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EX-31.2 - EXHIBIT 31.2 - VII Peaks Co-Optivist Income BDC II, Inc.v417490_ex31-2.htm
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EX-32.2 - EXHIBIT 32.2 - VII Peaks Co-Optivist Income BDC II, Inc.v417490_ex32-2.htm

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

Form 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the quarterly period ended June 30, 2015

 

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

 

Commission File No. 0-54615

 

 

 

VII Peaks Co-Optivist Income BDC II, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

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

 

4 Orinda Way, Suite 125-A

Orinda, CA 94563

(Address of principal executive offices)

 

(855) 889-1778

(Registrant’s telephone number, including area code)

 

Not applicable

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

  

 

 

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

  

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

 

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

 

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

 

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

 

The number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding as of August 13, 2015 was 6,113,227.

 

 

 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2015

 

TABLE OF CONTENTS

 

    Page
     
PART I. FINANCIAL INFORMATION 3
     
Item 1. Financial Statements 3
     
  Statements of Assets and Liabilities as of June 30, 2015 (unaudited) and December 31, 2014 3
     
  Statements of Operations for the three and six months ended June 30, 2015 (unaudited) and 2014 (unaudited) 4
     
  Statements of Changes in Net Assets for the six months ended June 30, 2015 (unaudited) and 2014 (unaudited) 5
     
  Statements of Cash Flows for the six months ended June 30, 2015 (unaudited) and 2014 (unaudited) 6
     
  Schedule of Investments as of June 30, 2015 (unaudited) 7
     
  Schedule of Investments as of December 31, 2014 8
     
  Notes to Financial Statements (unaudited) 9
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 29
     
Item 4. Controls and Procedures 30
     
PART II. OTHER INFORMATION 31
     
Item 1. Legal Proceedings 31
     
Item 1A. Risk Factors 31
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 31
     
Item 3. Defaults upon Senior Securities 31
     
Item 4. Mine Safety Disclosures 31
     
Item 5. Other Information 31
     
Item 6. Exhibits 31
   
Signatures 32

 

 2 
 

  

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF ASSETS AND LIABILITIES

(in thousands, except share and per share data) 

 

   As of 
   June 30, 2015   December 31, 2014 
   (Unaudited)     
ASSETS          
           
Investments, at fair value (amortized cost of $47,065 and $44,302, respectively)  $39,641   $37,428 
Investments, money market at fair value  (cost of $5,267 and $3,104, respectively)   5,267    3,104 
Total investments, at fair value   44,908    40,532 
Interest receivable   890    1,050 
Prepaid expenses   42    18 
Origination fee receivable   263    - 
Due from related party   9    167 
Receivable for common stock purchased   -    614 
Total assets  $46,112   $42,381 
           
LIABILITIES          
Payable for unsettled trades  $-   $1,340 
Management fees payable   -    7 
Accounts payable and accrued liabilities   74    183 
Stockholder distributions payable   188    163 
Total liabilities  $262   $1,693 
           
NET ASSETS          
Preferred stock, par value, $.001 per share, 50,000,000 authorized, none issued and outstanding  $-   $- 
Common stock, par value, $.001 per share, 200,000,000 authorized; 6,313,300 and 5,546,292 shares issued and outstanding, respectively   6    6 
Paid-in capital in excess of par value   57,934    51,096 
Treasury stock at cost, 85,478 and 79,667 shares, respectively   (837)   (778)
Accumulated distribution in excess of net investment income and net realized gain on investments   (3,829)   (2,762)
Net unrealized depreciation on investments   (7,424)   (6,874)
Total net assets   45,850    40,688 
Total liabilities and net assets  $46,112   $42,381 
           
Net asset value per share  $7.26   $7.34 

 

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

 

 3 
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)

(Unaudited)

 

   For the
Three Months
Ended

June 30, 2015
   For the
Three Months
Ended
June 30, 2014
   For the
Six Months
Ended
June 30, 2015
   For the
Six Months
Ended
June 30, 2014
 
                 
Investment income:                    
Interest from investments  $854   $848   $1,768   $1,558 
Other income   558    103    558    103 
Total investment income  $1,412   $951   $2,326   $1,661 
                     
Operating expenses:                    
Professional fees   134    78    230    136 
Directors fees   12    13    30    27 
Insurance   24    24    48    47 
Management fees   229    168    444    335 
Administrative services - related parties   54    12    108    24 
General and administrative   214    262    512    416 
Offering expense   40    22    96    136 
Total operating expenses   707    579    1,468    1,121 
                     
Net investment income  $705   $372   $858   $540 
                     
Realized and unrealized gain (loss) on investments:                    
Net realized gain from investments   163    -    215    85 
Net unrealized depreciation on investments   (526)   (951)   (550)   (1,218)
Net realized and unrealized gain (loss) on investments   (363)   (951)   (335)   (1,133)
                     
Net increase (decrease) in net assets resulting from operations  $342   $(579)  $523   $(593)
                     
Per share information - basic and diluted:                    
Net investment income  $0.11   $0.09   $0.14   $0.14 
Net increase (decrease) in net assets resulting from operations  $0.06   $(0.14)  $0.09   $(0.16)
Weighted average common shares outstanding   6,199,493    4,054,473    5,965,660    3,749,965 

 

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

 

 4 
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF CHANGES IN NET ASSETS

(in thousands, except share and per share data)

(Unaudited)

 

   For the Six Months Ended
June 30, 2015
   For the Six Months Ended
June 30, 2014
 
         
Operations:          
Net investment income  $858   $540 
Net realized gain from investments   215    85 
Net unrealized depreciation on investments   (550)   (1,218)
Net increase (decrease) in net assets from operations   523    (593)
Stockholder distributions:          
Distributions from net investment income   (858)   (540)
Distributions from net realized gain on investments   (215)   (85)
Distributions from paid in capital   (1,067)   (761)
Net decrease in net assets from stockholder distributions   (2,140)   (1,386)
Capital share transactions:          
Issuance of common stock, net of issuance costs   6,072    7,469 
Reinvestment of stockholder distributions   766    481 
Total investment contributions transferred in-kind   -    758 
Treasury capital/redemptions   (59)   (330)
Net increase in net assets from capital share transactions   6,779    8,378 
           
Total increase in net assets   5,162    6,399 
Net assets at beginning of period   40,688    27,424 
Net assets at end of period  $45,850   $33,823 
           
Net asset value per common share  $7.26   $8.32 
Common shares outstanding at end of period   6,313,300    4,067,009 
           
Accumulated distribution in excess of net investment income and net realized gain on investments  $(3,829)  $(1,370)

 

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

 

 5 
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

STATEMENTS OF CASH FLOWS

(in thousands, except share and per share data)

(Unaudited)

 

   For the Six Months
Ended
June 30, 2015
   For the Six Months
Ended
June 30, 2014
 
         
Operating activities:          
Net increase (decrease) in net assets from operations  $523   $(593)
Adjustments to reconcile net increase (decrease) in net assets from operations to net cash used in operating activities:          
Paid-in-kind interest income   -    (15)
Net accretion of premium/discount on investments   49    (40)
Repayments of investments   12,295    7,330 
Purchase of investments   (14,892)   (15,278)
Repayments of investments - money market   15,310    18,086 
Purchase of investments - money market   (17,473)   (18,511)
Net realized gain from investments   (215)   (85)
Net unrealized depreciation on investments   550    1,218 
(Increase) decrease in operating assets:          
Interest receivable   160    (339)
Prepaid expenses   (24)   (35)
Due from related party   158    1,178 
Origination fee receivable   (263)     
Receivable for common stock purchased   614    974 
Increase (decrease) in operating liabilities:          
Payable for unsettled trades   (1,340)   (104)
Management fees Payable   (7)   (8)
Accounts payable and accrued liabilities   (109)   (45)
Net cash used in operating activities   (4,664)   (6,267)
           
Financing activities:          
Proceeds from issuance of shares of common stock, net   6,072    7,469 
Redemption of common stock   -    7 
Stockholder distributions   (1,349)   (879)
Treasury stock   (59)   (330)
Net cash provided by financing activities   4,664    6,267 
           
Net increase in cash and cash equivalents   -    - 
Cash and cash equivalents, beginning of period   -    - 
Cash and cash equivalents, end of period  $-   $- 
           
Supplemental non-cash information:          
DRIP distribution payable  $66   $44 
Cash distribution payable  $122   $77 
DRIP distribution paid  $766   $221 

 

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

 

 6 
 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars and shares in thousands)

June 30, 2015

(Unaudited)

 

Portfolio Company   Industry  Investment
Coupon
Rate, Maturity
Date
  Principal No. of Shares   Amortized
Cost
   Fair Value   % of
Net
Assets
 
Senior Secured First Lien Debt - 22.7% (b)                    
American Media, Inc.  Media: Advertising, Printing & Publishing  11.50%, 12/15/2017  $1,320   $1,373   $1,356    2.9%
APX Group, Inc.  Services: Consumer  6.38%, 12/1/2019   825    825    800    1.8%
Caesars Entertainment Operating Co., Inc. (a)(d)  Hotel, Gaming & Leisure  11.25%, 6/1/2017   860    751    675    1.4%
EarthLink Holdings Corp. (a)  Telecommunications  7.38%, 6/1/2020   40    41    42    0.1%
Endeavour International Corp. (d)  Energy: Oil & Gas  12.00%, 3/1/2018   525    551    578    1.3%
EuraMax International, Inc.  Metals & Mining  9.50%, 4/1/2016   1,475    1,468    1,453    3.2%
Goodman Networks, Inc.  Telecommunications  12.13%, 7/1/2018   800    843    664    1.5%
Kratos Defense & Security Solutions, Inc. (a)  Aerospace and Defense  7.00%, 5/15/2019   1,550    1,346    1,412    3.0%
Ryerson Inc./Joseph T Ryerson & Son, Inc.  Metals & Mining  9.00%, 10/15/2017   1,315    1,366    1,325    2.9%
Titan International Inc. (a)  Automobile  6.88%, 10/1/2020   1,500    1,381    1,378    3.0%
Toys R Us Property Co II LLC  Retail  8.50%, 12/1/2017   725    734    728    1.6%
Sub Total Senior Secured First Lien Debt  $10,935   $10,679   $10,411    22.7%
                           
                           
Senior Secured Second Lien Debt - 5.4% (b)                    
Aspect Software, Inc.  Telecommunications  10.63%, 5/15/2017  $1,302   $1,318   $1,247    2.7%
Claire's Stores, Inc.  Retail  8.88%, 3/15/2019   825    807    367    0.8%
Endeavour International Corp. (d)  Energy: Oil & Gas  12.00%, 6/1/2018   725    708    239    0.5%
Logan's Roadhouse, Inc.  Beverage, Food & Tobacco  10.75%, 10/15/2017   770    743    570    1.2%
Saratoga Resources, Inc. (d)  Energy: Oil & Gas  12.50%, 7/1/2016   885    912    105    0.2%
Sub Total Senior Secured Second Lien Debt  $4,507   $4,488   $2,528    5.4%
                           
                           
Senior Unsecured Debt - 25.7% (b)                    
APX Group, Inc.  Services: Consumer  8.75%, 12/1/2020  $575   $554   $518    1.1%
Caesar's Entertainment Corp. (a)(d)  Hotel, Gaming & Leisure  10.75%, 2/1/2016   495    451    129    0.3%
Clear Channel Communications  Media: Broadcasting & Subscription  10.00%, 1/15/2018   1,400    1,344    1,127    2.5%
Colt Defense LLC (d)  Aerospace and Defense  8.75%, 11/15/2017   1,253    1,029    367    0.8%
DynCorp International Inc.  Aerospace and Defense  10.38%, 7/1/2017   1,135    1,146    817    1.8%
EarthLink Holdings Corp. (a)  Telecommunications  8.88%, 5/15/2019   279    273    291    0.6%
Gymboree Corp.  Retail  9.13%, 12/1/2018   810    769    308    0.7%
Nuverra Environmental Solutions, Inc.  Environmental Industries  9.88%, 4/15/2018   1,325    1,356    994    2.2%
Ryerson Inc./Joseph T Ryerson & Son, Inc.  Metals & Mining  11.25%, 10/15/2018   1,500    1,532    1,515    3.3%
Seitel, Inc.  Energy: Oil & Gas  9.50%, 4/15/2019   1,575    1,574    1,437    3.1%
Sitel LLC / Sitel Finance Corp  Media: Advertising, Printing & Publishing  11.50%, 4/1/2018   1,450    1,413    1,272    2.8%
Suntech Power Holdings Company, Ltd. (a)(c)  Environmental Industries  3.00%, 5/15/2013   100    112    0    0.0%
Toys R Us Inc.  Retail  10.38%, 8/15/2017   860    820    735    1.6%
UCI International Inc  Automobile  8.63%, 2/15/2019   1,400    1,362    1,246    2.7%
Visant Corp.  Media: Advertising, Printing & Publishing  10.00%, 10/1/2017   1,275    1,237    1,016    2.2%
Sub Total Senior Unsecured Debt  $15,432   $14,972   $11,772    25.7%
                           
Senior Subordinated Debt -7.4% (b)                    
Affinion Group, Inc.  Media: Advertising, Printing & Publishing  13.50%, 8/15/2018  $816   $717   $359    0.8%
Central Garden and Pet Co.  Retail  8.25%, 3/1/2018   1,246    1,278    1,276    2.8%
Claires Stores, Inc  Retail  10.50%, 6/1/2017   715    712    436    1.0%
DJO Finance, LLC.  Healthcare & Pharmaceuticals  9.75%, 10/15/2017   1,265    1,328    1,297    2.8%
QuickSilver Resources, Inc. (d)  Energy: Oil & Gas  7.13%, 4/1/2016   890    843    2    0.0%
Sub Total Senior Subordinated Debt  $4,932   $4,878   $3,370    7.4%
                           
Equity Securities - 25.2% (b)                    
Education Management LLC (d)  Services: Consumer  Common stock    2,530   $4   $382    0.8%
Education Management LLC (d)  Services: Consumer  Warrants   1,554    876    498    1.1%
NII Holdings, Inc. (d)  Telecommunications  Common stock    17    768    280    0.6%
Relativity Media, LLC (e)  Media: Diversified & Production  Preferred
stock
   832    10,400    10,400    22.7%
Sub Total Equity Securities       $12,048   $11,560    25.2%
                           
Investments - Money Market -11.5% (b)                    
Investments - U.S. Bank Money Market     0.03%  5,267   $5,267   $5,267    11.5%
Sub Total Investments - Money Market     $5,267   $5,267    11.5%
                           
TOTAL INVESTMENTS - 97.9% (b)       $52,332   $44,908    97.9%

  

(a) Represents a non-qualifying investment as defined under Section 55 (a) of the Investment Company Act of 1940, as amended. Non-qualifying assets represent 8.7% of the Company's portfolio at fair value. As a BDC, the Company can only invest 30% of its portfolio in non-qualifying asstes.
(b) Percentages are based on net assets of $45,850 as of June 30, 2015.
(c) Non-U.S. company. The principal place of business for Suntech Power Holdings Company, Ltd. Is China. Non-income producing as of June 30, 2015.
(d) Non-income producing as of June 30, 2015.

(e) The Class E Units are entitled to PIK dividends at the rate of 12.5% per annum, payable in additional Class E Units. The PIK dividends accrue quarterly in advance on the first day of each quarter, but are only issuable immediately prior to the mandatory redemption of the Class E Units, and are not issuable upon a conversion of the Class E Units to other equity interests of the issuer.

 

 

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

 

 7 
 

  

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

SCHEDULE OF INVESTMENTS

(dollars and shares in thousands)

December 31, 2014

 

Portfolio Company  Industry  Investment
Coupon
Rate, Maturity
Date
  Principal No. of Shares   Amortized
Cost
   Fair Value   % of
Net
Assets
 
Senior Secured First Lien Debt - 28.8% (b)                    
Accuride Corp.  Consumer Goods: Durable  9.50%, 8/1/2018  $1,400   $1,435   $1,442    3.5%
American Media, Inc.  Media: Advertising, Printing & Publishing  11.50%, 12/15/2017   1,320    1,382    1,307    3.2%
APX Group, Inc.  Services: Consumer  6.38%, 12/1/2019   825    825    790    1.9%
Caesars Entertainment Operating Co., Inc. (a)  Hotel, Gaming & Leisure  11.25%, 6/1/2017   860    765    630    1.5%
Cambrium Learning Group, Inc.  Services: Consumer  9.75%, 2/15/2017   1,375    1,392    1,347    3.3%
EarthLink Holdings Corp. (a)  Telecommunications  7.38%, 6/1/2020   40    41    41    0.1%
Endeavour International Corp. (d)  Energy: Oil & Gas  12.00%, 3/1/2018   525    551    578    1.4%
EuraMax International, Inc.  Metals & Mining  9.50%, 4/1/2016   1,475    1,464    1,371    3.4%
Goodman Networks, Inc.  Telecommunications  12.13%, 7/1/2018   800    849    826    2.0%
Kratos Defense & Security Solutions, Inc. (a)  Aerospace and Defense  7.00%, 5/15/2019   1,550    1,325    1,318    3.3%
Ryerson Inc./Joseph T Ryerson & Son, Inc.  Metals & Mining  9.00%, 10/15/2017   1,315    1,376    1,351    3.4%
Toys R Us Property Co II LLC  Retail  8.50%, 12/1/2017   725    736    720    1.8%
Sub Total Senior Secured First Lien Debt  $12,210   $12,141   $11,721    28.8%
                           
Senior Secured Second Lien Debt - 14.0% (b)                    
Aspect Software, Inc.  Telecommunications  10.63%, 5/15/2017  $1,302   $1,322   $1,230    3.0%
Bon-ton Department Stores, Inc.  Retail  10.63%, 7/15/2017   1,390    1,384    1,383    3.4%
Claire's Stores, Inc.  Retail  8.88%, 3/15/2019   825    805    668    1.6%
Endeavour International Corp. (d)  Energy: Oil & Gas  12.00%, 6/1/2018   725    708    239    0.6%
Logan's Roadhouse, Inc.  Beverage, Food & Tobacco  10.75%, 10/15/2017   770    738    566    1.4%
Radiation Therapy Services, Inc.  Healthcare & Pharmaceuticals  8.88%, 1/15/2017   1,285    1,277    1,298    3.2%
Saratoga Resources, Inc.  Energy: Oil & Gas  12.50%, 7/1/2016   885    897    310    0.8%
Sub Total Senior Secured Second Lien Debt  $7,182   $7,131   $5,694    14.0%
                           
Senior Unsecured Debt - 37.2% (b)                    
APX Group, Inc.  Services: Consumer  8.75%, 12/1/2020  $575   $553   $486    1.2%
Armored Autogroup, Inc.  Consumer Goods: Durable  9.25%, 11/1/2018   1,250    1,247    1,244    3.1%
Caesar's Entertainment Corp. (a)  Hotel, Gaming & Leisure  10.75%, 2/1/2016   495    475    74    0.2%
Cenveo Corp.  Services: Business  11.50%, 5/15/2017   1,571    1,576    1,430    3.5%
Clear Channel Communications  Media: Broadcasting & Subscription  10.00%, 1/15/2018   1,400    1,335    1,200    2.9%
Colt Defense LLC  Aerospace and Defense  8.75%, 11/15/2017   1,253    1,073    507    1.2%
DynCorp International Inc.  Aerospace and Defense  10.38%, 7/1/2017   1,135    1,148    965    2.4%
EarthLink Holdings Corp. (a)  Telecommunications  8.88%, 5/15/2019   375    366    370    0.9%
Gentiva Health Services, Inc.  Healthcare & Pharmaceuticals  11.50%, 9/1/2018   925    967    984    2.4%
Gymboree Corp.  Retail  9.13%, 12/1/2018   810    764    312    0.8%
Hutchinson Technology, Inc.  High Tech Industries  8.50%, 1/15/2026,   858    819    858    2.1%
      puttable on 01/15/2015               
NII Capital Corp. (d)  Telecommunications  10.00%, 8/15/2016   960    921    331    0.8%
Nuverra Environmental Solutions, Inc.  Environmental Industries  9.88%, 4/15/2018   1,325    1,361    795    2.0%
Seitel, Inc.  Energy: Oil & Gas  9.50%, 4/15/2019   1,575    1,574    1,307    3.2%
Sitel LLC / Sitel Finance Corp  Media: Advertising, Printing & Publishing  11.50%, 4/1/2018   1,450    1,413    1,138    2.8%
Suntech Power Holdings Company, Ltd. (a)(c)  Environmental Industries  3.00%, 5/15/2013   100    107    1    0.0%
Toys R Us Inc.  Retail  10.38%, 8/15/2017   860    821    684    1.7%
UCI International Inc  Automobile  8.63%, 2/15/2019   1,400    1,358    1,337    3.3%
Visant Corp.  Media: Advertising, Printing & Publishing  10.00%, 10/1/2017   1,275    1,238    1,106    2.7%
Sub Total Senior Unsecured Debt  $19,592   $19,116   $15,129    37.2%
                           
Senior Subordinated Debt - 9.8% (b)                    
Affinion Group, Inc.  Media: Advertising, Printing & Publishing  13.50%, 8/15/2018  $816   $707   $612    1.5%
Central Garden and Pet Co.  Retail  8.25%, 3/1/2018   1,400    1,440    1,411    3.4%
Claires Stores, Inc  Retail  10.50%, 6/1/2017   715    711    651    1.6%
DJO Finance, LLC.  Healthcare & Pharmaceuticals  9.75%, 10/15/2017   1,265    1,313    1,265    3.1%
QuickSilver Resources, Inc.  Energy: Oil & Gas  7.13%, 4/1/2016   890    863    71    0.2%
Sub Total Senior Subordinated Debt  $5,086   $5,034   $4,010    9.8%
                           
Equity Securities - 2.1% (b)                    
Education Management LLC  Services: Consumer  Common stock  874   $880   $874    2.1%
Sub Total Equity Securities       $880   $874    2.1%
                           
Investments - Money Market - 7.7% (b)                    
Investments - U.S. Bank Money Market     0.03%  3,104   $3,104   $3,104    7.7%
Sub Total Investments - Money Market     $3,104   $3,104    7.7%
                           
TOTAL INVESTMENTS - 99.6% (b)       $47,406   $40,532    99.6%

 

(a) All of our investments are issued by eligible U.S. portfolio companies, as defined in the Investment Company Act of 1940, except for Caesar's Entertainment Corp., Earthlink Holdings Corp., Kratos Defense & Security Solutions, Inc., and Suntech Power Holdings Company, Ltd. Non-qualifying assets represent 6.0% of the Company's portfolio at fair value. As a BDC, the Company can only invest 30% of its portfolio in non-qualifying assets.

(b) Percentages are based on net assets of $40,688 as of December 31, 2014.

(c) Non-U.S. company. The principal place of business for Suntech Power Holdings Company, Ltd. Is China. Non-income producing as of December 31, 2014.

(d) Non-income producing as of December 31, 2014.

 

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

 

 8 
 

 

VII PEAKS CO-OPTIVIST INCOME BDC II, INC.

 

NOTES TO FINANCIAL STATEMENTS

June 30, 2015

 

(Unaudited)

 

Note 1.  Nature of Operations

 

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

 

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

 

On August 9, 2011, we filed a registration statement on Form N-2 to sell up to 75,000,000 shares of common stock, $0.001 par value per share, at an initial public offering price of $10.00 per share. The registration statement was declared effective by the SEC on March 1, 2012. We commenced operations when we raised gross offering proceeds of over $1.0 million, all of which was from persons who were not affiliated with us or our manager by one year from the date the registration statement was declared effective by the SEC. Prior to the successful satisfaction of that condition, all subscription payments were placed in an account held by the escrow agent, UMB Bank, N.A., in trust for the benefit of our subscribers, pending release to us. We achieved the minimum offering requirement on July 10, 2012 and commenced operations on such date. As of June 30, 2015, we issued 6.3 million shares of common stock, including 0.3 million shares under our distribution reinvestment plan (“DRIP”) and less 0.09 million shares redeemed under our tender offer. Gross proceeds from our common stock issuances total $63.4 million, including $2.6 million under our DRIP less $0.8 million paid to redeem shares in our quarterly tender offers.

 

Note 2.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The financial statements of the Fund included herein were prepared in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these financial statements include all adjustments, consisting only of normal recurring adjustments and accruals, necessary for a fair presentation of the results for the interim period. This Form 10-Q should be read in conjunction with the Fund’s annual report on Form 10-K/A for the year ended December 31, 2014, which was filed with the SEC on July 16, 2015. The current period’s results of operations will not necessarily be indicative of results that ultimately may be achieved for the fiscal year ending December 31, 2015.

 

Use of Estimates in the Preparation of Financial Statements

 

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

 

Investments - Money Market

 

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

 

Organizational and Offering Costs

 

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

 

U.S. Federal Income Taxes

 

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

 

 9 
 

 

The Fund has evaluated the implications of Accounting Standards Codification (“ASC”) Topic 740, for all open tax years and in all major tax jurisdictions, and determined that there is no material impact on the financial statements. The Fund continues to remain subject to examination by U.S. federal and state authorities for the years 2011 through 2014.

 

New Accounting Pronouncements

 

In May 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-07, “Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share (or its Equivalent)”. The guidance removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the NAV per share practical expedient. Sufficient information must be provided to permit reconciliation of the fair value of assets categorized within the fair value hierarchy to the amounts presented in the Statements of Assets and Liabilities. The guidance is required to be presented for annual periods beginning after December 15, 2015, and for interim periods within those fiscal years. Management is currently reviewing the requirements and believes the adoption of the ASU will not have a material impact on its financial statements.

 

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

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue with Contracts from Customers. ASU No. 2014-09 provides clarification on the principles to recognize revenue and to develop a common standard between GAAP and IFRS. The standard is effective for the Fund for annual reporting periods beginning after December 15, 2016, including interim periods. In April 2015, the FASB has voted for a one year deferral of the effective date.

 

Revenue Recognition

 

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

 

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

 

Our total investment income was $1.4 million and $2.3 million for the three and six months ended June 30, 2015, as compared to $1.0 million and $1.7 million for the three and six months ended June 30, 2014, respectively.

 

For the six months ended June 30, 2015, eight of the investments in the portfolio did not accrue interest as the issuers were in default of the coupon payment for more than the thirty day grace period. Interest income was accrued through the date of the last coupon payment received for these investments. These eight are Colt Defense LLC, 8.75%, November 15, 2017; Caesars Entertainment Corp, 11.25%, June 1, 2017; Caesars Entertainment Corp, 10.75%, February 1, 2016; Endeavour International Corp., 12%, March 1, 2018; Endeavour International Corp., 12%, June 1, 2018; QuickSilver Resources, Inc., 7.13%, April 1, 2016; Saratoga Resources, Inc., 12.50% July 1, 2016; and Suntech Power Holdings Company, Ltd., 3%, May 15, 2013. Two other investments, Education Management, LLC and NII Holdings were restructured as a private equity instruments, and no longer have income producing attributes.

 

Expense Reimbursement Agreement

 

We entered into an expense reimbursement agreement with our prior manager under which the prior manager agreed to reimburse us for certain U.S. GAAP compliant expenses recognized on our quarterly financial statements for 2012, retroactive to the date of formation on August 3, 2011. In 2013, the expense reimbursement agreement was modified to exclude management fees and incentive fees payable to the prior manager effective as of January 1, 2013. The expense reimbursement agreement allowed the prior manager and us to offset the related receivables from and payables to each other resulting in a net receivable, or payable position. Our prior manager was obligated to reimburse us for zero as of December 31, 2014 and $0.8 million as of December 31, 2013.

 

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

 

 10 
 

 

During the year ended December 31, 2014, our Manager paid in full the due from affiliate balance of $1.3 million plus interest of $0.1 million on such amount at the rate of 7.35% per annum.

 

Note 3. Valuation of Portfolio Investments

 

The investment portfolio is recorded on a trade date basis. The Fund determines the net asset value of its investment portfolio each quarter. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Thirty-six of the forty investments were valued using the closing market price at period end June 30, 2015. The exceptions were the investments in equity and warrants of Education Management LLC; Endeavour International Corp., 12% notes due March 1, 2018; Endeavour International Corp., 12% notes due June 1, 2018; and preferred equity investment in Relativity Media. The market did not have a sufficient amount of trades to use the quoted price for these positions.

 

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

 

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

 

  preliminary valuation conclusions are then documented and discussed with the members of the Board of Directors, or committee thereof; and

 

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

 

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

 

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

 

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

 

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

 

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

 

Level 2:  Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices. USBank is the fund custodian. Through USBank, the fund uses FT Interactive, a third party valuation firm, to price the notes. The prices are reviewed by the CEO.

 

Level 3: Unobservable inputs for the asset or liability. These investments for the fund are three equity securities, a Senior Secured First Lien Note, and a Senior Secured Lien Note. Two of the equity investments have been issued by a company with terms settled. Their fair value was determined by their relative amount of the total company enterprise value. The other equity investment is being carried at cost since we just completed the transaction. The terms of Senior Secured First Lien Note and Senior Secured Second Lien Note, however, have not been finalized. The fair value was derived from the relative amounts of the notes to the total enterprise value as indicated would be the intended restructuring by the issuer.

 

 11 
 

 

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

 

The following table presents fair value measurements of investments, by major class, as of June 30, 2015, according to the fair value hierarchy (dollars in thousands):

 

   Level 1   Level 2   Level 3   Total 
Investments – Money Market  $5,267   $   $   $5,267 
Senior Secured First Lien Debt       9,833    578    10,411 
Senior Secured Second Lien Debt       2,289    239    2,528 
Senior Unsecured Debt       11,772        11,772 
Senior Subordinated Debt       3,370        3,370 
Equity Securities       280    11,280    11,560 
Total  $5,267   $27,544   $12,097   $44,908 

 

The following table presents fair value measurements of investments, by major class, as of December 31, 2014, according to the fair value hierarchy (dollars in thousands):

 

   Level 1   Level 2   Level 3   Total 
Investments – Money Market  $3,104   $   $   $3,104 
Senior Secured First Lien Debt       11,143    578    11,721 
Senior Secured Second Lien Debt       5,455    239    5,694 
Senior Unsecured Debt       15,129        15,129 
Senior Subordinated Debt       4,010        4,010 
Equity Securities           874    874 
Total  $3,104   $35,737   $1,691   $40,532 

 

During the three month period ended June 30, 2015, Saratoga Resources, Inc., 12.50%, July 1, 2016 was transferred from Level 3 to Level 2.

 

There were three transfers between levels for the period ended December 31, 2014. One transfer was Education Management, LLC, originally, 15%, July 1, 2018. The interest bearing note was restructured by the company to a non-interest bearing private equity holding. The other transfers were two Endeavour International notes. The first note had a March 1, 2018 maturity date and 12% coupon. The second note had a June 1, 2018 maturity date and 12% coupon.

 

During the year ended December 31, 2014, the following were the transfers in or out of levels:

 

   Level 1   Level 2   Level 3   Total 
Senior Secured First Lien Debt  $   $(578)  $578   $ 
Senior Secured Second Lien Debt       (239)   239     
Equity Securities       (874)   874     
Total  $   $(1,691)  $1,691   $ 

 

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

 

 12 
 

 

Changes in Level 3 assets measured at fair value for the six months ended June 30, 2015 are as follows:

 

   Fair Value at
December 31,
2014
   Purchases
(Sales and
Settlement)
   Amortization
and Accretion
of Fixed
Income
Premiums and
Discounts
   Realized
and
Unrealized
Gains
(Losses)
   Fair
Value at
June 30,
2015
   Change in
Unrealized
Gains and (Losses)
for Investments
held as of
June 30, 2015
 
Senior Secured First Lien Debt  $578   $   $   $   $578   $ 
Senior Secured Second Lien Debt   239                239     
Equity Securities   874    10,400        6    11,280    6 
Total  $1,691   $10,400   $   $6   $12,097   $6 

 

Changes in Level 3 assets measured at fair value for the year ended December 31, 2014 are as follows:

 

   Fair Value at
December 31,
2013
   Purchases
(Sales and
Settlement)
   Amortization
and Accretion
of Fixed
Income
Premiums and
Discounts
   Realized
and
Unrealized
Gains
(Losses)
   Fair
Value at
December 31,
2014
   Change in
Unrealized
Gains and (Losses)
for Investments
held as of
December 31, 2014
 
Senior Secured First Lien Debt  $539   $25   $   $14   $578   $14 
Senior Secured Second Lien Debt   655            (416)   239    (416)
Equity Securities   293    648        (67)   874    (67)
Total  $1,487   $673   $   $(469)  $1,691   $(469)

 

Realized and unrealized gains and losses are included in net realized gain (loss) on investments and net change in unrealized gain (loss) on investments in the Statement of Operations. There was no change in unrealized losses for Level 3 investments still held as of June 30, 2015.

 

 The following table provides quantitative information regarding Level 3 fair value measurements as of June 30, 2015 (dollars in thousands):

 

       Valuation  Unobservable      Range 
   Fair Value   Technique  Input  Mean   Minimum   Maximum 
Senior Secured First Lien Debt  $578   Liquidation  Transaction Value  $578   $578   $578 
Senior Secured Second Lien Debt   239   Liquidation  Transaction Value   258    239    275 
Equity Securities   11,280   Liquidation  Transaction Value   11,543    11,280    11,816 
Total  $12,097                      

 

 The following table provides quantitative information regarding Level 3 fair value measurements as of December 31, 2014 (dollars in thousands):

 

       Valuation  Unobservable      Range 
   Fair Value   Technique  Input  Mean   Minimum   Maximum 
Senior Secured First Lien Debt  $578   Liquidation  Transaction Value  $578   $578   $578 
Senior Secured Second Lien Debt   239   Liquidation  Transaction Value   258    239    275 
Equity Securities   874   Liquidation  Transaction Value   1,143    870    1,416 
Total  $1,691                      

 

The primary significant unobservable input used in the fair value measurement of the Fund’s equity securities is the completion of an exchange offer by the issuer in October 2014, whereby issuer completed the exchange of 94% of its indebtedness into shares of preferred stock and warrants that represent ownership of 96% of the company. The Fund believes that the value of the notes were artificially depressed by the heavy debt load carried by the issuer, which created a threat of default and bankruptcy. The issuer’s fundamentals for the year ended June 30, 2014 reflect that it had an operating loss only as a result of impairments taken against long-term assets, and that it had a positive cash flow from operations. As a result, the Fund determined that the preferred shares and warrants into which the notes were converted should be worth at least the face value of the notes based upon the recent operating performance of the company. The primary significant unobservable input used in the fair value measurement of the Fund's Senior Secured First Lien and one of the Senior Secured Second Lien was the terms of the restructuring offered by the issuer, not yet final. The primary significant unobservable input used in the fair value measurement of the Fund's other Senior Secured Second Lien was the relevant trades (over $100,000) that occurred during the first two quarters in 2015 in the secondary market.

 

 13 
 

 

The composition of the Fund’s investments as of June 30, 2015, at amortized cost and fair value were as follows (dollars in thousands):

 

   Investments at
Amortized Cost
   Investments at
Fair
Value
   Fair Value
Percentage
of Total
Portfolio
 
Investments – Money Market  $5,267   $5,267    11.7%
Senior Secured First Lien Debt   10,679    10,411    23.2 
Senior Secured Second Lien Debt   4,488    2,528    5.6 
Senior Unsecured Debt   14,972    11,772    26.2 
Senior Subordinated Debt   4,878    3,370    7.5 
Equity Securities   12,048    11,560    25.8 
Total  $52,332   $44,908    100.0%

 

The composition of the Fund’s investments as of December 31, 2014, at amortized cost and fair value were as follows (dollars in thousands):

 

   Investments at
Amortized Cost
   Investments at
Fair
Value
   Fair Value
Percentage
of Total
Portfolio
 
Investments – Money Market  $3,104   $3,104    7.7%
Senior Secured First Lien Debt   12,141    11,721    28.9 
Senior Secured Second Lien Debt   7,131    5,694    14.0 
Senior Unsecured Debt   19,116    15,129    37.3 
Senior Subordinated Debt   5,034    4,010    9.9 
Equity Securities   880    874    2.2 
Total  $47,406   $40,532    100.0%

 

Note 4.  Related Party Transactions

 

We have entered into agreements with the Manager, whereby we pay it certain fees and reimbursements. These include payments to our Manager for reimbursement of initial organization and offering costs, as well as payments for certain services that include, but are not limited to, the identification, execution, and management of our investments and also the management of our day-to-day operations provided to us by our Manager.

 

As a business development company, we are subject to certain regulatory restrictions in making our investments. For example, we generally are not permitted to co-invest with certain entities affiliated with our Manager in transactions originated by our Manager or its affiliates unless we obtain an exemptive order from the SEC or co-invest alongside our Manager or its affiliates in accordance with existing regulatory guidance and our allocation policy. Under existing regulatory guidance, we are permitted to, and may co-invest in syndicated deals and secondary loan market transactions where price is the only negotiated point.

 

We may seek exemptive relief from the SEC to engage in co-investment transactions with our Manager and/or its affiliates. However, there can be no assurance that we will obtain such exemptive relief, if requested. Even if we receive exemptive relief, neither our Manager nor its affiliates are obligated to offer us the right to participate in any transactions originated by them. Prior to obtaining exemptive relief, we may co-invest alongside our Manager or its affiliates only in accordance with existing regulatory guidance and our allocation policy.

 

Investment Advisory Agreement

 

The Fund has entered into an investment advisory agreement with the Manager to manage the Fund’s investment activities. Pursuant to the investment advisory agreement, the Manager implements the Fund’s business strategy on a day-to-day basis and performs certain services for us, subject to oversight by our Board of Directors, or a committee thereof. The Manager is responsible for, among other duties, determining investment criteria, sourcing, analyzing and executing investment transactions, asset sales, financings and performing asset management duties. Under the investment advisory agreement, the Manager is entitled to a base management and incentive fee as outlined in the investment advisory agreement with the Fund. The base management fee is 2% of net assets below $100 million; 1.75% of net assets between $100 million and $250 million; and 1.5% of net assets over $250 million. For the three and six months ended June 30, 2015, the Fund incurred $0.2 million and $0.4 million of base management fees, respectively. For the three and six months ended June 30, 2014, the Fund incurred $0.2 million and $0.3 million of base management fees, respectively.

 

The incentive fee has two parts. The first part, the subordinated incentive fee on income, is calculated and payable quarterly in arrears based upon the Fund’s “pre-incentive fee net investment income” for the immediately preceding quarter. The subordinated incentive fee on income is 20% of pre-incentive net investment income subject to a quarterly return to investors, expressed as a rate of return on adjusted capital at the beginning of the most recently completed calendar quarter, of 2.0% (8.0% annualized). The second part of the incentive fee, the incentive fee on capital gains, is an incentive fee on capital gains earned on liquidated investments from the portfolio and is determined and payable in arrears as of the end of each calendar year (or upon termination of the investment advisory agreement). This fee equals 20% of the Fund’s incentive fee capital gains, which will equal the Fund’s realized capital gains on a cumulative basis from inception, calculated as of the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gains incentive fees. For the three and six months ended June 30, 2015 and 2014, the Fund did not incur any incentive fees related to net investment income or capital gains.

 

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

 

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

 

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

 

From time to time, the Fund has paid directly certain expenses that were classified as organization or offering expenses that should have been borne by the prior manager and for which the prior manager is obligated to reimburse the Fund. As of June 30, 2015 and December 31, 2014, the unreimbursed amount of organization and offering expenses was $9,000 and $0.2 million, respectively, which amount is included in “Due from related party” on the Fund’s balance sheet as of that date.

 

Administration Agreement

 

Our Manager serves as our administrator. Pursuant to an administration agreement, our Manager furnishes us with office facilities, equipment and clerical, bookkeeping and record keeping services at such facilities. Under the administration agreement, our Manager also performs, or oversees the performance of, our required administrative services, which include, among other things, transfer agency and other service providers supervision and oversight, preparation and supervision of the financial records for which we are required to maintain for SEC reporting, stockholder reporting and other Fund needs, implementation and supervision of a robust compliance program and oversight and administration of the quarterly share repurchase program. In addition, our Manager assists us in activities which include, among other things, performance and supervision of investor relations, Fund Board of Director communication and reporting, determining and publishing our net asset value, overseeing the preparation and filing of our tax returns, the communication, printing and dissemination of reports to our stockholders, and generally oversees the payment of our expenses and other events such as distributions, and the performance of administrative and professional services rendered to us by others. Under the administration agreement, we are obligated to reimburse our Manager for our allocable portion of our Manager’s overhead in performing its obligations under the administration agreement, including rent, the fees and expenses associated with overseeing and performing the compliance functions and our allocable portion of the compensation of our chief financial officer, chief compliance officer and any administrative support staff; however, to date, cost of the chief financial officer, fund administration accounting and the chief compliance officer are charged directly to the Fund. Under the administration agreement, our Manager will also provide on our behalf managerial assistance to those portfolio companies that request such assistance. The administration agreement also provides the reimbursement to the Fund by the Manager for the Manager’s share of the Directors and Officers insurance, which is paid by the Fund in full. The administration agreement may be terminated by either party without penalty upon 60 days’ written notice to the other party.

 

The administration agreement provides that, absent willful misfeasance, bad faith or negligence in the performance of its duties or by reason of the reckless disregard of its duties and obligations, our Manager and its officers, managers, partners, agents, employees, controlling persons, members and any other person or entity affiliated with it are entitled to indemnification from us for any damages, liabilities, costs and expenses (including reasonable attorneys’ fees and amounts reasonably paid in settlement) arising from the rendering of our Manager’s services under the administration agreement or otherwise as administrator for us.

 

Under the administration agreement, our Manager will also provide on our behalf managerial assistance to portfolio companies that request such assistance. The amount of reimbursements to our Manager or services charged directly are captured in the Statement of Operations under “Administrative Services”. During the three and six months ended June 30, 2015, the Fund reimbursed the Manager or was charged directly for $0.05 million and $0.1 million in administration expenses under the administration agreement, respectively. During the three and six months ended June 30, 2014, the Fund reimbursed the Manager or was charged directly for $0.01 million and $0.02 million in administration expenses under the administration agreement, respectively.

 

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Note 5.  Common Stock

 

Initially, the Manager purchased 111 and 22,222 shares of common stock on August 31, 2011 and December 31, 2011, respectively. These shares were purchased at a price of $9.00 per share, which represents the initial public offering (“IPO”) price of $10.00 per share, net of selling commissions and dealer manager fees. The Manager sold these shares on June 27, 2014.

 

On July 10, 2012, the Fund had raised sufficient proceeds to break escrow on its IPO and through December 31, 2014, the Fund had sold 5.5 million shares of common stock for gross proceeds of $55.5 million, including the purchases made by the Manager.

 

During the six months ended June 30, 2015, the Fund sold 767,007 shares of common stock in its offering for net proceeds of $6.1 million.

 

Note 6. Earnings (Loss) Per Share

 

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

 

The following information sets forth the computation of the weighted average basic and diluted net increase (decrease) in net assets per share from operations for the three and six months ended June 30, 2015 and 2014 (dollars in thousands except share and per share amounts):

 

   For the three
months ended
June 30,
2015
   For the three
months ended
June 30,
2014
 
Basic and diluted          
Net increase (decrease) in net assets resulting from operations  $342   $(579)
Weighted average common shares outstanding   6,199,493    4,054,473 
Net increase (decrease) in net assets resulting from operations per share  $0.06   $(0.14)

 

   For the six
months ended
June 30,
2015
   For the six
months ended
June 30,
2014
 
Basic and diluted          
Net increase (decrease) in net assets resulting from operations  $523   $(593)
Weighted average common shares outstanding   5,965,660    3,749,965 
Net increase (decrease) in net assets resulting from operations per share  $0.09   $(0.16)

 

The Fund had no potentially dilutive securities as of June 30, 2015 or June 30, 2014, resulting in the same number of shares for basic and diluted.

 

Note 7. Tender Offer Program

 

We do not currently intend to list our shares on any securities exchange and do not expect a public market for them to develop in the foreseeable future. Therefore, shareholders should not expect to be able to sell their shares promptly or at a desired price. Beginning with fourth calendar quarter of 2013 and on a quarterly basis thereafter, as approved by the Board of Directors, we intend to offer to repurchase shares of our common stock at a price equal to 90% of our offering price on the date of repurchase. We currently intend to limit the number of shares to be repurchased during any calendar year to 20% of the weighted average number of shares outstanding in the prior calendar year, or 5.0% in each quarter, though the actual number of shares that we offer to repurchase may be less in light of the limitations noted above. We will offer to repurchase such shares on each date of repurchase at a price equal to 90% of our offering price. For the three months ended March 31, 2015, 5,811 treasury shares were repurchased at $8.775 for the total consideration of $0.05 million. A tender offer was conducted in the second quarter but because proper notifications were not distributed to the shareholders in a timely manner, the offer was extended until July 29, 2015 and therefore the number of shares tendered are not reflected on the June 30, 2015. Please see subsequent events for more information.

 

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

  

For the Three Months Ended  Repurchase Date  Shares
Repurchased
   Percent of
Shares
Tendered that
were
Repurchased
   Repurchase
Price Per
Share
   Aggregate
Consideration
for
Repurchased 
Shares ('000s) *
 
March 31, 2014  March 14, 2014   550    100%  $9.135   $5 
June 30, 2014  June 27, 2014   34,025    100%  $9.135    319 
September 30, 2014  September 30, 2014   38,482    100%  $9.135    346 
December 31, 2014  December 30, 2014   6,061    100%  $8.775    55 
March 31, 2015  March 30, 2015   5,811    100%  $8.775    51 
June 30, 2015  July 29, 2015**   -    -   $-    - 
                     $776 

 

* The difference between increase in treasury capital and aggregate consideration for repurchased shares is allocated to the capital/owners, equity account dealer fees.

** There were no shares repurchased during the quarter ended June 30, 2015. Additionally, the tender offer date expired on June 30, 2015 but was extended to July 29, 2015 because proper notifications were not distributed to the shareholders timely.

 

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

 

Note 8.  Distributions

 

Subject to our board of trustees' discretion and applicable legal restrictions, we authorize and declare ordinary cash distributions on a semi-monthly basis and pay such distributions on a semi-monthly basis. Any distributions to our shareholders will be declared out of assets legally available for distribution. We may fund our cash distributions to shareholders from any sources of funds available to us, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, and dividends or other distributions paid to us on account of preferred and common equity investments in portfolio companies. We have not established limits on the amount of funds we may use from available sources to make distributions.

 

When we commenced operations, we initiated a policy of declaring semi-monthly distributions at an annual distribution rate of 7.35% per annum of our offering price. We have authorized, declared and paid distributions to our shareholders at that rate on a semi-monthly basis since July 2012. Based upon our current level of operations, we estimate that about 80% of our distributions will constitute a return of capital. Our distributions historically have not been based on our investment performance. Prior to September 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities.

 

As of June 30, 2015, the Fund has accrued $0.2 million in stockholder distributions that were unpaid. This amount with record date of June 29, 2015 and paid on July 15, 2015 has been accrued in the June 30, 2015 financial statements. As of December 31, 2014, the Fund accrued $0.2 million in stockholder distributions that were unpaid. This amount, with record date of December 29, 2014 and paid on January 15, 2015 was accrued in the December 31, 2014 financial statements.

 

 17 
 

 

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

 

Source of Distribution by Cash vs. DRIP:

 

       Net
Investment
   Realized
Gain From
   Return of       Paid in     
Period  Per Share   Income   Investments   Capital   Total   Cash   DRIP 
July 12, 2012 - September 30, 2012  $0.183750   $32   $-   $18   $50   $34   $16 
October 1, 2012 - December 31, 2012 *   0.260750    118    -    82    200    123    77 
January 1, 2013 -March 31. 2013 *   0.262586    247    47    75    369    221    148 
April 1, 2013 - June 30, 2013   0.186504    235    43    27    305    186    119 
July 1, 2013 - September 30, 2013   0.186504    244    47    183    474    274    200 
October 1, 2013 - December 31, 2013   0.186504    72    258    219    549    345    204 
January 1, 2014 - March 31, 2014   0.186504    168    85    379    632    405    227 
April 1, 2014 - June 30, 2014   0.186504    372    -    382    754    491    263 
July 1, 2014 - September 30, 2014   0.184668    135    29    644    808    511    297 
October 1, 2014 – December 31, 2014   0.181452    144    52    748    944    584    360 
January 1, 2015 – March 31, 2015   0.179154    153    52    824    1,029    652    377 
April 1, 2015 - June 30, 2015   0.179154    705    163    243    1,111    719    392 
TOTAL  $2.364034   $2,625   $776   $3,824   $7,225   $4,545   $2,680 

 

* Includes a special distribution of $0.077 per share.

 

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

 

Percentage of Distributions by Source:

 

       Net   Realized     
       Investment   Gain From   Return of 
Period  Per Share   Income   Investments   Capital 
July 12, 2012 - September 30, 2012  $0.183750    64%   0%   36%
October 1, 2012 - December 31, 2012   0.260750    59%   0%   41%
January 1, 2013 -March 31. 2013   0.262586    67%   13%   20%
April 1, 2013 - June 30, 2013   0.186504    77%   14%   9%
July 1, 2013 - September 30, 2013   0.186504    51%   10%   39%
October 1, 2013 - December 31, 2013   0.186504    4%   47%   49%
January 1, 2014 - March 31, 2014   0.186504    27%   13%   60%
April 1, 2014 - June 30, 2014   0.186504    46%   0%   54%
July 1, 2014  - September 30, 2014   0.184668    17%   3%   80%
October 1, 2014 – December 31, 2014   0.181467    13%   6%   81%
January 1, 2015 – March 31, 2015   0.179154    15%   5%   80%
April 1, 2015 - June 30, 2015   0.179154    63%   15%   22%

 

The following table reflects the sources of the distributions on a tax basis that the Fund has paid on its common stock (dollars in thousands) during the six months ended June 30, 2015 and the fiscal years ended December 31, 2014, 2013 and 2012:

 

   Six months ended   Year ended   Year ended   Year ended 
Source of Distributions:  June 30, 2015   December 31, 2014   December 31, 2013   December 31, 2012 
Distributions from net investment income  $858  

 

40.1%  $819    26.1%  $798    47.0%  $150    60.0%
Distributions from realized gains   215    10.0%   166    5.3%   395    23.3%   -    0.0%
Distributions from paid In capital   1,067    49.9%   2,153    68.6%   504    29.7%   100    40.0%
TOTAL  $2,140    100.0%  $3,138    100.0%  $1,697    100.0%  $250    100.0%

 

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

 

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

 

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We are in a fund raising stage. As such, we incur offering expenses of 1.5% of the gross offering proceeds. The chart below shows the percentages of distributions from Net Investment Income excluding offering costs:

 

      Offering
Expenses
    Net Investment
Income
excluding
offering costs
    % Distribution
from Net
Investment
Income
excluding
offering costs
    % Distributions
from Realized
Gains excluding
offering costs
    % Distributions
from Paid In
Capital
excluding
offering costs
 
2015     $ 96     $ 954       45 %     10 %     45 %
2014     $ 352     $ 1,171       37 %     5 %     58 %
2013     $ 322     $ 1,120       66 %     23 %     11 %
2012     $ 142     $ 292       100 %     0 %     0 %

 

Note 9.  Financial Highlights

 

The following is a schedule of financial highlights for the six months ended June 30, 2015 and 2014:

 

   For the six
months
ended 
June 30, 2015
   For the six
months ended
June 30, 2014
 
Per share data:          
Net asset value, beginning of period  $7.34   $8.70 
           
Results of operations (1)          
Net investment income   0.14    0.14 
Net realized gain on investments   0.04    0.02 
Net unrealized loss on investments   (0.09)   (0.32)
           
Net increase (decrease) in net assets resulting from operations   0.09    (0.16)
           
Stockholder distributions (2)          
Distributions from net investment income   (0.14)   (0.14)
Distributions from realized gains   (0.04)   (0.02)
Distributions from capital   (0.18)   (0.21)
Net decrease in net assets resulting from stockholder distributions   (0.36)   (0.37)
           
Capital share transactions          
Impact from issuance of common stock (3)   0.19    0.15 
Net increase in net assets resulting from capital share transactions   0.19    0.15 
Net asset value, end of period  $7.26   $8.32 
Shares outstanding at end of period   6,313,300    4,067,009 
Total return (5)   2.47%   (0.60)%
Ratio/Supplemental data:          
Net assets, end of period (in thousands)  $45,850   $33,823 
Average net assets (in thousands)  $42,140   $30,091 
Ratio of net investment income to average net assets (4)(7)   4.11%   3.62%
Ratio of operating expenses to average net assets (4)(7)   7.02%   7.51%
Portfolio turnover ratio (6)   33.15%   28.75%

 

(1) The per share amounts were derived by using the weighted average shares outstanding during the period. There was no expense waiver and reimbursement for the six months ended June 30, 2015 and 2014.
(2) The per share data for distributions reflects the actual amount of distributions declared per share during the period.
(3) The issuance of common stock on a per share basis reflects the incremental net asset value changes as a result of the issuance of shares of common stock in the Fund's continuous offering.
(4) The ratios are after giving effect to amounts reimbursed by the Manager under an expense reimbursement agreement. See “Note 4 – Related Party Transactions.” For the six months ended June 30, 2015 and 2014, there was no expense waiver and reimbursement.
(5) Total return is calculated assuming a purchase of shares at the current net asset value on the first day and a sale at the current net asset value on the last day of the periods reported. Distributions, if any, are assumed for purposes of this calculation to be reinvested at prices obtained under the DRIP. For the six months ended June 30, 2015 and 2014, there was no expense reimbursement.
(6) Portfolio turnover rate is calculated using the lesser of year-to-date sales or purchases over the average of the invested assets at fair value. Not annualized.

(7) Ratios are annualized based on average net assets using current and prior 3 quarters net assets.

 

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Note 10.  Subsequent Events

 

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

 

On July 30, 2015 Relativity Media, LLC filed for chapter 11 bankruptcy. The Fund made a convertible preferred equity investment that is the senior most equity investment in the capital structure. We are working with the company and the management team via our co-optivist approach to restructure the company’s balance sheet through the bankruptcy process.

 

On August 10, 2015, the Fund received a notice for mandatory full call from Euramax International, Inc. 9.50%. Senior Secured Second Lien debt due June 1, 2018 at par plus accrued interest.

 

On May 18th, 2015, the Board of Directors approved a tender offer for 214,082 shares of its issued and outstanding common stock, which represents 5% of the weighted average number of shares outstanding for the calendar year ended December 31, 2014. The offer originally expired on June 30, 2015, but because proper notification was not sent to the shareholders in a timely manner, the offer was extended to July 29, 2015. Subsequent to June 30, 2015, the Fund received tender offer requests for 311,937 shares. Since the amount of repurchase requests exceeded the number of shares the Fund would repurchase, the Fund repurchased shares on a pro rata basis. A total of 27 investors requested to tender their shares and each investor received 69% of their request. The offer is for cash at a price equal to 90% of the offering price on July 29, 2015, which was $8.78. The total dollar amount of this tender offer transaction was $1,878,570.

 

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

 

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

 

Forward-Looking Statements

 

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

 

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

  

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

 

  a limited pool of prospective target businesses;

 

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

 

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

 

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

 

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

 

Overview

 

We invest in discounted corporate debt and equity-linked debt securities of companies that have a perceived risk of near term liquidity issues but have solid business fundamentals and prospects, including historical revenue growth, positive cash flow, significant and sustainable market presence, and sufficient asset coverage. We take a principal position in discounted debt securities with the primary goal of restructuring the terms of the debt to allow the target company to increase its liquidity and strengthen its balance sheet. Our typical target company has a debt redemption event (typically either a put or maturity event) on average within 24 months of our investment and has experienced a significant decline in its equity value reflective of a highly leverage capital structure or general market conditions. We believe that proactively guiding such companies to restructure their debt will allow them to increase liquidity and free up resources to grow their businesses rather than focusing on managing their debt obligations. We also believe that our involvement can allow the target company more flexibility to explore strategic alternatives, since the terms of the existing debt structure often limits strategic options for the target company.

 

Our investment activities are managed by our Manager. Our Manager is responsible for sourcing potential investments, conducting research on prospective investments, analyzing investment opportunities, structuring our investments, and monitoring our investments and portfolio companies on an ongoing basis.

 

Our Manager has an investment committee that is responsible for reviewing, discussing and approving each investment opportunity we seek to pursue. Our investment committee meets routinely to discuss new and existing opportunities and developments on current investments.

 

 20 
 

 

Critical Accounting Policies

 

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

 

Valuation of Portfolio Investments

 

The investment portfolio is recorded on a trade date basis. We determine the net asset value of our investment portfolio each quarter. Securities that are publicly-traded are valued at the reported closing price on the valuation date. Thirty-six of the forty investments were valued using the closing market price at period end June 30, 2015. The exceptions were the investment in Education Management LLC, restructured to private equity in the quarter, and the two notes from Endeavour International Corp., one with a 12.00% interest rate and maturity date of June 1, 2018, the second with a 12.00% interest rate and maturity date of March 1, 2018 and Relativity Media, LLC. Endeavour International Corp. made its intent to restructure during the quarter, with the specific terms not yet finalized.

 

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

 

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

 

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

 

  preliminary valuation conclusions are then documented and discussed with the members of our Board of Directors, or a committee thereof; and

 

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

 

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

 

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

 

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

 

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

 

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Level 2:  Quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets or liabilities in markets that are not active, or other observable inputs other than quoted prices. USBank is the fund custodian. Through USBank, the fund uses FT Interactive, a third party valuation firm, to price the notes. The prices are reviewed by the CEO.

 

Level 3: Unobservable inputs for the asset or liability. These investments for the fund are three equity securities, a Senior Secured First Lien Note, and a Senior Secured Lien Note. Two of the equity investments have been issued by a company with terms settled. Their fair value was determined by their relative amount of the total company enterprise value. The other equity investment is being carried at cost since we just completed the transaction. The terms of Senior Secured First Lien Note and Senior Secured Second Lien Note, however, have not been finalized. The fair value was derived from the relative amounts of the notes to the total enterprise value as indicated would be the intended restructuring by the issuer.

 

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

 

Revenue Recognition

 

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

 

For loans and debt securities with contractual payment-in-kind (“PIK”) interest, which represents contractual interest accrued and added to the principal balance, we generally will not accrue PIK interest for accounting purposes if the portfolio company valuation indicates that such PIK interest is not collectible. We do not accrue as a receivable interest on loans and debt securities for accounting purposes if we have reason to doubt our ability to collect such interest. Original issue discounts, market discounts or premiums are accreted or amortized using the effective interest method as interest income. We record prepayment premiums on loans and debt securities as interest income. Dividend income, if any, is recognized on an accrual basis to the extent that we expect to collect such amount. We record prepayment premiums on loans and debt securities as interest income when we receive such amounts. In addition, we may generate revenue in the form of commitment, origination, structuring or diligence fees, monitoring fees, fees for providing managerial assistance and possibly consulting fees and performance-based fees. Any such fees generated in connection with investments will be recognized when earned.

 

Loans and debt securities, including those that are individually identified as being impaired under Accounting Standards Codification 310 — Receivables, or ASC 310, are generally placed on nonaccrual status immediately if, in the opinion of management, principal or interest is not likely to be paid in accordance with the terms of the debt agreement, or when principal or interest is past due 90 days or more. Interest accrued but not collected at the date a loan or security is placed on nonaccrual status is reversed against interest income. Interest income is recognized on nonaccrual loans or debt securities only to the extent received in cash. However, where there is doubt regarding the ultimate collectability of principal, cash receipts, whether designated as principal or interest, are thereafter applied to reduce the carrying value of the loan or debt security. Loans or securities are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured.

  

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

 

We measure realized gains or losses by the difference between the net proceeds from the repayment or sale and the weighted-average amortized cost of the investment, without regard to unrealized appreciation or depreciation previously recognized, but considering unamortized upfront fees and prepayment penalties. Net change in unrealized appreciation or depreciation reflects the change in portfolio investment values during the reporting period, including any reversal of previously recorded unrealized appreciation or depreciation when gains or losses are realized.

 

Payment-in-Kind Interest

 

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

 

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Organizational and Offering Costs

 

The Fund is a closed-end fund with a continuous offering period. Organization costs include, among other things, the cost of organizing us as a Maryland corporation, including the cost of legal services and other fees pertaining to our organization. Offering expenses include, among other things, legal fees and other costs pertaining to the preparation of our registration statement in connection with the Fund’s continuous offering. Under the investment advisory agreement between the Fund and the Manager, our Manager fronted the cost of the organizational and offering expenses which are reimbursable by the Fund with up to 1.5% of the gross offering proceeds. The Fund expenses organizational and offering costs as they become payable under the investment advisory agreement.

 

U.S. Federal Income Taxes

 

The Fund has elected to be treated for federal income tax purposes as a RIC under subchapter M of the Code and to operate in a manner so as to qualify for the tax treatment applicable to RICs. In order to qualify as a RIC, among other things, the Fund is required to annually distribute to its stockholders at least 90% of investment company taxable income, as defined by Internal Revenue Code of 1986, or (the “Code”). So long as the Fund maintains its status as a RIC, it generally will not pay corporate-level U.S. federal income taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as distributions. Rather, any tax liability related to income earned by the Fund represents obligations of the Fund’s investors and will not be reflected in the financial statements of the Fund. The Fund will also be subject to nondeductible federal excise taxes if it does not distribute at least 98% of net ordinary income, 98.2% of capital gain net income, if any, and any recognized and undistributed income from prior years for which it paid no federal income taxes.

 

Portfolio and Investment Activity

 

During the six months ended June 30, 2015, we made $14.8 million of investments in new portfolio companies and had $10.7 million in aggregate amount of exits and repayments, resulting in net investments of $4.1 million for the period. During the six months ended June 30, 2014, we made $15.3 million of investments in new portfolio companies and had $7.3 million in aggregate amount of exits and repayments, resulting in net investments of $8.0 million for the period.

 

As of June 30, 2015, we have invested an aggregate of approximately $47.1 million in 40 investment positions in 32 portfolio companies. At June 30, 2015, the fair value of our investment positions was $40.6 million (excluding cash and including the accrued interest of $0.9 million). As of such date, our estimated gross annual portfolio current yield was 9.53% and gross annual portfolio yield to maturity was 10.82% based on the purchase price of our investments. The average duration of our portfolio was approximately 2.7 years. During the six months ended June 30, 2015, we exited 9 portfolio companies in full and 1 partially for aggregate sales proceeds of $10.7 million. As of June 30, 2015, we had one portfolio investment in default of payment of its par value at maturity date, Suntech Power Holdings Company, with a fair value of $1 which represented a negligible amount of our total portfolio. As of June 30, 2015, in addition to the investment in maturity date default, seven additional investments had not paid coupon interest as due beyond the thirty day grace period. These investments are Colt Defense LLC, 8.75%, November 15, 2017; Caesars Entertainment Corp, 11.25%, June 1, 2017; Caesars Entertainment Corp, 10.75%, February 1, 2016; Endeavour International Corp., 12%, March 1, 2018; Endeavour International Corp., 12%, June 1, 2018; QuickSilver Resources, Inc., 7.13%, April 1, 2016; and Saratoga Resources, Inc., 12.50% July 1, 2016. Interest on these investments was accrued through the date that the last coupon payment was received. These investments were placed in a nonaccrual status. Two other investments, Education Management, LLC and NII Holdings were restructured as a private equity instruments, and no longer have income producing attributes.

 

The following table presents our portfolio composition based on fair value as of June 30, 2015:

 

   As of June 30, 2015 
   Percentage of
Total Portfolio
   Weighted
Average Current
Coupon Yield  
 
Investments – Money Market   11.7%   %
Senior Secured First Lien Debt   23.2    9.1 
Senior Secured Second Lien Debt   5.6    10.9 
Senior Unsecured Debt   26.2    9.9 
Senior Subordinated Debt   7.5    9.6 
Equity Securities   25.8    n/a 
Total   100.0%   9.5%

 

 As of June 30, 2015, our debt investment portfolio had a yield to maturity of 10.82%, and an average duration of 2.70 years.

 

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The following table presents our portfolio composition based on fair value as of December 31, 2014:

 

   As of December 31, 2014 
   Percentage of
Total Portfolio
   Weighted
Average Current
Coupon Yield
 
Investments – Money Market   7.7%   %
Senior Secured First Lien Debt   28.9    9.5 
Senior Secured Second Lien Debt   14.0    10.5 
Senior Unsecured Debt   37.3    9.9 
Senior Subordinated Debt   9.9    9.6 
Equity Securities   2.2    n/a 
Total   100.0%   10.0%

 

 As of December 31, 2014, our investment portfolio had a yield to maturity of 10.35%, and an average duration of 2.55 years.

 

The following table shows the portfolio composition by industry grouping at fair value as of June 30, 2015 (dollars in thousands):

 

   As of June 30, 2015 
   Investments at
Fair Value
   Percentage of
Total
Portfolio
 
Media: Advertising, Printing & Publishing  $14,404    32.1%
Investments – Money Market   5,267    11.7 
Metals & Mining   4,293    9.5 
Retail   3,850    8.6 
Automobile   2,624    5.8 
Aerospace and Defense   2,596    5.8 
Telecommunications   2,523    5.6 
Energy: Oil & Gas   2,361    5.3 
Services: Consumer   2,198    4.9 
Healthcare and Pharmaceuticals   1,297    2.9 
Media: Broadcasting & Subscription   1,127    2.5 
Environmental Industries   994    2.2 
Hotel, Gaming & Leisure   804    1.8 
Beverage, Food & Tobacco   570    1.3 
Total  $44,908    100.0%

 

The following table shows the portfolio composition by industry grouping at fair value as of December 31, 2014 (dollars in thousands):

 

   As of December 31, 2014 
   Investments
at
Fair Value
   Percentage of
Total
Portfolio
 
Retail  $5,827    14.4%
Media: Advertising, Printing & Publishing   4,163    10.3 
Healthcare & Pharmaceuticals   3,547    8.7 
Services: Consumer   3,497    8.6 
Investments – Money Market   3,104    7.7 
Telecommunications   2,798    6.9 
Aerospace and Defense   2,790    6.9 
Metals & Mining   2,723    6.7 
Consumer Goods: Durable   2,686    6.6 
Energy: Oil & Gas   2,505    6.2 
Services: Business   1,430    3.5 
Automobile   1,337    3.3 
Media: Broadcasting & Subscription   1,201    3.0 
High Tech Industries   858    2.1 
Environmental Industries   795    2.0 
Hotel, Gaming & Leisure   704    1.7 
Beverage, Food & Tobacco   567    1.4 
Total  $40,532    100.0%

 

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Our fair value of total investments was $44.9 million as of June 30, 2015 as compared to $40.5 million as of December 31, 2014. The portfolio increase in the three and six months ending June 30, 2015 is mainly due to invested proceeds from continuous investor closings.

 

Results of Operations

 

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

 

Operating results for the three and six months ended June 30, 2015 and 2014 are as follows (dollars in thousands):   

 

   For the three
months ended
June 30, 2015
   For the three
months ended
June 30, 2014
 
Total investment income  $1,412   $951 
Total expenses, net   707    579 
Net investment income   705    372 
Net realized gains from investments   163    - 
Net unrealized depreciation on investments   (526)   (951)
Net increase (decrease) in net assets resulting from operations  $342   $(579)

 

   For the six
months ended
June 30, 2015
   For the six
months ended
June 30, 2014
 
Total investment income  $2,326   $1,661 
Total expenses, net   1,468    1,121 
Net investment income   858    540 
Net realized gains from investments   215    85 
Net unrealized depreciation on investments   (550)   (1,218)
Net increase (decrease) in net assets resulting from operations  $523   $(593)

 

Revenues

 

We generated investment income of $1.4 million and $2.3 million for the three and six months ended June 30, 2015, as compared to $1.0 million and $1.7 million for the three and six months ended June 30, 2014. Interest revenue was $0.9 million and $1.8 million for the three and six months ended June 30, 2015, as compared to $0.8 million and $1.6 million for the three and six months ended June 30, 2014. The increase in interest revenue in 2015 as compared to 2014 was attributable to an increase in the average size of our debt portfolio, offset by an increase in debt investments placed on non-accrual status. Other income was $0.6 million and $0.6 million for the three and six months ended June 30, 2015, as compared to $0.1 million and $0.1 million for the three and six months ended June 30, 2014. The substantial increase in other income in 2015 as compared to 2014 is the result of fee income derived from an equity investment in Relativity Media in the second quarter of 2015.

 

Interest from investments is in the form of interest and fees earned on senior secured loans, senior secured notes, subordinated debt, senior unsecured debt and collateralized securities in our debt portfolio. Our debt portfolio constituted approximately 71.8% of investment portfolio at June 30, 2014 (excluding money market investments). The level of income we receive is directly related to the balance of collectible income producing investments multiplied by the weighted average yield of our investments, offset by debt investments held in non-accrual status. We expect the dollar amount of interest and any dividend income that we earn to increase as the size of our investment portfolio increases. With the continuous offerings and periodic closings through April 30, 2015, the assets available for and deployed to investment received a boost. The average balance of the debt portfolio during the three and six months ended June 30, 2015 was significantly higher than the same periods in fiscal 2014, resulting in the increase in interest income. At June 30, 2015, the weighted average coupon yield was 9.5%, as compared to the 10.5% as of June 30, 2014. For the six months ended June 30, 2015, the average net assets were $42.1 million, as compared to $30.1 million for the six months ended June 30, 2014.

 

For the six months ended June 30, 2015, eight of the investments in the debt portfolio did not accrue interest as the issuers were in default of the coupon payment for more than the thirty day grace period. Interest income was accrued through the date of the last coupon payment received for these investments. These eight are Colt Defense LLC, 8.75%, November 15, 2017; Caesars Entertainment Corp, 11.25%, June 1, 2017; Caesars Entertainment Corp, 10.75%, February 1, 2016; Endeavour International Corp., 12%, March 1, 2018; Endeavour International Corp., 12%, June 1, 2018; QuickSilver Resources, Inc., 7.13%, April 1, 2016; Saratoga Resources, Inc., 12.50% July 1, 2016; and Suntech Power Holdings Company, Ltd., 3%, May 15, 2013. Two other investments, Education Management, LLC and NII Holdings were restructured as a private equity instruments, and no longer have income producing attributes.

 

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

 

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Expenses

 

The composition of our operating expenses for the three and six months ended June 30, 2015 and 2014 was as follows (dollars in thousands):

  

   For the three
months ended
June 30, 2015
   For the three
months ended
June 30, 2014
 
Professional fees  $134   $78 
Director fees   12    13 
Insurance   24    24 
Management fees   229    168 
Administrative services – related parties   54    12 
General and administrative   214    262 
Offering expense   40    22 
Total operating expenses  $707   $579 

 

   For the six
months ended
June 30, 2015
   For the six
months ended
June 30, 2014
 
Professional fees  $230   $136 
Director fees   30    27 
Insurance   48    47 
Management fees   444    335 
Administrative services – related parties   108    24 
General and administrative   512    416 
Offering expense   96    136 
Total operating expenses  $1,468   $1,121 

 

For the six months ended June 30, 2015 and 2014, our operating expenses were $1.5 million and $1.1 million, respectively. For the three months ended June 30, 2015 and 2014, our operating expenses were $0.7 million and $0.6 million, respectively. The rise in expenses for the three and six months ended June 30, 2015 as compared to the three and six months ended June 30, 2014, was due to higher management fees, administrative services, professional fees and general and administrative in 2015 as the operation of the Fund have increased. The increase in expenses in the six months ended June 30, 2015 as compared to June 30, 2014 was offset by lower offering expenses as an update to our registration statement was delayed approval, which reduced the gross proceeds in our continuous offering. The amount of offering costs is directly related to the gross offering price of shares sold in the period. Professional fees were lower in 2014, as less legal and audit support was needed.

 

The management fees for the three and six months ended June 30, 2015 and 2014 remain at 2% of the net asset value. The offering costs are consistent at 1.5% of the gross closing proceeds for the three months ended June 30, 2015 and 2014.

 

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Net Investment Income

 

Our net investment income totaled $0.7 million and $0.4 million for the three months ended June 30, 2015 and 2014, respectively. Our net investment income totaled $0.9 million and $0.5 million for the six months ended June 30, 2015 and 2014, respectively. Our net investment income is derived from investment income less operating expenses for the period.

 

The increase in net investment income in the three months ended June 30, 2015 as compared to the three months ended June 30, 2014 is primarily due to an increase in other income derived from an equity investment in Relativity Media, and to a lesser extent by a higher interest earnings on our debt portfolio, which was offset by an increase in operating expenses during each period.

 

Net Realized Gains or Losses from Investments

 

For the three and six months ended June 30, 2015, we had $10.2 million and $12.3 million of principal repayments, resulting in $0.2 million and $0.2 million of realized gains, respectively. For the three and six months ended June 30, 2014, we had $3.0 million and $7.3 million of principal repayments, resulting in $0.1 thousand and $0.1 million of realized gains, respectively.

 

Net Change in Unrealized Appreciation or Depreciation on Investments

 

For the three and six months ended June 30, 2015, we experienced $0.5 million and $0.6 million of unrealized depreciation, respectively. For the three and six months ended June 30, 2014, we experienced $1.0 million and $1.2 million of unrealized depreciation, respectively. The global bond markets finished the second quarter with negative returns, as a sharp increase in European government bonds set the tone for the rest of the world. In addition, investors began to position for what appears to be a growing likelihood that the U.S. Federal Reserve will start to raise interest rates before the end of 2015. These circumstances had the largest negative impact on the most rate sensitive market segments, including U.S. Treasuries, higher-quality bonds, and longer-term debt. However, the market’s credit sectors— most notably high-yield and emerging-market bonds—outperformed thanks to the backdrop of positive global growth, favorable credit conditions, and investors’ continued appetite for yield. During the second quarter, high-yield bonds enjoyed two solid months in April and May. These were followed by retreating prices in June, prompted by an uptick in defaults and concern about the increasing likelihood of debt-strapped Greece defaulting on its payment of roughly €1.6 billion due to the International Monetary Fund by June 30.

 

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

 

Changes in Net Assets from Operations

 

For the three and six months ended June 30, 2015, we recorded a net increase in net assets resulting from operations of $0.3 million and $0.5 million, respectively. For the three and six months ended June 30, 2015, this increase is mainly due to net investment income of $0.7 million and $0.9 million, respectively, and net realized gain from investment of $0.2 million and $0.2 million, respectively, earned on our portfolio investments, partially offset by net unrealized depreciation of $0.5 million and $0.6 million, respectively. Based on 6,199,493 and 5,965,660 weighted average common shares outstanding for the three and six months ended June 30, 2015, our per share net increase in net assets resulting from operations was $0.06 and $0.09, respectively.

 

For the three and six months ended June 30, 2014, we recorded a net decrease in net assets resulting from operations of $0.6 million and $0.6 million, respectively. Based on 4,054,473 and 3,749,965 weighted average common shares outstanding for the three and six months ended June 30, 2014, respectively, our per share net decrease in net assets resulting from operations was $0.14 and $0.16, respectively.

 

Liquidity and Capital Resources

 

We generate cash primarily from the net proceeds of our ongoing continuous public offering and from cash flows from fees, interest and dividends earned from our investments as well as principal repayments and proceeds from sales of our investments. On July 10, 2012, we satisfied our minimum offering requirement of raising gross offering proceeds in excess of $1.0 million from persons who are not affiliated with us or our Manager, and commenced operations. As of June 30, 2015, we had issued 6.4 million shares of common stock, including 0.3 million shares under our distribution reinvestment plan (“DRIP”) less 0.09 million shares redeemed under our tender offer. As of June 30, 2015, we had received gross proceeds from our continuous offering of total $63.4 million, including $2.6 million under our DRIP less $0.8 paid to redeem shares in our quarterly tender offers.

 

We currently sell our shares on a continuous basis at a current offering price of $9.75; however, to the extent that our net asset value per share increases, we will sell at a price necessary to ensure that our shares are not sold at a price, after deduction of selling commissions and dealer manager fees, that is below our net asset value per share.

 

Prior to investing in portfolio securities, we invest the net proceeds from our continuous offering primarily in money market funds that invest in U.S. government securities and high-quality debt instruments maturing in one year or less from the time of investment. As of June 30, 2015 and December 31, 2014, we had $5.3 million and $3.1 million, respectively, invested in money market investments pending investment in debt instruments.

 

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For the six months ended June 30, 2015, we experienced a net increase in money market investments of $2.2 million. For the six months ended June 30, 2015, approximately $4.7 million was generated from our financing activities, which primarily consisted of $6.0 million in net offering proceeds received, offset by $1.4 million in distributions. We used approximately $4.7 million of cash in our operating activities primarily as the result of the purchase of new portfolio debt investments of $14.9 million, offset by the receipt of proceeds from the sale of, repayment of and principal payments on portfolio investments of $12.3 million.

 

We have thus far not borrowed any funds to make investments. In the future, however, if the market for debt financing presents attractively priced debt financing opportunities, or if our Board of Directors determines that leveraging our portfolio would be in our best interests and the best interests of our shareholders, we may decide to borrow funds to make investments. We do not currently anticipate issuing any preferred shares.

 

Distributions

 

Subject to our board of trustees' discretion and applicable legal restrictions, we authorize and declare ordinary cash distributions on a semi-monthly basis and pay such distributions on a semi-monthly basis. Any distributions to our shareholders will be declared out of assets legally available for distribution. We may fund our cash distributions to shareholders from any sources of funds available to us, including offering proceeds, borrowings, net investment income from operations, capital gains proceeds from the sale of assets, non-capital gains proceeds from the sale of assets, and dividends or other distributions paid to us on account of preferred and common equity investments in portfolio companies. We have not established limits on the amount of funds we may use from available sources to make distributions.

 

When we commenced operations, we initiated a policy of declaring semi-monthly distributions at an annual distribution rate of 7.35% per annum of our offering price. We have authorized, declared and paid distributions to our shareholders at that rate on a semi-monthly basis since July 2012. Based upon our current level of operations, we estimate that about 80% of our distributions will constitute a return of capital. Our distributions historically have not been based on our investment performance. Prior to September 30, 2013, our distributions were supported by our Manager in the form of operating expense support payments to us, and a portion of our distributions constituted a return of capital. Since September 30, 2013, we have not had an expense support agreement with our Manager and as a result a greater portion of our distributions have constituted a return of capital. A return of capital generally is a return of your investment rather than a return of earnings or gains derived from our investment activities.

 

We expect to continue making distributions at the same distribution rate unless our results of operations, our general financial condition, general economic conditions, or other factors prohibit us from doing so. From time to time, but not less than quarterly, we review our accounts to determine whether distributions to our shareholders are appropriate. There can be no assurance that we will be able to sustain distributions at any particular level.

 

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

 

The determination of the tax attributes of our distributions is made annually as of the end of our fiscal year based upon our taxable   income for the full year and distributions paid for the full year. Therefore, a determination made on a quarterly basis may not be representative of the actual tax attributes of our distributions for a full year. The actual tax characteristics of distributions to shareholders are reported to shareholders annually on a Form 1099-DIV.

 

Distribution Reinvestment Plan

 

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

 

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We are in a fund raising stage. As such, we incur offering expenses of 1.5% of the gross offering proceeds. The chart below shows the percentages of distributions from Net Investment Income excluding offering costs:

 

      Offering
Expenses
    Net Investment
Income
excluding
offering costs
    % Distribution
from Net
Investment
Income
excluding

offering costs
    % Distributions
from Realized
Gains excluding
offering costs
    % Distributions
from Paid In
Capital
excluding

offering costs
 
2015     $ 96     $ 954       45 %     10 %     45 %
2014     $ 352     $ 1,171       37 %     5 %     58 %
2013     $ 322     $ 1,120       66 %     23 %     11 %
2012     $ 142     $ 292       100 %     0 %     0 %

 

Election as a RIC

 

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

 

Related-Party Transactions and Agreements

 

We have entered into agreements with the Manager, whereby we pay certain fees and reimbursements. These include payments to our Manager for reimbursement of organization and offering costs. In addition, we make payments for certain services that include, but are not limited to, the identification, execution, and management of our investments and also the management of our day-to-day operations provided to us by our Manager, pursuant to various agreements that we have entered into. See Note 4 to the financial statements included elsewhere in this quarterly report on Form 10-Q for additional information regarding such contractual obligations.

 

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

 

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

 

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

 

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

 

Off-Balance Sheet Arrangements

 

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

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

We are subject to financial market risks, including changes in interest rates. Any investments we make that are denominated in a foreign currency will be subject to risks associated with changes in currency exchange rates. These risks include the possibility of significant fluctuations in the foreign currency markets, the imposition or modification of foreign exchange controls and potential illiquidity in the secondary market. These risks will vary depending upon the currency or currencies involved.

 

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

 

Assuming that our current balance sheet was to remain constant and no actions were taken to alter our existing interest rate sensitivity, a 100 basis point move in interest rates up or down from their June 30, 2015 levels would result in an increase or decrease in net asset value of $0.4 million or 0.78%.

 

Item 4. Controls and Procedures

 

Disclosure Controls

 

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

 

Change in Internal Control over Financial Reporting

 

During the quarter ending June 30, 2015, we determined that a material weakness in internal control over financial reporting existed relating to the determination of offering expenses that should have been borne by our Fund manager instead of us, and reimbursed to our manager at the rate of 1.5% of gross offering proceeds in accordance with our investment management agreement with the Fund manager, and that the material weakness existed from the fourth quarter of 2013 to the end of fiscal 2014, including at December 31, 2013 and 2014 when management had previously concluded that its internal controls were effective.  In response, in 2015 we implemented additional controls whereby officers will map out financial statement line items to the relevant portions of the agreements with our Fund manager to ensure compliance and proper accounting for amounts due thereunder.  We believe the material weakness has been remediated by the additional controls and procedures that have been implemented.

 

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PART II

 

OTHER INFORMATION

 

Item 1. Legal Proceedings

 

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

 

Item 1A. Risk Factors

 

There have been no material changes from the risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2014.

 

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

 

Not applicable.

 

Item 3. Defaults upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable.

 

Item 6. Exhibits

 

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

 

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

 

*    Filed herewith.

 

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SIGNATURES

 

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

 

  VII Peaks Co-Optivist Income BDC II, Inc.
     
Date: August 14, 2015 By /s/ Gurpreet S. Chandhoke
    Gurpreet S. Chandhoke
    Chairman of the Board of Directors,
    Chief Executive Officer and President
    (Principal Executive Officer)

  

  VII Peaks Co-Optivist Income BDC II, Inc.
     
Date: August 14, 2015 By /s/ Michelle Kleier
    Michelle Kleier
    Chief Financial Officer,
    Treasurer and Secretary
    (Principal Financial Officer and Principal Accounting Officer)

 

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