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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to____________
Commission file number 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.)
101 Second Street SE, Suite 800, Cedar Rapids, Iowa 52401
---------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(319) 363-8249
----------------------------------------------------
(Registrant's telephone number, including area code)
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Please 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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
At April 30, 2004, the registrant had issued and outstanding 2,329,255
shares of common stock.
Index
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
Condensed Consolidated Balance
Sheets at March 31, 2004 and September 30, 2003 ................. 3
Condensed Consolidated Statements of
Operations for the three months ended
March 31, 2004 and March 31, 2003
and the six months ended
March 31, 2004 and March 31, 2003 ............................... 4
Condensed Consolidated Statements of
Cash Flows for the six months ended
March 31, 2004 and March 31, 2003 ............................... 5
Notes to Condensed Consolidated
Financial Statements ............................................ 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations................. 8
Item 3. Quantitative and Qualitative
Disclosure About Market Risk ................................... 15
Item 4. Controls and Procedures ........................................ 16
Part II. OTHER INFORMATION .................................................. 18
Item 1. Legal Proceedings............................................... 18
Item 4. Submission of Matters to a
Vote of Security Holders........................................ 19
Item 6. Exhibits and Reports on Form 8-K................................ 20
Signatures...................................................... 22
Certifications...............................See Exhibits 31 and 32
2
PART 1 -- FINANCIAL INFORMATION
Item 1. Financial Statements
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
(Unaudited)
March 31, September 30,
2004 2003
------------- -------------
Assets
Loans and investments in portfolio securities, at market
or fair value:
Unaffiliated companies (cost of $11,490,011 and $13,439,514) $ 9,733,065 12,803,914
Affiliated companies (cost of $18,773,191 and $20,949,721) 19,904,287 20,875,512
Controlled companies (cost of $4,536,308 and $4,490,502) 4,480,058 4,921,751
Cash and money market accounts 6,689,397 722,691
Other assets, net 1,083,679 1,909,250
------------- -------------
Total assets $ 41,890,486 41,233,118
============= =============
Liabilities and net assets
Liabilities:
Debentures payable, net of discount $ 27,940,000 27,940,000
Incentive fees payable 48,792 27,528
Accrued interest 187,839 185,664
Accounts payable and other liabilities 439,895 334,014
------------- -------------
Total liabilities 28,616,526 28,487,206
------------- -------------
Net assets:
Common stock, $.01 par value per share;
authorized 10,000,000 shares and 4,000,000 shares
in 2004 and 2003, respectively;
issued and outstanding 2,329,255 shares 23,293 23,293
Additional paid-in-capital 13,932,767 13,001,179
Unrealized depreciation on investments (682,100) (278,560)
------------- -------------
Total net assets 13,273,960 12,745,912
------------- -------------
Total liabilities and net assets $ 41,890,486 41,233,118
============= =============
Net assets per share $ 5.70 5.47
============= =============
See accompanying notes to unaudited condensed consolidated financial statements.
3
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
(Unaudited)
For the three For the three For the six For the six
months ended months ended months ended months ended
March 31, March 31, March 31, March 31,
2004 2003 2004 2003
------------- ------------- ------------ ------------
Investment income:
Interest
Unaffiliated companies $ 241,933 138,032 363,553 244,856
Affiliated companies 211,364 246,422 366,771 513,877
Controlled companies 68,298 60,238 137,769 134,500
Other 15,571 7,671 24,367 15,909
Dividends
Unaffiliated companies --- 93,656 78,204 164,751
Affiliated companies 287,251 2,397 342,267 57,405
Controlled companies --- 7,871 --- 15,742
Processing fees --- 9,435 --- 17,185
Other 1,855 75,971 7,659 86,026
------------- ------------ ------------ ------------
Total investment income 826,272 641,693 1,320,590 1,250,251
------------- ------------ ------------ ------------
Operating expenses:
Interest expenses 531,714 550,421 1,063,428 1,100,841
Management fees 259,264 280,017 519,798 555,085
Professional fees 262,020 230,810 453,846 330,267
Other 847,401 142,726 915,486 227,837
------------- ------------ ------------ ------------
Total operating expenses before
management fees waived 1,900,399 1,203,974 2,952,558 2,214,030
Management fees waived (34,292) (70,655) (87,092) (70,655)
------------- ------------ ------------ ------------
Net operating expenses 1,866,107 1,133,319 2,865,466 2,143,375
Investment expense,
net before tax expense (1,039,835) (491,626) (1,544,876) (893,124)
------------- ------------ ------------ ------------
Income tax expense --- (15,000) --- (15,000)
------------- ------------ ------------ ------------
Investment expense, net (1,039,835) (506,626) (1,544,876) (908,124)
------------- ------------ ------------ ------------
Realized and unrealized gain (loss)
on investments:
Net realized gain (loss) on investments (net
incentive fees of $514,314 in 2004
and $0 in 2003):
Unaffiliated companies 9,681 (218,959) 1,948,163 (748,780)
Affiliated companies 579,727 --- 61,310 (2,043,502)
Controlled companies --- --- 466,991 ---
Net change in unrealized appreciation/
depreciation on investments 1,365,962 (575,371) (403,540) 2,453,021
------------- ------------ ------------ ------------
Net gain (loss) on investments 1,955,370 (794,330) 2,072,924 (339,261)
------------- ------------ ------------ ------------
Net change in net assets
from operations $ 915,535 (1,300,956) 528,048 (1,247,385)
============= ============ ============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
4
MACC PRIVATE EQUITIES INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the six For the six
months ended months ended
March 31, March 31,
2004 2003
------------ ------------
Cash flows from operating activities:
Increase (decrease) in net assets from operations $ 528,048 (1,247,385)
------------ ------------
Adjustments to reconcile increase (decrease)
in net assets from operations to net cash
provided by operating activities:
Net realized and unrealized gain on investments (2,072,924) 339,261
Net realized and unrealized loss on other assets 726,329 ---
Proceeds from disposition of and payments on
loans and investments in portfolio securities 7,102,879 1,619,700
Payments of incentive fees to investment advisor (493,050) ---
Purchases of loans and investments in
portfolio securities (481,934) (124,027)
Change in accrued interest, accounts payable,
and other liabilities 108,056 34,775
Other 549,302 21,001
------------ ------------
Total adjustments 5,438,658 1,890,710
------------ ------------
Net cash provided by operating activities 5,966,706 643,325
------------ ------------
Cash flows from financing activities:
Payment of commitment fees --- (65,000)
------------ ------------
Net cash used in financing activities --- (65,000)
------------ ------------
Net increase in cash and cash equivalents 5,966,706 578,325
Cash and cash equivalents at beginning of period 722,691 1,802,603
------------ ------------
Cash and cash equivalents at end of period $ 6,689,397 2,380,928
============ ============
Supplemental disclosure of cash flow information -
Cash paid during the period for interest $ 1,011,490 1,034,157
============ ============
Supplemental disclosure of noncash investing and financing
information -
Assets received in exchange of securities $ 476,074 194,523
============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
5
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) and its wholly owned
subsidiary MorAmerica Capital Corporation (MorAmerica Capital) which have been
prepared in accordance with accounting principles generally accepted in the
United States of America for investment companies. All material intercompany
accounts and transactions have been eliminated in consolidation.
The financial statements included herein have been prepared in accordance
with accounting principles generally accepted in the United States of America
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 its Subsidiary as of and for the year ended September 30, 2003. 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, 2003 has been derived
from the audited balance sheet as of that date.
(2) Critical Accounting Policy
Investments in securities traded on a national securities exchange (or
reported on the NASDAQ national market) are stated at the average of the bid
price on the three final trading days of the valuation period which is not
materially different from the bid price on the final day of the period.
Restricted and other securities for which quotations are not readily available
are valued at fair value as determined by the 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; 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, MorAmerica Capital uses financial information
received monthly, quarterly, and annually from its 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.
6
(3) Loss Contingency
MorAmerica Capital is party to arbitration proceedings instituted by
TransCore Holdings, Inc., a company (Buyer) seeking indemnification under the
Stock Purchase Agreement (the Stock Purchase Agreement), pursuant to which
MorAmerica Capital and certain other individuals and institutional investors
(collectively, the Sellers) sold their interest in a former portfolio company
investment (Portfolio Company). The arbitration proceedings are being
administered by JAMS. Under the Stock Purchase Agreement, the Sellers agreed to
indemnify Buyer for breaches of representations and warranties as to Portfolio
Company made by the Sellers. Buyer claims that accounting irregularities at
Portfolio Company resulted in a breach of the Sellers' representations and
warranties. The Sellers have retained counsel and forensic accountants to defend
the Sellers against Buyer's claim for indemnification. Following discovery,
depositions and other preliminary proceedings, in June, 2003, the formal
arbitration proceedings commenced and are being intensively contested by all
parties. Based on the current schedule for the arbitration, a decision will not
be rendered until at least August, 2004. Based on its evaluation of the Buyer's
claim and discussions with external legal counsel, MACC believes that it is
reasonably possible that a loss may have been incurred as a result of the
indemnification claim, against which no accrual for loss has been made as of
March 31, 2004, because the amount of the possible loss, and therefore its
materiality to the financial statements, cannot be estimated. MorAmerica Capital
intends to continue vigorously defending this arbitration. MorAmerica Capital
received approximately $939,000 of proceeds from the sale of the Portfolio
Company. MorAmerica Capital owned debt securities of Buyer with a face value of
$508,761 and warrants with a cost of $24,000 received as part of the sale. Buyer
has defaulted on interest payments due on these debt securities. On March 31,
2003, MorAmerica Capital reduced the valuation of the debt securities by
$254,380 in light of the interest default and information regarding the related
dispute as of that date. On June 30, 2003, MorAmerica Capital further reduced
the valuation of these debt securities by $254,380 to $1 and reduced the
valuation of the warrants to zero based upon the continuing interest default and
additional information regarding the related dispute as of that date. Subsequent
to December 31, 2003, Buyer refinanced certain of its obligations, including the
debt securities held by MorAmerica Capital, and the principal amount of these
debt securities and accrued interest has been deposited in an escrow account
pending conclusion of the arbitration proceedings.
In a related development, MorAmerica Capital and another small business
investment company, NDSBIC, L.P., which co-invested in Portfolio Company, filed
suit on December 24, 2003 in the United States District Court for the Northern
District of Texas against Patton Boggs LLP and Charles P. Miller, Esq., of
Patton Boggs alleging legal malpractice and breach of fiduciary duty. Patton
Boggs and Mr. Miller represented MorAmerica Capital and NDSBIC in connection
with their investment in the Portfolio Company and the subsequent sale of the
Portfolio Company to Buyer. MorAmerica Capital and NDSBIC are seeking monetary
damages, in an amount that has not been determined.
7
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, 2003,
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, the effects of recent or future losses on the ability of MorAmerica
Capital to comply with applicable regulations of the Small Business
Administration and MorAmerica Capital's ability to obtain future funding, any
failure to achieve annual investment level objectives, changes in prevailing
market interest rates, contractions in the markets for corporate acquisitions
and initial public offerings, and an adverse outcome on the pending arbitration
proceedings against MorAmerica Capital. 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
MACC's investment income includes income from interest, dividends and fees.
Investment expense, net represents total investment income minus total 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. Another one of MACC's on-going
goals is to achieve net investment income and increased earnings stability. In
this regard, a significant proportion of new portfolio investments are
structured so as to provide a current yield through interest or dividends. MACC
also earns interest on short-term investments of cash.
Second Quarter Ended March 31, 2004 Compared to Second Quarter Ended March 31, 2003
For the three months
ended March 31,
---------------------------
2004 2003 Change
--------------------------- ---------
Investment income $ 826,272 641,693 184,579
Operating expenses (1,866,107) (1,148,319) (717,788)
----------- ----------- ----------
Investment expense, net (1,039,835) (506,626) (533,209)
----------- ----------- ----------
Net realized gain (loss) on investments 589,408 (218,959) 808,367
Net change in unrealized appreciation/
depreciation on investments 1,365,962 (575,371) 1,941,333
----------- ----------- ----------
Net gain on investments 1,955,370 (794,330) 2,749,700
----------- ----------- ----------
Net change in net assets from operations $ 915,535 (1,300,956) 2,216,491
========== =========== =========
Net asset value:
Beginning of period $ 5.31 6.74
========== ===========
End of period $ 5.70 6.19
========== ===========
8
Investment Income
During the current year second quarter, total investment income was
$826,272, an increase of $184,579, or 29%, from total investment income of
$641,693 for the prior year second quarter. In the current year second quarter
as compared to the prior year second quarter, interest income increased $84,803,
or 19%, dividend income increased $183,327, or 176%, processing fees decreased
$9,435, or 100%, and other income decreased $74,116, or 98%. The increase in
interest income is mainly due to one investment which converted all interest
accrued and reserved to an equity investment in the current year second quarter
which was on a non-accrual of interest status in the prior year second quarter.
In the current year second quarter, MACC received dividends on five existing
portfolio companies, as compared to dividend income received in the prior year
second quarter on four existing portfolio companies. Processing fees decreased
due to no fees received on the two follow-on portfolio company investments made
in the current year second quarter, compared to one follow-on portfolio company
investment in which MACC received a processing fee at closing in the prior year
second quarter. The decrease in other income is due to advisory fees received
from two portfolio companies in the prior year second quarter.
Operating Expenses
Total operating expenses for the second quarter of the current year were
$1,866,107, an increase of $717,788, or 63%, as compared to total operating
expenses for the prior year second quarter of $1,148,319. Interest expense
decreased $18,707, or 3%, in the current year second quarter due to a reduction
in the interest rate on $2,150,000 of SBA-guaranteed debentures to 3.125% in the
current year second quarter, from 6.12% in the prior year second quarter.
Following the expiration of the terms of the investment advisory agreements
between each of MACC and MorAmerica Capital and InvestAmerica Investment
Advisors, Inc. ("InvestAmerica"), MACC and MorAmerica Capital each entered into
an investment advisory agreement with Atlas Management Partners, LLC (the
"Investment Advisor"). Contemporaneously with this change in investment advisor,
MACC, MorAmerica Capital, the Investment Advisor and InvestAmerica entered into
an a agreement pursuant to which InvestAmerica will act as a subadvisor (the
"Subadvisor") with respect to the companies' existing investment portfolio as of
the transition date. Management fees increased $15,610, or 7%, in the current
year second quarter due to a voluntary reduction in management fees by
InvestAmerica in the prior year second quarter which terminated on February 29,
2004. Professional fees increased $31,210, or 14%, in the current year second
quarter primarily due to increased legal expenses associated with the change in
MACC's investment advisor which became effective on March 1, 2004 and various
corporate governance changes. Professional fees are expected to be high in the
next three to six months due to the item identified in Note 3 to the Unaudited
Condensed Consolidated Financial Statements and legal advice in implementing the
future direction of MACC. Other expenses increased $704,675, or 494%, in the
current year second quarter as compared to the prior year second quarter mainly
due to the change in the other assets loss provision. The other assets loss
provision increased because depreciated portfolio securities were reclassified
as other assets in the current year second quarter, which required the
unrealized depreciation on such assets in the amount of $532,760 to be recorded
as other assets loss provision, and because additional loss provision of
$197,727 was recorded in the current year second quarter with respect to other
securities which had been classified as other assets in a prior period.
9
Investment Expense, Net
For the current year second quarter, MACC recorded investment expense, net
of $1,039,835, as compared to investment expense, net of $506,626 during the
prior year second quarter.
Net Realized Gain (Loss) on Investments
During the current year second quarter, MACC recorded net realized gain on
investments of $589,408, as compared with net realized loss on investments of
$218,959 during the prior year second quarter. In the current year second
quarter, MACC realized a gain of $579,727 from the sale of one portfolio company
of which $611,340 was previously recorded as unrealized appreciation and $9,681
of additional sale proceeds from the sale of an equity interest of one portfolio
company which occurred in the current year first 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 and investing in new portfolio
investments.
Net Change in Unrealized Appreciation/Depreciation of Investments
MACC recorded net change in unrealized appreciation/depreciation on
investments of $1,365,962 during the current year second quarter, as compared to
($575,371) during the prior year second quarter. This net change in unrealized
appreciation/depreciation on investments of $1,365,962 is the net effect of
increases in fair value of five portfolio companies totaling $1,444,543, a
decrease in fair value of one portfolio company totaling $1, the reversal of
$611,340 of appreciation resulting from the sale of one portfolio investment and
the reversal of $532,760 of depreciation resulting from the restructure of one
portfolio investment to 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 MACC's total investment portfolio. When MACC
increases the fair value of a portfolio investment above its cost, the
unrealized appreciation for the portfolio as a whole increases, and when MACC
decreases the fair value of a portfolio investment below its cost, unrealized
depreciation for the portfolio as a whole increases. When MACC sells an
appreciated portfolio investment for a gain, unrealized appreciation for the
portfolio as a whole decreases as the gain is realized. Similarly, when MACC
sells or writes off a depreciated portfolio investment for a loss, unrealized
depreciation for the portfolio as a whole decreases as the loss is realized.
Net Change in Net Assets from Operations
MACC experienced an increase of $915,535 in net assets at the end of the
second quarter of fiscal year 2004, and the resulting net asset value per share
was $5.70 as of March 31, 2004, as compared to $5.47 as of September 30, 2003.
General economic conditions have recently appeared to have a positive impact on
the operating results and financial condition of a number of MACC's portfolio
companies, and the majority of MACC's thirty-four operating portfolio companies
continue to be valued at cost or above. MACC has fourteen portfolio
10
investments valued at cost, has recorded unrealized appreciation on eight
portfolio investments and has recorded unrealized depreciation on twelve
portfolio investments.
To mitigate the effects of the current economic environment on MACC's
operating performance, MACC has projected fewer investments and has projected no
new borrowings under the SBIC leverage program in the current fiscal year 2004
budget. Recent years have been difficult years for the venture capital industry.
With the recent improvement in the economy, MACC's overall portfolio is showing
signs of increasing strength. If the economy continues to improve, management
believes MACC's investment portfolio will benefit from improved operating
performance at a number of portfolio companies and from a more robust merger and
acquisition market.
Six Months Ended March 31, 2004 Compared to Six Months Ended March 31, 2003
For the six months
ended March 31,
---------------------------
2004 2003 Change
--------------------------- ---------
Investment income $ 1,320,590 1,250,251 70,339
Operating expenses (2,865,466) (2,158,375) (707,091)
------------ ----------- ----------
Investment expense, net (1,544,876) (908,124) (636,752)
------------ ----------- ----------
Net realized gain (loss) on investments 2,476,464 (2,792,282) 5,268,746
Net change in unrealized appreciation/
depreciation on investments (403,540) 2,453,021 (2,856,561)
------------ ----------- ----------
Net gain on investments 2,072,924 (339,261) 2,412,185
------------ ----------- ----------
Net change in net assets from operations $ 528,048 (1,247,385) 1,775,433
=========== =========== ==========
Net asset value:
Beginning of period $ 5.47 6.72
=========== ===========
End of period $ 5.70 6.19
=========== ===========
Investment Income
During the current year six-month period, total investment income was
$1,320,590, an increase of $70,339, or 6%, from total investment income of
$1,250,251 for the prior year six-month period. In the current year six-month
period as compared to the prior year six-month period, interest income decreased
$16,682, or 2%, dividend income increased $182,573, or 77%, processing fees
decreased $17,185, or 100%, and other income decreased $78,367, or 91%. The
decrease in interest income is the net result of only two follow-on investments
made during the current year second quarter, one investment which converted all
interest accrued and reserved to an equity investment, the placing of debt
portfolio securities issued by three portfolio companies on non-accrual of
interest status in the current year six-month period which were accruing
interest in the prior year six-month period and the receipt of $1,252,627 in
principal payments on five portfolio investments. In the current year six-month
period and in the prior year six-month period, MACC received dividends on seven
existing portfolio companies, however dividend payments were greater in the
current year six-month period. Processing fees decreased due to no fees received
on the three follow-on investments made in the current year six-month period,
compared to one follow-on investment and one existing portfolio company
investment in which MACC received processing fees in the prior year six-month
period. The period-over-period decrease in other income is due to a decrease in
advisory fees received from two portfolio companies in the prior year six-month
period.
11
Operating Expenses
Total operating expenses for the six-month period of the current year were
$2,865,466, an increase of $707,091, or 33%, as compared to total operating
expenses for the prior year six-month period of $2,158,375. Interest expense
decreased $37,413, or 3%, in the current year six-month period due to a
reduction in the interest rate on $2,150,000 of SBA-guaranteed debentures to
3.125% in the current year six-month period, from 6.12% in the prior year
six-month period. Management fees decreased $51,724, or 11%, in the current year
six-month period due to InvestAmerica agreeing to a voluntary, temporary
reduction in management fees to reduce the expenses of MACC. This voluntary,
temporary reduction in management fees terminated at February 29, 2004.
Professional fees increased $123,579, or 37%, in the current year six-month
period primarily due to increased legal expenses due to arbitration proceedings
related to the sale of a former portfolio company and legal expenses associated
with the change in MACC's investment advisor which became effective on March 1,
2004 and various corporate governance changes. Professional fees are expected to
be high for at least the next three to six months as a result of the item
identified in Note 3 to the Unaudited Condensed Consolidated Financial
Statements and legal advice in implementing the future direction of MACC. Other
expenses increased $702,649, or 330%, in the current year second quarter as
compared to the prior year six-month period mainly due to the change in the
other assets loss provision. The other assets loss provision increased because
depreciated portfolio securities were reclassified as other assets in the
current year second quarter, which required the unrealized depreciation on such
assets in the amount of $532,760 to be recorded as other assets loss provision,
and because additional loss provision of $197,727 was recorded in the current
year second quarter with respect to other securities which had been classified
as other assets in a prior period.
Investment Expense, Net
For the current year six-month period, MACC recorded investment expense,
net of $1,544,876, as compared to investment expense, net of $908,124 during the
prior year six-month period.
Net Realized Gain (Loss) on Investments
During the current year six-month period, MACC recorded net realized gain
on investments of $2,476,464, as compared with net realized loss on investments
of $2,792,282 during the prior year six-month period. In the current year
six-month period, MACC realized a gain of $328,968 from the sale of warrants of
one portfolio company, and $2,994,881 from the sale of equity interests of three
portfolio companies of which $3,259,790 was previously recorded as unrealized
appreciation. MACC also realized a loss of $847,385 from the write-off of one
portfolio company of which $847,384 was previously recorded as unrealized
depreciation. Management does not attempt to maintain a comparable level of
realized gains quarter to quarter but instead attempts to maximize total
investment portfolio appreciation by appropriately realizing gains in the
disposition of securities and investing in new portfolio investments.
12
Net Change in Unrealized Appreciation/Depreciation of Investments
MACC recorded net change in unrealized appreciation/depreciation on
investments of ($403,540) during the current year six-month period, as compared
to $2,453,021 during the prior year six-month period. This net change in
unrealized appreciation/depreciation on investments of ($403,540) is the net
effect of increases in fair value of six portfolio companies totaling
$1,620,098, decreases in fair value of two portfolio companies totaling
$143,992, the reversal of $3,259,790 of appreciation resulting from the sale of
warrants of one portfolio investment and the sale of equity interests of three
portfolio investments referenced above, the reversal of $847,384 of depreciation
resulting from the write-off of the investment in one portfolio investment, and
the reversal of $532,760 of depreciation resulting from the restructure of one
portfolio investment to other assets.
Financial Condition, Liquidity and Capital Resources
To date, MACC has relied upon several sources to fund its investment
activities, including MACC's cash and money market accounts and the Small
Business Investment Company ("SBIC") leverage program operated by the Small
Business Administration (the "SBA").
MACC, through its wholly-owned subsidiary, MorAmerica Capital, from time to
time may seek to procure additional capital through the SBIC leverage program to
fund a portion of its investment capital requirements. At present, committed
leverage with a commitment period of up to four years is available through the
SBIC leverage program and MACC anticipates that leverage may be available in
future periods. MACC has not currently budgeted to borrow any funds through the
SBIC leverage program during fiscal year 2004.
As of March 31, 2004, MACC's cash and money market accounts totaled
$6,689,397. MACC has commitments for an additional $3,500,000 and $6,500,000 in
SBA guaranteed debentures, which expire on September 30, 2005 and September 30,
2007, respectively. Subject to the risks and uncertainties described in this
report on Form 10-Q, MACC believes that its existing cash and money market
accounts, the $10,000,000 of SBA commitments, and other anticipated cash flows,
will provide adequate funds for MACC's anticipated budgeted cash requirements
during the current fiscal year, including portfolio investment activities,
principal and interest payments on outstanding debentures payable and
administrative expenses. MACC's budgeted investment objective is to invest
$2,500,000 in new and follow-on investments during the current fiscal year,
subject to further adjustment based upon current economic and operating
conditions.
Debentures payable are composed of $27,940,000 in principal amount of
SBA-guaranteed debentures issued by MACC's subsidiary, MorAmerica Capital, which
mature as follows: $2,150,000 in fiscal year 2005, $1,000,000 in fiscal year
2007, $2,500,000 in fiscal year 2009, $9,000,000 in fiscal year 2010, $5,835,000
in fiscal year 2011, and $7,455,000 in fiscal year 2012. Subject to the risks
and uncertainties described in this report on Form 10-Q, it is anticipated
MorAmerica Capital will be able to roll over these debentures with new ten-year
debentures when they mature.
13
MACC currently anticipates that it will rely primarily on its current cash
and money market accounts and its cash flows from operations to fund its
investment activities and other cash requirements during the remainder of fiscal
year 2004. Although management believes these sources will provide sufficient
funds for MACC to meet its fiscal 2004 investment level objective and other
anticipated cash requirements, there can be no assurances that MACC's cash flows
from operations will be as projected, or that MACC's cash requirements will be
as projected. MACC's cash flow has been negatively affected by expenses
associated with the pending arbitration proceedings described in Note 3 to the
Unaudited Condensed Consolidated Financial Statements. An adverse outcome on
such arbitration proceedings could further adversely affect MACC's cash flow.
As an SBIC, MorAmerica Capital is required to comply with the regulations
of the SBA (the "SBA Regulations"). These regulations include the capital
impairment rules, as defined by Regulation 107.1830 of the SBA Regulations. As
of March 31, 2004, the capital of MorAmerica Capital was impaired less than the
maximum impairment percentage permitted under SBA Regulations. No assurances can
be given, however, that MorAmerica Capital will continue to be less than the
maximum impairment percentage in future periods if MorAmerica Capital continues
to experience negative operating results. If MorAmerica Capital would exceed the
maximum impairment percentage in future periods, a number of events could occur
which could have a material adverse effect on the financial position, results of
operations, cash flow and liquidity of MACC and MorAmerica Capital.
MorAmerica Capital is currently limited by the SBA Regulations in the
amount of distributions it may make to MACC. MACC historically has relied in
large part on distributions from MorAmerica Capital to fund its operating
expenses and other cash requirements. While the paragraphs above describe MACC's
liquidity on a consolidated basis, due to current limitations on MorAmerica
Capital's ability to make distributions to MACC, MACC has limited liquidity to
pay its holding company operating expenses. During the second quarter of the
current fiscal year, MACC entered into a loan agreement providing for advances
of up to $400,000 through a loan made by one of its directors. MACC obtained
$200,000 under this loan agreement in the second quarter of the current fiscal
year and it is anticipated that additional drawings will be necessary in the
third quarter of the current fiscal year. In addition to utilizing this loan
facility, MACC is currently evaluating a number of alternatives to provide for
its liquidity, including one or more of the capital transactions approved by
shareholders at the 2004 annual meeting.
Portfolio Activity
MACC's primary business is investing in and lending to businesses through
investments in subordinated debt (generally with detachable equity warrants),
preferred stock and common stock. The total portfolio value of investments in
publicly and non-publicly traded securities was $34,117,410 at March 31, 2004
and $38,601,177 at September 30, 2003. During the three months ended March 31,
2004, MACC invested $245,126 in follow-on investments in two existing portfolio
companies. Management views investment objectives for any given year as
secondary in importance to MACC's overriding concern of investing in only those
portfolio companies which satisfy MACC's investment criteria. MACC's budgeted
investment objective for fiscal year 2004 is to invest $2,500,000 in new and
follow-on
14
investments, subject to further adjustment based on current economic and
operating conditions.
MACC has frequently co-invested with other funds managed by the Subadvisor.
When it makes any co-investment with these related funds, MACC follows certain
procedures consistent with orders of the Securities and Exchange Commission for
related party co-investments to reduce or eliminate conflict of interest issues.
Of the $245,126 invested during the current year second quarter, $245,126
represented co-investments with funds managed by the Subadvisor.
Critical Accounting Policy
Investments in securities traded on a national securities exchange (or
reported on the NASDAQ national market) are stated at the average of the bid
price on the three final trading days of the valuation period which is not
materially different from the bid price on the final day of the period.
Restricted and other securities for which quotations are not readily available
are valued at fair value as determined by the 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 investee; the long-term potential of the business of the investee; 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, MorAmerica Capital uses financial information
received monthly, quarterly, and annually from its 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 MACC's 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
MACC is exposed to market risk from changes in the market price of publicly
traded equity securities held from time to time in the MACC consolidated
investment portfolio. At
15
March 31, 2004, MACC held only one publicly traded equity security in its
consolidated investment portfolio, and the fair value of that portfolio
investment was not material. Therefore, a hypothetical 10% adverse change in
quoted market price of that portfolio investment would not be material.
MACC is also exposed to market risk from changes in market interest rates
that affect the fair value of MorAmerica Capital's debentures payable determined
in accordance with Statement of Financial Accounting Standards No. 107,
Disclosures About Fair Value of Financial Instruments. The estimated fair value
of MorAmerica Capital's outstanding debentures payable at March 31, 2004, was
$30,409,000, with a cost of $27,940,000. Fair value of MorAmerica Capital's
outstanding debentures payable is calculated by discounting cash flows through
estimated maturity using the borrowing rate currently available to MorAmerica
Capital for debt of similar original maturity. None of MorAmerica Capital's
outstanding debentures payable are publicly traded. Market risk is estimated as
the potential increase in fair value resulting from a hypothetical 0.5% decrease
in interest rates. Actual results may differ.
______________________________________________________
March 31, 2004
______________________________________________________
Fair Value of Debentures Payable $30,409,000
Amount Above Cost $2,469,000
Additional Market Risk $747,000
______________________________________________________
Item 4. Controls and Procedures
In accordance with Item 307 of Regulation S-K promulgated under the
Securities Act of 1933, as amended, and within 90 days of the date of this
Quarterly Report on Form 10-Q, the Chief Executive Officer and Chief Financial
Officer of MACC (the "Certifying Officers") have conducted evaluations of MACC's
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 Commission'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 MACC's 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
16
compliance with Section 302 of the Sarbanes-Oxley Act of 2002, 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 MACC's 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.
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
MorAmerica Capital is party to arbitration proceedings instituted
by TransCore Holdings, Inc., a company (Buyer) seeking indemnification
under the Stock Purchase Agreement (the Stock Purchase Agreement),
pursuant to which MorAmerica Capital and certain other individuals and
institutional investors (collectively, the Sellers) sold their
interest in a former portfolio company investment (Portfolio Company).
The arbitration proceedings are being administered by JAMS. Under the
Stock Purchase Agreement, the Sellers agreed to indemnify Buyer for
breaches of representations and warranties as to Portfolio Company
made by the Sellers. Buyer claims that accounting irregularities at
Portfolio Company resulted in a breach of the Sellers' representations
and warranties. The Sellers have retained counsel and forensic
accountants to defend the Sellers against Buyer's claim for
indemnification. Following discovery, depositions and other
preliminary proceedings, in June, 2003, the formal arbitration
proceedings commenced and are being intensively contested by all
parties. Based on the current schedule for the arbitration, a decision
will not be rendered until at least August, 2004. Based on its
evaluation of the Buyer's claim and discussions with external legal
counsel, MACC believes that it is reasonably possible that a loss may
have been incurred as a result of the indemnification claim, against
which no accrual for loss has been made as of March 31, 2004, because
the amount of the possible loss, and therefore its materiality to the
financial statements, cannot be estimated. MorAmerica Capital intends
to continue vigorously defending this arbitration. MorAmerica Capital
received approximately $939,000 of proceeds from the sale of the
Portfolio Company. MorAmerica Capital owned debt securities of Buyer
with a face value of $508,761 and warrants with a cost of $24,000
received as part of the sale. Buyer has defaulted on interest payments
due on these debt securities. On March 31, 2003, MorAmerica Capital
reduced the valuation of these debt securities by $254,380 in light of
the interest default and information regarding the related dispute as
of that date. On June 30, 2003, MorAmerica Capital further reduced the
valuation of these debt securities by $254,380 to $1 and reduced the
valuation of the warrants to zero based upon the continuing interest
default and additional information regarding the related dispute as of
that date. Subsequent to December 31, 2003, Buyer refinanced certain
of its obligations, including the debt securities held by MorAmerica
Capital, and the principal amount of these debt securities and accrued
interest has been deposited in an escrow account pending conclusion of
the arbitration proceedings.
In a related development, MorAmerica Capital and another small
business investment company, NDSBIC, L.P., which co-invested in
Portfolio Company, filed suit on December 24, 2003 in the United
States District Court for the Northern District of Texas against
Patton Boggs LLP and Charles P. Miller, Esq., of Patton Boggs alleging
legal malpractice and breach of fiduciary duty. Patton Boggs and Mr.
Miller represented MorAmerica Capital and NDSBIC in connection with
their investment in the Portfolio Company and the subsequent sale of
the Portfolio Company to Buyer. MorAmerica Capital and NDSBIC are
seeking monetary damages, in an amount that has not been determined.
BFS Diversified Products, LLC ("BFS") was a supplier to Water
Creations, Inc. ("Water Creations"), a former portfolio company of
MorAmerica Capital. Water
18
Creations went out of business in December, 2002, at which time BFS
was owed approximately $900,000 for products sold to Water Creations.
On March 26, 2004, BFS filed suit in the Iowa District Court of Polk
County, Iowa against board members of and investors in Water
Creations, including MorAmerica Capital, David Schroder (Chief
Financial Officer of MACC), and InvestAmerica Venture Group, Inc., an
affiliate of the Subadvisor. BFS has sued the defendants for fraud,
fraudulent transfer, breach of fiduciary duty, civil conspiracy,
breach of contract, conversion, and alter ego/piercing corporate veil.
The central allegation of the case is that the defendants knew that
Water Creations was insolvent and owed a duty to BFS to protect it
from selling to Water Creations under these circumstances. The
defendants have hired counsel and intend to vigorously defend this
litigation.
Item 2. Changes in Securities
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 February 24, 2004, MACC's 2004 Annual Meeting of Shareholders
(the "Meeting") was held in Salt Lake City, Utah. A quorum of
1,396,582 shares, or approximately 59.96% of issued and outstanding
shares as of December 31, 2003, were represented in person or by proxy
at the Meeting. The shareholders considered eight proposals at the
meeting.
With respect to the first proposal, the shareholders elected
eight nominees to serve as directors until the 2005 Annual Meeting of
Shareholders or until their respective successors shall be elected and
qualified. One director, Paul M. Bass, Jr., was not elected at the
Meeting because his current term as a director continues until the
2005 Annual Meeting of Shareholders. The eight 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 1,382,885 13,697
Benjamin Jiaravanon 1,385,185 11,397
Jasja Kotterman 1,381,466 15,116
Kent I. Madsen 1,382,452 14,130
Shane Robison 1,385,185 11,397
Gordon J. Roth 1,382,885 13,697
19
For Withheld
Martin Walton 1,385,185 11,397
Geoffrey T. Woolley 1,385,485 11,097
With regard to the second proposal, the shareholders approved an Investment
Advisory Agreement between the Corporation and Atlas Management Partners LLC by
a vote of 1,352,936 in favor of approval and 22,435 against approval, with
21,211 shares abstaining.
With regard to the third proposal, the shareholders approved an Investment
Advisory Agreement between MorAmerica Capital Corporation and Atlas Management
Partners LLC by a vote of 1,350,538 in favor of approval and 19,323 against
approval, with 26,721 shares abstaining.
With regard to the fourth proposal, the shareholders approved an Investment
Advisory Support Services Agreement among the Corporation, MorAmerica Capital
Corporation, Atlas Management Partners LLC and InvestAmerica Investment
Advisors, Inc. by a vote of 1,347,748 in favor of approval and 23,243 against
approval, with 25,591 shares abstaining.
With regard to the fifth proposal, the shareholders approved amending the
Corporation's Certificate of Incorporation to increase the number of authorized
shares of Common Stock of the Corporation from 4,000,000 to 10,000,000 by a vote
of 1,352,789 in favor of approval and 23,974 against approval, with 19,819
shares abstaining.
With regard to the sixth proposal, the shareholders authorized the
Corporation to issue rights to acquire any authorized shares of Common Stock of
the Corporation by a vote of 1,347,060 in favor of approval and 25,820 against
approval, with 23,702 shares abstaining.
With regard to the seventh proposal, the shareholders authorized the
Corporation to issue warrants, rights or options to purchase, or securities
convertible into, shares of the Corporation's Common Stock by a vote of
1,349,373 in favor of approval and 23,375 against approval, with 23,834 shares
abstaining.
With regard to the eighth proposal, the shareholders voted to ratify the
appointment of KPMG LLP as independent auditors for MACC for fiscal year 2004 by
a vote of 1,372,794 in favor of approval and 3,818 against approval, with 19,970
shares abstaining.
Item 5. Other Information
There are no items to report.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
The following exhibits are filed with this quarterly report on Form 1O-Q:
20
10.4 Investment Advisory Agreement dated as of March 1, 2004 between
MACC Private Equities Inc. and Atlas Management Partners, LLC
10.5 Investment Advisory Agreement dated as of March 1, 2004 between
MorAmerica Capital Corporation and Atlas Management Partners, LLC
10.6 Investment Advisory Support Services Agreement dated as of March
1, 2004 among MACC Private Equities Inc., MorAmerica Capital
Corporation, Atlas Management Partners, LLC and InvestAmerica
Investment Advisors, Inc.
10.7 Convertible Note and Security Agreement dated as of March 1, 2004
between MACC Private Equities Inc. and Geoffrey T. Woolley
10.8 Letter Agreement Regarding Subsidiary Support dated as of March
1, 2004 between MorAmerica Capital Corporation and MACC Private
Equities Inc.
10.9 Guaranty dated as of March 1, 2004 by Atlas Management Partners,
LLC in favor of Geoffrey T. Woolley
10.10 Employment Agreement between David R. Schroder and MACC Private
Equities Inc. dated as of March 1, 2004*
10.11 Employment Agreement between Robert A. Comey and MorAmerica
Capital Corporation dated as of March 1, 2004*
31.1 Section 302 Certification of Kent I. Madsen (CEO)
31.2 Section 302 Certification of David R. Schroder (CFO)
32.1 Section 1350 Certification of Kent I. Madsen (CEO)
32.2 Section 1350 Certification of David R. Schroder (CFO)
*Indicates a management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
MACC filed no current reports on Form 8-K during the quarter ended
March 31, 2004.
21
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: 5/13/04 By: /s/ Kent I. Madsen
--------------------------------
Kent I.Madsen, President
Date: 5/13/04 By: /s/ David R. Schroder
--------------------------------
David R. Schroder, Chief
Financial Officer
22
EXHIBIT INDEX
Exhibit Description
10.4 Investment Advisory Agreement dated as of March 1, 2004
between MACC Private Equities Inc. and Atlas Management
Partners, LLC
10.5 Investment Advisory Agreement dated as of March 1, 2004
between MorAmerica Capital Corporation and Atlas
Management Partners, LLC
10.6 Investment Advisory Support Services Agreement dated as
of March 1, 2004 among MACC Private Equities Inc., MorAmerica
Capital Corporation, Atlas Management Partners, LLC
and InvestAmerica Investment Advisors, Inc.
10.7 Convertible Note and Security Agreement dated as of March 1,
2004 between MACC Private Equities Inc. and Geoffrey T. Woolley
10.8 Letter Agreement Regarding Subsidiary Support dated as of
March 1, 2004 between MorAmerica Capital Corporation and
MACC Private Equities Inc.
10.9 Guaranty dated as of March 1, 2004 by Atlas Management
Partners, LLC in favor of Geoffrey T. Woolley
10.10 Employment Agreement between David R. Schroder and MACC
Private Equities Inc. dated as of March 1, 2004*
10.11 Employment Agreement between Robert A. Comey and MorAmerica
Capital Corporation dated as of March 1, 2004*
31.1 Section 302 Certification of Kent I. Madsen (CEO)
31.2 Section 302 Certification of David R. Schroder (CFO)
32.1 Section 1350 Certification of Kent I. Madsen (CEO)
32.2 Section 1350 Certification of David R. Schroder (CFO)
*Indicates a management contract or compensatory plan or arrangement.
23