Integrity Capital Income Fund, Inc. (the “Company”), an externally managed investment company was organized as a Colorado corporation on December 10, 2013 (Inception) and was initially funded on January 21, 2014 (commencement of operations). The Company has elected to be regulated as a business development company (“BDC”) under the Investment Company Act of 1940, as amended (the “1940 Act”). In addition, for U.S. federal income tax purposes, the Company has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).
The Company invests principally in debt, equity securities, including convertible preferred securities, limited liability companies, partnerships and other debt securities convertible into equity securities, of primarily non-public U.S.-based companies. The investment objective is to maximize income and capital appreciation. In accordance with the investment objective, the Company intends to provide capital principally to U.S.-based, private companies with an equity value of less than $250 million, which the Company refers to as “micro-cap companies.” The Company’s primary emphasis is to identify companies with experienced management and positive cash flow from operations by (1) accessing established relationship channels of Integrity Trust Company, LLC, a Colorado limited liability company (the “Adviser”), (2) selecting investments within our core markets, (3) partnering with experienced private equity, real estate and investment firms, (4) implementing the disciplined underwriting standards of the Adviser and (5) drawing upon the combined experience and resources of the Adviser and its affiliates.
The Company generally invests in securities that have not been rated by independent rating agencies or that would be rated below investment grade if they were rated. These securities have predominately speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.
The Company is managed by Integrity Trust Company, LLC. On December 1, 2015, this adviser role was transferred from Integrity Bank & Trust, an affiliated entity, to Integrity Trust Company, LLC. The Company notes that this was just a change in legal structure and did not change the Adviser employees or physical address.
| 2. | SIGNIFICANT ACCOUNTING POLICIES |
Basis of Accounting
The accompanying financial statements of the Company and related financial information have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and pursuant to the requirements for reporting on Form 10-Q and Articles 6 or 10 of Regulation S-X. The Company has determined it meets the definition of an investment company and follows the accounting and reporting guidance in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 946—Financial Services—Investment Companies (“ASC Topic 946”). In the opinion of management, the financial statements reflect all adjustments and reclassifications that are necessary for the fair presentation of financial results as of and for the periods presented.
Use of Estimates
Financial statements prepared on a GAAP basis require management to make estimates and assumptions that affect the amounts and disclosures reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein. Investment valuation represents a significant estimate within these financial statements.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
Reclassification of Prior Year Presentation
Certain prior year amounts have been reclassified for consistency with the current period presentation. These reclassifications had no effect on the reported results of operations. In the first quarter of fiscal 2016, the Company concluded it was appropriate to capitalize loan origination fees charged on promissory notes as a reduction to the initial cost of the investment and accrete such amounts over the estimated life of the investment as interest income. Previously, such fees were deferred and amortized over the estimated life of the investment. Accordingly, the Company had revised the classification to report these amounts as interest income on investments. Corresponding reclassifications have also been made to the statements of cash flows for the first six months of fiscal year 2015. This change in classification does not materially affect previously reported cash flows from operations or from financing activities in the statements of cash flows, and had no effect on the previously reported statements of operations for any period.
Cash and Cash Equivalents
The Company deposits its cash in financial institutions and, at times, such balances may be in excess of the Federal Deposit Insurance Corporation insurance limits; however, management does not believe it is exposed to any significant credit risk.
Fair Value of Investments
The Company's fair value accounting policies adhere to the provisions of FASB ASC Topic 820, Fair Value Measurements and Disclosures. Topic ASC 820 establishes a fair value hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs reflect the Company’s assumption about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The fair value hierarchy is categorized into three levels based on the inputs as follows:
Level 1 -Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 securities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant degree of judgment.
Level 2 -Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.
Level 3 -Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the securities existed. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement falls in its entirety is determined by the lowest level input that is significant to the fair value measurement.
Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. See further description of fair value methodology in Note 5.
Deferred Offering Costs
Offering costs are expenses such as legal fees pertaining to the Company’s shares offered for sale. The Company has accounted for offering costs in the current period as a deferred charge, Deferred Offering Costs on the Statements of Assets, Liabilities and Net Assets. The deferred offering costs are being amortized to expense over 12 months on a straight-line basis beginning with the period after the Company’s registration under the Securities and Exchange Act of 1934 (the “Exchange Act”) was effective (November 1, 2014). As of October 31, 2015, the deferred offering costs incurred by the Company had been fully amortized.
Revenue Recognition
Investments and related investment income: Interest income is accrued based upon the outstanding principal amount and contractual interest terms of debt investments. For the three and six months ended April 30, 2016, the Company earned interest income of $286,763 and $646,989 (including $15,790 and $31,931 interest on investments from affiliate company), respectively. During the three months ended April 30, 2016, the Company wrote-off $6,243, $7,180, and $10,333 in interest income and interest receivable related to its equity securities with Aequitas Commercial Finance, LLC, Aequitas Peer-to-Peer Funding, LLC, and Care Payment Holdings, LLC, respectively, as the amounts were determined to be uncollectible. For the three and six months ended April 30, 2015, the Company earned interest income of $247,453 and $462,664 (including no interest on investments from affiliate company). As of April 30, 2016 and October 31, 2015, the Company had interest receivable of $629,714 and $245,706, respectively.
Fee income such as loan origination, closing, commitment, structuring and other upfront fees is capitalized, and the Company accretes or amortizes such amounts over the life of the loan as interest income. For the three and six months ended April 30, 2016, interest income included $4,742 and $18,393, respectively, of accretion of loan origination fees. There was no accretion of loan origination fees for the three and six months ended April 30, 2015. For the three and six months ended April 30, 2016 and April 30, 2015, the Company received loan origination fees of $2,818 and $36,000, respectively.
Investment transactions are accounted for on a trade-date basis. Realized gains or losses on investments are measured by the difference between the net proceeds from the disposition and the cost basis of investment, without regard to unrealized gains or losses previously recognized. The Company reports current period changes in fair value of investments that are measured at fair value as a component of the net change in unrealized appreciation (depreciation) on investments in the statements of operations.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
For investments with contractual payment-in-kind (“PIK”) interest, which represents contractual interest accrued and added to the principal balance that generally becomes due at maturity, the Company will not accrue PIK interest if the portfolio company valuation indicates that the PIK interest is not collectible. As of April 30, 2016, the Company held three investments, Ajubeo, Inc., Northstar Portfolio, LLC and 5500 South Quebec Holdings, LLC with contractual PIK interest. As of April 30, 2016 the balance of accrued PIK interest related to these investments was $42,489, $135,616, and $208,400, respectively. For the year ended October 31, 2015, the Company held three investments, Ajubeo, Inc. Northstar Portfolio, LLC and 5500 South Quebec Holdings, LLC with contractual PIK interest. As of October 31, 2015, the balance of PIK interest related to these investments was $26,583, $23,750, and $56,667, respectively. All PIK interest amounts are recorded within the interest receivable balance as of April 30, 2016. The Company notes that investments held with PIK interest do not have cash interest rates.
Dividend income from investments in other investment companies is recorded as dividend income on an accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Each distribution received from limited liability company (“LLC”) and limited partnership (“LP”) investments is evaluated to determine if the distribution should be recorded as dividend income or a return of capital. Generally, the Company will not record distributions from equity investments in LLCs and LPs as dividend income unless there are sufficient accumulated tax-basis earnings and profits in the LLC or LP prior to the distribution. Distributions that are classified as a return of capital are recorded as a reduction in the cost basis of the investment. For the three and six months ended April 30, 2016, the Company recorded dividend income of $5,392 and $13,356. For the three and six months ended April 30, 2015, the Company recorded dividend income of $8,191 and $13,495, respectively.
Non-accrual loans: A loan may be left on accrual status during the period the Company is pursuing repayment of the loan. Management reviews all loans that become 90 days or more past due on principal and interest, or when there is reasonable doubt that principal or interest will be collected, for possible placement on non-accrual status. When a loan is placed on non-accrual status, unpaid interest credited to income is reversed. Additionally, any original issue discount and market discount are no longer accreted to interest income as of the date the loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current. There were three non-accrual loans held as of April 30, 2016 (Aequitas Commercial Finance, LLC, Aequitas Peer-to-Peer Funding, LLC, and Care Payment Holdings, LLC) and no non-accrual loans held as of October 31, 2015.
Partial loan sales: The Company follows the guidance in FASB ASC Topic 860 when accounting for loan participations and other partial loan sales. Such guidance requires a participation or other partial loan sale to meet the definition of a “participating interest”, as defined in the guidance, in order for sale treatment to be allowed. Participations or other partial loan sales which do not meet the definition of a participating interest remain on the Company’s statements of assets, liabilities and net assets and the proceeds are recorded as a secured borrowing until the definition is met. Secured borrowings are carried at fair value to correspond with the related investments, which are carried at fair value. For the three months ended April 30, 2016 and April 30, 2015, there were no partial loan sales. For the six months ended April 30, 2016, there were partial loan sales which met the definition of a participating interest to a related party of $40,000 of the Company’s interest in its Promissory Note in eCOS, LLC. For the six months ended April 30, 2015 there were partial loan sales which met the definition of a participating interest to an unrelated third party of $800,000 of the Company’s interest in its $3,257,500 Promissory Note in Camel Parkwood, LLC. There was no gain or loss resulting from this partial loan sale.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
Income Taxes
The Company has elected to be treated as a BDC under the 1940 Act. The Company elected to be treated as a RIC under the Internal Revenue Code beginning with the tax year ended October 31, 2015. Such election was made upon the filing of the Company's first federal tax return for RIC purposes. In order to continue to qualify as a RIC, among other things, the Company must meet certain source of income and asset diversification requirements and timely distribute to its stockholders at least 90% of investment company taxable income, as defined by the Code, for each tax year. The Company has made, and intends to continue to make, the requisite distributions to its stockholders, which generally relieves the Company from U.S. federal income taxes with respect to all income distributed to its stockholders. So long as the Company maintains its status as a RIC, it will generally not pay corporate-level U.S. federal income or excise taxes on any ordinary income or capital gains that it distributes at least annually to its stockholders as distributions of income. As a result, any tax liability related to income earned and distributed by the Company represents obligations of the Company’s stockholders and will not be reflected in the financial statements of the Company.
As a RIC, the Company is subject to a 4% nondeductible federal excise tax on certain undistributed income unless the Company distributes in a timely manner an amount at least equal to the sum of (i) 98.0% of ordinary income for each calendar year, (ii) 98.2% of capital gain net income for the one-year period ending October 31 in that calendar year, and (iii) any income realized, but not distributed, in the preceding year. The Company will not be subject to excise taxes on amounts on which the Company is required to pay corporate income tax (such as retained net capital gains). The Company currently intends to make sufficient distributions each taxable year to satisfy the Excise Tax Avoidance Requirement. For the three and six months ended April 30, 2016 there was no amount recorded for U.S. federal excise tax.
The Company accounts for income taxes in conformity with ASC Topic 740 — Income Taxes (“ASC Topic 740”). ASC Topic 740 provides guidelines for how uncertain tax positions should be recognized, measured, presented and disclosed in financial statements. ASC Topic 740 requires the evaluation of tax positions taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax benefits of positions not deemed to meet the more-likely-than-not threshold would be recorded as a tax expense in the current year. It is the Company’s policy to recognize accrued interest and penalties related to uncertain tax benefits in income tax expense. There were no material uncertain income tax positions through April 30, 2016. All tax years since inception remain subject to examination by U.S. federal and most state tax authorities.
Distributions
Distributions to common stockholders are recorded on the record date. The amount to be paid out as a distribution is determined by the Board each quarter and is generally based upon the earnings estimated by management. Net realized capital gains, if any, are distributed at least annually, although the Company may decide to retain such capital gains for investment. During the six months ended April 30, 2016, there were total distributions of $860,924. During the six months ended April 30, 2015, there were total distributions of $377,497.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
Accounting for derivative instruments
The Company does not utilize hedge accounting and marks its derivatives, if any, to market through a net change in unrealized appreciation (depreciation) on derivative instruments in the statements of operations.
Recently adopted accounting pronouncements
In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Interest — Imputation of interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance is effective for annual and interim periods beginning after December 15, 2015. The Company notes that the adoption of this accounting standard did not have a material impact on its financial statements.
In May 2015, FASB issued ASU 2015-07 “Fair Value Measurement (Topic 820) – Disclosures for Investments in Certain Entities that Calculate Net Asset Value (“NAV”) per Share (or Its Equivalent).” This new guidance no longer requires investments for which NAV is determined based on practical expedient reliance to be reported utilizing the fair value hierarchy. This guidance is effective for annual and interim periods beginning after December 15, 2015, however, early adoption is permitted. The Company elected to early adopt ASU 2015-07 as of October 31, 2015. The adoption did not have a material impact on the Company's financial statements, other than enhancing the disclosures.
Revolving Credit Facility
On October 21, 2015, the Company entered into a senior secured revolving credit facility up to $3,200,000. The line of credit expires on October 21, 2016, unless extended. Borrowings under the line of credit bear interest at a fixed rate of 4.85%. All borrowings are collateralized by all assets of the Company. The outstanding balance on the line of credit was $0 at April 30, 2016 and $1,701,008 at October 31, 2015. Borrowings under the line of credit are subject to certain financial covenants and restrictions on indebtedness, distribution of income payments, financial guarantees, business combinations, and other related items. As of April 30, 2016, the Company is in compliance with all covenants.
In accordance with the 1940 Act, with certain limited exceptions, the Company is only allowed to borrow amounts such that its asset coverage, calculated pursuant to the 1940 Act, is at least 200% after such borrowing. As of October 31, 2015, the Company’s asset coverage was 1207%.
| 4. | RELATED PARTY TRANSACTIONS AND AGREEMENTS |
Investment Advisory and Management Agreement
The Company pays the Adviser a fee for its investment advisory services under the Investment Advisory Agreement consisting of two components - a base management fee and an incentive fee. The cost of both the base management fee and any incentive fees earned by the Adviser is ultimately borne by the common shareholders.
The base management fee (the “Base Fee”) is calculated at an annual rate of 1.5% of gross assets, which includes the use of leverage, if any. The Base Fee is payable quarterly in arrears, and is calculated based on the value of gross assets at the end of the most recently completed fiscal quarter, and appropriately adjusted for any equity capital raises or repurchases during the current fiscal quarter. The Base Fee for any partial month or quarter will be appropriately prorated.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
The Incentive Fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Investment Advisory Agreement, as of the termination date), commencing with the calendar year beginning November 1, 2014, and equals 20% of “Net Investment Income” above 7.5% for the year. “Net Investment Income” is defined as all income accrued during the year minus operating expenses, Base Management Fee and expenses paid under the Investment Advisory Agreement. Net Investment Income includes, in the case of investments with a deferred interest feature (such as original issue discount debt instruments with payable-in-kind interest and zero coupon securities) accrued income not yet received in cash. Net Investment Income does include any realized capital gains, realized capital losses, or unrealized capital depreciation. It does not include unrealized capital appreciation.
For the three and six months ended April 30, 2016, the Adviser earned $92,221 and $181,192, respectively, in base management fees. For the three and six months ended April 30, 2015, the Adviser earned $41,286 and $72,538, respectively, in base management fees. There was no Incentive Fee for the three and six months ended April 30, 2016 and April 30, 2015.
Custody Agreement
As compensation for the Adviser’s services related to the Custody Agreement the Company has agreed to pay an annual fee of 0.15% of the Custodial Property defined as all investments and cash equivalents held by the Adviser through October 31, 2015. Effective November 1, 2015, Custodial Property was amended to be defined as gross assets at the end of the most recently completed fiscal quarter, appropriately adjusted for any equity capital raises or repurchases during the current fiscal quarter. The Adviser invoices the Company quarterly in arrears for the pro-rata portion of the annual amount. For the three and six months ended April 30, 2016, the Adviser earned $9,222 and $18,119, respectively, in custody fees. For the three and six months ended April 30, 2015, the Adviser earned $5,125 and $8,706, respectively, in custody fees.
Administration Agreement
Pursuant to the Investment Advisory Agreement, the Adviser furnishes the Company with equipment and clerical, bookkeeping and record-keeping services, as well as certain administrative services, which include being responsible for the financial records which the Company is required to maintain and preparing reports to shareholders and reports filed with the SEC. In addition, the Adviser assists the Company in monitoring portfolio accounting and bookkeeping, managing portfolio collections and reporting, performing internal audit services, determining and publishing the net asset value, overseeing the preparation and filing of tax returns and the printing and dissemination of reports to shareholders, providing support for risk management efforts and generally overseeing the payment of expenses and the performance of administrative and professional services rendered to the Company by others. The Company reimburses the Adviser for the allocable portion of overhead and other expenses incurred in performing its administrative obligations under the Advisory Agreement. The Adviser prepares and delivers statements documenting its expenses which are subject to reimbursement.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
The Adviser has entered into an Operating Expense Limitation Agreement (“OELA”) with the Company effective January 2, 2014, to limit total operating expense to 2.34% of total operating expenses of the Company. Effective September 1, 2014, the OELA was amended to 2.95%, whereby any expenses in excess of the OELA will be reimbursed to the Company by the Adviser. However, the Adviser will be able to recoup from the Company these expenses reimbursed in excess of the limit over a period not to exceed three years. For the three months ended April 30, 2016, the total amount of operating expenses incurred by the Company was less than the limit by $2,639, and this amount was therefore refunded by the Company to the Adviser. The total amount of operating expenses incurred by the Company which exceeded the limit and were reimbursed by the Adviser for the six months ended April 30, 2016 was $75,557. The total amount of operating expenses incurred by the Company which exceeded the limit and were reimbursed by the Adviser for the three and six months ended April 30, 2015 was $49,943 and $127,779, respectively. Such expenses paid by the Adviser each quarter will be subject to reimbursement to the Adviser over a period not to exceed three years, if the Company’s expense ratio for such future period is less than the 2.95% limit or the 2.34% limit related to each respective period. The OELA remains in effect until terminated by the Company and Adviser. The following table presents the amounts reimbursed by the Adviser and the expiration date for such future possible reimbursement by the Company.
| Date Reimbursed | | Amount | | Expiration Date |
| June 30, 2014 | | $ | 121,939 | | June 30, 2017 |
| October 31, 2014 | | | 55,091 | | October 31, 2017 |
| January 31, 2015 | | | 77,836 | | January 31, 2018 |
| April 30, 2015 | | | 49,943 | | April 30, 2018 |
| July 31, 2015 | | | 15,643 | | July 31, 2018 |
| October 31, 2015 | | | 16,920 | | October 31, 2018 |
| January 31, 2016 | | | 78,196 | | January 31, 2019 |
| April 30, 2016 | | | (2,639 | ) | April 30, 2019 |
| | | $ | 412,929 | | |
Through the normal course of business, the Adviser or an affiliate of the Adviser processes payments on behalf of the Company and then is reimbursed for expenses paid on behalf of the Company. As of April 30, 2016, $156,047 was due to the Adviser for such reimbursements, including the OELA refund of $2,639. As of October 31, 2015, $119,157 was due to the Adviser for such reimbursements, net of the OELA reimbursed of $16,920. The Due to Adviser balance is settled monthly in arrears. Amounts paid by the Adviser on behalf of the Company are non-interest bearing.
| 5. | FAIR VALUE OF INVESTMENTS |
The Company invests in direct debt and equity securities that are not traded on a public market. These securities are recorded at fair value as determined by the Company using the framework of Topic ASC 820. In addition, the Company has adopted written guidelines for determining the fair value of its investments for reporting in the accompanying financial statements. Under these guidelines, investment valuations are reviewed on a quarterly basis and investments without readily available market values are valued at fair value as determined by the Company. In the absence of readily ascertainable market values, the Company uses valuation techniques consistent with the market, income and cost approaches, as prescribed by Topic ASC 820, in order to estimate the fair value of investments. In all cases, the Company evaluates whether the valuation techniques used and the resultant fair value estimate is representative of what the most likely buyers of the company would also pay upon exit, and therefore, whether the value is deemed to be the price expected in an orderly transaction between market participants at the measurement date. The Company’s investment in Landmark Dividend Growth Fund – G LLC is valued using NAV. As of April 30, 2016 and October 31, 2015, the fair value of Landmark Dividend Growth Fund – G LLC was $523,131 and $526,940, respectively.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
Under Topic ASC 820, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. Topic ASC 820 permits the Company, as a practical expedient, to estimate the fair value of investments in other investment companies based on the net asset value (NAV) per share, or its equivalent, if the NAV of such investments is calculated in a manner consistent with the measurement principles of Topic ASC 946, Financial Services — Investment Companies. As such the Company’s estimate of fair value for its investments in other investment companies is generally based on the NAV provided to the Company by each Investee Fund, supported by the independently audited financial statements of the Investee Fund, when available.
The transaction price is typically the Company’s best estimate of fair value at inception of the investment. When evidence supports a change to the carrying value from the transaction price, adjustments are made to reflect expected exit values. Ongoing reviews by the Company are based on an assessment of significant assumptions related to each underlying investment including incorporating valuations that consider the evaluation of financing and sale transactions with third parties, the financial condition and operating results of the portfolio company, achievement of technical milestones, and expected cash flows. All investments at April 30, 2016 and October 31, 2015 had no readily available market value and are included in Level 3 of the fair value hierarchy.
As part of the valuation process, management may take into account the following types of factors, if relevant, in determining the fair value of the Company’s investments: the enterprise value of a portfolio company (the entire value of the portfolio company to a market participant, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time), the nature and realizable value of any collateral, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, a comparison of the portfolio company’s securities to any similar publicly traded securities, changes in the interest rate environment and the credit markets generally that may affect the price at which similar investments would trade in their principal markets and other relevant factors. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, management considers the pricing indicated by the external event to corroborate its valuation.
Because there is not a readily available market value for most of the investments in its portfolio, the Company values substantially all of its portfolio investments at fair value as determined in good faith by management, as described throughout this note. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may fluctuate from period to period. Additionally, the fair value of the Company’s investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If the Company was required to liquidate a portfolio investment in a forced or liquidation sale, the Company could realize significantly less than the value at which the Company has recorded it.
In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned.
All debt securities in TVO Capital Management, LLC ("TVO") are interim loans to assist with pursuit costs and out-of-pocket due diligence expenses related to real estate transactions. If the property acquisitions are unsuccessful, TVO shall repay such interim loan, with interest, upon demand. If the property acquisitions are successful, TVO shall repay such interim loan's interest and the principal will convert to general partner equity upon final close of each respective transaction.
The following tables present information about the Company’s assets measured at fair value on a recurring basis at April 30, 2016 and October 31, 2015. The Company assesses the levels for the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer in accordance with the Company’s accounting policy regarding the recognitions of transfers between levels of the fair value hierarchy. For the period ended April 30, 2016 and year ended October 31, 2015, there were no transfers in or out of Level 1, 2, and 3.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
Assets Measured at Fair Value on a Recurring Basis at April 30, 2016:
| | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | Balance at April 30, 2016 | |
| | | (Level 1) | | | (Level 2) | | | (Level 3) | | | | |
| Investments: | | | | | | | | | | | | |
| Debt Securities | | $ | - | | | $ | - | | | $ | 15,905,833 | | | $ | 15,905,833 | |
| Equity Securities | | | - | | | | - | | | | 523,931 | | | | 523,931 | |
| Investments in Partnership | | | | | | | | | |
| Interests | | | - | | | | - | | | | 1,024,878 | | | | 1,024,878 | |
| Investment in Other | | | | | | | | | | | | | |
| Investment Companies* | | | - | | | | - | | | | - | | | | 523,131 | |
| Total | | $ | - | | | $ | - | | | $ | 17,454,642 | | | $ | 17,977,773 | |
| | | | | | | | | | | | | | | | | |
Assets Measured at Fair Value on a Recurring Basis at October 31, 2015:
| | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | Balance at October 31, 2015 | |
| | | (Level 1) | | | (Level 2) | | | (Level 3) | | | | |
| Investments: | | | | | | | | | | | | |
| Debt Securities | | $ | - | | | $ | - | | | $ | 14,067,446 | | | $ | 14,067,446 | |
| Equity Securities | | | - | | | | - | | | | 301,084 | | | | 301,084 | |
| Investments in Partnership | | | - | | | | - | | | | - | | | | - | |
| Interests | | | - | | | | - | | | | 1,706,233 | | | | 1,706,233 | |
| Investment in Other | | | - | | | | - | | | | - | | | | - | |
| Investment Companies* | | | - | | | | - | | | | - | | | | 526,940 | |
| Total | | $ | - | | | $ | - | | | $ | 17,730,077 | | | $ | 16,601,703 | |
| | | | | | | | | | | | | | | | | |
* In accordance with ASC 820, certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the financial statements.
The Company estimates that it will receive liquidating distributions from its investments in Other Investment Companies over a period consistent with the investee company’s estimated life plus available extension periods, which is 3 years from the effective date with two additional 12-month extensions available at the discretion of the Managing Member. For the investment in Other Investment Companies, the Company will pay the management of such investment company a monthly management fee based on the product of $65 and the number of portfolio assets then held by the investment company. The investment company specializes in the acquisition of real property rights to ground leases and easements primarily under infrastructure assets. The Company has fully funded its capital commitment to the investment company. The Company’s investment in Other Investment Companies is stated at fair value based on the underlying NAV as a practical expedient.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis
| | | Debt Securities | | | Equity Securities | | | Investments in Partnership Interests | | | Investment in Other Investment Companies | | | Total | |
| | | | | | | | | | | | | | | | |
| Balance at October 31, 2014 | | | 5,796,500 | | | | - | | | | - | | | | 465,116 | | | | 6,261,616 | |
| Purchase of investments | | | 14,200,112 | | | | - | | | | 687,800 | | | | - | | | | 14,887,912 | |
| Proceeds from principal payments | | | (5,057,500 | ) | | | - | | | | - | | | | (465,116 | ) | | | (5,522,616 | ) |
| and sales of investments | | | | | | | | | | | | | |
| Settlements/Conversions | | | (850,000 | ) | | | - | | | | 850,000 | | | | - | | | | - | |
| Net unrealized gains/(losses) | | | (21,666 | ) | | | 301,084 | | | | 168,433 | | | | - | | | | 447,851 | |
| Balance at October 31, 2015 | | $ | 14,067,446 | | | $ | 301,084 | | | $ | 1,706,233 | | | $ | - | | | $ | 16,074,763 | |
| Purchase of investments | | | 2,450,783 | | | | - | | | | - | | | | - | | | | 2,450,783 | |
| Proceeds from principal payments | | | (712,722 | ) | | | - | | | | (860,916 | ) | | | - | | | | (1,573,638 | ) |
| and sales of investments | | | | | | | | | | | | | |
| Net realized gains | | | - | | | | - | | | | 173,116 | | | | - | | | | 173,116 | |
| Net unrealized gains | | | 81,933 | | | | 222,847 | | | | 6,445 | | | | - | | | | 311,225 | |
| Acretion of loan origination fees | | | 18,393 | | | | - | | | | - | | | | - | | | | 18,393 | |
| Balance at April 30, 2016 | | $ | 15,905,833 | | | $ | 523,931 | | | $ | 1,024,878 | | | $ | - | | | $ | 17,454,642 | |
Quantitative Information About Level 3 Fair Value Measurements
Below is a table summarizing the valuation techniques, the unobservable inputs used in the valuation, along with ranges used to determine the fair value of certain Level 3 investments held at April 30, 2016 and October 31, 2015.
| April 30, 2016 | |
| Type of Security | | Fair Value | | Valuation Technique | | Unobservable Input | | Range (Wtd Avg) | |
| Debt Securities | | $ | 15,905,833 | | Yield Analysis | | Market Yield | | | 6.0 - 14.5% (8.8%) | |
| Equity Securities | | $ | 523,931 | | Earnings Multiple | | Market Comparables | | | 2.0 - 3.0(2.7) | |
| | | $ | - | | Income Approach | | Capitalization Rate | | | 14.8% | |
| Investments in Partnership Interests | | $ | 1,024,878 | | Income Approach | | Capitalization Rate | | | 7.0% | |
| | | | | | | | | | | | |
| October 31, 2015 | |
| Type of Security | | Fair Value | | Valuation Technique | | Unobservable Input | | Range (Wtd Avg) | |
| Debt Securities | | $ | 14,067,446 | | Yield Analysis | | Market Yield | | | 6.0 - 14.5% (9.0%) | |
| Equity Securities | | $ | 301,084 | | Earnings Multiple | | Market Comparables | | | 2.0 - 3.0(2.5) | |
| | | $ | - | | Income Approach | | Capitalization Rate | | | 14.8% | |
| Investments in Partnership Interests | | $ | 1,706,233 | | Income Approach | | Capitalization Rate | | | 6.4 - 7.8% (6.9%) | |
The above tables are not intended to be all-inclusive but rather to provide information on significant unobservable inputs and valuation techniques used by the Company. The significant unobservable input used in the fair value measurement of the Company’s debt investments is market interest rates. The Company uses market interest rates for loans to determine if the effective yield on a loan is commensurate with the market yields for that type of loan. If a loan’s effective yield is significantly less than the market yield for a similar loan with a similar credit profile, then the resulting fair value of the loan may be lower.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
| 6. | COMMITMENTS AND CONTINGENCIES |
In the normal course of business, the Company may enter into commitments to invest in certain private equity funds. Under these agreements, the Company would be required to make payments to third parties upon request. The Company had no such commitments outstanding at April 30, 2016 and October 31, 2015.
The following information sets forth the computation of basic net increase in net assets per share (earnings per share) resulting from operations for the three and six months ended April 30, 2016 and April 30, 2015.
| | | Three months ended | | | Six Months Ended | |
| | | April 30, 2016 | | | April 30, 2015 | | | April 30, 2016 | | | April 30, 2015 | |
| Earnings per share - basic: | | | | | | | | | | | | |
| Net increase in net assets resulting from operations | | $ | 471,044 | | | $ | 289,323 | | | $ | 798,535 | | | $ | 537,566 | |
| Weighted average shares outstanding - basic | | | 2,407,129 | | | | 1,115,545 | | | | 2,276,373 | | | | 985,300 | |
| Earnings per share - basic: | | $ | 0.20 | | | $ | 0.26 | | | $ | 0.35 | | | $ | 0.55 | |
| 8. | DISTRIBUTIONS FROM INCOME |
The Company’s distributions from income and realized gains are recorded on the date declared (record date). The following table summarizes the Company’s declarations and distributions during the six months ended April 30, 2016:
| Declaration Date | Distribution Date | Amount Per Share | Cash Distribution |
| 11/25/2015 | 11/27/2015 | $0.0625 | $122,898 |
| 12/28/2015 | 12/30/2015 | $0.0625 | $141,633 |
| 1/25/2016 | 1/26/2016 | $0.0625 | $144,291 |
| 2/25/2016 | 2/26/2016 | $0.0625 | $149,912 |
| 3/25/2016 | 3/28/2016 | $0.0625 | $150,458 |
| 4/25/2016 | 4/27/2016 | $0.0625 | $151,732 |
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
| Per Share Data: | | For the six months ended April 30, 2016 | | | For the six months ended April 30, 2015 | |
| | | | | | | |
| Net asset value at beginning of period | | $ | 10.18 | | | $ | 9.86 | |
| Issuance of common stock | | | - | | | | - | |
| Net investment income/(loss) (2) | | | 0.14 | | | | 0.34 | |
| Net realized and unrealized gain (loss) (3) | | | 0.21 | | | | 0.21 | |
| Net increase in shareholders’ equity | | | 0.35 | | | | 0.55 | |
| Accretive effect of share issuance above NAV | | | 0.01 | | | | 0.04 | |
| Shareholder distributions: | | | | | | | | |
| From net investment income | | | (0.38 | ) | | | (0.38 | ) |
| Income tax expense | | | - | | | | - | |
| Net asset value at end of period | | $ | 10.16 | | | $ | 10.07 | |
| Shares outstanding at end of period | | | 2,437,523 | | | | 1,165,597 | |
| Ratio/Supplemental Data: | | | | | | | | |
| Weighted average net assets at end of period | | | 23,209,644 | | | | 9,704,175 | |
| | | | | | | | | |
| Total return based on net asset value (4) | | | 3.44 | % | | | 5.58 | % |
| | | | | | | | | |
| Ratio of gross operating expenses to average net assets (1) | | | 3.60 | % | | | 5.58 | % |
| Deferred or reimbursed expenses (1) | | | -0.65 | % | | | -2.63 | % |
| Ratio of net operating expenses to average net assets (1) | | | 2.95 | % | | | 2.95 | % |
| Ratio of net investment income/(loss) to average net assets | | | 2.74 | % | | | 6.86 | % |
| Average debt outstanding | | | 850,504 | | | | - | |
| Average debt outstanding per share | | $ | 0.35 | | | $ | - | |
| Portfolio turnover | | | 10.65 | % | | | 21.63 | % |
| (1) | The ratios have been annualized except for those expenses that are not recurring. |
| (2) | Calculated using the weighted average shares outstanding during the respective period. |
| (3) | Amounts are balancing amounts necessary to reconcile the change in net asset value per unit to the per unit information. |
| (4) | Total return based on market value is calculated assuming a purchase of common shares at the market value on the first day and a sale at the market 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 Company’s distribution reinvestment plan. Total return based on market value does not reflect brokerage commissions. Return calculations are not annualized. |
These financial highlights may not be indicative of the future performance of the Company. Financial highlights are calculated for all outstanding common stock as a whole. An individual shareholder’s return and ratios may vary.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
| 10. | RISKS AND UNCERTAINTIES |
The Company in the normal course of business makes investments in financial instruments where the risk of potential loss exists due to changes in the market (market risk), or failure or inability of the counterparty to a transaction to perform (credit and counterparty risk). See below for a detailed description of select principal risks.
Market Risk
Market risk is the company’s investments in financial instruments and derivatives that expose it to various risks such as, but not limited to, interest rate, foreign currency, and equity. Interest rate risk is the risk that a fixed income investment's value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. Such changes usually affect securities inversely and can be reduced by diversifying (for example, investing in fixed- income securities with different durations) or hedging (for example, through an interest rate swap).
Equity Risk
Equity risk is the risk that the market values of equities, such as common stocks or equity related investments such as futures and options, may decline due to general market conditions, such as political or macroeconomic factors. Additionally, equities may decline in value due to specific factors affecting a related industry or industries. Equity securities and equity related investments generally have greater market price volatility than fixed income securities.
Credit and Counterparty Risk
The Company is exposed to credit risk to counterparties with whom it transacts with and also bears the risk of settlement default. The company may lose money if the issuer or guarantor of a fixed income security, or the counterparty to a derivative instrument contract, repurchase agreement or securities lending is unable or unwilling to make timely principal and/or interest payments, or to otherwise honor its obligations. Securities are subject to varying degrees of credit risk, which are often reflected in credit ratings. The Company minimizes concentrations of credit risk by undertaking transactions with a diverse population of counterparties with a history of good credit quality. Further, the company manages counterparty risk by entering into appropriate legally enforceable master netting agreements, or similar agreements which include provisions for offsetting positions, collateral, or both in the event of counterparty default or nonperformance.
As the Company currently holds three investments with PIK interest, we note that the interest rate and warrants received on PIK securities reflects the payment deferral and increased credit risk associated with such instruments. Such investments generally represent a significantly higher credit risk than coupon loans. We note that even if accounting conditions were met, the borrower could still default when the Company's actual collection is supposed to occur at the maturity of the obligation. PIK securities may have unreliable valuations because their continuing accruals require continuing judgments about the collectability of the deferred payments and the value of associated collateral. PIK interest has the effect of generating investment income and increasing the incentive fees payable at a compounding rate. In addition, the deferral of PIK interest also reduces the loan-to-value ratio at a compounding rate. PIK securities also create the risk that incentive fees will be paid to the Adviser based on non-cash accruals that ultimately may not be realized, but the Adviser will be under no obligation to reimburse the Company for these fees.
Integrity Capital Income Fund, Inc.
Notes to Financial Statements
Three and Six Months Ended April 30, 2016
(unaudited)
The Company has provided general indemnifications to the Adviser, any affiliate of the Adviser and any person acting on behalf of the Adviser or such affiliate when they act, in good faith, in the best interest of the Company. The Company is unable to develop an estimate of the maximum potential amount of future payments that could potentially result from any hypothetical future claim, but expects the risk of having to make any payments under these general business indemnifications to be remote.
For the purpose of issuing these financial statements, the Company evaluated events and transactions through the date the financial statements were issued.
The Company continued to pay its monthly distribution of $0.0625 per share.
The Company’s $500,000 investment in TVO North America, LLC matured in January, 2016 but remains outstanding. A partial payment of accrued interest for $20,000 was made on April 19, 2016. After discussions with management at TVO North America, LLC, the Company considers the par value of this note collectible.
On March 10th the SEC filed a complaint against one of the issuers of securities held in the fund related to three of the Company’s debt investments. Subsequently a receiver has been appointed over these investments. The Company’s $500,000 investment in Aequitas Commercial Finance, LLC and $110,000 investment in Aequitas Peer-To-Peer Funding, LLC matured in May, 2016. Both notes have been placed on non-accrual and the Company has reversed all unpaid accrued interest. The notes have not been paid in full as of June 14, 2016. In addition, the Care Payment Holdings promissory note due 09/18/2018 has also been placed on non-accrual. The Company is monitoring the notes and the potential impact on valuations and income to the Fund. At this time, the Company still considers the par value of these promissory notes collectible.
On May 26, 2016, the Company made an additional investment of $302,050 through a promissory note with eCOS, LLC.
From May 1, 2016 to June 14, 2016, the Company sold 9,709 shares of common stock at a price of $10.30 per share, for a total of $100,000 of new capital invested. On May 6, 2016, 43,127 shares of common stock were redeemed at a price per share of $10.14.
