News Column

VENTURE LENDING & LEASING VI, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 8, 2014

In addition to the historical information contained herein, the information in this Quarterly Report on Form 10-Q contains certain "forward-looking statements" within the meaning of the securities laws. These forward-looking statements reflect the current view of Venture Lending & Leasing VI, Inc. (the "Fund") with respect to future events and financial performance and are subject to a number of risks and uncertainties, many of which are beyond the Fund's control. All statements, other than statements of historical facts included in this report, regarding the strategy, future operations, financial position, estimated revenues, projected costs, prospects, plans and objectives of the Fund are forward-looking statements. When used in this report, the words "will", "believe", "anticipate", "intend", "estimate", "expect", "project" and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. All forward-looking statements speak only as of the date of this report. The reader of this Quarterly Report should understand that all such forward-looking statements are subject to various uncertainties and risks that could affect their outcome. The Fund's actual results could differ materially from those suggested by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, variances in the actual versus projected growth in assets, return on assets, loan losses, expenses, rates charged on loans and earned on securities investments and competition. This entire Quarterly Report should be read to put such forward-looking statements in context and to gain a more complete understanding of the uncertainties and risks involved in the Fund's business. The Fund does not undertake any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

The Fund is 100% owned by Venture Lending & Leasing VI, LLC (the "Company").

The Fund's shares of Common Stock, at $0.001 par value, were sold to its shareholder, the Company, under a stock purchase agreement. The Fund has issued 100,000 of the Fund's 10,000,000 authorized shares. The Company may make additional capital contributions to the Fund.

The Fund is a financial services company primarily providing financing and advisory services to a variety of carefully selected venture-backed companies primarily located throughout the United States with a focus on growth-oriented companies. The Fund's portfolio is well diversified and consists of companies in the communications, information services, media, and technology, including software and technology-enabled business services, bio-technology, and medical devices industry sectors, among others. The Fund's capital is generally used by our portfolio companies to finance acquisitions of fixed assets and/or for working capital. On June 29, 2010, the Fund completed its first closing of capital contributions, made its first investments, and became a non-diversified, closed-end investment company that elected to be treated as a business development company under the Investment Company Act of 1940. The Fund elected to be treated for federal income tax purposes as a Regulated Investment Company ("RIC") under the Internal Revenue Code with the filing of its federal corporate income tax return for 2010. Pursuant to this election, the Fund generally will not have to pay corporate-level taxes on any income it distributes to the Company as dividends, allowing the Company to substantially reduce or eliminate its corporate-level tax liability.

The Fund will seek to meet the ongoing requirements, including the diversification requirements, to qualify as a RIC under the Internal Revenue Code. If the Fund fails to meet these requirements, it would be taxed as an ordinary corporation on its taxable income for that year (even if that income were distributed to the Company) and all distributions out of its earnings and profits would be taxable to the Members of the Company as ordinary income; thus, such income would be subject to a double layer of tax. There is no assurance that the Fund will meet the ongoing requirements to qualify as a RIC for tax purposes.

The Fund's investment objective is to achieve superior risk adjusted investment returns. The Fund seeks to achieve its investment objective by providing debt financing to portfolio companies. Since inception, the Fund's investing activities have focused primarily on private debt securities. The Fund generally receives warrants to acquire equity securities in connection with its portfolio investments. The Fund distributes these warrants to the

30



--------------------------------------------------------------------------------

Company upon receipt. The Fund also has guidelines for the percentages of total assets which will be invested in different types of assets.

The portfolio investments of the Fund primarily consist of debt financing to venture capital backed companies. The borrower's ability to repay its loans may be adversely impacted by a number of factors, and as a result, the loan may not fully be repaid. Furthermore, the Fund's security interest in any collateral over the borrower's assets may be insufficient to make up any shortfall in payments.

Transactions with Venture Lending & Leasing V, Inc. ("Fund V")

The Manager also serves as investment manager for Fund V. The Fund's Board of Directors determined that so long as Fund V has capital available to invest in loan transactions with final maturities earlier than December 31, 2015 (the date on which Fund V will be dissolved), the Fund will invest in each portfolio company in which Fund V invests ("Investments"). Initially the amount of each Investment was allocated 50% to the Fund and 50% to Fund V so long as Fund V had capital available to invest. After June 2014, the Fund is no longer permitted to enter into new commitments to borrowers; however, the Fund will be permitted to fund existing commitments. After February 2011, Fund V is no longer permitted to enter into new commitments to borrowers; however, Fund V will be permitted to fund existing commitments. While investing the Fund's capital in the same companies in which Fund V is also investing could provide the Fund with greater diversification and access to larger transactions, it could also result in a slower pace of investment than would be the case if the Fund were investing in companies by itself.

Transactions with Venture Lending & Leasing VII, Inc. ("Fund VII")

The Manager also serves as investment manager for Fund VII. The Fund's Board of Directors determined that so long as the Fund has capital available to invest in loan transactions with final maturities earlier than December 31, 2020 (the date on which the Fund will be dissolved), the Fund will invest in each portfolio company in which Fund VII invests ("Investments"). Initially the amount of each Investment has been allocated 50% to the Fund and 50% to Fund VII so long as the Fund has capital available to invest. After June 2014, the Fund is no longer permitted to enter into new commitments to borrowers; however, the Fund will be permitted to fund existing commitments. While investing the Fund's capital in the same companies in which Fund VII is also investing could provide the Fund with greater diversification and access to larger transactions, it could also result in a slower pace of investment than would be the case if the Fund were investing in companies by itself.

Critical Accounting Policies

We identified and determined the most critical accounting principles upon which our financial statements depend by considering accounting policies that involve the most complex or subjective decisions or assessments. Such critical accounting policies relate to the valuation of loans and treatment of non-accrual loans.

Loans are held at estimated fair value as determined by Management, in accordance with the valuation methods described in the valuation of loans section of Note 2 in the Fund's financial statements (Summary of Significant Accounting Policies). Critical factors in determining the fair value of a loan include payment history, collateral position, financial strength of the borrower, prospects for the borrower raising future equity rounds, likelihood of sale or acquisition of the borrower, and length of expected holding period of the loan, as well as an evaluation of the general interest rate environment.

The actual value of the loans may differ from Management's estimates, which would affect net income as well as assets.

Results of Operations - For the three and six months ended June 30, 2014 and 2013

Total investment income for the three months ended June 30, 2014 and 2013 was $12.4 million and $15.0 million, respectively, which primarily consisted of interest on the venture loans outstanding. Total investment income for the six months ended June 30, 2014 and 2013 was $26.4 million and $29.3 million, respectively, which

31



--------------------------------------------------------------------------------

primarily consisted of interest on the venture loans outstanding. The remaining income consisted of interest and dividends on the temporary investment of cash, forfeited commitment fees, and fees earned from waivers to loan agreements. The decrease in investment income is due to the decrease in the average loans outstanding from $308.9 million for the three months ended June 30, 2013 to $270.2 million for the three months ended June 30, 2014, from $304.7 million for the six months ended June 30, 2013 to $275.9 million for the six months ended June 30, 2014, and the slight decrease in average interest rates from 18.89% for the three months ended June 30, 2013 to 18.23% for the three months ended June 30, 2014, from 18.92% for the six months ended June 30, 2013 to 18.60% for the six months ended June 30, 2014. Interest is calculated using the effective interest method, and rates earned by the Fund will fluctuate based on many factors including volatility of values ascribed to warrants, and new loans funded during the year and early payoffs.

Management fees for the three months ended June 30, 2014 and 2013 were $1.8 million and $2.2 million, respectively. Management fees for the six months ended June 30, 2014 and 2013 were $3.8 million and $4.3 million, respectively. Prior to June 29, 2012, management fees were calculated as 2.5 percent of the committed capital of the Company. Starting on June 29, 2012, management fees are calculated as 2.5 percent of the Fund's total assets. Management fees decreased because assets under management as of June 30, 2014 were lower than assets as of June 30, 2013.

Total interest expense was $1.1 million and $1.2 million for the three months ended June 30, 2014 and 2013, respectively. Total interest expense was $2.2 million and $2.4 million for the six months ended June 30, 2014 and 2013, respectively. Interest expense decreased primarily due to the decreased average borrowings, which decreased from $142.8 million for the three months ended June 30, 2013 to $122.6 million for the three months ended June 30, 2014, from $139.0 million for the six months ended June 30, 2013 to $125.9 million for the six months ended June 30, 2014.

Total banking and professional fees were less than $0.1 million and $0.2 million for the three months ended June 30, 2014 and 2013, respectively. Total banking and professional fees were $0.2 million and $0.3 million for the six months ended June 30, 2014 and 2013, respectively. The banking and professional fees were comprised of legal, audit, banking and other professional fees. These fees decreased in 2014 primarily because of decreased legal fees.

Total other operating expenses were less than $0.1 million for the three and six months ended June 30, 2014 and 2013.

Net investment income for the three months ended June 30, 2014 and 2013, was $9.4 million and $11.4 million, respectively. Net investment income for the six months ended June 30, 2014 and 2013, was $20.2 million and $22.2 million, respectively.

Total net realized loss from investments was $0.7 million and $0.9 million for the three months ended June 30, 2014 and 2013, respectively. Total net realized loss from investments was $2.0 million and $1.8 million for the six months ended June 30, 2014 and 2013, respectively.

Net change in unrealized gain (loss) from investments was $2 million and $1.6 million for the three months ended June 30, 2014 and 2013, respectively. Net change in unrealized loss from investments was $0.8 million and $4.6 million for the six months ended June 30, 2014 and 2013, respectively. The unrealized loss consists of fair market value adjustments to loans.

Net change in realized and unrealized gain (loss) from hedging activities was less than ($0.1 million) for the three and six months ended June 30, 2014 and 2013. The realized and unrealized loss consists of the unrealized losses from hedging activities and the net interest received or paid on the interest rate swap transaction. The Fund entered into interest rate swap transactions with Union Bank, N.A and Wells Fargo Bank, N.A. to convert floating rate liabilities to fixed rates (see Note 7 in the Fund's financial statements).

32



--------------------------------------------------------------------------------

Net increase in net assets resulting from operations for the three months ended June 30, 2014 and 2013 was $6.7 million and $8.8 million, respectively. Net increase in net assets resulting from operations for the six months ended June 30, 2014 and 2013 was $17.4 million and $15.8 million, respectively. On a per share basis, the net increase in net assets resulting from operations was $67.00 and $88.20 for the three months ended June 30, 2014 and 2013, respectively. On a per share basis, the net increase in net assets resulting from operations was $173.76 and $158.45 for the six months ended June 30, 2014 and 2013, respectively.

Liquidity and Capital Resources - June 30, 2014 and December 31, 2013

Total capital contributed to the Fund was $241.5 million, prior to distribution of capital, as of June 30, 2014. Committed capital to the Company at June 30, 2014 was $294.0 million, of which $279.3 million had been called. The remaining $14.7 million in committed capital as of June 30, 2014 is due to expire in June 2015 as the five year anniversary will have passed, at which time no further capital can be called.

The Fund has established a secured revolving loan facility in an amount of up to $160 million with Union Bank, N.A., Wells Fargo Bank, N.A. and Bank Leumi USA. Pursuant to the Loan Agreement, as amended, the Fund has the option to request that the lenders providing such facility increase the borrowing availability thereunder to no more than $170 million in the aggregate, as commitments may be obtained. Loans under the facility may be, at the option of the Fund, either Reference Rate loans (as defined in the agreement) or LIBOR loans.

The facility will terminate on September 23, 2014, but can be accelerated under an event of default such as failure by the Fund to make timely interest or principal payments. As of June 30, 2014 and December 31, 2013, outstanding balance under the facility are $121.5 million and $134.2 million, respectively. The Fund is in the process of renewing its revolving credit line and anticipates this to close prior to the expiration of the line.

As of June 30, 2014 and December 31, 2013, 6% and 11%, respectively, of the Fund's assets consisted of cash and cash equivalents. The Fund invested its assets in venture loans during the six months ended June 30, 2014. Amounts disbursed under the Fund's loan commitments totaled approximately $62.0 million during the six months ended June 30, 2014. Net loan amounts outstanding after amortization and fair market adjustment decreased by approximately $22.9 million for the same period. Unexpired, unfunded commitments totaled approximately $96.9 million as of June 30, 2014.

As of Cumulative Amount Principal Balance Unexpired Disbursed Reductions and Fair Outstanding - Fair Unfunded Market Adjustments Value Commitments



June 30, 2014$669.5 million$398.6 million$270.9 million$96.9 millionDecember 31, 2013$607.5 million$313.7 million$293.8 million$57.4 million

Because venture loans are privately negotiated transactions, investments in these assets are relatively illiquid. It is the Fund's experience that not all unfunded commitments will be used by borrowers.

The Fund seeks to meet the requirements to qualify for the special pass-through status available to RICs under the Internal Revenue Code, and thus to be relieved of federal income tax on that part of its net investment income and realized capital gains that it distributes to the Company. To qualify as a RIC, the Fund must distribute to the Company for each taxable year at least 90% of its investment company taxable income (consisting generally of net investment income and net short-term capital gain) ("Distribution Requirement"). To the extent that the terms of the Fund's venture loans provide for the receipt by the Fund of additional interest at the end of the loan term or provide for the receipt by the Fund of a purchase price for the asset at the end of the loan term ("residual income"), the Fund would be required to accrue such residual income over the life of the loan, and to include such accrued income in its gross income for each taxable year even if it receives no portion of such residual income in that year. Thus, in order to meet the Distribution Requirement and avoid payment of income taxes or an excise tax on undistributed income, the Fund may be required in a particular year to distribute as a dividend an amount in excess

33



--------------------------------------------------------------------------------

of the total amount of income it actually receives. Those distributions will be made from the Fund's cash assets, from amounts received through amortization of loans or from borrowed funds.


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters