Form 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2008
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number 0-24412
MACC Private Equities Inc.
--------------------------
(Exact name of registrant as specified in its charter)
Delaware 42-1421406
-------- ----------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
580 2nd Street, Suite 102, Encinitas, CA 92024
----------------------------------------------
(Address of principal executive offices)
(Zip Code)
(760) 479-5075
(Registrant's telephone number, including area code)
-----------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer or a smaller reporting company.
See definitions of "large accelerated filer," "accelerated filer," and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [X] Smaller Reporting Company [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
At June 30, 2008, the registrant had issued and outstanding 2,464,621 shares of
common stock.
Index
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
Condensed Consolidated Balance
Sheets at June 30, 2008 (Unaudited)
and September 30,
2007....................................................... 2
Condensed Consolidated Statements of
Operations (Unaudited) for the three months
and nine months ended June 30, 2008 and
June 30, 2007.............................................. 3
Condensed Consolidated Statements of
Cash Flows (Unaudited) for the nine months
ended June 30, 2008 and June 30, 2007...................... 4
Notes to Unaudited Condensed Consolidated
Financial Statements....................................... 5
Consolidated Schedule of Investments (Unaudited)
at June 30, 2008........................................... 8
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations .......... 11
Item 3. Quantitative and Qualitative
Disclosure About Market Risk............................... 16
Item 4T. Controls and Procedures.................................... 17
Part II. OTHER INFORMATION..........................................
Item 1. Legal Proceedings.......................................... 17
Item 1A. Risk Factors............................................... 17
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds................................................... 21
Item 3. Defaults Upon Senior Securities............................ 21
Item 4. Submission of Matters to a Vote of Security Holders........ 21
Item 5. Other Information.......................................... 21
Item 6. Exhibits................................................... 22
Signatures.................................................
Certifications............................See Exhibits 31 and 32
1
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
June 30, September 30,
2008 2007
(Unaudited)
----------------- ----------------
Assets
Cash and cash equivalents $ 345,967 822,295
Loans and investments in portfolio securities, at market or fair value:
Unaffiliated companies (cost of $2,281,494 and $2,301,385) 1,637,026 2,095,665
Affiliated companies (cost of $12,270,802 and $13,007,879) 10,804,221 11,595,183
Controlled companies (cost of $2,979,106 and $3,040,043) 2,490,150 3,014,106
Interest receivable 312,237 268,598
Other assets 301,630 212,940
--------------------- ----------------
Total assets $ 15,891,231 18,008,787
===================== ================
Liabilities and net assets
Liabilities:
Note payable $ 4,855,661 6,108,373
Incentive fees payable 23,061 252,130
Accounts payable and other liabilities 189,014 127,474
--------------------- ----------------
Total liabilities 5,067,736 6,487,977
--------------------- ----------------
Net assets:
Common stock, $.01 par value per share; authorized 10,000,000 shares;
issued and outstanding 2,464,621 shares 24,646 24,646
Additional paid-in-capital 13,398,854 13,140,517
Unrealized depreciation on investments (2,600,005) (1,644,353)
--------------------- ----------------
Total net assets 10,823,495 11,520,810
--------------------- ----------------
Total liabilities and net assets $ 15,891,231 18,008,787
===================== ================
Net assets per share $ 4.39 4.67
===================== ================
See accompanying notes to unaudited condensed consolidated financial statements.
2
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
(Unaudited)
For the three For the three For the nine For the nine
months ended months ended months ended months ended
June 30, June 30, June 30, June 30,
2008 2007 2008 2007
---------------- ---------------- ---------------- ------------------
Investment income:
Interest
Unaffiliated companies $ 8,263 12,394 25,189 41,727
Affiliated companies 101,248 144,720 407,061 415,740
Controlled companies 8,952 29,129 39,942 89,029
Other 72 13,495 2,341 74,064
Dividends
Affiliated companies 163,326 53,414 261,624 99,862
Other income --- --- 6 ---
------------------- ---------------- ---------------- ------------------
Total investment income 281,861 253,152 736,163 720,422
-- ---------------- ---------------- ---------------- ------------------
Operating expenses:
Interest expenses 93,377 158,695 330,304 560,527
Management fees 75,107 78,159 205,200 251,119
Professional fees 99,263 26,830 353,959 165,082
Other 94,274 66,908 245,903 234,878
------------------- ---------------- ---------------- ------------------
Total operating expenses 362,021 330,592 1,135,366 1,211,606
------------------- ---------------- ---------------- ------------------
Investment expense, net (80,160) (77,440) (399,203) (491,184)
------------------- ---------------- ---------------- ------------------
Realized and unrealized gain (loss) on
investments and other assets:
Net realized gain on investments:
Unaffiliated companies 101,616 309,357 107,109 213,377
Affiliated companies 584,431 --- 584,431 ---
Net change in unrealized
appreciation/depreciation
on investments (34,322) 270,950 (955,652) 750,307
Net change in unrealized gain
on other assets (40,628) (25,686) (34,000) ---
------------------- ---------------- ---------------- ------------------
Net gain (loss) on investments 611,097 554,621 (298,112) 963,684
------------------- ---------------- ---------------- ------------------
Net change in net assets from
operations $ 530,937 477,181 (697,315) 472,500
=================== ================ ================ ==================
See accompanying notes to unaudited condensed consolidated financial statements.
3
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the nine For the nine
months ended months ended
June 30, June 30,
2008 2007
----------------- -------------------
Cash flows (used in) from operating activities:
Net change in net assets from operations $ (697,315) 472,500
Adjustments to reconcile net change in net assets from operations to net
cash provided by operating activities:
Net realized and unrealized loss (gain) on investments 264,112 (750,307)
Net realized and unrealized loss (gain) on other assets 34,000 (213,377)
Proceeds from disposition of and payments on
loans and investments in portfolio securities 1,561,445 1,052,031
Purchases of loans and investments in portfolio securities (52,000) (65,000)
Change in interest receivable (43,639) 160,663
Change in other assets (122,690) 894,105
Change in accrued interest, deferred incentive fees payable,
accounts payable and other liabilities (167,529) 118,958
------------------ -------------------
Net cash provided by operating activities 776,384 1,669,573
Cash flows from financing activities:
Note repayment (1,252,712) ---
Debt repayment --- (2,000,000)
------------------ -------------------
Net cash used in financing activities (1,252,712) (2,000,000)
------------------ -------------------
Net decrease in cash and cash equivalents (476,328) (330,427)
Cash and cash equivalents at beginning of period 822,295 2,132,350
------------------ ------------------
Cash and cash equivalents at end of period $ 345,967 1,801,923
================== ==================
Supplemental disclosure of cash flow information -
Cash paid during the period for interest $ 318,103 369,075
================== ==================
Supplemental disclosure of noncash investing and
Financing information -
Assets received in exchange of securities $ --- 84,000
================== ==================
See accompanying notes to unaudited condensed consolidated financial statements.
4
MACC PRIVATE EQUITIES INC.
Notes to Unaudited Condensed Consolidated Financial Statements
(1) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of MACC Private Equities Inc. ("MACC," "we" or "us") and
our wholly-owned subsidiary MorAmerica Capital Corporation ("MorAmerica
Capital") which have been prepared in accordance with U.S. generally accepted
accounting principles ("GAAP") for investment companies. All material
intercompany accounts and transactions have been eliminated in consolidation.
Effective April 30, 2008, MorAmerica Capital was merged with and into MACC (the
"Merger"). As a result of the Merger, MACC has assumed all of MorAmerica
Capital's assets and liabilities. Because MorAmerica was a wholly-owned
subsidiary of MACC prior to the Merger, the Merger had no impact on the
consolidated financial statements.
The financial statements included herein have been prepared in accordance
with GAAP for interim financial information and instructions to Form 10-Q and
Article 6 of Regulation S-X. The financial statements should be read in
conjunction with the consolidated financial statements and notes thereto of MACC
Private Equities Inc. and MorAmerica Capital as of and for the year ended
September 30, 2007. The information reflects all adjustments consisting of
normal recurring adjustments which are, in the opinion of management, necessary
for a fair presentation of the results of operations for the interim periods.
The results of the interim period reported are not necessarily indicative of
results to be expected for the year. The balance sheet information as of
September 30, 2007 has been derived from the audited balance sheet as of that
date.
(2) Critical Accounting Policy
Investments in securities that are traded in on a stock exchange are valued
based on the last quoted sale price on the valuation date (or if no sales
occurred on the valuation date, the closing bid price on that date). Securities
traded on the over-the-counter market are valued by taking the bid price on the
valuation date. Restricted and other securities for which quotations are not
readily available are valued at fair value as determined by our Board of
Directors. Among the factors considered in determining the fair value of
investments are the cost of the investment; developments, including recent
financing transactions, since the acquisition of the investment; financial
condition and operating results of the investee; the long-term potential of the
business of the investee; market interest rates for similar debt securities;
overall market conditions and other factors generally pertinent to the valuation
of investments. However, because of the inherent uncertainty of valuation, those
estimated values may differ significantly from the values that would have been
used had a ready market for the securities existed, and the differences could be
material.
In the valuation process, we use financial information received monthly,
quarterly, and annually from our portfolio companies which includes both audited
and unaudited financial statements. This information is used to determine
financial condition, performance, and valuation of the portfolio investments.
Realization of the carrying value of investments is subject to future
developments. Investment transactions are recorded on the trade date and
identified cost is used to determine realized gains and losses. Under the
provisions of SOP 90-7, the fair value of loans and investments in portfolio
securities on February 15, 1995, the fresh-start date, is considered the cost
basis for financial statement purposes.
5
MACC PRIVATE EQUITIES INC.
Notes to Unaudited Condensed Consolidated Financial Statements
________________________________________________________________________________
(3) Financial Highlights (Unaudited)
For the nine For the nine
months ended months ended
June 30, 2008 June 30, 2007
--------------- ---------------
Per Share Operating Performance (For a share of capital stock outstanding
throughout the period):
Net asset value, beginning of period $ 4.67 4.71
--------------- ---------------
Income from investment operations:
Investment expense, net (0.16) (0.19)
Net realized and unrealized gain
(loss) on investment transactions (0.12) 0.39
--------------- ---------------
Total from investment operations (0.28) 0.20
--------------- ---------------
Net asset value, end of period $ 4.39 4.91
=============== ===============
Closing bid price $ 2.15 2.30
=============== ===============
For the nine For the nine
months ended months ended
June 30, 2008 June 30, 2007
--------------- ---------------
Total return
Net asset value basis (6.05) % 4.07
Market price basis (12.24) % 29.21
Net asset value, end of period
(in thousands) $ 10,823 12,091
Ratio to weighted average net assets:
Investment expense, net 3.68 % 4.23
Operating and income tax expense 10.48 % 10.42
The ratios of investment expense, net to average net assets, of operating and
income tax expenses to average net assets and total return are calculated for
common stockholders as a class. Total return, which reflects the annual change
in net assets, was calculated using the weighted average change in net assets
between the beginning of the current fiscal year and end of the current year
period. An individual common stockholders' return may vary from these returns.
(4) Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements".
This statement defines fair value, establishes a framework for measuring fair
value in GAAP, and expands disclosures about fair value measurements. The
provisions of SFAS No. 157 are effective as of the beginning of the first fiscal
year that begins after November 15, 2007. We are evaluating the effect, if any,
the adoption of SFAS 157 will have on our consolidated financial statements.
6
In February 2007 the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities--Including an amendment of FASB
Statement No. 115." This statement permits entities to choose to measure many
financial instruments and certain other items to be measured at fair value. The
provisions of SFAS No. 159 are effective as of the beginning of the first fiscal
year that begins after November 15, 2007. We are evaluating the effect, if any,
the adoption of SFAS 159 will have on our consolidated financial statements.
In June 2007, the AICPA issued Statement of Position 07-1, "Clarification
of the Scope of the Audit and Accounting Guide Investment Companies and
Accounting by Parent Companies and Equity Method Investors for Investments in
Investment Companies." SOP 07-1 provides guidance for determining whether an
entity is within the scope of the AICPA Audit and Accounting Guide Investment
Companies. Statement of Position 07-1 is effective for financial statements
issued for fiscal years beginning on or after December 15, 2007. We are
evaluating the effect, if any, the adoption of SOP 07-1 will have on our
consolidated financial statements.
7
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS (UNAUDITED)
JUNE 30, 2008
Manufacturing:
Percent
of Net
Company Security assets Value Cost (d)
-------------------------------------------- ---------------------------------------------------------------------------------------
Aviation Manufacturing Group, LLC (a) 14% debt security, due October 1, 2008 $ 616,000 616,000
Yankton, South Dakota 154,000 units preferred 154,000 154,000
Manufacturer of flight critical parts Membership interest 795,559 39
for aircraft 14% note, due October 1, 2008 89,320 89,320
----------- ------------
1,654,879 859,359
----------- ------------
Central Fiber Corporation 12% debt security, due March 31, 2009 205,143 205,143
Wellsville, Kansas 12% debt security, due March 31, 2009 53,079 53,079
Recycles and manufactures Warrant to purchase 273.28 common shares --- ---
cellulose fiber products ----------- ------------
258,222 258,222
----------- ------------
Detroit Tool Metal Products Co. (a) 12% debt security, due November 18, 2009 1,371,507 1,371,507
Lebanon, Missouri 19,853.94 share Series A preferred (c) 195,231 195,231
Metal stamping 7,887.17 common shares (c) 126,742 126,742
----------- ------------
1,693,480 1,693,480
----------- ------------
Handy Industries, LLC (a) 12.5% debt security, due January 8, 2008 667,327 667,327
Marshalltown, Iowa 167,171 units Class B preferred (c) 68,528 167,171
Manufacturer of lifts for Membership interest --- 1,357
motorcycles, trucks and ----------- ------------
industrial metal products 735,855 835,855
----------- ------------
Kwik-Way Products, Inc. (a) 2% debt security, due January 31, 2008 (c) 1 267,254
Marion, Iowa 2% debt security, due January 31, 2008 (c) --- 281,795
Manufacturer of automobile 38,008 common shares (c) --- 126,651
aftermarket engine and brake 29,340 common shares (c) --- 92,910
Repair machinery ----------- ------------
1 768,610
----------- ------------
Linton Truss Corporation 542.8 common shares (c) ---- ----
Delray Beach, Florida 400 shares Series 1 preferred (c) 340,000 40,000
Manufacturer of residential roof and Warrants to purchase common shares (c) 15 15
floor truss systems ----------- ------------
340,015 40,015
----------- ------------
M.A. Gedney Company (a) 648,783 shares preferred (c) 140,000 1,450,601
Chaska, Minnesota 12% debt security, due June 30, 2009 152,000 76,000
Pickle Processor Warrant to purchase 83,573 preferred shares (c) --- ---
----------- ------------
292,000 1,526,601
----------- ------------
Magnum Systems, Inc. (a) 12% debt security, due November 1, 2008 574,163 574,163
Parsons, Kansas 48,038 common shares (c) 48,038 48,038
Manufacturer of industrial bagging 292,800 shares preferred (c) 304,512 304,512
equipment Warrant to purchase 56,529 common shares (c) 380,565 565
----------- ------------
1,307,278 927,278
----------- ------------
8
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS CONTINUED (UNAUDITED)...
JUNE 30, 2008
Manufacturing Continued: Security Percent
of Net
Company assets Value Cost (d)
------------------------------------------------------------------------------------------------------------------------------------
Pratt-Read Corporation (a) 13,889 shares Series A Preferred (c) $ 421,460 750,000
Bridgeport, Connecticut 7,718 shares Services A preferred (c) 234,097 416,667
Manufacturer of screwdriver shafts 13% debt security, due July 26, 2007 (c) 250,020 277,800
and handles and other hand tools Warrants to purchase common shares (c) ---- ----
----------- ------------
905,577 1,444,467
----------- ------------
Spectrum Products, LLC (b) 13% debt security, due January 1, 2008 (c) 1,077,649 1,077,649
Missoula, Montana 385,000 units Series A preferred (c) --- 385,000
Manufacturer of equipment for the Membership interest (c) --- 351
swimming pool industry 17,536.75 units Class B preferred (c) --- 47,355
----------- ------------
1,077,649 1,510,355
----------- ------------
Superior Holding, Inc. (a) 6% debt security, due April 1, 2010 780,000 780,000
Wichita, Kansas Warrant to purchase 11,143 common shares (c) 1 1
Manufacturer of industrial and 6% debt security, due April 1, 2010 221,000 221,000
commercial boilers and shower 121,457 common shares (c) 121,457 121,457
doors, frames and enclosures 6% debt security, due April 1, 2010 308,880 308,880
312,000 common shares (c) 3,120 3,120
----------- ------------
1,434,458 1,434,458
----------- ------------
Total manufacturing 89.61% 9,699,414 11,298,700
========== ----------- ------------
Service:
Monitronics International, Inc. 73,214 common shares (c) 439,284 54,703
Dallas, Texas ----------- ------------
Provides home security systems
monitoring services
Morgan Ohare, Inc. (b) 0% debt security, due January 1, 2009 (c) 1,068,750 1,125,000
Addison, Illinois 10% debt security, due January 1, 2009 343,750 343,750
Fastener plating and heat treating 57 common shares (c) 1 1
---------- ------------
1,412,501 1,468,751
---------- ------------
SMWC Acquisition Co., Inc. (a) 13% debt security due September 30, 2011 96,250 96,250
Kansas City, Missouri 12% debt security due September 30, 2011 482,900 482,900
Steel warehouse distribution and Warrant to purchase 2,200 common shares (c) ---- ----
processing ---------- ------------
579,150 579,150
---------- ------------
Warren Family Funeral Homes, Inc. Warrant to purchase 346.5 common shares (c) 200,012 12
Topeka, Kansas ---------- ------------
Provider of value priced funeral
services
Total Service 24.31% 2,630,947 2,102,616
========== ---------- -----------
9
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF INVESTMENTS CONTINUED (UNAUDITED)...
JUNE 30, 2008
Service Continued: Percent
of Net
Company Security assets Value Cost (d)
------------------------------------------------------------------------------------------------------------------------------------
Technology and Communications:
Feed Management Systems, Inc. (a) 540,551 common shares (c) 1,327,186 1,327,186
Brooklyn Center, Minnesota 674,309 shares Series A preferred (c) 674,309 674,309
Batch feed software and systems ---------- ------------
and B2B internet services 2,001,495 2,001,495
---------- ------------
MainStream Data, Inc. (a) 322,763 shares Series A preferred (c) 200,049 200,049
Salt Lake City, Utah ---------- ------------
Content delivery solutions
provider
Phonex Broadband Corporation 1,855,302 shares Series A preferred (c) 1 1,155,000
----------- ------------
Midvale, Utah
Power line communications
Portrait Displays, Inc. 8% debt security, due April 1, 2009 23,541 23,541
Pleasanton, California 8% debt security, due April 1, 2012 (c) 375,950 750,001
Designs and markets pivot ---------- -----------
enabling software for LCD 399,491 773,542
computer monitors ---------- -----------
Total technology and communications 24.03% 2,601,036 4,130,086
========== ---------- -----------
$14,931,397 17,531,402
========== ==========
(a) Affiliated company.
(b) Controlled company.
(c) Non-income producing.
(d) For all debt securities presented, the cost is equal to the principal
balance.
See accompanying notes to unaudited condensed consolidated financial statements.
10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This section contains certain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995 (the "1995 Act"). Such
statements are made in good faith by MACC pursuant to the safe-harbor provisions
of the 1995 Act, and are identified as including terms such as "may," "will,"
"should," "expects," "anticipates," "estimates," "plans," or similar language.
In connection with these safe-harbor provisions, MACC has identified in its
Annual Report to Shareholders for the fiscal year ended September 30, 2007,
important factors that could cause actual results to differ materially from
those contained in any forward-looking statement made by or on behalf of MACC,
including, without limitation, the high risk nature of MACC's portfolio
investments, the effects of general economic conditions on MACC's portfolio
companies and MorAmerica Capital's ability to obtain future funding, changes in
prevailing market interest rates, and contractions in the markets for corporate
acquisitions and initial public offerings. MACC further cautions that such
factors are not exhaustive or exclusive. MACC does not undertake to update any
forward-looking statement which may be made from time to time by or on behalf of
MACC.
Results of Operations
Our investment income includes income from interest, dividends and fees.
Investment expense, net represents total investment income minus net operating
expenses. The main objective of portfolio company investments is to achieve
capital appreciation and realized gains in the portfolio. These gains and losses
are not included in investment expense, net.
Third Quarter Ended June 30, 2008 Compared to Third Quarter Ended June 30, 2007
For the three months ended
June 30,
--------------------------------------
2008 2007 Change
-------------------------------------- --------------
Total investment income $ 281,861 253,152 28,709
Net operating and income tax expense (362,021) (330,592) (31,429)
------------- ---------------- --------------
Investment expense, net (80,160) (77,440) (2,720)
------------- ---------------- --------------
Net realized gain on investments 686,047 309,357 376,690
Net change in unrealized appreciation/
depreciation on investments and other assets (34,322) 270,950 (305,272)
Net change in unrealized loss on other assets (40,628) (25,686) (14,942)
------------- ---------------- --------------
Net gain on investments 611,097 554,621 56,476
------------- ---------------- --------------
Net change in net assets from operations $ 530,937 477,181 53,756
================= ================ ==============
Net asset value per share:
Beginning of period $ 4.18 4.71
================= ================
End of period $ 4.39 4.91
================= ================
Total Investment Income
During the current fiscal year third quarter, total investment income was
$281,861, an increase of $28,709, or 11%, from total investment income of
$253,152 for the prior year third quarter. In the current year third quarter as
compared to the prior year third quarter, interest income decreased $81,203, or
41%, and dividend income increased $109,912, or 206%. The decrease in interest
income is the net result of (i) repayments of principal on debt portfolio
securities issued to us by four portfolio companies, (ii) an increase in
interest income due to an additional debt investment from the restructure in one
debt portfolio security, and (iii) a decrease in interest income on three debt
portfolio securities which have been placed on non-accrual of interest status.
In the current year third quarter, we
11
received dividends on two existing portfolio investments, as compared to
dividend income received in the prior year third quarter from three existing
portfolio investments, however the current year dividends were larger. We do not
anticipate that our dividend income will continue to increase in future periods.
Net Operating Expenses
Net operating expenses for the third quarter of the current year were
$362,021, an increase of $31,429, or 10%, as compared to net operating expenses
for the prior year third quarter of $330,592. Interest expense decreased
$65,318, or 41%, in the current year third quarter due to the repayment in the
prior fiscal year of $10,790,000 of borrowings (the "SBA Debentures") from the
Small Business Administration. Management fees decreased $3,052, or 4%, in the
current year third quarter due to the decrease in capital under management.
Professional fees increased $72,433, or 270%, in the current year third quarter
as compared to the prior year third quarter due to expenses related to changes
in the investment advisory structure, the Merger and the exploration of capital
raising options. Other expenses increased $27,366, or 41%, in the current year
third quarter as compared to the prior year third quarter. The increase in other
expenses is primarily the result of an increase in expenses associated with
compliance with the Security and Exchange Commission ("SEC") regulations.
Investment Expense, Net
For the current year third quarter, we recorded investment expense, net of
$80,160, as compared to investment expense, net of $77,440 during the prior year
third quarter, an increase of $2,720, or 4%. The increase in investment expense,
net is the result of the decrease in investment income described above and the
increase in operating expenses described above.
Net Realized Gain on Investments
During the current year third quarter, we recorded net realized gain on
investments of $686,047, as compared with net realized gain on investments of
$309,357 during the prior year third quarter. Management does not attempt to
maintain a comparable level of realized gains quarter to quarter but instead
attempts to maximize total investment portfolio appreciation through realizing
gains in the disposition of securities. Under the Investment Advisory Agreements
between us and our investment adviser, InvestAmerica Investment Advisors, Inc.
("InvestAmerica"), and between MorAmerica and InvestAmerica (together, the
"InvestAmerica Advisory Agreements"), both of which were in effect prior to
their termination during the third quarter of fiscal 2008, InvestAmerica earned
an incentive fee calculated as a percentage of the excess of our realized gains
in a particular period, over the sum of net realized losses and unrealized
depreciation during the same period. As a result, the timing of realized gains,
realized losses and unrealized depreciation can have an effect on the amount of
the incentive fee payable to InvestAmerica under the InvestAmerica Advisory
Agreements.
Effective April 29, 2008, the InvestAmerica Advisory Agreements were
terminated and we entered into an Investment Advisory Agreement (the "EAM
Advisory Agreement") with Eudaimonia Asset Management, LLC ("EAM"). Under the
EAM Advisory Agreement, EAM earns an incentive fee which is calculated as a
percentage of the excess of our realized gains in a particular period, over the
sum of net realized losses and unrealized depreciation during the same period.
As a result, the timing of realized gains, realized losses and unrealized
depreciation can have an effect on the amount of the incentive fee payable to
EAM under the EAM Advisory Agreement.
Also effective April 29, 2008, we entered into an Investment Subadvisory
Agreement (the "Subadvisory Agreement") with EAM and InvestAmerica, pursuant to
which InvestAmerica will continue to manage our portfolio of investments which
existed on the effective date of the Subadvisory Agreement (the "Existing
Portfolio"). Under the terms of the Subadvisory Agreement, EAM pays
InvestAmerica an incentive fee based on a portion of the incentive fees paid to
EAM by us under the EAM Advisory Agreement attributable to the Existing
Portfolio.
Net Change in Unrealized Appreciation/Depreciation of Investments and Other
Assets
Net change in unrealized appreciation/depreciation on investments
represents the change for the period in the unrealized appreciation, net of
unrealized depreciation, on our total investment portfolio based on the
valuation method described under "Critical Accounting Policy."
12
We recorded net change in unrealized appreciation/depreciation on
investments of ($34,322) during the current year third quarter, as compared to
$270,950 during the prior year third quarter. This net change resulted from:
• No unrealized appreciation during the current year third quarter, as
compared to unrealized appreciation in the fair value of two portfolio
companies totaling $466,300 during the prior year third quarter.
• Unrealized depreciation in the fair value of one portfolio company of
$34,322 during the current year third quarter, as compared to no
unrealized depreciation during the prior year third quarter.
• No reversal of unrealized appreciation during the current year third
quarter, as compared to the reversal of unrealized appreciation of
$195,350 in one portfolio company during the prior year third quarter.
Net Change in Net Assets from Operations
We experienced an increase of $530,937 in net assets for the third quarter
of fiscal year 2008, and the resulting net asset value per share was $4.39 as of
June 30, 2008, as compared to $4.67 as of September 30, 2007. The increase in
net assets recorded during the current year third quarter was the result of the
net realized gain on investments, as described above.
We have six portfolio investments valued at cost, has recorded unrealized
appreciation on five portfolio investments, and has recorded unrealized
depreciation on eight portfolio investments. Quarterly valuations can be
affected by a portfolio company's short term performance that results in
increases or decreases in unrealized depreciation and unrealized appreciation
for the quarter. Changes in the fair value of a portfolio security may or may
not be indicative of the long term performance of the portfolio company.
Although we are not currently making investments in new portfolio companies
(but may periodically make follow-on investments in Existing Portfolio
companies), as previously announced, our investment strategy under the EAM
Advisory Agreement going forward is to make new equity investments in small-cap
and micro-cap companies which qualify for investment by business development
companies ("BDCs") under the Investment Company Act of 1940, as amended (the
"1940 Act"). Under the Subadvisory Agreement, InvestAmerica will continue to
oversee the Existing Portfolio. We will continue to prudently sell Existing
Portfolio investments and use the resulting proceeds to pay down the Note
Payable, as further described below. The ability to exit the Existing Portfolio
investments is affected by company performance and external factors unrelated to
the portfolio companies. These factors include sub prime lending, credit
contraction, inflationary pressures, high commodity prices, recessional
pressures, a slowing economy and current world tensions.
Nine Months Ended June 30, 2008 Compared to Nine Months Ended June 30, 2007
For the nine months ended
June 30,
--------------------------------------
2008 2007 Change
-------------------------------------- --------------
Total investment income $ 736,163 720,422 15,741
Net operating and income tax expense (1,135,366) (1,211,606) 76,240
------------- ---------------- --------------
Investment expense, net (399,203) (491,184) 91,981
------------- ---------------- --------------
Net realized (loss) gain on investments 691,540 213,377 478,163
Net change in unrealized appreciation/
depreciation on investments and other assets (955,652) 750,307 (1,705,959)
Net change in unrealized loss on other assets (34,000) --- (34,000)
------------- ---------------- --------------
Net gain (loss) on investments (298,112) 963,684 (1,261,796)
------------- ---------------- --------------
13
Net change in net assets from operations $ (697,315) 472,500 (1,169,815)
================= ================ ==============
Net asset value per share:
Beginning of period $ 4.67 4.71
================= ================
End of period $ 4.39 4.91
================= ================
Total Investment Income
During the current fiscal year nine-month period, total investment income
was $736,163, an increase of $15,741, or 2%, from total investment income of
$720,422 for the prior year nine-month period. In the current year nine-month
period as compared to the prior year nine-month period, interest income
decreased $146,027, or 24%, and dividend income increased $161,762 or 162%. The
decrease in interest income is the net result of (i) repayments of principal on
debt portfolio securities issued to us by five Existing Portfolio companies,
(ii) an increase in interest income due to an additional debt investment from
the restructure of one debt portfolio security, (iii) an increase in interest
income on one debt portfolio security which had been on non-accrual of interest
status during the prior year nine-month period, but which made interest payments
during the current nine-month period prior to being placed again on non-accrual
of interest status, and (iv) a decrease in interest income on two debt portfolio
securities which have been placed on non-accrual of interest status. Debt
portfolio securities are placed on non-accrual of interest status when the
borrower is financially unable to make required interest payments. In both the
current year nine-month period and the prior year nine-month period, we received
dividends on three Existing Portfolio investments; however, the current-year
dividends were larger.
Net Operating Expenses
Net operating expenses for the nine-month period of the current year were
$1,135,366, a decrease of $76,240, or 6%, as compared to net operating expenses
for the prior year nine-month period of $1,211,606. Interest expense decreased
$230,223, or 41%, in the current year nine-month period due to the repayment in
the prior fiscal year of the SBA Debentures. Management fees decreased $45,919,
or 18%, in the current year nine-month period due to the decrease in capital
under management. Professional fees increased $188,877, or 114%, in the current
year nine-month period due to expense related to changes in the investment
advisory structure, the Merger and the exploration of capital raising options.
Other expenses increased $11,025, or 5%, in the current year nine-month period
as compared to the prior year nine-month period. The increase in other expenses
is the net result of (i) a decrease in prepayment penalties incurred on the
repayment of the SBA Debentures during the prior year nine-month period, (ii) a
decrease in administrative expenses due to timing of payments, (iii) an increase
in directors and officers insurance, (iv) an increase in directors travel
expenses, and (v) an increase in expenses associated with compliance with SEC
regulations.
Investment Expense, Net
For the current year nine-month period, we recorded investment expense, net
of $399,203, as compared to investment expense, net of $491,184 during the prior
year nine-month period, a decrease of $91,981, or 19%. The decrease in
investment expense, net is primarily the result of the decrease in net operating
expenses described above.
Net Realized Gain on Investments
During the current year nine-month period, we recorded net realized gain on
investments of $691,540, as compared with net realized gain on investments of
$213,377 during the prior year nine-month period. Management does not attempt to
maintain a comparable level of realized gains quarter to quarter but instead
attempts to maximize total investment portfolio appreciation through realizing
gains in the disposition of securities. Under the InvestAmerica Advisory
Agreements (prior to their termination during the current year third quarter),
InvestAmerica earned an incentive fee calculated as a percentage of the excess
of our realized gains in a particular period, over the sum of net realized
losses and unrealized depreciation during the same period. Similarly, under the
EAM Advisory Agreement, EAM is entitled to earn an incentive fee which is
calculated as a percentage of the excess of our realized gains in a particular
period, over the sum of net realized losses and unrealized depreciation during
the same period. As a result, the timing of realized gains, realized losses and
unrealized depreciation can have an effect on the amount
14
of the incentive fee payable to EAM under the EAM Advisory Agreement and to
InvestAmerica under the InvestAmerica Advisory Agreements.
Net Change in Unrealized Appreciation/Depreciation of Investments and Other
Assets
Net change in unrealized appreciation/depreciation on investments
represents the change for the period in the unrealized appreciation, net of
unrealized depreciation, on our total investment portfolio based on the
valuation method described under "Critical Accounting Policy." We recorded net
change in unrealized depreciation on investments of ($955,652) during the
current year nine-month period, as compared to $750,307 during the prior year
nine-month period. This net change resulted from:
• Unrealized appreciation in the fair value of two portfolio companies
totaling $743,338 during the current year nine-month period, as
compared to unrealized appreciation in the fair value of five portfolio
companies totaling $1,520,657 during the prior year nine-month period.
• Unrealized depreciation in the fair value of eight portfolio companies
of $1,698,990 during the current year nine-month period, as compared to
unrealized depreciation in the fair value of five portfolio companies
of $770,350 during the prior year nine-month period.
The net change in unrealized loss on other assets of $34,000 during the
current year nine-month period was recorded with respect to other securities
which are classified as other assets, as compared to no change in unrealized
loss on other assets during the prior year nine-month period.
Financial Condition, Liquidity and Capital Resources
As of June 30, 2008, our cash and money market accounts totaled $345,967.
As reported elsewhere, MorAmerica Capital had entered into (i) a term loan to
refinance the SBA Debentures, which was assumed by us on April 30, 2008 as a
result of the Merger, and which has a current balance of $4,855,661 (the "Note
Payable"), and (ii) a revolving loan permitting MorAmerica Capital (now us) to
borrow up to $500,000, with Cedar Rapids Bank & Trust Company. As of June 30,
2008, we believe that our existing cash and money market accounts, the revolving
loan, and other anticipated cash flows will provide adequate funds for our
anticipated cash requirements during fiscal year 2008, including follow-on
investments respecting the Existing Portfolio, interest payments on the Note
Payable and administrative expenses. With respect to the Existing Portfolio, we
are not making new investments, is prudently disposing of Existing Portfolio
assets and is using the resulting proceeds to pay down the Note Payable. We
anticipate commencing our new investment strategy under the EAM Advisory
Agreement when we raise additional capital.
The following table shows our significant contractual obligations for the
repayment of the Note Payable and other contractual obligations as of June 30,
2008:
Payments due by period
Contractual Obligations
Less
than 1 3-5 More than
Total Year 1-3 Years Years 5 Years
-------------- --------- --------------- -------- ------------
Note Payable $ 4,855,661 --- 4,855,661 --- ---
Incentive Fees Payable $ 23,061 23,061 --- --- ---
We currently anticipate that we will rely primarily on our current cash and
money market accounts and our cash flows from operations to fund our investment
activities in the Existing Portfolio and other cash requirements during fiscal
year 2008. With respect to our investment strategy under the EAM Advisory
Agreement, our Board of Directors sought and received approval by the
shareholders for a proposal to issue rights to acquire shares of our Common
Stock as a means by which we may raise additional equity capital. Although
management believes these sources will provide sufficient funds for us to meet
our fiscal year 2008 investment level objective and other
15
anticipated cash requirements, there can be no assurances that our cash flows
from operations or cash requirements will be as projected.
Portfolio Activity
With respect to the Existing Portfolio, we have invested in and lended to
businesses through investments in subordinated debt (generally with detachable
equity warrants), preferred stock and common stock. We, however, are not
currently making new investments. The total portfolio value of investments in
publicly and non-publicly traded securities was $14,931,397 at June 30, 2008 and
$16,704,954 at September 30, 2007. During the three months ended June 30, 2008,
we invested $52,000 in a follow-on investment in one portfolio company. As noted
above, we intend to pursue an investment strategy consisting of new equity
investments in very small public companies that qualify for investment by BDCs
under the 1940 Act, and may continue to make follow-on investments in our
Existing Portfolio.
With respect to the Existing Portfolio, we frequently co-invest with other
funds managed by InvestAmerica. When it makes any co-investment with these
related funds, we follow certain procedures consistent with orders of the SEC
for related party co-investments to reduce or eliminate conflict of interest
issues. All of the $52,000 invested during the current year third quarter
represented co-investments with another fund managed by InvestAmerica.
Critical Accounting Policy
Investments in securities that are traded in on a stock exchange are valued
based on the last quoted sale price on the valuation date (or if no sales
occurred on the valuation date, the closing bid price on that date). Securities
traded on the over-the-counter market are valued by taking the bid price on the
valuation date. Restricted and other securities for which quotations are not
readily available are valued at fair value as determined by our Board of
Directors. Among the factors considered in determining the fair value of
investments are the cost of the investment; developments, including recent
financing transactions, since the acquisition of the investment; the financial
condition and operating results of the portfolio company; the long-term
potential of the business of the portfolio company; market interest rates on
similar debt securities; overall market conditions and other factors generally
pertinent to the valuation of investments. However, because of the inherent
uncertainty of valuation, those estimated values may differ significantly from
the values that would have been used had a ready market for the securities
existed, and the differences could be material.
In the valuation process, we use financial information received monthly,
quarterly, and annually from our portfolio companies which includes both audited
and unaudited financial statements. This information is used to determine
financial condition, performance, and valuation of the portfolio investments.
Realization of the carrying value of investments is subject to future
developments. Investment transactions are recorded on the trade date and
identified cost is used to determine realized gains and losses. Under the
provisions of SOP 90-7, the fair value of loans and investments in portfolio
securities on February 15, 1995, the fresh-start date, is considered the cost
basis for financial statement purposes.
Determination of Net Asset Value
The net asset value per share of our outstanding common stock is determined
quarterly, as soon as practicable after and as of the end of each calendar
quarter, by dividing the value of total assets minus total liabilities by the
total number of shares outstanding at the date as of which the determination is
made.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
We are subject to market risk from changes in market prices of
publicly-traded equity securities held from time to time in our investment
portfolio. At June 30, 2008, we had no publicly-traded equity securities in the
Existing Portfolio, but, as noted elsewhere, we intend to pursue an investment
strategy consisting of new equity investments in very small public companies
that qualify for investment by BDCs under the 1940 Act.
16
We are also subject to financial market risks from changes in market
interest rates. The Note Payable is subject to a variable interest rate that is
based on an independent index. Although this independent index is subject to
change, the maximum increase or decrease in the interest rate at any one time
may not exceed 1.000 percentage points. General interest rate fluctuations may
therefore have a material adverse effect on our net investment income.
In addition, in the future, we may from time to time opt to draw on our
revolving line of credit to fund cash requirements. These future borrowings will
have a variable interest rate based on an independent index that is subject to
change; however, the maximum increase or decrease in the interest rate at any
one time will not exceed 1.000 percentage points.
Item 4T. Controls and Procedures
As of the end of the period covered by this report, in accordance with Item
307 of Regulation S-K promulgated under the Securities Act of 1933, as amended,
our Chief Executive Officer and Chief Financial Officer (the "Certifying
Officers") have conducted evaluations of our disclosure controls and procedures.
As defined under Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), the term "disclosure controls and
procedures" means controls and other procedures of an issuer that are designed
to ensure that information required to be disclosed by the issuer in the reports
that it files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by an issuer in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the issuer's management,
including its principal executive officer or officers and principal financial
officer or officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure. The Certifying Officers
have reviewed our disclosure controls and procedures and have concluded that
those disclosure controls and procedures are effective as of the date of this
Quarterly Report on Form 10-Q. In compliance with Section 302 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350), each of the Certifying Officers
executed an Officer's Certification included in this Quarterly Report on Form
10-Q.
As of the date of this Quarterly Report on Form 10-Q, there have not been
any significant changes in our internal controls or other factors that could
significantly affect these controls subsequent to the date of their evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
There are no items to report.
Item 1A. Risk Factors.
We have identified the following risk factors applicable to us following
the effectiveness of the EAM Advisory Agreement and the implementation of our
new investment strategy by EAM, which will focus on equity investments in
small-cap and micro-cap companies.
EAM has no experience managing a BDC, and will serve as investment adviser to
other accounts and funds, which may create conflicts of interest not in the best
interest of us or our stockholders.
EAM has no experience serving as an investment adviser to a BDC. While EAM
intends to allocate investment opportunities in a fair and equitable manner
consistent with our investment objectives and strategies, and in accordance with
its written allocation procedures so that we will not be disadvantaged in
relation to any other client, EAM's services under the EAM Advisory Agreement
are not exclusive. EAM is free to furnish the same or similar services to other
entities, including businesses that may directly or indirectly compete with us,
so long as EAM notifies us prior to being engaged to serve as investment adviser
to another fund and further provided that any such
17
investment management services and any co-investments shall at all times be
provided in strict accordance with rules and regulations under the 1940 Act,
EAM's asset allocation policy required thereunder and any exemptive order
applicable to us. In addition, the private accounts managed by EAM may make
investments similar to investments that we may pursue. Accordingly, EAM may have
obligations to other investors, the fulfillment of which might not be in the
best interests of us or our stockholders, and it is possible that EAM might
allocate investment opportunities to other client, and thus might divert
attractive investment opportunities away from us.
The Incentive Fee payable to EAM may create conflicting incentives.
EAM will receive an incentive fee based, in part, upon net realized capital
gains on our investments. As a result, EAM may have an incentive to pursue
investments that are likely to result in capital gains as compared to
income-producing securities. Such a practice could result in our investing in
more speculative or long-term securities than would otherwise be the case, which
could result in higher investment losses, particularly during economic downturns
or longer return cycles.
We will be exposed to market risks associated with investments in equity
securities.
Upon implementation by EAM of our new investment strategy, we will
ordinarily have substantial exposure to common stocks and other equity
securities in pursuing our investment objective and policies. The market price
of equity securities, including common and preferred stocks, may go up or down,
sometimes rapidly or unpredictably. Equity securities may decline in value due
to factors affecting equity securities markets generally, particular industries
represented in those markets or the issuer itself, including the historical and
prospective earnings of the issuer and the value of its assets. The values of
equity securities may decline due to general market conditions which are not
specifically related to a particular company, such as real or perceived adverse
economic conditions, changes in the general outlook for corporate earnings,
changes in interest or currency rates or adverse investor sentiment generally.
They may also decline due to factors which affect a particular industry or
industries, such as labor shortages or increased production costs and
competitive conditions within an industry. Equity securities, and particularly
common stocks, generally have greater price volatility than bonds and other debt
securities.
We will be particularly sensitive to the risks associated with equity
investments in small-cap and micro-cap companies.
As noted above, our new investments will be focused on common stocks of
small-cap and micro-cap companies. We will therefore be particularly sensitive
to the risks associated with small companies. The general risks associated with
equity securities are particularly pronounced for securities issued by companies
with small market capitalizations. Micro-cap and other small capitalization
companies may offer greater opportunities for capital appreciation than larger
companies, but may also involve certain special risks. They are more likely than
larger companies to have limited product lines, markets or financial resources,
or to depend on a small, inexperienced management group. Securities of smaller
companies may trade less frequently and in lesser volume than more widely held
securities and their values may fluctuate more sharply than other securities.
They may also trade in the over-the-counter market or on a regional exchange, or
may otherwise have limited liquidity. These securities may therefore be more
vulnerable to adverse developments than securities of larger companies, and we
may have difficulty establishing or closing out our securities positions in
smaller companies at prevailing market prices. Also, there may be less publicly
available information about smaller companies or less market interest in their
securities as compared to larger companies, and it may take longer for the
prices of the securities to reflect the full value of the issuers' earnings
potential or assets.
We may engage in short selling, which creates the risk of a theoretically
unlimited loss.
Upon implementation by EAM of our new investment strategy, we may engage in
short selling. Short selling involves selling securities which may or may not be
owned and borrowing the same securities for delivery to the purchaser, with an
obligation to replace the borrowed securities at a later date. Short selling
allows the investor to profit from declines in securities. A short sale creates
the risk of a theoretically unlimited loss, in that the price of the underlying
security could theoretically increase without limit, thus increasing the cost of
buying those securities to cover the short position. There can be no assurance
that the security necessary to cover a short position will be
18
available for purchase. Purchasing securities to close out the short position
can itself cause the price of the securities to rise further, thereby
exacerbating the loss.
As a BDC, we are subject to limitations on our ability to engage in certain
transactions with affiliates.
As a result of our election to be regulated as a BDC, we are prohibited
under the 1940 Act from knowingly participating in certain transactions with our
affiliates without the prior approval of our independent directors or the SEC.
The 1940 Act defines "affiliates" broadly to include (i) any person that owns,
directly or indirectly, 5% or more of our outstanding voting securities, (ii)
any person of which we own 5% or more of their outstanding securities, (iii) any
person who directly or indirectly controls us, (iv) our officers, directors and
employees, and (v) EAM and InvestAmerica, among others, and we are generally
prohibited from buying or selling any security from or to such affiliate, absent
the prior approval of our independent directors. The 1940 Act also prohibits
"joint" transactions with an affiliate, which could include investments in the
same portfolio company (whether at the same or different times), without prior
approval of our independent directors. If a person acquires more than 25% of our
voting securities, we will be prohibited from buying or selling any security
from or to such person, or entering into joint transactions with such person,
absent the prior approval of the SEC.
If our investments are deemed not to be qualifying assets, we could lose our
status as a BDC or be precluded from investing according to our current business
plan.
As a result of our election to be regulated as a BDC, we must not acquire
any assets other than "qualifying assets" unless, at the time of and after
giving effect to such acquisition, at least 70% of our total assets are
qualifying assets. Generally, "qualifying assets" are (i) securities purchased
in private offerings from (a) "eligible portfolio companies" or from affiliates
of the eligible portfolio company, or (b) U.S.-organized companies which are not
investment companies having a class of securities for which a broker may extend
margin credit, if at the time of purchase, we own at least 50% of such company's
equity and debt securities, and we are one of the 20 largest holders of the
company's outstanding voting securities; (ii) securities of eligible portfolio
companies which we control; (iii) securities purchased in private offerings from
either a U.S.-organized company which is not an investment company with a class
of securities for which a broker may extend margin credit or from an affiliate
of such company, if the company is in reorganization, consummating a plan of
reorganization or insolvent; (iv) securities purchased in private offerings from
an eligible portfolio company if there is no market for such securities and if
prior to such purchase we own at least 60% of the company's outstanding equity
securities; (v) securities received in exchange for or distributed on or with
respect to the securities described in (i) - (iv) above or pursuant to the
exercise of an option or warrant; (vi) cash, government securities or high
quality debt securities having maturities of one year or less; and (vii) our
office furniture, real estate or leases, deferred organizational and operating
expenses and our other noninvestment assets required for our operations as a
BDC.
"Eligible portfolio companies" are generally companies which are organized
in the United States, are not investment companies, and which either: (i) do not
have securities for which a broker may extend margin credit, (ii) are controlled
by a BDC or a group including a BDC, (iii) are solvent and have assets under $4
million and capital and surplus of at least $2 million, or (iv) (A) do not have
a class of securities listed on a national securities exchange, or (B) do have a
class of securities listed on a national securities exchange, but have a market
capitalization below $250,000,000.
If, for example, we acquire debt or equity securities from an issuer that
has outstanding marginable securities at the time we make such an investment, or
if we acquire securities from an issuer which otherwise meets the definition of
an eligible portfolio company but we purchase the securities in a public
offering, these acquired assets cannot be treated as "qualifying assets." The
failure of an investment to meet the definition of a qualifying asset could
preclude us from otherwise taking advantage of an investment opportunity we find
attractive. In addition, our failure to meet the BDC qualifying asset
requirements could result in the loss of BDC status, which would significantly
and adversely affect our business plan by, among other things, requiring us to
register as a closed-end investment company.
19
Our portfolio may be concentrated in a limited number of portfolio companies.
We intend to make investments in a limited number of portfolio companies.
An inherent risk associated with this investment concentration is that we may be
adversely affected if one or two of our investments perform poorly or if we need
to write down the value of any one investment. Financial difficulty on the part
of any single portfolio company will expose us to a greater risk of loss than
would be the case if we were a more "diversified" company holding numerous
investments.
Our portfolio companies may incur debt that ranks equally with, or senior to,
our investments in such companies.
Portfolio companies in which we invest usually will have, or may be
permitted to incur, debt that ranks senior to, or equally with, our investments,
including debt investments. As a result, payments on such securities may have to
be made before we receive any payments on our investments. For example, these
debt instruments may provide that the holders are entitled to receive payment of
interest or principal on or before the dates on which we are entitled to receive
payments with respect to our investments. These debt instruments will usually
prohibit the portfolio companies from paying interest on or repaying our
investments in the event and during the continuance of a default under such
debt. In the event of insolvency, liquidation, dissolution, reorganization or
bankruptcy of a portfolio company, holders of debt instruments ranking senior to
our investment in that portfolio company would typically be entitled to receive
payment in full before we receive any distribution in respect of our investment.
After repaying its senior creditors, a portfolio company may not have any
remaining assets to use to repay its obligation to us. In the case of debt
ranking equally with our investments, we would have to share on an equal basis
any distributions with other creditors holding such debt in the event of an
insolvency, liquidation, dissolution, reorganization or bankruptcy of the
relevant portfolio company.
We expect our debt investments will generally be unsecured and even if we make a
secured loan, if the assets securing a loan we make decrease in value, we may
not have sufficient collateral to cover losses.
We believe our portfolio companies generally will be able to repay our debt
investments from their available capital, from future capital-raising
transactions or from cash flow from operations. We expect generally that our
debt investments that we make will be unsecured. However, in the event we take a
security interest in the available assets of a portfolio company, there is a
risk that the collateral securing our investment may decrease in value over
time, may be difficult to sell in a timely manner, may be difficult to appraise
and may fluctuate in value based upon the success of the business and market
conditions, including as a result of the inability of the portfolio company to
raise additional capital, and, in some circumstances, our lien could be
subordinated to claims of other creditors. In addition, a deterioration in a
portfolio company's financial condition and prospects, including its inability
to raise additional capital, may be accompanied by a deterioration in the value
of the collateral for the investment. Moreover, we may not have a first lien
position on the collateral. Consequently, the fact that investment is secured
does not guarantee that we will receive principal and interest payments
according to the investment's terms or that we will be able to collect on the
investment should we be forced to enforce our remedies. In addition, a portion
of the assets securing our investment may be in the form of intellectual
property, if any, inventory and equipment and, to a lesser extent, cash and
accounts receivable. Intellectual property, if any, that is securing our
investment could lose value if, among other things, the company's rights to the
intellectual property are challenged or if the company's license to the
intellectual property is revoked or expires. Inventory may not be adequate to
secure our investment if our valuation of the inventory at the time we made the
loan was not accurate or if there is a reduction in the demand for the
inventory. Similarly, any equipment securing our loan may not provide us with
the anticipated security if there are changes in technology or advances in new
equipment that render the particular equipment obsolete or of limited value or
if the company fails to adequately maintain or repair the equipment. Any one or
more of the preceding factors could materially impair our ability to recover
principal in a foreclosure.
The lack of liquidity in our investments may adversely affect our business, and
if we need to sell any of our investments, we may not be able to do so at a
favorable price. As a result, we may suffer losses.
The Existing Portfolio generally consists of investments in debt securities
with terms of two to ten years, which we generally hold until maturity, and we
do not expect that our related holdings of equity securities in the Existing
20
Portfolio will provide liquidity opportunities in the near-term. We expect that
a majority of the new portfolio investments made pursuant to the EAM Advisory
Agreement will consist of companies whose securities are not publicly-traded,
and whose securities will be subject to legal and other restrictions on resale
or will otherwise be less liquid than publicly-traded securities. The
illiquidity of these investments may make it difficult for us to sell these
investments when desired. In addition, if we are required to liquidate all or a
portion of our portfolio quickly, we may realize significantly less than the
value at which we had previously recorded these investments. As a result, we do
not expect to achieve liquidity in our investments in the near-term. However, to
maintain our election to be regulated as a BDC, we may have to dispose of
investments if we do not satisfy one or more of the applicable criteria under
1940 Act. Our investments are usually subject to contractual or legal
restrictions on resale or are otherwise illiquid because there is no established
trading market for such investments. The illiquidity of a majority of our
investments may make it difficult for us to dispose of them at a favorable
price, and, as a result, we may suffer losses.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
There are no items to report.
Item 3. Defaults Upon Senior Securities.
There are no items to report.
Item 4. Submission of Matters to a Vote of Security Holders.
On April 29, 2008, we held our 2008 Annual Meeting of Shareholders (the
"Meeting") in Newport Beach, California. A quorum of 1,732,076 shares, or
approximately 70.28% of issued and outstanding shares as of March 25, 2008, were
represented in person or by proxy at the Meeting. The shareholders considered
five proposals at the meeting.
With respect to the first proposal, the shareholders elected five nominees
to serve as directors until the 2009 Annual Meeting of Shareholders or until
their respective successors shall be elected and qualified. The five directors
elected at the Meeting, and the votes cast in favor of and withheld with respect
to each, are as follows:
For Withheld
--- --------
Michael W. Dunn 1,585,220 146,856
James W. Eiler 1,584,152 147,924
Benjamin Jiaravanon 1,546,413 185,663
Gordon J. Roth 1,576,636 155,440
Geoffrey T. Woolley 1,583,751 148,325
With regard to the second proposal, the shareholders voted to approve the
EAM Advisory Agreement by a vote of 1,263,492 in favor and 162,139 against
approval, with 16,173 shares abstaining.
With regard to the third proposal, the shareholders voted to approve the
Subadvisory Agreement by a vote of 1,263,116 in favor and 163,567 against
approval, with 15,121 shares abstaining.
With regard to the fourth proposal, the shareholders voted to authorize a
rights offering by a vote of 1,539,382 in favor and 176,382 against approval,
with 16,312 shares abstaining.
With regard to the fifth proposal, the shareholders voted to ratify the
appointment of KPMG LLP as our independent registered public accounting firm for
fiscal year 2008 by a vote of 1,714,287 in favor and 5,348 against approval,
with 12,441 shares abstaining.
Item 5. Other Information.
There are no items to report.
21
Item 6. Exhibits.
The following exhibits are filed with this Quarterly Report on Form 10-Q:
31.1 Section 302 Certification of Travis Prentice (CEO)
31.2 Section 302 Certification of Derek Gaertner (CFO)
32.1 Section 1350 Certification of Travis Prentice (CEO)
32.2 Section 1350 Certification of Derek Gaertner (CFO)
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MACC PRIVATE EQUITIES INC.
Date: August 14, 2008 By: /s/ Travis Prentice
-----------------------------------------
Travis Prentice, President and CEO
Date: August 14, 2008 By: /s/ Derek Gaertner
-----------------------------------------
Derek Gaertner, Chief Financial Officer
23
EXHIBIT INDEX
Exhibit Description
------- -----------
31.1 Section 302 Certification of Travis Prentice (CEO)
31.2 Section 302 Certification of Derek Gaertner (CFO)
32.1 Section 1350 Certification of Travis Prentice (CEO)
32.2 Section 1350 Certification of Derek Gaertner (CFO)
24