10-Q 1 sep01qvll.txt VLL2 - SEPTEMBER 30, 2001 10Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ending September 30, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ______________ Commission file number 814-00141 Venture Lending & Leasing II, Inc. (Exact Name of Registrant as specified in its charter) Maryland 77-0456589 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) or organization) 2010 North First Street, Suite 310, San Jose, CA 95131 ------------------------------------------------------ (Address of principal executive offices) (Zip Code) (408) 436-8577 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant has (i) filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Class Outstanding as of November 9, 2001 ---------------- ----------------------------------- Common Stock, $.001 par value 101,159 Page 1 of 15 VENTURE LENDING & LEASING II, INC. INDEX

VENTURE LENDING & LEASING II, INC. STATEMENTS OF FINANCIAL POSITION (UNAUDITED)

The accompanying notes are an integral part of these statements VENTURE LENDING & LEASING II, INC. STATEMENTS OF OPERATIONS (UNAUDITED) FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 2001 2000 ---------------- ---------------- INVESTMENT INCOME: Interest on loans $4,974,053 $6,070,648 Interest on short-term investments 115,487 241,145 ---------------- ---------------- Total investment income 5,089,540 6,311,793 ---------------- ---------------- EXPENSES: Management fees 845,176 1,707,688 Interest expense 890,725 1,571,159 Other operating expenses 145,252 126,756 ---------------- ---------------- Total expenses 1,881,153 3,405,603 ---------------- ---------------- Net investment income 3,208,387 2,906,190 ---------------- ---------------- Net change in unrealized gain from investment transactions (9,709,854) 53,220,095 Net realized gain (loss) from investment transactions (54,897) 9,973,118 Incentive management fee 1,311,273 (13,172,292) ---------------- ---------------- Net Income (loss) $(5,245,091) $52,927,111 ================ ================ Amounts per common share: ---------------- ---------------- Net Income (loss) $(51.85) $554.22 ================ ================ Weighted average shares outstanding 101,159 95,498 ================ ================

The accompanying notes are an integral part of these statements VENTURE LENDING & LEASING II, INC. STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) FOR THE YEAR ENDED JUNE 30, 2001 AND THE THREE MONTHS ENDED SEPTEMBER 30, 2001

The accompanying notes are an integral part of these statements VENTURE LENDING & LEASING II, INC. STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000

The accompanying notes are an integral part of these statements VENTURE LENDING & LEASING II, INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2001 1. BASIS OF PRESENTATION The accompanying condensed financial statements in Management's opinion, include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of financial position and results of operations for interim periods. Certain information and note disclosures normally included in audited annual financial statements prepared in accordance with generally accepted accounting principles have been omitted; however, the Fund believes that the disclosures made are adequate to make the information presented not misleading. Certain amounts in the prior year financial statements have been reclassified to conform to the current financial statement presentation. These reclassifications had no impact on previously reported net income or shareholders' equity. The interim results for the three months ended September 30, 2001 and 2000, are not necessarily indicative of the results for the full year. It is suggested that these financial statements be read in conjunction with the financial statements and the notes included in the Fund's Annual Report for the year ended June 30, 2001. 2. SUMMARY OF INVESTMENTS: Loans generally are made to borrowers pursuant to commitments whereby the Fund commits to finance assets up to a specified amount for the term of the commitments, upon the terms and subject to the conditions specified by such commitment. The Fund's investments in loans are entirely within the United States and are diversified among the industries shown below. The percentage of shareholders' equity (net assets) that each industry group represents is shown with the industry totals below. (The sum of the percentages does not equal 100 percent because the percentages are based on net assets as opposed to total loans. Also, the sum of the percentages of net assets is greater than 100 percent due to the Fund's use of leverage (debt) as a means of financing investments.)

As of September 30, 2001 loans with a cost basis of $11.8 million and a fair value of $2.0 million have been classified as non-accrual. The Fund provides asset-based financing primarily to start-up and emerging growth venture-capital-backed companies. As a result, the Fund is subject to general credit risk associated with such companies. At September 30, 2001, the Fund has unfunded commitments to borrowers of $105.2 million. Of these commitments $88.2 million have expired and the Fund is not obligated to disburse them. The Fund's investments in warrants and stock are entirely within the United States and are diversified among the following industries. The percentage of net assets that each industry group represents is shown with the industry totals:

No single security represented over 5% of net assets. 3. EARNINGS PER SHARE: Basic earnings per share are computed by dividing net income, less dividends on preferred stock, by the weighted average common shares outstanding. Diluted earnings per share are computed by dividing net income, less dividends on preferred stock, by the weighted average common shares outstanding, including the dilutive effects of potential common shares (e.g., stock options). The Fund has no preferred stock or instruments that would be potential common shares; thus, reported basic and diluted earnings are the same. Item 2. Management's Discussion and Analysis of Financial Condition and ------- ---------------------------------------------------------------- Results of Operations --------------------- GENERAL Venture Lending & Leasing II, Inc. ("Fund") is a closed-end, non- diversified management investment company electing status as a business development company under the Investment Company Act of 1940 ("1940 Act"). The Fund's investment objective is to achieve a high total return. The Fund provides asset-based financing to carefully selected venture capital-backed companies, in the form of secured loans. The Fund generally receives warrants to acquire equity securities in connection with its portfolio investments. The Fund's shares of Common Stock, $.001 par value ("Shares") were sold to subscribers pursuant to one or more capital calls to be made from time to time until September 30, 2001. The Fund has made ten capital calls since inception for a total of 100% of committed capital. Total committed capital as of December 31, 1998 was $110 million when the Fund stopped accepting new subscriptions. In addition to the historical information contained herein, this Quarterly Report contains certain forward-looking statements. The reader of this Quarterly Report should understand that all such forward-looking statement 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 effects as well as other factors. 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. RESULTS OF OPERATIONS -- FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 Total investment income for the three months ending September 30, 2001 and 2000 was $5.1 million and $6.3 million, respectively, of which $5.0 million and $6.1 million, consisted of interest on venture loans outstanding during the period. The remaining income consisted of interest on the temporary investment of cash, pending investment in venture loans or application to the Fund's expenses and collection of late fees. The decrease in investment income is due primarily to the decrease in loans outstanding from September 30, 2000 to September 30, 2001. Expenses for the three months ended September 30, 2001 and 2000 were $1.9 million and $3.4 million, respectively. Management fees decreased from $1.7 million for the three months ended September 30, 2000 to $0.8 million for the three months ended September 30, 2001. This decrease was due to the decrease in total assets from which management fees are calculated. Interest expense decreased to $0.9 million for the three months ended September 30, 2001 from $1.6 million for the prior year period. This decrease was largely due to a decrease in the average debt outstanding as well as lower interest rates in general. Other operating expenses were $0.1 million for the three months ended September 30, 2001 and $0.1 million for the three months ended September 30, 2000. The Fund experienced a decrease in unrealized gain from investment transactions in the amount of $9.7 million for the three months ended September 30, 2001 as opposed to an increase of $53.2 million for the same three months in the prior year. The unrealized gains for the three months ended September 30, 2000 were unusually high due to the fact that there were an unusual number of equity transactions and relatively high valuations of the equity securities. The decrease in unrealized gain from investment transactions for the three months ended September 30, 2001 was due mostly to lower equity valuations as well as an adjustment to the fair value of certain loans. The Fund had $0.1 million of realized losses during the quarter ended September 30, 2001 compared to realized gains of $10.0 million for the same period in 2000. The realized gains in 2000 were the result of the sale of equity securities, while the realized losses in 2001 pertained mostly to a loan that was charged off during the quarter. Net income (loss) for the three months ended September 30, 2001 and September 30, 2000 was ($5.2 million) and $52.9 million, respectively. LIQUIDITY AND CAPITAL RESOURCES -- SEPTEMBER 30, 2001 AND JUNE 30, 2001 Total capital committed to the purchase of shares pursuant to subscription agreements was approximately $110 million at September 30, 2001 and June 30, 2001. As of September 30, 2001 and June 30, 2001, 100% of this committed capital had been called and collected to fund investments in venture loans and to meet the Fund's expenses. The Fund has in place $85 million in debt facilities to finance the acquisition of asset-based loans. As of September 30, 2001 and June 30, 2001, $52.4 million and $64.4 million were outstanding under these facilities. The Fund enters into interest rate swap transactions to hedge its interest rate on the debt facility. At September 30, 2001 and June 30, 2000, the Fund had interest rate swap and cap transactions outstanding with a total notional principal amount of $46.2 million and $50.0 million, respectively. The effect of these swap transactions is to convert flexible rate commercial paper into a fixed rate on the contract notional value. The amortization schedule for each borrowing under the facility is expected to correspond to the amortization of the loans acquired with the proceeds of each borrowing. As of September 30, 2001 and June 30, 2001, 11% and 28% respectively of the Fund's assets consisted of cash and cash equivalents. A majority of the cash held at June 30, 2001 was distributed in the first part of July, 2001. The Fund continued to invest its assets in venture loans during the period, but has ceased making new commitments as of September 15, 2001. Amounts disbursed under the Fund's loan commitments increased by approximately $2.4 million during the three month period ended September 30, 2001. Net loan amounts outstanding after amortization decreased by approximately $18.9 million. Unfunded commitments decreased by approximately $1.3 million.

Because venture loans are privately negotiated transactions, investments in these assets are relatively illiquid. At September 30, 2001 and June 30, 2001 the Fund has unfunded commitments to borrowers of $105.2 million and $106.5 million respectively. Of these commitments, $88.2 million have expired and the Fund is not obligated to disburse them. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK ------- --------------------------------------------------------- The Fund's business activities contain elements of risk. The Fund considers the principal types of market risk to be interest rate risk and valuation risk. The Fund considers the management of risk essential to conducting its businesses and to maintaining profitability. Accordingly, the Fund's risk management procedures are designed to identify and analyze the Fund's risks, to set appropriate policies and limits and to continually monitor these risks and limits by means of reliable administrative and information systems and other policies and programs. The Fund manages its market risk by maintaining a portfolio that is diverse by industry, size of investment, stage of development, and borrower. The Fund has limited exposure to public market price fluctuations as the Fund primarily invests in private business enterprises. Since there is typically no public market for the equity interests of the companies in which the Fund invests, the valuation of the equity interests in the Fund's portfolio is subject to the estimate of the Fund's management. In the absence of a readily ascertainable market value, the estimated value of the Fund's portfolio of equity interests may differ significantly from the values that would be placed on the portfolio if a ready market for the equity interests existed. Any changes in estimated value are recorded in the Fund's statement of operations as "Net unrealized gains (losses)." Each hypothetical 1% increase or decrease in value of the Fund's portfolio of equity interests of $8.1 million at September 30, 2001 would have resulted in unrealized gains or losses and would have increased or decreased net income for the nine months by 1.5%. The Fund's sensitivity to changes in interest rates is regularly monitored and analyzed by measuring the characteristics of assets and liabilities. The Fund utilizes various methods to assess interest rate risk in terms of the potential effect on interest income net of interest expense, the value of net assets and the value at risk in an effort to ensure that the Fund is insulated from any significant adverse effects from changes in interest rates. Based on the model used for the sensitivity of interest income net of interest expense, if the balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical immediate 100 basis point change in interest rates would have affected net income by 1.3% during the quarter. Although management believes that this measure is indicative of the Fund's sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of the balance sheet and other business developments that could affect net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by this estimate. PART II -- OTHER INFORMATION Item 1. Legal Proceedings ------- ----------------- The Fund may become party to certain lawsuits from time to time in the normal course of business. While the outcome of these legal proceedings cannot at this time be predicted with certainty, the Fund does not expect these proceedings will have a material effect upon the Fund's financial condition or results of operation. Item 2. Changes in Securities and Use of Proceeds ------- ------------------------------------------ None Item 3. Defaults Upon Senior Securities ------- --------------------------------- Not applicable Item 4. Submission of Matters to a Vote of Security Holders ------- --------------------------------------------------- None Item 5. Other Information ------- ----------------- None Item 6 Exhibits ------ -------- None 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 duly authorized. VENTURE LENDING & LEASING II, INC. (Registrant) By: /S/ Ronald W. Swenson By: /S/ Brian R. Best Ronald W. Swenson Brian R. Best Chairman and Chief Executive Officer Chief Financial Officer Date: November 9, 2001 Date: November 9, 2001

VENTURE LENDING & LEASING II INC 10-Q