributable to shares of such class of common stock and (B) the percentage of our average net assets attributable

 

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to shares of such class of common stock represented by other operating expenses (as defined in the Expense Support Agreement) during the fiscal year in which such expense support payment from the Advisors was made (provided, however, that this clause (B) shall not apply to any reimbursement payment which relates to an expense support payment from the Advisors made during the same fiscal year). Notwithstanding anything to the contrary in the Expense Support Agreement, no Reimbursement Payment shall be made with respect to any class of common stock if the effective rate of distributions per share on such class of common stock declared by the Company at the time of such Reimbursement Payment is less than the effective rate of distributions per share on such class of common stock at the time the Expense Support Payment was made to which such Reimbursement Payment relates. For this purpose, “effective rate of distributions per share” means actual declared distribution rate per share exclusive of return of capital, if any. The Company’s obligation to reimburse each Expense Support Payment will terminate three years from the date on which such Expense Support Payment was paid or waived. Management believes that Reimbursement Payments are not probable as of September 30, 2016.

As of September 30, 2016, the amount of Expense Support Payment obligation paid or payable by the Advisors is $1,447,589, representing all of the Company’s operating expenses, excluding distribution and shareholder servicing fees and performance based incentive fees, incurred between March 1, 2016 (commencement of operations) and September 30, 2016.

Related party fees and expenses incurred on behalf of the Company during the three and nine months ended September 30, 2016 are summarized below:

 

Related Party

  

Source Agreement & Description

   Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

CNL Securities Corp.

  

Managing Dealer Agreement:

Up-front selling commissions and dealer manager fees

   $ 920,740       $ 1,444,446   
   Distribution and shareholder servicing fees      79,074         109,816   

CNL and KKR

  

Investment Advisory Agreement:

Base management fees (investment advisory fees)

     165,183         225,666   
   Incentive fee on capital gains (1)      —           —     

KKR

  

Investment Sub-Advisory Agreement:

Investment expenses reimbursement

     4,483         4,483   

CNL

  

Administrative Services Agreement:

Administrative and compliance services

     87,021         175,817   

 

(1) Incentive fees on capital gains are included in performance-based incentive fees in the condensed statement of operations. The following table provides additional details for the incentive fee on capital gains for the three and nine months ended September 30, 2016:

 

Incentive fee on Capital Gains

   Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Accrued incentive fee as of beginning of period,

   $ 14,180       $ —     

Incentive fee on capital gains during the three and nine months ended September 30,

     96,726         110,906   

Less: Incentive fee on capital gains paid to the Advisors during the three and nine months ended September 30,

     —           —     
  

 

 

    

 

 

 

Accrued incentive fee as of September 30,

     110,906         110,906   

Less: Accrued incentive fee on capital gains attributable to unrealized gains as of September 30,

     (110,906      (110,906
  

 

 

    

 

 

 

Incentive fee on capital gains earned by and payable to the advisors as of September 30,

   $ —         $ —     
  

 

 

    

 

 

 

Indemnification - The Investment Advisory Agreement and the Sub-Advisory Agreement provide certain indemnification in favor of the Advisors, their directors, officers, persons associated with the Advisors, and their affiliates. The managing dealer agreement contains certain indemnification provisions in favor of the managing dealer and each participating broker and their respective officers, directors, partners, employees, associated persons, agents and control persons. In addition, the Company’s declaration of trust contains certain indemnifications in favor of the Company’s officers, trustees, agents, and certain other persons. As of September 30, 2016, management believed that the risk of incurring any losses for such indemnification was remote.

 

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6. Distributions

The Company’s board of trustees declared distributions of $0.010904 per share for 32 weekly record dates beginning on March 1, 2016 through and including October 4, 2016. Distributions were paid on March 30, 2016, April 27, 2016, June 1, 2016, June 29, 2016, July 27, 2016, August 31, 2016, September 28, 2016 and October 26, 2016. The Advisors received distributions of $187,866 from the Company for the nine months ended September 30, 2016.

The total and the sources of declared distributions on a GAAP basis for the nine months ended September 30, 2016 are presented in the tables below.

 

     Nine Months Ended September 30,  
     2016  
     Per
Share
     Amount      Allocation  

Total Declared Distributions

   $ 0.34       $ 540,791         100.0

From net investment income

     0.14         223,439         41.3   

From net realized gains

     0.05         71,831         13.3   

Distributions in excess of net investment income

   $ 0.15       $ 245,521         45.4   

Sources of distributions, other than net investment income and realized gains on a GAAP basis, include required adjustments to GAAP net investment income in the current period to determine taxable income available for distributions. The following table summarizes the primary sources of differences between GAAP net increase in net assets from operations and estimated taxable income available for distributions for the nine months ended September 30, 2016.

 

Nine Months Ended September 30,

   2016(1)  

Net increase in net assets from operations

   $ 777,969   

Net change in unrealized appreciation

     (482,699

Distribution and shareholder servicing fees

     109,816   

Estimated unearned performance-based incentive fees

     105,609   
  

 

 

 

Estimated taxable income available for distributions

   $ 510,695   
  

 

 

 

 

(1) The above table does not represent all adjustments to calculate taxable income available for distributions.

For the nine months ended September 30, 2016, the tax-related sources of distributions of $510,695 are less than shareholder distributions of $540,791. A final determination of taxable income and the tax classifications of the calendar year paid distributions is made annually at the end of the year.

7. Fee Income

Fee income, which is nonrecurring, consisted of the following:

 

Fee Income

   Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Commitment fees

   $ 4,100       $ 4,100   

Amendment fees

     402         1,549   

Consent fees

     268         268   
  

 

 

    

 

 

 
   $ 4,770       $ 5,917   
  

 

 

    

 

 

 

 

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8. Share Transactions

On September 25, 2014, the Company entered into founder stock purchase agreements for the sale of (i) 111.11 shares of common stock to CNL Fund Advisors Company for consideration of $1,000, and (ii) 111.11 shares of common stock to KKR for consideration of $1,000. On December 31, 2014, CNL Fund Advisors Company transferred its shares in the Company’s common stock to CNL, one of the Company’s Advisors.

On August 26, 2015 and August 27, 2015, respectively, the Company entered into share purchase agreements for the sale of (i) 277,777.78 shares of common stock to CNL for consideration of $2.5 million effective after the Company’s initial registration statement was declared effective by the SEC and prior to acceptance of other shareholders unaffiliated with the Company, and (ii) 277,777.78 shares of common stock to KKR for consideration of $2.5 million effective after the Company’s initial registration statement was declared effective by the SEC and prior to acceptance of other shareholders unaffiliated with the Company. As part of this agreement, on August 26, 2015, CNL purchased 22,222.22 shares of common stock for consideration of $200,000. On March 1, 2016, the Advisors completed their purchases under the share purchase agreements. The Company met its minimum offering requirement with proceeds received from CNL and KKR from these share purchase agreements.

On February 12, 2016, the Company amended and restated its Declaration of Trust, increasing the number of authorized shares of Preferred Stock from 1,000,000 shares to 100,000,000 shares.

The following table summarizes the total shares issued and proceeds received in connection with the Company’s Offering for the nine months ended September 30, 2016.

 

     Nine Months Ended
September 30, 2016(1)
 
     Shares      Amount  

Gross proceeds from offering

     3,781,001       $ 35,896,388   

Up-front selling commissions and dealer manager fees

     —           (1,444,446
  

 

 

    

 

 

 

Net proceeds to company

     3,781,001         34,451,942   

Reinvestment of distributions

     20,021         183,613   
  

 

 

    

 

 

 

Net proceeds from offering

     3,801,022       $ 34,635,555   
  

 

 

    

 

 

 

Average net proceeds per share

     $9.11   

 

(1)  Commenced operations on March 1, 2016.

As of September 30, 2016, the Company has sold or issued 3,823,466 shares of common stock through the Offering, including reinvestment of distributions, for total gross proceeds of $36,282,001.

On March 29, 2016, the Company’s board of trustees increased the public offering price of the Company’s continuous public offering of common stock from $9.45 per share to $9.50 per share. This increase became effective as of March 29, 2016. As a result of the increase in the Company’s public offering price per share, the Company’s maximum sales load and the net proceeds per share correspondingly increased from $0.450 to $0.452 and from $9.00 to $9.05, respectively.

On May 27, 2016, our board of trustees increased the public offering price of our continuous public offering of common stock from $9.50 per share to $9.55 per share. This increase in our public offering price became effective as of June 1, 2016. As a result of the increase in our public offering price per share, our maximum sales load per share and the net proceeds per share correspondingly increased from $0.452 to $0.454 and from $9.05 to $9.10, respectively.

On July 26, 2016, our board of trustees increased the public offering price of our continuous public offering of common stock from $9.55 per share to $9.60 per share. This increase in our public offering price became effective as of July 27, 2016. As a result of the increase in our public offering price per share, our maximum sales load per share and the net proceeds per share correspondingly increased from $0.454 to $0.456 and from $9.10 to $9.14, respectively.

On August 15, 2016, our board of trustees increased the public offering price of our continuous public offering of common stock from $9.60 per share to $9.65 per share. This increase in our public offering price became effective as of August 17, 2016. As a result of the increase in our public offering price per share, our maximum sales load per share and the net proceeds per share correspondingly increased from $0.456 to $0.458 and from $9.14 to $9.19, respectively.

 

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9. Financial Highlights

The following is a schedule of financial highlights for one share of common stock during the period from March 1, 2016 (commencement of operations) through September 30, 2016.

 

     For the
period ended
September 30,
2016(1)
 

OPERATING PERFORMANCE PER SHARE

  

Net Asset Value, Beginning of Period

   $ 9.00   
  

 

 

 

Net investment loss, before expense support (2)

     (0.74

Expense support(2)

     0.88   
  

 

 

 

Net investment income(2)

     0.14   

Net realized and unrealized gains(2)(3)

     0.34   
  

 

 

 

Net increase resulting from investment operations

     0.48   
  

 

 

 

Distributions from net investment income(4)

     (0.14

Distributions from net realized gains(4)

     (0.05

Distributions in excess of net investment income(4)(5)

     (0.15
  

 

 

 

Net decrease resulting from distributions to common shareholders

     (0.34
  

 

 

 

Issuance of common stock above net asset value (6)

     0.03   

Net increase resulting from capital share transactions

     0.03   
  

 

 

 

Net Asset Value, End of Period

   $ 9.17   
  

 

 

 

OPERATING PERFORMANCE PER SHARE

  

Total investment return-net price(7)

     5.73

Total investment return-net asset value(8)

     5.73

RATIOS/SUPPLEMENTAL DATA (all amounts in thousands except ratios)

  

Net assets, end of period

   $ 35,075   

Average net assets(9)

   $ 14,997   

Shares outstanding, end of period

     3,823   

Weighted average shares outstanding

     1,646   

Ratios to Average Net Assets:(9)

  

Total operating expenses before expense support

     11.12

Total operating expenses after expense support

     1.47

Net investment income

     1.49

Portfolio turnover rate

     13

 

(1) Commenced operations on March 1, 2016
(2) The per share data was derived by using the weighted average shares outstanding during the period.
(3) The amount shown at this caption is the balancing figure derived from the other figures in the schedule. The amount shown at this caption for a share outstanding throughout the period may not agree with the change in the aggregate gains and losses in portfolio securities for the period because of the timing of sales of the Company’s shares in relation to fluctuating market values for the portfolio.
(4) The per share data for distributions is the actual amount of distributions paid or payable per share of common stock outstanding during the entire period; distributions per share are rounded to the nearest $0.01.
(5) See Note 6 for further information on the source of distributions from other than net investment income and realized gains.
(6) The continuous issuance of common stock may cause an incremental increase in net asset value per share due to the sale of shares at the then prevailing public offering price and the receipt of net proceeds per share by the Company in excess of net asset value per share on each subscription closing date. The per share data was derived by computing (i) the sum of (A) the number of shares issued in connection with subscriptions and/or distribution reinvestment on each share transaction date times (B) the differences between the net proceeds per share and the net asset value per share on each share transaction date, divided by (ii) the total shares outstanding at the end of the period.

 

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(7) Total investment return-net price is a measure of total return for shareholders who purchased the Company’s common stock at the beginning of the period, including distributions declared during the period. Total investment return-net price is based on (i) the purchase of one share at the public offering price, net of sales load, on the first day of the period, (ii) the sale at the net asset value per share on the last day of the period, of (A) one share plus (B) any fractional shares issued in connection with the reinvestment of monthly distributions, and (iii) distributions payable relating to one share, if any, on the last day of the period. The total investment return-net price calculation assumes that (i) monthly cash distributions are reinvested in accordance with the Company’s distribution reinvestment plan and (ii) the fractional shares issued pursuant to the distribution reinvestment plan are issued at the then current public offering price, net of sales load, on each monthly distribution payment date. Since there is no public market for the Company’s shares, the terminal sales price per share is assumed to be equal to the net asset value per share on the last day of the period presented. The Company’s performance changes over time and currently may be different than that shown above. Past performance is no guarantee of future results. Investment performance is presented without regard to sales load that may be incurred by shareholders in the purchase of the Company’s shares of common stock.
(8) Total investment return-net asset value is a measure of the change in total value for shareholders who held the Company’s common stock at the beginning and end of the period, including distributions declared during the period. Total investment return-net asset value is based on (i) net asset value per share on the first day of the period, (ii) the net asset value per share on the last day of the period, of (A) one share plus (B) any fractional shares issued in connection with the reinvestment of monthly distributions, and (iii) distributions payable relating to one share, if any, on the last day of the period. The total investment return-net asset value calculation assumes that (i) monthly cash distributions are reinvested in accordance with the Company’s distribution reinvestment plan and (ii) the fractional shares issued pursuant to the distribution reinvestment plan are issued at the then current public offering price, net of sales load, on each monthly distribution payment date. Since there is no public market for the Company’s shares, terminal market value per share is assumed to be equal to net asset value per share on the last day of the period presented. The Company’s performance changes over time and currently may be different than that shown above. Past performance is no guarantee of future results. Investment performance is presented without regard to sales load that may be incurred by shareholders in the purchase of the Company’s shares of common stock.
(9) The computation of average net assets during the period is based on the daily value of net assets. Ratios are not annualized.

10. Commitment & Contingences

Unfunded commitments to provide funds to portfolio companies are not recorded in the Company’s condensed statements of assets and liabilities. Since these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Company has sufficient liquidity to fund these commitments. As of September 30, 2016, the Company’s unfunded commitments consisted of the following:

 

Category/Company (1)

      

Equity:

  

Polyconcept North America Holdings, Inc.

   $ 25,737   
  

 

 

 

Total Unfunded Commitments

   $ 25,737   
  

 

 

 

 

(1) May be commitments to one or more entities affiliated with the named company.

The Company funds its equity investments as it receives funding notices from the portfolio companies. At September 30, 2016, the Company’s unfunded commitments have a fair value of $0.

In the normal course of business, the Company may enter into guarantees on behalf of portfolio companies. Under these arrangements, the Company would be required to make payments to third parties if the portfolio companies were to default on their related payment obligations. The Company had no such guarantees outstanding at either September 30, 2016 or December 31, 2015.

11. Subsequent Events

During the period from October 1, 2016 through November 10, 2016, the Company received additional net proceeds of approximately $9.7 million from its Offering, including amounts through its distribution reinvestment plan.

On October 10, 2016, our board of trustees increased the public offering price of our continuous public offering of common stock from $9.65 per share to $9.75 per share. This increase in our public offering price became effective as of October 11, 2016. As a result of the increase in our public offering price per share, our maximum sales load per share and the net proceeds per share will correspondingly increase from $0.458 to $0.463 and from $9.19 to $9.29, respectively.

On October 10, 2016, the Company’s board of trustees declared distributions of $0.011250 per share for thirteen record dates beginning October 11, 2016 through January 3, 2017.

 

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

The following discussion is based on the unaudited condensed financial statements as of September 30, 2016 and December 31, 2015, and for the three and nine months ended September 30, 2016. Amounts as of December 31, 2015 included in the unaudited condensed financial statements have been derived from the audited financial statements as of that date. This information should be read in conjunction with the accompanying unaudited condensed financial statements and the notes thereto, as well as, the audited financial statements, notes and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the period ended December 31, 2015. Capitalized terms used in this Item 2 have the same meaning as in the accompanying unaudited condensed financial statements in Item 1 unless otherwise defined herein.

Statement Regarding Forward-Looking Information

The following information contains statements that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements generally are characterized by the use of terms such as “may,” “should,” “plan,” “anticipate,” “estimate,” “intend,” “predict,” “believe” and “expect” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, our actual results could differ materially from those set forth in the forward-looking statements. Some factors that might cause such a difference include the following: persistent economic weakness at the global or national level, increased direct competition, changes in government regulations or accounting rules, changes in local, national and global capital market conditions, our ability to obtain or maintain credit lines or credit facilities on satisfactory terms, changes in interest rates, availability of proceeds from our offering of shares, our ability to identify suitable investments, our ability to close on identified investments, our ability to obtain or maintain our qualification as a regulated investment company and as a business development company, the ability of our Advisors (defined below) and their affiliates to attract and retain highly talented professionals, inaccuracies of our accounting estimates, the ability of our Advisors to locate suitable borrowers for our loans and the ability of such borrowers to make payments under their respective loans. Given these uncertainties, we caution you not to place undue reliance on such statements, which apply only as of the date hereof. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect future events or circumstances or to reflect the occurrence of unanticipated events. The forward-looking statements should be read in light of the risk factors identified in the “Risk Factors” section of our Annual Report on Form 10-K filing for the period ended December 31, 2015 and Item 1A in Part II of this Quarterly Report.

The forward-looking statements and projections contained in this report are excluded from the safe harbor protection provided by Section 27A of the Securities Act and Section 21E of the Exchange Act.

Overview

We are a non-diversified closed-end management investment company that has elected to be treated as a business development company under the 1940 Act. Formed as a Delaware statutory trust on August 12, 2014, we are externally managed by CNL Fund Advisors II, LLC (“CNL”) and KKR Credit Advisors (US) LLC (“KKR”) collectively, the “Advisors”, which are collectively responsible for sourcing potential investments, conducting due diligence on prospective investments, analyzing investment opportunities, structuring investments, determining the securities and other assets that we will purchase, retain or sell and monitoring our portfolio on an ongoing basis. Both of our Advisors are registered as investment advisers with the SEC. We have filed for exemptive relief from the SEC to allow us to co-invest with certain affiliates of our Advisors. We have also applied for exemptive relief from the SEC to offer multiple share classes.

Investment Objective and Investments

On March 1, 2016 we raised the minimum offering requirement via share purchases from the Advisors, commenced investment operations and began executing our strategy of investing in the debt of privately owned and thinly traded U.S. companies. These investments were sourced, underwritten and monitored by our Advisors. As of September 30, 2016, our investment portfolio consisted of investments in 43 portfolio companies, and had a total fair value of $31,841,824.

 

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Our investment objective is to provide our shareholders with current income and, to a lesser extent, long-term capital appreciation. We intend to meet our investment objective by investing primarily in the debt of privately owned U.S. companies (also referred to as “portfolio companies”) with a focus on originated transactions sourced through the networks of our Advisors upon obtaining exemptive relief from the SEC allowing us to co-invest with certain affiliates of our Advisors. We define originated transactions as any negotiated investment where we, through our Advisors’ direct efforts, provide funds directly to a portfolio company. A substantial portion of our portfolio currently consists, and we anticipate will consist, of direct lending investments, which we believe offer potential opportunities for superior risk-adjusted returns and income generation. Our debt investments may take the form of corporate loans or bonds, may be directly originated as primary market negotiated transactions or purchased on the secondary market, may be secured or unsecured and may, in some cases, be accompanied by warrants, options or other forms of equity participation. We may separately purchase common or preferred equity interests in transactions.

Our investment strategy is focused on creating and growing an Investment Portfolio that generates superior risk-adjusted returns by carefully selecting investments through rigorous due diligence and actively managing and monitoring our Investment Portfolio. When evaluating an investment and the related portfolio company, we use the resources of our Advisors to develop an investment thesis and a proprietary view of a potential portfolio company’s intrinsic value. We believe our flexible approach to investing allows us to take advantage of opportunities that offer favorable risk/reward characteristics.

We pursue our strategy by focusing on the following investment types:

 

    Senior Debt. We invest in senior debt, in which we generally take a security interest in the available assets of the portfolio company, including equity interests in any of its subsidiaries. These investments generally take the form of senior secured first lien loans, senior secured second lien loans or senior secured bonds. In some circumstances, our lien could be subordinated to claims of other creditors.

 

    Subordinated Debt. Our subordinated debt investments are generally subordinated to senior debt and are generally unsecured. These investments are generally structured with interest-only payments throughout the life of the security, with the principal due at maturity.

 

    Equity Investments. We also make selected equity investments. In addition, when we invest in senior and subordinated debt, we may acquire warrants or options to purchase equity securities or benefit from other types of equity participation. Our goal is ultimately to dispose of these equity securities and realize gains upon our disposition of such interests.

 

    Convertible Securities. We may invest in convertible securities, such as bonds, debentures, notes, preferred stocks or other securities that may be converted into, or exchanged for, a specified amount of common stock of the same or different issuer within a particular period of time at a specified price or formula.

 

    Investments in Private Investment Funds. We may invest in, or wholly own, private investment funds, including hedge funds, private equity funds, limited liability companies, REITs, and other business entities. In valuing our investments in private investment funds, we rely primarily on information provided by managers of such funds. Valuations of illiquid securities, such as interests in certain private investment funds, involve various judgments and consideration of factors that may be subjective. There is a risk that inaccurate valuations provided by managers of private investment funds could adversely affect the value of our common stock. We may not be able to withdraw our investment in certain private investment funds promptly after we have made a decision to do so, which may result in a loss to us and adversely affect our investment returns.

 

    Derivatives. We may invest in various types of derivatives, including total return swaps, interest rate swaps and foreign currency forward contracts and options.

The level of our investment activity can and will vary substantially from period to period depending on many factors, including: the amount of capital we have available for investment, the availability of credit to finance investment transactions, the demand for debt from creditworthy privately owned U.S. companies, the level of merger, acquisition and refinancing activity involving private companies, the general economic environment, and the competitive investment environment for the types of investments we intend to make. Based on prevailing market conditions, we anticipate that we will invest the proceeds from the periodic sale of our common stock within 30-90 days. The precise timing will depend on the availability of investment opportunities that are consistent with our investment objective and strategies. Any distributions we make during such period may be substantially lower than the distributions that we expect to pay when our portfolio is fully invested.

 

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As a business development company, we are required to comply with certain regulatory requirements. For instance, we may not acquire any assets other than “qualifying assets” as specified in the 1940 Act unless, at such time such acquisition is made, at least 70% of our total assets are qualifying assets as determined at the end of the prior quarter (with certain limited exceptions). Qualifying assets include investments in “eligible portfolio companies.” Under the relevant SEC rules, the term “eligible portfolio company” includes all U.S. private companies, U.S. companies whose securities are not listed on a national securities exchange, and certain U.S. public companies that have listed their securities on a national securities exchange and have a market capitalization of less than $250 million. These rules also permit us to include as qualifying assets certain follow-on investments in companies that were eligible portfolio companies at the time of initial investment but no longer meet the definition of eligible portfolio company at the time of the follow-on investment.

Revenues

We generate revenue primarily in the form of interest on the debt securities of portfolio companies that we acquire and hold for investment purposes. We expect that our investments in debt securities will generally have an expected maturity of three to ten years, although we have no lower or upper constraint on maturity, and we expect to earn interest at a fixed or floating rate. Interest on our debt securities is generally payable to us quarterly or semi-annually In addition, we may generate revenue in the form of prepayment fees, amendment fees, commitment fees, origination fees, and fees for providing significant managerial assistance.

Operating Expenses

Our primary operating expenses include an investment advisory fee and, depending on our operating results, performance-based incentive fees, administrative expenses, custodian and accounting fees and other third-party professional services and expenses. The investment advisory fee and performance-based incentive fees compensate the Advisors for their services in identifying, evaluating, negotiating, closing and monitoring our investments.

 

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Financial and Operating Highlights

The following table presents financial and operating highlights as of September 30, 2016, and for the nine months ended September 30, 2016:

 

As of

   September 30,
2016
 

Total assets

   $ 52,270,846   

Adjusted total assets (Total assets, net of payable for investments purchased)

   $ 35,786,069   

Investments in portfolio companies

   $ 31,841,824   

Net assets

   $ 35,074,733   

Net asset value per share

   $ 9.17   

Activity for the Nine Months Ended September 30,

   2016  

Average net assets

   $ 14,997,441   

Purchases of investments

   $ 32,768,960   

Sales, principal payments and other exits

   $ 1,583,921   

Net investment income

   $ 223,439   

Net realized gains on investments

   $ 71,831   

Net change in unrealized appreciation on investments and foreign currency translation

   $ 482,699   

Net increase in net assets resulting from operations

   $ 777,969   

Total distributions declared

   $ 540,791   

Net investment income before unearned incentive fees per share

   $ 0.20   

Net investment income per share

   $ 0.14   

Earnings per share

   $ 0.47   

Distributions declared per share outstanding for the entire period

   $ 0.34   

Summary of Common Stock Offering for the Nine Months Ended September 30,

   2016  

Gross proceeds, excluding reinvestment of distributions

   $ 35,896,388   

Net proceeds to Company, excluding reinvestment of distributions

   $ 34,451,942   

Reinvestment of distributions

   $ 183,613   

Average net proceeds per share

   $ 9.11   

Shares issued in connection with Offering, excluding reinvestment of distributions

     3,781,001   

Shares issued in connection with reinvestment of distributions

     20,021   

Business Environment

During the nine months ended September 30, 2016, markets continued to be influenced by geopolitical concerns, the increased regulation of financial institutions, as well as sector specific dislocations. The credit markets, especially high yield, experienced a rally in mid-2016, and significant inflows and outflows in open end credit mutual funds and exchange traded funds continue. These factors, along with lagging volume in lending in the middle market compared to recent years, have contributed to an increase in volatility and resulted in a more competitive lending environment.

Given the backdrop we have experienced, we continue to believe that our closed-end structure and long term fundamental underwriting approach positions us well. We continue to focus on providing capital to companies that, for a variety of reasons, are unable to access the syndicated debt markets. We believe three items continue to support our underlying investment thesis. First, leveraged lending guidelines at traditional lenders result in corporate and financial buyers looking beyond traditional financial intermediaries to support their deals. Second, there is less capital available for small-to-medium-sized businesses, as banks reduce their footprints amidst shrinking net interest margins and heightened regulation. Finally, we believe the current environment offers attractive risk adjusted transaction terms through our ability to provide long term and large financing solutions to our borrowers.

We believe future lending opportunities will expand given financial regulation stemming from the 2009 credit crisis that is resulting in commercial banks reducing lending levels to middle market companies. We maintain a high degree of caution and believe continued focus on the fundamentals, including rigorous due diligence, robust credit underwriting and direct structuring of investments, best positions the portfolio to protect principal and generate attractive risk-adjusted returns.

 

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Portfolio and Investment Activity

Portfolio Investment Activity for the three and nine months ended September 30, 2016

The following table summarizes our investment activity as of September 30, 2016 and for the three and nine months ended September 30, 2016:

 

     Investment
Portfolio
 

Total fair value

   $ 31,841,824   

No. portfolio companies

     43   

No. debt investments

     48   

No. equity investments

     1   

Weighted average annual yield of debt investments (1)

     9.1

 

(1)  The weighted average annual yield for our debt investments is computed as (i) the sum of (a) the annual interest rate of each accruing debt investment multiplied by its par amount as of the end of the applicable reporting period, plus (b) the annual amortization of the purchase or original issue discount or premium of accruing each debt investment, if any; divided by (ii) the total amortized cost of all accruing debt investments included in the calculated group as of the end of the applicable reporting period.

 

     Three Months
Ended

September 30,
2016
     Nine Months
Ended

September 30,
2016
 

Purchases of investments:

     

Senior secured loans – first lien

   $ 20,724,037       $ 26,873,347   

Senior secured loans – second lien

     2,672,060         5,568,214   

Subordinated debt

     —           264,975   

Equity

     62,424         62,424   
  

 

 

    

 

 

 

Total

   $ 23,458,521       $ 32,768,960   
  

 

 

    

 

 

 

Sales, principal payments and other exits:

     

Senior secured loans – first lien

   $ 1,245,975       $ 1,245,975   

Senior secured loans – second lien

     112,224         112,224   

Subordinated debt

     204,084         225,722   
  

 

 

    

 

 

 

Total

   $ 1,562,283       $ 1,583,921   
  

 

 

    

 

 

 

Portfolio Company Additions

     13         45   

Portfolio Company Exits

     2         2   

Debt Investment Additions

     18         55   

Debt Investment Exits

     5         7   

The changes in the fair value of our Investment Portfolio are directly related to (i) the changes in their cost basis as a result of incremental purchases and (ii) the changes in fair value for assets held at the beginning and end of the period. The net change in unrealized appreciation for the nine months ended September 30, 2016 was $482,699. See “Results of Operations – Net Change in Unrealized Appreciation or Depreciation” below for further details relating to the changes.

 

     September 30, 2016  

Asset Category

   Amortized
Cost
     Fair Value  

Senior debt

     

Senior secured loans – first lien

   $ 25,656,901       $ 26,022,408   

Senior secured loans – second lien

     5,597,289         5,712,465   
  

 

 

    

 

 

 

Total senior debt

     31,254,190         31,734,873   

Subordinated debt

     44,785         46,125   

Equity

     62,424         60,826   
  

 

 

    

 

 

 

Total

   $ 31,361,399       $ 31,841,824   
  

 

 

    

 

 

 

 

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The weighted average yield on debt investments at amortized cost and fair value held in our Investment Portfolio as of September 30, 2016 were as follows:

 

Asset Category

   Investment
Portfolio
at
Amortized
Cost(2)
 

Senior debt (1)

  

Senior secured loans – first lien

     8.9

Senior secured loans – second lien

     10.2

Subordinated debt(1)

     7.0

 

(1) The weighted average yield on debt investments is based on amortized cost as of the end of the applicable period. The weighted average yield for our debt investments is computed as, (i) the sum of (a) the annual interest rate of each accruing debt investment multiplied by its par amount as of the end of the applicable reporting period, plus (b) the annual amortization of the purchase or original issue discount or premium of each accruing debt investment, if any; divided by (ii) the total amortized cost of all accruing debt investments included in the calculated group as of the end of the applicable reporting period.
(2) The yield on the Company’s investments does not represent the return to the Company’s shareholders.

The following table presents a summary of interest rate and maturity statistics for the debt investments, based on par value, in our Investment Portfolio as of September 30, 2016:

 

Floating interest rate debt investments:

   September 30,
2016
 

Percent of debt portfolio

     99.9

Percent of floating rate debt investments with interest rate floors

     100

Weighted average interest rate floor

     1.1

Weighted average coupon spread to base rate

     553 bps 

Weighted average years to maturity

     4.9   

Fixed interest rate debt investments:

      

Percent of debt portfolio

     0.1

Weighted average coupon rate

     6.88

Weighted average years to maturity

     8.5   

All of our floating interest rate debt investments have base rate reset frequencies of less than twelve months with the majority resetting at least quarterly. The three-month LIBOR, the most prevalent index employed among our floating interest rate debt investments, ranged between 0.61% and 0.87%, during the nine months ended September 30, 2016 and was 0.85% on September 30, 2016. Base rate resets for floating interest rate investments will only result in interest income increases when the reset base interest rate exceeds the associated interest rate floor.

Our weighted average annual yield on debt investments was 9.1% as of September 30, 2016. The weighted average annual yield on debt investments is higher than what investors in our Company will realize because it does not reflect expenses of the Company or any sales load. Total investment return-net price and total investment return-net asset value were 5.73% and 5.73%, respectively, for the nine months ended September 30, 2016. See Note 9 “Financial Highlights” in our unaudited condensed financial statements.

 

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The following table shows the credit ratings of the investments in our Investment Portfolio, based upon the rating scale of Standard & Poor’s Ratings Services, as of September 30, 2016:

 

     September 30, 2016  

Standard & Poor’s rating

   Fair Value      Percentage
of Portfolio
 

BB-

   $ 46,125         0.1

B+

     7,693,522         24.2   

B

     8,395,381         26.3   

B-

     7,926,467         24.9   

CCC+

     5,742,458         18.0   

CCC

     398,903         1.3   

CCC-

     1,578,142         5.0   

Not Rated

     60,826         0.2   
  

 

 

    

 

 

 

Total

   $ 31,841,824         100.0
  

 

 

    

 

 

 

The following table presents a summary of our Investment Portfolio arranged by industry classifications of the portfolio companies as of September 30, 2016:

 

     September 30, 2016  

Industry Classification

   Fair
Value
     Percentage
of Portfolio
 

Capital Goods

   $ 8,648,030         27.3

Health Care Equipment & Services

     4,266,951         13.4   

Retailing

     3,768,092         11.8   

Software & Services

     3,271,804         10.3   

Consumer Services

     3,055,934         9.6   

Telecommunication Services

     1,856,101         5.8   

Technology Hardware & Equipment

     1,759,982         5.5   

Food, Beverage & Tobacco

     1,157,500         3.6   

Commercial & Professional Services

     1,114,109         3.5   

Consumer Durables & Apparel

     1,011,555         3.2   

Media

     920,119         2.9   

Transportation

     550,313         1.7   

Pharmaceuticals, Biotechnology & Life Sciences

     262,941         0.8   

Food & Staples Retailing

     198,393         0.6   
  

 

 

    

 

 

 

Total

   $ 31,841,824         100.0
  

 

 

    

 

 

 

Capital Resources and Liquidity

Sources and Uses of Capital

Our capital resources and liquidity are primarily derived from (i) equity capital proceeds from our Offering, (ii) cash flows from operations, including investment sales and repayments, (iii) our distribution reinvestment plan, and (iv) expense support payments received from our Advisors. Our primary uses of funds include (i) investments in portfolio companies, (ii) distributions to our shareholders, (iii) advisory fees and (iv) operating expenses. We expect to use proceeds from the turnover of our Investment Portfolio and equity capital proceeds from our Offering to finance our investment activities.

Liquidity

During the nine months ended September 30, 2016, proceeds from sales of investments and principal payments totaled $1.58 million. As of September 30, 2016, we had the following sources of immediate liquidity available to us:

 

     Amount  

Cash

   $ 19,219,208   

Less: Payables for investments purchased

     (16,484,777
  

 

 

 

Total

   $ 2,734,431   
  

 

 

 

In addition to the source of liquidity listed above, we continue to raise capital through our Offering. As of September 30, 2016, we had approximately 271 million additional shares of common stock available for sale through the Offering.

 

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Table of Contents

Commitments and Contingencies

See Note 10 “Commitments and Contingencies” in our unaudited condensed financial statements for information on our commitments and contingencies as of September 30, 2016.

Distributions to Shareholders

We pay monthly distributions to our shareholders in the form of cash. Shareholders may elect to reinvest their distributions as additional shares of our common stock under our distribution reinvestment plan. Dividends are taxable to our shareholders even if they are reinvested in additional shares of our common stock. The following table reflects the cash distributions per share and the total amount of distributions that we have declared on our common stock during the nine months ended September 30, 2016:

 

Quarter Ended:

   Per Share      Amount  

March 31, 2016 (5 record dates)

   $ 0.054520       $ 30,301   

June 30, 2016 (13 record dates)

     0.141752         125,022   

September 30, 2016 (13 record dates)

     0.141752         385,468   
  

 

 

    

 

 

 

Total

   $ 0.338024       $ 540,791   
  

 

 

    

 

 

 

Approximately 34% of the distributions declared during the nine months ended September 30, 2016 were reinvested in shares of our common stock by participants in our dividend reinvestment plan and the reinvested distributions represents an additional source of capital to us. See Note 6 “Distributions” in our unaudited condensed financial statements for additional disclosures on distributions.

We do not expect any portion of our distributions paid in 2016 to be treated as a return of capital for tax purposes. We disclose the sources of funds used to pay distributions to our shareholders in periodic reports that accompany (i) quarterly account statements and (ii) monthly distribution checks that are prepared and sent directly by our transfer agent to our shareholders. See Note 6 “Distributions” in our unaudited condensed financial statements for a discussion of the sources of funds used to pay distributions on a GAAP basis for the periods presented.

Results of Operations

As of September 30, 2016, the fair value of our Investment Portfolio totaled $31.84 million. The majority of our investments at September 30, 2016 consisted of debt investments. See the section entitled “Portfolio and Investment Activity” above for a discussion of the general terms and characteristics of our investments, and for information regarding investment activities during the nine months ended September 30, 2016.

The following is a summary of our operating results for the three and six months ended September 30, 2016:

 

     Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Total investment income

   $ 331,643       $ 444,161   

Operating expenses, net of expense support

     (175,800      (220,722
  

 

 

    

 

 

 

Net investment income

     155,843         223,439   

Net realized gains on investments

     71,463         71,831   

Net change in unrealized appreciation

     412,913         482,699   
  

 

 

    

 

 

 

Net increase in net assets resulting from operations

   $ 640,219       $ 777,969   
  

 

 

    

 

 

 

 

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Investment income

Investment income consisted of the following for the three and nine months ended September 30, 2016:

 

     Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Interest income

   $ 326,873       $ 438,244   

Fee income

     4,770         5,917   
  

 

 

    

 

 

 

Total investment income

   $ 331,643       $ 444,161   
  

 

 

    

 

 

 

As of September 30, 2016, our weighted average annual yield on our accruing debt investments was 9.1% based on amortized cost, as defined above in “Portfolio and Investment Activity.” The weighted average annual yield on debt investments is higher than what investors in our Company will realize because it does not reflect expenses of the Company or any sales load. As of September 30, 2016, approximately 99.9% of our debt investments had floating rate interest; therefore, changes in interest rates could have a material impact on our interest income in the future. See Item 3 “Quantitative and Qualitative Disclosures about Market Risk” for further information on the impact interest rate changes could have on our results of operations.

Our fee income consists of transaction-based fees and is nonrecurring. See Note 7. “Fee Income” in Item 1. “Financial Statements” for additional information on fee income.

We commenced investment operations on March 1, 2016. Incremental amounts of investment capital were deployed in the acquisition of portfolio investments throughout the nine months ended September 30, 2016 as we received net proceeds from our Offering on a weekly basis. However, we believe that our interest income and total investment income is not representative of either our stabilized performance or our future performance. We expect an increase in interest income in future periods due to (i) an increasing proportion of investments held for the entire period relative to incremental investment activity during each quarter, and (ii) an increasing base of investments that we expect to result from the expected increase in capital available for investment as related to our Offering.

Operating expenses

Our operating expenses for the three and nine month period ended September 30, 2016 were as follows:

 

     Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Professional services

   $ 129,162       $ 600,304   

Administrative services

     127,974         268,582   

Investment advisory fees

     165,183         225,666   

Trustee fees and expenses

     49,017         114,017   

Custodian and accounting fees

     48,977         113,568   

Performance-based incentive fees

     96,726         110,906   

Distribution and shareholder servicing fees

     79,074         109,816   

Insurance fees

     40,191         64,498   

Other

     43,080         60,954   
  

 

 

    

 

 

 

Total operating expenses

     779,384         1,668,311   

Expense support

     (603,584      (1,447,589
  

 

 

    

 

 

 

Net operating expenses

   $ 175,800       $ 220,722   
  

 

 

    

 

 

 

All operating expenses except for performance-based incentive fees and distribution and shareholder servicing fees since inception were offset by the Advisors’ expense support payments. We consider the following expense categories to be relatively fixed in the near term: administrative services, trustee fees and expenses and custodian and accounting fees. Variable operating expenses include professional services, investment advisory fees, performance–based incentive fees, distribution and shareholder servicing fees, and a component of other operating expenses related to transfer agency services and shareholder services. We expect these variable operating expenses to increase either in connection with the growth in the asset base (investment advisory fees, performance-based incentive fees, and interest expense), the number of shareholders and open accounts (transfer agency services and shareholder services, distribution and shareholder servicing fees) and the complexity of our investment processes and capital structure (professional services).

 

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Investment advisory fees and performance-based incentive fees

Our investment advisory fees are calculated at an annual rate of 2% of our average gross assets. Our Advisors are also eligible to receive incentive fees based on our performance. Our performance-based incentive fees, which are comprised of two parts, consisted of the following for the three and nine month period ended September 30, 2016:

 

     Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Incentive fee on capital gains

   $ 96,726       $ 110,906   
  

 

 

    

 

 

 

Total performance-based incentive fees

   $ 96,726       $ 110,906   
  

 

 

    

 

 

 

A subordinated incentive fee on income is payable to our Advisors each calendar quarter if our pre-incentive fee net investment fee income (as defined in the Investment Advisory Agreement and approved by our board of trustees) exceeds the 1.75% quarterly preference return to our shareholders (the ratio of pre-incentive fee net investment income divided by average adjusted capital). We did not incur any subordinated incentive fee on income during the nine months ended September 30, 2016.

The annual incentive fees on capital gains recorded for GAAP purposes is equal to (i) 20% of our realized and unrealized capital gains on a cumulative basis since inception, net of all realized capital losses and unrealized depreciation on a cumulative basis from inception, less (ii) the aggregate amount of any previously paid incentive fees on capital gains. For financial reporting purposes, in accordance with GAAP, we include unrealized appreciation on our Investment Portfolio in the calculation of incentive fees on capital gains; however, such amounts are not payable by us unless and until the net unrealized appreciation is actually realized. The actual amount of incentive fees on capital gains that are due and payable to the Advisors is determined at the end of the calendar year.

See “–Contractual Obligations – Investment Advisory Agreements,” below for further details about the performance-based incentive fees.

Net realized gains

For the three and nine month period ended September 30, 2016, the Company had proceeds from sales of investments of $1.45 million and $1.47 million , respectively, and recognized $71,463 and $71,831, respectively, in realized gains from the sale of investments.

Net change in unrealized appreciation or depreciation

For the three and nine months ended September 30, 2016, net unrealized appreciation consisted of the following:

 

     Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Investments

   $ 410,639       $ 480,425   

Foreign currency translation

     2,274         2,274   
  

 

 

    

 

 

 

Total net unrealized appreciation

   $ 412,913       $ 482,699   
  

 

 

    

 

 

 

For the three and nine month period ended September 30, 2016, net unrealized appreciation and depreciation on investments consisted of the following:

 

     Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Net change in unrealized appreciation (depreciation) on investments:

     

Unrealized appreciation

   $ 408,517       $ 525,773   

Unrealized depreciation

     2,122         (45,348
  

 

 

    

 

 

 

Total net unrealized appreciation

   $ 410,639       $ 480,425   
  

 

 

    

 

 

 

 

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We are not aware of any material trends or uncertainties, favorable or unfavorable, that may be reasonably anticipated to have a material impact on either capital resources or the revenues or income to be derived from our investments, other than those described above, the risk factors, if any, identified in Part II, Item 1A of this report, and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” sections of our Annual Report on Form 10-K for the period ended December 31, 2015.

Adjusted net investment income

Our net investment income totaled $155,843 ($0.06 per share) and $223,439 ($0.14 per share) for the three and nine months ended September 30, 2016, respectively. As described above in “Investment advisory fees and performance-based incentive fees,” we accrue estimated performance-based incentive fees with respect to any net realized and unrealized appreciation in our Investment Portfolio. The performance-based incentive fees are treated as an operating expense and therefore are a deduction in calculating our net investment income on a GAAP basis. However, our net realized and unrealized appreciation on our Investment Portfolio that partly determines these fees are not included in net investment income. Therefore, in order to evaluate our net investment income without regard to realized and unrealized appreciation in our Investment Portfolio, including the impact of related accrued performance-based fees, we have developed a supplemental, non-GAAP measure, which we refer to as “adjusted net investment income,” which presents net investment income before the effects of unearned performance-based incentive fees. Adjusted net investment income is also impacted by the expense support payments and reimbursements.

We believe that adjusted net investment income is useful to assess the sustainability of our distributions and operating performance. Adjusted net investment income is not necessarily indicative of cash flows available to fund cash needs and should not be considered as an alternative to net investment income as an indication of our performance, as an alternative to cash flows from operations as an indication of our liquidity, or indicative of funds available to fund our cash needs including our ability to make future distributions to our shareholders. Adjusted net investment income should not be construed as an historic performance measure or as more relevant or accurate than the current GAAP methodology in calculating net investment income and its applicability in evaluating our operating performance.

The following table presents a reconciliation of our net investment income to adjusted net investment income for the three and nine month period ended September 30, 2016.

 

     Three Months
Ended
September 30,
2016
     Nine Months
Ended
September 30,
2016
 

Net investment income (GAAP)

   $ 155,843       $ 223,439   

Deduct: Expense Support

     (603,584      (1,447,589

Add: Estimated unearned performance-based incentive fees

     91,429         105,609   
  

 

 

    

 

 

 

Adjusted net investment loss (non-GAAP)

   $ (356,312    $ (1,118,541
  

 

 

    

 

 

 

Net investment income per share (GAAP)

   $ 0.06       $ 0.14   
  

 

 

    

 

 

 

Adjusted net investment loss per share (non-GAAP)

   $ (0.13    $ (0.68
  

 

 

    

 

 

 

Net Assets, Net Asset Value per Share and Annual Investment Return

Net assets increased $34.87 million during the nine months ended September 30, 2016. The most significant increase in net assets during the nine months ended September 30, 2016 was attributable to capital transactions including the issuance of shares of common stock of $34.64 million. Our operations resulted in net assets increasing $0.78 million during the nine months ended September 30, 2016. Our overall increase in net assets was slightly offset by distributions to shareholders in the amount of $0.54 million during the nine months ended September 30, 2016.

Our net asset value per share was $9.17 on September 30, 2016. After considering (i) the overall changes in net asset value per share, (ii) distributions paid of approximately $0.34 per share during the nine months ended September 30, 2016, and (iii) the assumed reinvestment of those distributions at 95.25% of the prevailing offering price per share, the total investment return was 5.73% (not annualized) for shareholders who held our shares over the entire March 1, 2016 through September 30, 2016 period.

Our shares are illiquid investments for which there is currently not a secondary market. You should not expect to be able to resell your shares regardless of how we perform. If you are able to sell your shares, you will likely receive less than your purchase price. Our net asset value and annualized returns – which are based in part upon determinations of fair value of Level 3 investments by our board of trustees, not active market quotations – are inherently uncertain. Past performance is not a guarantee of future results.

 

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Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed financial statements which have been prepared in accordance with GAAP. The preparation of our unaudited condensed financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Note 2 “Significant Accounting Policies” to our unaudited condensed financial statements describes the significant accounting policies and methods used in the preparation of our financial statements. We consider the accounting policies listed below to be critical because they involve management judgments and assumptions, require estimates about matters that are inherently uncertain and are important for understanding and evaluating our reported financial results. These judgments affect (i) the reported amounts of assets and liabilities, (ii) our disclosure of contingent assets and liabilities as of the dates of the financial statements and (iii) the reported amounts of revenue and expenses during the reporting periods. With different estimates or assumptions, materially different amounts could be reported in our financial statements. Changes in the economic environment, financial markets and any other parameters used in determining such estimates could cause actual results to differ materially from the amounts reported based on these policies.

Valuation of Investments and Unrealized Gain (Loss) – Our investments consist primarily of investments in senior and subordinated debt of private U.S. companies and are presented in our financial statements at fair value. See Note 3 “Investments,” in our unaudited condensed financial statements for more information on our investments. As described more fully in Note 2 “Significant Accounting Policies” and Note 4 “Fair Value of Financial Instruments” in our unaudited condensed financial statements, a valuation hierarchy based on the level of independent, objective evidence available regarding value is used to measure the fair value of our investments. Investments for which market quotations are readily available are valued using market quotations, which are generally obtained from independent pricing services, broker-dealers or market makers. With respect to our portfolio investments for which market quotations are not readily available, our board of trustees is responsible for determining in good faith the fair value of our portfolio investments in accordance with, and the consistent application of, the valuation policy and procedures approved by the board of trustees, based on, among other things, the input of our Advisors, audit committee and independent third-party valuation firms.

We utilize several valuation techniques that use unobservable inputs and assumptions in determining the fair value of our Level 3 investments. For senior debt, subordinated debt and structured products categorized as Level 3 investments, we initially value the investment at its transaction price and subsequently value using (i) market data for similar instruments (e.g., recent transactions or indicative broker quotes), (ii) comparisons to benchmark derivative indices and/or (iii) valuation models. Valuation models are based on yield analysis and discounted cash flow techniques, where the key inputs are based on relative value analyses and the assignment of risk-adjusted discounted rates derived from the analysis of similar credit investments from similar issuers. In addition, an illiquidity discount is applied where appropriate. The valuation techniques used by us for other types of assets and liabilities that are classified as Level 3 investments are described in Note 2 to our unaudited condensed financial statements. The unobservable inputs and assumptions may differ by asset and in the application of our valuation methodologies. The reported fair value estimates could vary materially if we had chosen to incorporate different unobservable inputs and other assumptions.

We and our board of trustees conduct our fair value determination process on a monthly basis and any other time when a decision regarding the fair value of our portfolio investments is required. A determination of fair value involves subjective judgments and estimates. Due to the inherent uncertainty of determining the fair value of portfolio investments that do not have a readily available market value, the fair value of the our portfolio investments may differ significantly from the values that would have been determined had a readily available market value existed for such investments, and the differences could be material. Further, such investments are generally less liquid than publicly traded securities. If we were required to liquidate a portfolio investment that does not have a readily available market value in a forced or liquidation sale, we could realize significantly less than the fair value recorded by us.

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements as of September 30, 2016.

 

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Contractual Obligations

Investment Advisory Agreements – We have entered into the Investment Advisory Agreement with CNL for the overall management of our investment activities. We and CNL have also entered into the Sub-Advisory Agreement with KKR, under which KKR is responsible for the day-to-day management of our Investment Portfolio. CNL compensates KKR for advisory services that it provides to us with 50% of the base management fees and performance-based incentive fees that CNL receives under the Investment Advisory Agreement. Pursuant to the Investment Advisory Agreement, CNL earns a base management fee equal to an annual rate of 2% of our average gross assets and an incentive fee based on our performance. The incentive fee will comprise the following two parts:

 

    An incentive fee on net investment income, which we refer to as the subordinated incentive fee on income, is calculated and payable quarterly in arrears and is based upon our pre-incentive fee net investment income for the calendar quarter. The quarterly incentive fee on net investment income is (a) 100% of the pre-incentive fee net investment income between 1.75% and 2.1875% of average adjusted capital, plus (b) 20% of pre-incentive fee net investment income in excess of 2.1875% of average adjusted capital. Adjusted capital is defined as cumulative proceeds generated from sales of our common stock, including proceeds from our distribution reinvestment plan, net of sales load (upfront sales commissions and upfront dealer manager fees) reduced for (i) distributions paid to our shareholders that represent return of capital on a tax basis and (ii) amounts paid for share repurchases pursuant to our share repurchase program. Average adjusted capital is computed on the daily adjusted capital for the actual number of days in the quarter. The quarterly preference return of 1.75% and upper level breakpoint of 2.1875% are also adjusted for the actual number of days in each calendar quarter. For purposes of computing the subordinated incentive fee on income, net interest, if any, associated with a derivative or swap, (which represents the difference between (i) the interest income and fees received in respect of the reference assets of the derivative or swap and (ii) the interest expense paid by us to the derivative or swap counterparty) is included in pre-incentive fee net investment income for purposes of the subordinated incentive fee on income.

 

    An incentive fee on capital gains is calculated and payable in arrears as of the end of each calendar year. It is equal to 20% of our realized capital gains on a cumulative basis from inception through the end of such 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 incentive fees on capital gains. For purposes of computing the incentive fee on capital gains, realized gains and realized losses on the disposition of any reference assets, if any, as well as unrealized depreciation on reference assets retained in the derivative or swap, if any, will be included on a cumulative basis in the calculation of the incentive fee on capital gains that may be payable annually to our Advisors.

As of September 30, 2016, we had accrued an incentive fee on capital gains of $110,906. See Note 5 “Related Party Transactions” in our financial statements for expanded discussion of the Investment Advisory Agreement and Sub-Advisory Agreement.

The terms of the Investment Advisory Agreement entitle CNL (and indirectly KKR) to receive up to 1.5% of gross proceeds in connection with the Offering as reimbursement for organization and offering expenses incurred by the Advisors on our behalf. The Advisors waived the reimbursement of organization and offering expenses in connection with the Company’s gross capital raised before December 31, 2016. After the O&O Reimbursement Waiver period ends, subsequent gross capital raised by the Company will be subject to the maximum organization and offering cost reimbursement of 1.5%. The O&O Reimbursement Waiver does not reduce the amount of organization and offering expenses incurred by the Advisors that are eligible for reimbursement in future periods.

Unfunded Commitments

Unfunded commitments to provide funds to portfolio companies are not recorded on our statements of assets and liabilities. Because these commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. As of September 30, 2016, our unfunded investment commitments totaled $0.03 million. We estimate that we have sufficient liquidity to fund such unfunded loan commitments should the need arise.

 

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Related Party Transactions

We have entered into agreements with our Advisors and certain of their affiliates, whereby we agree to pay certain fees to, or reimburse certain expenses of, our Advisors and their affiliates for investment and advisory services, selling commissions and dealer manager fees in connection with our Offering, and reimbursement of offering and administrative and operating fees and costs. See Note 5 “Related Party Transactions” in our unaudited condensed financial statements and Part III – Item 13. “Certain Relationships and Related Transactions, and Trustee Independence” in our Form 10-K for the period ended December 31, 2015 for a discussion of the various related party transactions, agreements and fees.

Impact of Recent Accounting Pronouncements

See Item 1. “Financial Statements” for a summary of the impact of any recent accounting pronouncements, if any.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

We are subject to financial market risks, in particular changes in interest rates. Future changes in interest rates will likely have effects on the interest income we earn on our portfolio investments, the fair value of our fixed income investments, the interest rates and interest expense associated with the money we borrow and the fair value of loan balances.

Subject to the requirements of the 1940 Act, we may hedge against interest rate fluctuations by using standard hedging instruments such as futures, options and forward contracts. Although hedging activities may insulate us against adverse changes in interest rates, they may also limit our ability to participate in the benefits of lower interest rates.

As of September 30, 2016, approximately 99.9% of our portfolio of debt investments, or approximately $32.7 million measured at par value, featured floating or variable interest rates. The variable interest rate debt investments usually provide for interest payments based on three-month LIBOR (the base rate) and typically have durations of three months after which the base rates are reset to then prevailing three-month LIBOR. As of September 30, 2016, 100% of our portfolio of variable interest rate debt investments, or approximately $32.7 million measured at par value, featured minimum base rates, or base rate floors, and the weighted average base rate floor for such investments was 1.1%. Variable interest rate investments that feature a base rate floor generally reset to the then prevailing three-month LIBOR only if the reset base rate exceeds the base rate floor on the applicable interest rate reset date, in which cases we may benefit through an increase in interest income from such interest rate adjustments.

Approximately 0.1% of our debt investment portfolio was invested in fixed interest rate, high yield corporate debt investments as of September 30, 2016. Rising market interest rates will most likely lead to fair value declines for high yield corporate bonds and a decline in the net asset value of our common stock, while declining market interest rates will most likely lead to an increase in bond values.

As of September 30, 2016, 98.1% of our debt investments had prices that are generally available from third party pricing services. We consider these debt investments to be liquid since these types of assets are generally broadly syndicated and owned by a wide group of institutional investors, business development companies, mutual funds and other investment funds. Additionally, this group of assets is susceptible to revaluation, or changes in bid-ask values, in response to sudden changes in expected rates of return associated with these investments.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Pursuant to Rule 13a-15(b) under the Exchange Act, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our management, including our principal executive officer and principal financial officer, concluded that our disclosure controls and procedures are effective as of the end of the period covered by this report to provide reasonable assurance that material information required to be included in our periodic SEC reports is recorded, processed, summarized and reported within the time periods specified in the relevant SEC rules and forms.

 

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Changes in Internal Control over Financial Reporting

During the most recent fiscal quarter, there was no change in our internal controls over financial reporting (as defined under Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings – None

Item 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in response to Item 1A. to Part I. of our Annual Report on Form 10-K for the fiscal period ended December 31, 2015 (the “Annual Report”), except for the following:

The “Risk Factors” section of the Annual Report is amended by replacing the third paragraph under the risk factor entitled “Our ability to achieve our investment objective depends on our Advisors’ ability to manage and support our investment process. If our Advisors were to lose a significant number of their respective key professionals, or terminate the Advisory Agreement and/or the Sub-Advisory Agreement, our ability to achieve our investment objective could be significantly harmed.” with the following:

In addition, both the Investment Advisory Agreement and the Sub-Advisory Agreement have similar termination provisions that allow the agreements to be terminated without penalty. The Investment Advisory Agreement may be terminated at any time, without the payment of any penalty, by (i) CNL upon 120 days’ prior written notice to us and (ii) us upon 60 days’ prior written notice to CNL if our independent trustees or holders of a majority of our outstanding shares of common stock so direct. The Sub-Advisory Agreement may be terminated at any time, without the payment of any penalty, by (i) KKR upon 120 days’ prior written notice to CNL and us, and (ii) by CNL or us upon 60 days’ prior written notice to KKR if our independent trustees or holders of a majority of our outstanding shares of common stock so direct. In addition, CNL and KKR have agreed that, in the event that one of them is removed by us other than for cause, or the advisory agreement of either of them is not renewed, the other will also terminate its agreement with us. The termination of either agreement may adversely affect the quality of our investment opportunities. In addition, in the event either agreement were terminated, it may be difficult for us to replace CNL or for CNL to replace KKR.

The “Risk Factors” section of the Annual Report is amended by replacing the first and second paragraphs under the risk factor entitled “A majority of our investment portfolio will be recorded at fair value as determined in good faith in accordance with procedures established by our board of trustees and, as a result, there is and will be uncertainty as to the value of our portfolio investments.” with the following:

Under the 1940 Act, we are required to carry our portfolio investments at market value or, if there is no readily available market value, at fair value as determined in accordance with procedures established by our board of trustees. There is not a public market or active secondary market for many of the securities of the privately held companies in which we intend to invest. The majority of our investments may not be publicly traded or actively traded on a secondary market but, instead, may be traded on a privately negotiated over-the-counter secondary market for institutional investors. As a result, we will value a majority of these securities monthly at fair value as determined in good faith in accordance with the valuation policy and procedures approved by our board of trustees.

The determination of fair value, and thus the amount of unrealized gains or losses we may recognize in any reporting period, is to a degree subjective, and our Advisors have a conflict of interest in making recommendations of fair value. We will value our investments monthly at fair value as determined in good faith in accordance with procedures established by our board of trustees based on input from our Advisors. Our board of trustees may utilize the services of an independent third-party valuation firm to aid us in determining the fair value of certain securities. The types of factors that may be considered in determining the fair values of our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow, current market interest rates and other relevant factors. Because such valuations, and particularly valuations of private securities and private companies, are inherently uncertain, the valuations may fluctuate significantly over short periods of time due to changes in current market conditions. The determinations of fair value in accordance with procedures established by our board of trustees may differ materially from the values that would have been used if an active market and market quotations existed for such investments. Our net asset value could be adversely affected if the determinations regarding the fair value of the investments were materially higher than the values that we ultimately realize upon the disposal of such investments.

 

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The “Risk Factors” section of the Annual Report is amended by replacing the fifth paragraph under the risk factor entitled “Our investments in private investment funds, including hedge funds, private equity funds, limited liability companies and other business entities, subject us indirectly to the underlying risks of such private investment funds and additional fees and expenses.” with the following:

Our board of trustees – with the assistance of the Advisors, officers and, through them, independent valuation agents – is responsible for determining in good faith the fair value of our portfolio investments for which market quotations are not readily available (as is the case of private investment funds). Our board of trustees will make this determination on a monthly basis and any other time when a decision is required regarding the fair value of our investments in private investment funds or other portfolio investments for which market quotations are not available. A determination of fair value involves subjective judgments and estimates, and it is possible that the fair value determined for a security may differ materially from the value that could be realized upon the sale of the security.

The “Risk Factors” section of the Annual Report is amended by replacing the first paragraph under the subheading “Our investments in private investment funds, including hedge funds, private equity funds, limited liability companies and other business entities, subject us indirectly to the underlying risks of such private investment funds and additional fees and expenses” with the following:

We may invest up to 15% of our net assets in private investment funds, including hedge funds, private equity funds, limited liability companies and other business entities which would be required to register as investment companies but for an exemption under Sections 3(c)(1) and 3(c)(7) of the 1940 Act. Our investments in such private investment funds expose us to the risks associated with the businesses of such funds or entities. These private investment funds may or may not be registered investment companies and, thus, may not be subject to protections afforded by the 1940 Act, covering, among other areas, liquidity requirements, governance by an independent board, affiliated transaction restrictions, leverage limitations, public disclosure requirements and custody requirements.

The “Risk Factors” section of the Annual Report is amended by adding the following paragraph after the last paragraph under the “Risks Related to Our Investments” subheading:

Investments in which we have a non-controlling interest may involve risks specific to third-party management of those investments.

We may also co-invest with third parties through partnerships, joint ventures or other entities, thereby acquiring jointly-controlled or non-controlling interests in certain investments in conjunction with participation by one or more third parties in such investment. Such joint venture partners or third party managers may include former KKR personnel or associated persons. As co-investors, we may have interests or objectives that are inconsistent with those of the third-party partners or co-venturers. Although we may not have full control over these investments and therefore, may have a limited ability to protect its position therein, we expect that we will negotiate appropriate rights to protect our interests. Nevertheless, such investments may involve risks not present in investments where a third party is not involved, including the possibility that a third-party partner or co-venturer may have financial difficulties, resulting in a negative impact on such investment, may have economic or business interests or goals which are inconsistent with ours, or may be in a position to take (or block) action in a manner contrary to the our investment objectives or the increased possibility of default by, diminished liquidity or insolvency of, the third party, due to a sustained or general economic downturn. Third-party partners or co-venturers may opt to liquidate an investment at a time during which such liquidation is not optimal for us. In addition, we may in certain circumstances be liable for the actions of its third-party partners or co-venturers. In those circumstances where such third parties involve a management group, such third parties may receive compensation arrangements relating to such investments, including incentive compensation arrangements.

The “Risk Factors” section of the Annual Report is amended by replacing the risk factor entitled “Investors will not know the purchase price per share at the time they submit their subscription agreements and could receive fewer shares of common stock than anticipated if our board of trustees determines to increase the offering price to comply with the requirement that we avoid selling shares below net asset value.” with the following:

Shares will be offered at an offering price of $9.75 per share. We will seek to avoid interruptions in the continuous offering of our common shares, however, if our net asset value per share: (i) declines more than 10% from the net asset value per share as of the effective date of this registration statement, (ii) increases to an amount that is greater than the net proceeds per share as stated in the prospectus, or (iii) declines below 97.5% of the net proceeds per share as stated in the prospectus, to the extent permitted or required under the rules and regulations of the SEC, we will either supplement the prospectus or file an amendment to the registration statement with the SEC to change our offering price or will voluntarily suspend selling shares in the offering. However, there can be no assurance that our continuous offering will not be interrupted during the SEC’s review of any such registration statement amendment or if our board of trustees determine to voluntarily suspend selling shares in this offering as opposed to supplementing or amending the registration statement with the SEC.

 

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Additionally, our board of trustees may change the offering price at any time to ensure that our net asset value per share is equal to or less than the public offering price, net of sales load and equal to or greater than 97.5% of the net proceeds per share when we sell shares of common stock.

As a result, your purchase price may be higher than the prior subscription closing price per share, and therefore you may receive a smaller number of shares than if you had subscribed at the prior subscription closing price.

The “Risk Factors” section of the Annual Report is amended by replacing the risk factor entitled “The price that the investor pays for our shares may not reflect the current net asset value of our company at the time of his or her subscription.” with the following:

If our net asset value increases above our net proceeds per share as stated in this prospectus, we will sell our shares at a higher price as necessary to ensure that shares are not sold at a net price, after deduction of upfront selling commissions and dealer manager fees, that is below our net asset value per share. Also, if our net asset value per share: (i) declines more than 10% from the net asset value per share as of the effective date of this registration statement, (ii) increases to an amount that is greater than the net proceeds per share as stated in the prospectus, or (iii) declines below 97.5% of the net proceeds per share as stated in the prospectus, to the extent permitted or required under the rules and regulations of the SEC, we will either supplement the prospectus or file an amendment to the registration statement with the SEC to change our offering price or will voluntarily suspend selling shares in the offering. Additionally, our board of trustees may change the offering price at any time to ensure that our net asset value per share is equal to or less than the public offering price, net of upfront sales load and equal to or greater than 97.5% of the net proceeds per share when we sell shares of common stock. Therefore, the net proceeds per share, net of all upfront sales load, from a new investor may be in excess of the then current net asset value per share.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds – None

Item 3. Defaults Upon Senior Securities – None

Item 4. Mine Safety Disclosures Not applicable

Item 5. Other InformationNone

Item 6. Exhibits

The exhibits required by this item are set forth in the Exhibit Index attached hereto and are filed or incorporated as part of this report.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on the 11th day of November 2016.

 

CORPORATE CAPITAL TRUST II
By:   /s/    Thomas K. Sittema        
  THOMAS K. SITTEMA
  Chief Executive Officer
  (Principal Executive Officer)
By:   /s/    Steven D. Shackelford        
  STEVEN D. SHACKELFORD
  Chief Financial Officer
  (Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

The following exhibits are filed or incorporated as part of this report

 

10.1    Second Amendment to the Expense Support Agreement dated as of September 26, 2016 (Incorporated by reference to the Company’s Current Report on Form 8-K filed on September 29, 2016.)
31.1    Certification of Chief Executive Officer of Corporate Capital Trust II, Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)
31.2    Certification of Chief Financial Officer of Corporate Capital Trust II, Pursuant to Rule 13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)
32.1    Certification of Chief Executive Officer and Chief Financial Officer of Corporate Capital Trust II, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Filed herewith.)

 

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