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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 June 30, 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
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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
------- -------
Please indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).
Yes No X
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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 July 31, 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
(Unaudited) at June 30, 2004
and September 30, 2003............................................ 3
Condensed Consolidated Statements of
Operations (Unaudited) for the three months
ended June 30, 2004 and June 30, 2003
and the nine months ended
June 30, 2004 and June 30, 2003................................... 4
Condensed Consolidated Statements of
Cash Flows (Unaudited) for the nine months ended
June 30, 2004 and June 30, 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......................................16
Item 4. Controls and Procedures...........................................17
Part II. OTHER INFORMATION.................................................18
Item 1. Legal Proceedings.................................................18
Item 5. Other Information.................................................19
Item 6. Exhibits and Reports on Form 8-K..................................20
Signatures........................................................20
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)
June 30, September 30,
2004 2003
------------ -------------
Assets
Loans and investments in portfolio securities, at market
or fair value:
Unaffiliated companies (cost of $11,613,758 and $14,546,361) $ 9,383,813 13,610,760
Affiliated companies (cost of $17,786,705 and $19,842,874) 19,175,441 20,068,666
Controlled companies (cost of $4,536,308 and $4,490,502) 4,614,758 4,921,751
Cash and money market accounts 7,884,630 722,691
Other assets, net 1,006,255 1,909,250
------------ -------------
Total assets $ 42,064,897 41,233,118
============ =============
Liabilities and net assets
Liabilities:
Debentures payable, net of discount $ 27,940,000 27,940,000
Deferred incentive fees 18,353 27,528
Accrued interest 657,214 185,664
Accounts payable and other liabilities 528,722 334,014
------------ -------------
Total liabilities 29,144,289 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 13,660,074 13,001,179
Unrealized depreciation on investments (762,759) (278,560)
------------ -------------
Total net assets 12,920,608 12,745,912
------------ -------------
Total liabilities and net assets $ 42,064,897 41,233,118
============ =============
Net assets per share $ 5.55 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 nine For the nine
months ended months ended months ended months ended
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------------- ------------- ------------ ------------
Investment income:
Interest
Unaffiliated companies $ 154,724 171,562 531,052 416,418
Affiliated companies 184,070 245,839 538,066 759,716
Controlled companies 68,247 60,626 206,016 195,126
Other 12,690 6,998 37,057 22,907
Dividends
Unaffiliated companies --- 74,141 78,204 238,892
Affiliated companies 250,335 131,756 592,602 189,161
Controlled companies --- 7,700 --- 23,442
Processing fees --- 5,556 --- 22,741
Other 2,507 11,556 10,166 97,582
------------- ------------- ------------ ------------
Total investment income 672,573 715,734 1,993,163 1,965,985
------------- ------------- ------------ ------------
Operating expenses:
Interest expenses 531,714 550,420 1,595,142 1,651,261
Management fees 262,810 270,782 782,608 825,867
Professional fees 93,155 467,257 547,001 797,524
Other 87,462 245,389 1,002,948 473,226
------------- ------------- ------------ ------------
Total operating expenses before
management fees waived 975,141 1,533,848 3,927,699 3,747,878
Management fees waived --- (61,420) (87,092) (132,075)
------------- ------------- ------------ ------------
Net operating expenses 975,141 1,472,428 3,840,607 3,615,803
Investment expense,
net before tax expense (302,568) (756,694) (1,847,444) (1,649,818)
------------- ------------- ------------ ------------
Income tax expense --- --- --- (15,000)
------------- ------------- ------------ ------------
Investment expense, net (302,568) (756,694) (1,847,444) (1,664,818)
------------- ------------- ------------ ------------
Realized and unrealized (loss) gain
on investments:
Net realized (loss) gain on investments (net
incentive fees of $514,837 in 2004
and $0 in 2003):
Unaffiliated companies 26,495 748,734 1,974,658 (46)
Affiliated companies 3,380 150,500 64,690 (1,893,002)
Controlled companies --- --- 466,991 ---
Net change in unrealized appreciation/
depreciation on investments (80,659) (2,955,958) (484,199) (502,937)
------------- ------------- ------------ ------------
Net (loss) gain on investments (50,784) (2,056,724) 2,022,140 (2,395,985)
------------- ------------- ------------ ------------
Net change in net assets
from operations $ (353,352) (2,813,418) 174,696 (4,060,803)
============= ============= ============ ============
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 nine For the nine
months ended months ended
June 30, June 30,
2004 2003
------------ ------------
Cash flows from operating activities:
Increase (decrease) in net assets from operations $ 174,696 (4,060,803)
------------ ------------
Adjustments to reconcile increase (decrease)
in net assets from operations to net cash
provided by operating activities:
Net realized and unrealized gain on investments (2,022,140) 2,395,985
Proceeds from disposition of and payments on
loans and investments in portfolio securities 8,023,128 2,218,500
Payments of incentive fees to investment advisor (497,517) ---
Purchases of loans and investments in
portfolio securities (481,934) (977,027)
Change in other assets 724,823 238,309
Change in accrued interest, accounts payable,
and other liabilities 657,083 777,288
Other 583,800 (169,305)
------------ ------------
Total adjustments 6,987,243 4,483,750
------------ ------------
Net cash provided by operating activities 7,161,939 422,947
------------ ------------
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 7,161,939 357,947
Cash and cash equivalents at beginning of period 722,691 1,802,603
------------ ------------
Cash and cash equivalents at end of period $ 7,884,630 2,160,550
============ ============
Supplemental disclosure of cash flow information -
Cash paid during the period for interest $ 1,048,948 1,071,804
============ ============
Supplemental disclosure of noncash investing and financing
information -
Assets received in exchange of securities $ 196,687 448,125
In-kind interest income received in the form of securities 323,820 251,303
============ ============
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 September, 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
June 30, 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. Effective June 30, 2004, Patton Boggs executed a
tolling agreement with MorAmerica Capital and NDSBIC, L.P. waiving any statue of
limitations defense until the agreement is cancelled by either party with 30
days notice. This litigation was then dismissed without prejudice. MorAmerica
Capital intends to monitor the outcome of the TransCore arbitration and then
determine whether to re-institute this litigation.
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.
Third Quarter Ended June 30, 2004 Compared to Third Quarter Ended June 30, 2003
For the three months
ended June 30,
---------------------------
2004 2003 Change
----------- ----------- ---------
Investment income $ 672,573 715,734 (43,161)
Net operating expenses (975,141) (1,472,428) 497,287
----------- ----------- ---------
Investment expense, net (302,568) (756,694) 454,126
----------- ----------- ---------
Net realized gain on investments 29,875 899,234 (869,359)
Net change in unrealized appreciation/
depreciation on investments (80,659) (2,955,958) 2,875,299
----------- ----------- ---------
Net loss on investments (50,784) (2,056,724) 2,005,940
----------- ----------- ---------
Net change in net assets from operations $ (353,352) (2,813,418) 2,460,066
=========== =========== =========
Net asset value:
Beginning of period $ 5.70 6.74
=========== ===========
End of period $ 5.55 4.98
=========== ===========
8
Investment Income
During the current year third quarter, total investment income was
$672,573, a decrease of $43,161, or 6%, from total investment income of $715,734
for the prior year third quarter. In the current year third quarter as compared
to the prior year third quarter, interest income decreased $65,294, or 13%,
dividend income increased $36,738, or 17%, processing fees decreased $5,556, or
100%, and other income decreased $9,049, or 78%. The decrease in interest income
is mainly due to the receipt of $2,159,800 in principal payments on five
portfolio investments during the current fiscal year. In the current year third
quarter, MACC received dividends on six existing portfolio companies, as
compared to dividend income received in the prior year third quarter on seven
existing portfolio companies. The distributions from limited liability companies
in the current year third quarter were larger than in the prior year third
quarter. Processing fees decreased due to no new or follow-on portfolio company
investments made in the current year third quarter, compared to one restructure
of an existing portfolio company investment in which MACC received a processing
fee at closing in the prior year third quarter. The decrease in other income is
due to advisory fees received from one portfolio company in the prior year third
quarter.
Operating Expenses
Total operating expenses for the third quarter of the current year were
$975,141, a decrease of $497,287, or 34%, as compared to total operating
expenses for the prior year third quarter of $1,472,428. Interest expense
decreased $18,706, or 3%, in the current year third 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 third 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 $53,448, or 26%, in the current
year third quarter due to a voluntary reduction in management fees taken by
InvestAmerica in the prior year third quarter which terminated on February 29,
2004. Professional fees decreased $374,102, or 80%, in the current year third
quarter primarily due to decreased legal expenses in connection with arbitration
proceedings related to the sale of a former portfolio company and legal and
accounting fees to comply with new securities and exchange corporate governance
requirements in the prior year third quarter. 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 decreased $157,927, or
64%, in the current year third quarter as compared to the prior year third
quarter mainly due to the change in the other assets loss provision. The other
assets loss provision was higher in the prior year third quarter because an
additional loss provision of $205,433 was recorded with respect to other
securities which had been classified as other assets.
9
Investment Expense, Net
For the current year third quarter, MACC recorded investment expense, net
of $302,568, as compared to investment expense, net of $756,694 during the prior
year third quarter.
Net Realized Gain (Loss) on Investments
During the current year third quarter, MACC recorded net realized gain on
investments of $29,875, as compared with net realized gain on investments of
$899,234 during the prior year third quarter. In the current year third quarter,
MACC realized an additional gain of $3,380 from the sale of one portfolio
company which occurred in the current year second quarter and the adjustment of
$26,495 in deferred incentive fees due to the revaluation of the deferred gain.
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 ($80,659) during the current year third quarter, as compared to
($2,955,958) during the prior year third quarter. This net change in unrealized
appreciation/depreciation on investments of ($80,659) is the net effect of
increases in fair value of three portfolio companies totaling $652,732 and
decreases in fair value of four portfolio companies totaling $733,391.
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 a decrease of $353,352 in net assets at the end of the
third quarter of fiscal year 2004, and the resulting net asset value per share
was $5.55 as of June 30, 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-two operating portfolio companies
continue to be valued at cost or above. MACC has ten portfolio investments
valued at cost, has recorded unrealized appreciation on nine portfolio
investments and has recorded unrealized depreciation on thirteen portfolio
investments.
10
General economic conditions adversely affected a number of MACC's portfolio
companies during fiscal year 2003, which contributed to a decline in MACC's
operating performance and liquidity during the period. In an effort to improve
operating performance and liquidity in the current fiscal year, MACC projected
no new borrowings under the SBIC leverage program in the fiscal year 2004 budget
and has actively pursued opportunities to liquidate a number of portfolio
investments. As a result of these efforts and improvements in general economic
conditions, MACC's operating performance and liquidity through the first nine
months of the current fiscal year have significantly improved, as compared to
the comparable period during fiscal year 2003. Management anticipates that if
general economic conditions continue to be conducive to portfolio investment
liquidity events, subject to the risks described in this report, MACC will
experience further improvements in its operating performance.
Nine Months Ended June 30, 2004 Compared to Nine Months Ended June 30, 2003
For the nine months
ended June 30,
---------------------------
2004 2003 Change
----------- ----------- ---------
Investment income $ 1,993,163 1,965,985 27,178
Net operating expenses (3,840,607) (3,630,803) (209,804)
----------- ----------- ---------
Investment expense, net (1,847,444) (1,664,818) (182,626)
----------- ----------- ---------
Net realized gain (loss) on investments 2,506,339 (1,893,048) 4,399,387
Net change in unrealized appreciation/
depreciation on investments (484,199) (502,937) 18,738
----------- ----------- ---------
Net gain (loss) on investments 2,022,140 (2,395,985) 4,418,125
----------- ----------- ---------
Net change in net assets from operations $ 174,696 (4,060,803) 4,235,499
=========== =========== =========
Net asset value:
Beginning of period $ 5.47 6.72
=========== ===========
End of period $ 5.55 4.98
=========== ===========
Investment Income
During the current year nine-month period, total investment income was
$1,993,163, an increase of $27,178, or 1%, from total investment income of
$1,965,985 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 $81,976, or 6%, dividend income increased $219,311, or 49%, processing
fees decreased $22,741, or 100%, and other income decreased $87,416, or 90%. The
decrease in interest income is the net result of only three follow-on
investments made during the current year nine-month period, 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 nine-month period which were accruing
interest in the prior year nine-month period and the receipt of $2,159,800 in
principal payments on five portfolio investments. In the current year nine-month
period and in the prior year nine-month period, MACC received dividends on eight
existing portfolio companies, however dividend payments were greater in the
current year nine-month period. Processing fees decreased due to no fees
received on the three follow-on investments made in the current year nine-month
period, compared to one follow-on investment and two existing portfolio company
investments in which MACC received processing fees in the prior year nine-month
period. The period-over-period decrease in other
11
income is due to a decrease in advisory fees received from two portfolio
companies in the prior year nine-month period.
Operating Expenses
Total operating expenses for the nine-month period of the current year were
$3,840,607, an increase of $224,804, or 6%, as compared to total operating
expenses for the prior year nine-month period of $3,615,803. Interest expense
decreased $56,119, or 3%, in the current year nine-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 nine-month period, from 6.12% in the prior year
nine-month period. Management fees increased $1,724, or 1%, in the current year
nine-month period mainly due to the termination of the agreement with
InvestAmerica 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 decreased $250,523, or 31%,
in the current year nine-month period primarily due to decreased legal expenses
in connection with arbitration proceedings related to the sale of a former
portfolio company 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 $529,722, or 112%, in the current year nine-month period as
compared to the prior year nine-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 nine-month period, which required the unrealized depreciation on
such assets in the amount of $532,760 to be recorded as other assets loss
provision, and because an additional loss provision of $197,727 was recorded in
the current year nine-month period with respect to other securities which had
been classified as other assets in a prior period.
Investment Expense, Net
For the current year nine-month period, MACC recorded investment expense,
net of $1,847,444, as compared to investment expense, net of $1,664,818 during
the prior year nine-month period.
Net Realized Gain (Loss) on Investments
During the current year nine-month period, MACC recorded net realized gain
on investments of $2,506,339, as compared with net realized loss on investments
of $1,893,048 during the prior year nine-month period. In the current year
nine-month period, MACC realized a gain of $328,968 from the sale of warrants of
one portfolio company, and $3,024,756 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 ($484,199) during the current year nine-month period, as compared
to ($502,937) during the prior year nine-month period. This net change in
unrealized appreciation/depreciation on investments of ($484,199) is the net
effect of increases in fair value of seven portfolio companies totaling
$2,166,255, decreases in fair value of four portfolio companies totaling
$770,809, the reversal of $3,259,789 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 June 30, 2004, MACC's cash and money market accounts totaled
$7,884,630. 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.
Based upon current economic and operating conditions, actual investment results
for fiscal year ending September 30, 2004 may be somewhat below budget. MACC has
invested $481,934 in follow-on investments through June 30, 2004.
Debentures payable are composed of $27,940,000 in principal amount of
SBA-guaranteed debentures issued by MACC's subsidiary, MorAmerica Capital.
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. The following table shows our
significant contractual obligations for the repayment of debt and other
contractual obligations as of June 30, 2004.
13
Payments due by period
---------------------------------------------------
Contractual Obligations
Less than 1-3 Years 3-5 Years More than
Total 1 Year 5 Years
------- --------- --------- --------- ---------
SBA Debentures $ 27,940,000 2,150,000 --- 2,000,000 23,790,000
Loan Agreement¹ $ 270,000 67,500 202,500 --- ---
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 June 30, 2004, the capital of MorAmerica Capital was impaired less than the
maximum impairment percentage permitted under SBA Regulations. If MorAmerica
Capital continues to experience negative operating results, no assurances can be
given that MorAmerica Capital will continue to be less than the maximum
impairment percentage in future periods. 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 and $70,000 under this loan agreement in the second quarter and third
quarter, respectively, of the current fiscal year. It is anticipated that no
additional drawings will be
________________________________
¹ During the second quarter of the current fiscal year, MACC entered into a loan
agreement with one of its directors, Geoffrey T. Woolley, providing for advances
of up to $400,000 on a revolving credit basis through February 28, 2005. The
outstanding principal amount of the loan as of March 1, 2005 will be due and
payable in four equal installments on the first day of June, September,
December, and March, commencing June 1, 2005 and concluding March 1, 2006. The
payment obligations in the table set forth above are based on the amount
outstanding under the loan agreement as of June 30, 2004. The entire unpaid
amount of the loan is convertible into shares of MACC's common stock at the
option of the lender.
14
necessary in the fourth 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 $33,174,012 at June 30, 2004 and
$38,601,177 at September 30, 2003. During the three months ended June 30, 2004,
MACC made no new or follow-on investments. 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 investments. Based on current
economic and operating conditions, actual results for fiscal year ending
September 30, 2004 may be somewhat below budget. MACC has invested $481,934 in
follow-on investments through June 30, 2004.
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.
During the current year third quarter no co-investments were made 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
15
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 June 30, 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 June 30, 2004, was
$30,341,000, 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.
_____________________________________________________
June 30, 2004
_____________________________________________________
Fair Value of Debentures Payable $30,341,000
Amount Above Cost $2,401,000
Additional Market Risk $719,000
_____________________________________________________
16
Item 4. Controls and Procedures
As of the end of the period coverd by this report, in accordance with Item
307 of Regulation S-K promulgated under the Securities Act of 1933, as amended,
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 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 over financial reporting 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 September, 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 June 30, 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. Effective June 30, 2004, Patton Boggs executed a tolling agreement
with MorAmerica Capital and NDSBIC L.P. waiving any statute of limitations
defense until the agreement is cancelled by either party with 30 days
notice. This litigation was then dismissed without prejudice. MorAmerica
Capital intends to monitor the outcome of the TransCore arbitration and
then determine whether to re-institute this litigation.
18
BFS Diversified Products, LLC ("BFS") was a supplier to Water
Creations, Inc. ("Water Creations"), a former portfolio company of
MorAmerica Capital. Water 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
There are no items to report.
Item 5. Other Information
Pending SBA Approval of Atlas
As noted, MorAmerica Capital is a small business investment company
regulated by the U.S. Small Business Administration. In anticipation of the
changes to the Board of Directors of MACC and MorAmerica and the change in
investment advisors, Atlas periodically notified the SBA of the proposed
changes and, as required by SBA regulations, submitted the MorAmerica
Capital Investment Advisory Agreement to the SBA for approval on January
29, 2004. Section 107.400 of the SBA regulations requires prior approval by
the SBA of an event that results in a change of control by any persons not
previously approved as SBIC management by the SBA. Because Mr. Madsen and a
majority of Atlas members are approved SBIC managers, Atlas did not view
the change of investment advisors as a change of control requiring SBA
approval. The SBA has taken the position that both the MorAmerica
Investment Advisory Agreement and the change of control require SBA
approval and the review process on both issues is proceeding. However, the
SBA has indicated that due to a backlog of work by the relevant SBA
internal committee, this process may take some time. Nonetheless, the SBA
has notified MorAmerica Capital in writing that (i) Mr. Efstratis, Mr.
Stevens, Mr. Bridgewater and Mr. Madsen have SBA's approval as management
of MorAmerica Capital; and (ii) MorAmerica Capital's SBA Account
19
Executive has recommended approval of the MorAmerica Capital Investment
Advisory Agreement and prospects are positive for final official approval.
The SBA has made several comments on the MorAmerica Capital Investment
Advisory Agreement that are technical in nature. When finally agreed with
the SBA, these changes will be submitted to a meeting of MACC shareholders
for approval.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
The following exhibits are filed with this quarterly report on Form 1O-Q:
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)
(b) Reports on Form 8-K
MACC filed no current reports on Form 8-K during the quarter ended June 30,
2004.
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: 8/13/04 By: /s/ Kent I. Madsen
------------------------- ------------------------------------------
Kent I. Madsen, President
Date: 8/13/04 By: /s/ David R. Schroder
------------------------- ------------------------------------------
David R. Schroder, Chief Financial Officer
20
EXHIBIT INDEX
Exhibit Description
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)
21