10-Q 1 a2038527z10-q.txt 10-Q FORM 10-Q[PRIVATE] 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 December 31, 2000 [ ] 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 814-00132 Venture Lending & Leasing, Inc. ------------------------------------------------------ (Exact Name of Registrant as specified in its charter) Maryland 13-3775187 ----------------------------------- ----------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 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 January 10, 2001 ----------------------------- ---------------------------------- Common Stock, $.001 par value 48,318.58 Page 1 of 15 VENTURE LENDING & LEASING, INC. INDEX

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

The accompanying notes are an integral part of these statements 3 VENTURE LENDING & LEASING, INC. STATEMENTS OF OPERATIONS (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2000 AND 1999

The accompanying notes are an integral part of these statements 4 VENTURE LENDING & LEASING, INC. STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) FOR THE YEAR ENDED JUNE 30, 2000 AND THE PERIOD ENDED DECEMBER 31, 2000

The accompanying notes are an integral part of these statements 5 VENTURE LENDING & LEASING, INC. STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE SIX MONTHS ENDED DECEMBER 31, 2000 AND 1999

The accompanying notes are an integral part of these statements 6 VENTURE LENDING & LEASING, INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) DECEMBER 31, 2000 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 six months ended December 31, 2000 and 1999, 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, 2000. 2. SUMMARY OF INVESTMENTS: Loans and leases 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 and leases 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 and leases. BIOTECHNOLOGY Biosys $ 841,684 Ceres 754,828 Gene Logic 256,753 Nobex 277,335 ---------- SUBTOTAL: 10.0% $2,130,600 COMMUNICATION EQUIPMENT Cisco Systems [Cerent] $ 845,586 mDiversity 644,463 ---------- SUBTOTAL: 7.0% $1,490,049 COMMUNICATION SERVICE PROVIDERS Exodus $ 664,053 iAsiaWorks 157,949 ---------- SUBTOTAL: 3.9% $ 822,002

7 COMPUTERS & PERIPHERALS Aptix $ 80,031 DAS Devices 101,738 Headway Technologies 1,337,277 Quantum3D 13,432 ----------- SUBTOTAL: 7.2% $ 1,532,478 INTERNET Adforce $ 288,752 Keynote Systems 102,513 NetRatings 88,546 Visual Networks 99,329 ----------- SUBTOTAL: 2.7% $ 579,140 MEDICAL DEVICES Encelle $ 26,809 HeartStent 25,823 Integ 1,422,239 IntraTherapeutics 604,965 SurVivaLink 198,075 Visionary BioMedical 98,675 Volumetrics 296,763 ----------- SUBTOTAL: 12.6% $ 2,673,349 OTHER Webvan $ 838,753 ----------- SUBTOTAL: 4.0% $ 838,753 PHOTONICS Lightwave Microsystems $ 90,697 ----------- SUBTOTAL: 0.4% $ 90,697 SEMICONDUCTORS HotRail $ 215,276 I-Cube 108,102 iCompression 56,527 TeleCruz 205,255 Transmeta 1,147,409 ----------- SUBTOTAL: 8.2% $ 1,732,569 SOFTWARE Documentum $ 27,907 E.piphany [RightPoint] 43,267 MineShare 159,790 Optivision 22,441 Personic Software 255,039 Tenth Planet 46,741 Zero-In Design $ 80,109 ----------- SUBTOTAL: 3.0% $ 635,294 TOTAL: 59.0% $12,524,929

8 As of December 31, 2000, loans with a cost basis of $2.3 million dollars and a fair value of $1.3 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 December 31, 2000, the Fund has unfunded commitments to borrowers of $36.8 million, all of which have expired. 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:

Within the communications equipment segment, the Fund's holdings in ONI Systems represented $4.9 million or 23% of net assets. Within the semiconductor segment, the Fund's holdings in Transmeta Corporation represented $4.5 million or 21% of net assets. No other 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 9 preferred stock or instruments that would be potential common shares; thus, reported basic and diluted earnings are the same. 4. IMPLEMENTATION OF FINANCIAL ACCOUNTING STANDARDS: In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000, and the Fund has adopted its provisions effective July 1, 2000. Derivatives that are used to hedge the company's floating rate debt are now marked to market at the end of each quarter. The resulting gain or loss is recorded as an increase or decrease in unrealized gains from other security transactions. The market value of the instrument is treated either an asset or as a liability depending on if its value is negative or positive. 5. CHANGE IN ACCOUNTING PRINCIPLE In the 2nd quarter of Fiscal Year End June 30, 2000, the Company changed its method of accounting for its incentive management fee. The previous method was to record the incentive management fee as the Company became legally obligated. The new method is to record the fee based on the Company's current income. According to the management of the Company, this change was made to more closely match the incentive fee to current performance. The new method has been applied to management incentive fee calculations of prior years. The $9,302,185 cumulative effect of the change on prior years is included in income of the 3 months ended September 30, 1999. The effect of the change on the quarter ended December 31, 1999 was to decrease income before cumulative effect of a change in accounting principle $822,579 ($17.02 per share). The effect of the change on the six months ended December 31, 1999 was to decrease income before cumulative effect of change in accounting principle $10,933,536 ($226.28 per share) and net income $20,235,721 ($418.80 per share). The pro forma amounts reflect the effect of retroactive application on management incentive fees and the change in provisions for incentive compensation that would have been made in 1998. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Venture Lending & Leasing, Inc. ("Fund") is a non-diversified closed-end management investment company electing status as a "business development company" ("BDC") under the Investment Company Act of 1940 ("1940 Act") whose 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, installment sales contracts or equipment leases. The Fund generally receives warrants to acquire equity securities in connection with its portfolio investments. There can be no assurance that the Fund will attain its investment objective. The Fund's shares of Common Stock, $.001 par value ("Shares") were sold to subscribers pursuant to capital calls made through August 1998. Total committed capital of $46.6 million has been fully funded as of December 31, 2000. The Fund has completed its investment period and will now focus on efficiently managing the Fund's portfolio. As of December 31, 2000, the Fund has distributed $245.7 million to its investors. 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 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 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 AND SIX MONTHS ENDED DECEMBER 31, 2000 AND 1999 Total investment income for the three months ending December 31, 2000 and 1999 was $0.6 million and $1.7 million, respectively, of which $0.6 million and $1.5 million, consisted of interest on venture loans and leases outstanding during the period. The remaining income consisted of interest on the temporary investment of cash and late fees collected. Total investment income for the six months ended December 31, 2000 and 1999 was $1.4 million and $3.6 million respectively, of which $1.3 million and $3.4 million, consisted of interest on venture loans and leases outstanding during the period. The remaining income consisted of interest on the temporary investment of cash and late fees collected. The decrease in investment income reflects the decrease in loans and leases outstanding from December 31, 1999 to December 31, 2000. Expenses for the three months ended December 31, 2000 and 1999 were $0.3 million and $1.2 million, respectively, resulting in net investment income of $0.4 million and $0.5 million, respectively. Expenses for the six months ended December 31, 2000 and 1999 were $0.6 million and $2.7 million, respectively. Interest expense declined during the three months and six months ended December 31, 2000 11 primarily reflecting the complete repayment of bank loans by December 31, 2000 from a balance of $17.2 million on December 31, 1999. Management fees decreased from $0.8 million for the three months ended December 31, 1999 to $0.2 million for the three months ended December 31, 2000 and decreased from $1.5 million for the six months ended December 31, 1999 to $0.3 million for the six months ended December 31, 2000; reflecting the decreased asset base throughout the year upon which fees are calculated. The decrease in the asset base reflected the decreased value of the Fund's publicly traded securities, the decrease in venture loans outstanding, and a decrease in cash held. Other operating expenses were $0.2 million and $0.5 million for the six months ended December 31, 2000 and 1999 respectively. A decline in legal expenses represented a majority of this decline in other operating expenses. The Fund experienced a reduction in unrealized gain from investment transactions of $14.2 million for the three months ended December 31, 1999 as compared to an increase of $2.2 million for the three months ended December 31, 2000. For the six months ended December 31, 2000 the fund experienced a reduction in unrealized gain from investment transactions of $7.5 million as compared to an increase of $9.9 million for the six months ended December 31, 1999. Most of the increase in unrealized gain for the three months ended December 31, 2000 and the decrease in unrealized gain for the six months ended December 31, 2000 was caused by the change in value of restricted warrants and stocks during these periods. The Fund had $0.0 million and $1.2 million of realized gains during the three and six months ended December 31, 2000, respectively as compared to $163.5 million and $186.1 million, respectively in the same period in 1999. These gains were generated by sales and distributions of stock in several of the Fund's portfolio companies. Warrants with readily ascertainable market values are assigned a fair value based on the difference, if any, between the exercise price of the warrant and the fair value of the equity securities for which the warrant may be exercised, adjusted for illiquidity. The larger realized gains in 1999 were due to the larger volume and value of the sales transactions and distributions of stock. Net income before cumulative effect and net income for the three months ended December 31, 2000 was $2.1 million compared to net income of $120.6 million for the three months ended December 31, 1999. Net loss before cumulative effect for the six months ended December 31, 2000 was $4.4 million compared to net income of $157.6 million for the six months ended December 31, 1999. On a per share basis, for the three month period ended December 31, 2000 and 1999, net income before cumulative effect of a change in accounting principle was $42.47 and $2,495.05 respectively. On a per share basis, for the six month period ended December 31, 2000 and 1999, net income (loss) before cumulative effect of a change in accounting principle was ($91.04) and $3,260.82 respectively. In the 2nd quarter of Fiscal Year End June 30, 2000, the Company changed its method of accounting for its incentive management fee. The previous method was to record the incentive management fee as the Company became legally obligated. The new method is to record the fee based on the Company's current income. According to the management of the Company, this change was made to more closely match the incentive fee to current performance. The new method has been applied to management incentive fee calculations of prior years. The $9.3 million cumulative effect of the change on prior years is included in income of the 3 months ended September 30, 1999. The effect of the change on the quarter ended December 31, 1999 was to decrease income before cumulative effect of a change in accounting principle $0.8 million ($17.02 per share). The effect of the change on the six months ended December 31, 1999 was to decrease income before cumulative effect of change in accounting principle $10.9 million ($226.28 per share) and net income $20.2 million ($418.80 per 12 share). The pro forma amounts reflect the effect of retroactive application on management incentive fees and the change in provisions for incentive compensation that would have been made in 1998. LIQUIDITY AND CAPITAL RESOURCES -- DECEMBER 31, 2000 AND JUNE 30, 2000 Total capital committed to the purchase of shares pursuant to subscription agreements was approximately $46.6 million at December 31, 2000. As of December 31, 2000, 100% of committed capital was called to fund investments in venture loans and leases and to meet the Fund's expenses. The Fund had in place a securitization debt facility to finance the acquisition of asset-based loans and leases. The principal balance is a 47-month term loan. As of December 31, 2000, $0 was outstanding under this facility, compared with $8.3 million as of June 30, 2000. The Fund enters into interest rate swap transactions to hedge its interest rate on the debt facility. At December 31, 2000, the Fund had no interest rate swap transactions outstanding. The effect of these swap transactions was to convert the variable LIBOR rate into a fixed rate. As of December 31, 2000, 12% of the Fund's assets consisted of cash and cash equivalents, compared to 21% as of June 30, 2000. Cumulative amounts disbursed under the Fund's loan commitments remained the same as of December 31, 2000 compared to June 30, 2000. Net loan amounts outstanding after amortization decreased by approximately $7.6 million. Unfunded commitments remained the same.

Because venture loans and leases are privately negotiated transactions, investments in these assets are relatively illiquid. Since all unfunded commitments have expired, no capital will be required to fund them. 13 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 $11.0 million at December 31, 2000 would have resulted in unrealized gains or losses and would have increased or decreased net income for the six months period by approximately 2.3%. 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 less than 1% 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. 14 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Fund will 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, INC. (Registrant) By: /s/ Ronald W. Swenson By: /s/ Brian R. Best ------------------------------------ ------------------------------- Ronald W. Swenson Brian Best Chairman and Chief Executive Officer Chief Financial Officer Date: February 13, 2001 Date: February 13, 2001 15

VENTURE LENDING & LEASING INC 10-Q