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EX-32 - EXHIBIT 32 - Mill City Ventures III, Ltdv418128_ex32.htm
EX-31.2 - EXHIBIT 31.2 - Mill City Ventures III, Ltdv418128_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Mill City Ventures III, Ltdv418128_ex31-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

xQUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015 OR

 

¨TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                       

 

Commission File Number 814-00991

 

MILL CITY VENTURES III, LTD.

 

(Exact name of registrant as specified in its charter)

 

Minnesota   90-0316651
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

 

328 Barry Avenue South #210, Wayzata, MN 55391

(Address of Principal Executive Offices)

 

(952) 479-1923

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed from last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨   Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No  x

 

As of June 30, 2015, there were 12,151,493 shares of the issuer’s common stock, $0.001 par value, outstanding.

 

 

 

  

Table of Contents

 

Index

 

    Page
PART I . FINANCIAL INFORMATION    
     
Item 1. Financial Statements   1
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   14
     
Item 4. Controls and Procedures   22
     
PART II. OTHER INFORMATION    
     
Item 6 . Exhibits   22
     
SIGNATURES   23

 

 

 

  

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Mill City Ventures III, Ltd.

Balance Sheets

 

   June 30, 2015   December 31, 2014 
   (unaudited)   (audited) 
ASSETS          
Investments, at fair value          
Non-control / Non-affiliate investments (cost of $6,482,465 and $5,797,518, respectively)  $7,178,811   $7,171,509 
           
Cash   3,708,311    4,105,911 
Prepaid expenses   86,304    49,623 
Receivable from sale of investments   -    82,103 
Interest and dividends receivable   112,311    59,794 
Leasehold improvements, net   27,828    31,882 
Property and equipment, net   16,592    18,962 
Total Assets  $11,130,157   $11,519,784 
           
LIABILITIES          
           
Current Liabilities          
Accounts payable  $12,641   $36,098 
Deferred interest income   20,645    - 
Deferred rent   10,560    9,996 
Total Current Liabilities   43,846    46,094 
           
Total Liabilities   43,846    46,094 
           
SHAREHOLDERS’ EQUITY          
Common Stock, par value $0.001 per share (250,000,000 common shares authorized; 12,151,493 and 12,151,493 issued and outstanding)   12,151    12,151 
Additional paid-in capital   11,857,660    11,857,660 
Accumulated deficit   (1,159,665)   (1,159,665)
Accumulated undistributed investment loss   (1,024,300)   (1,028,423)
Accumulated undistributed net realized gains on investment transactions   704,119    417,976 
Net unrealized appreciation in value of investments   696,346    1,373,991 
Total Shareholders’ Equity   11,086,311    11,473,690 
           
Total Liabilities and Shareholders’ Equity  $11,130,157   $11,519,784 
           
Net Asset Value Per Common Share  $0.91   $0.94 

 

See accompanying notes to financial statements.

 

1 

 

  

Mill City Ventures III, Ltd.

Statement of Operations

(unaudited)

  

   Three Months
Ended
June 30, 2015
   Three Months
Ended
June 30, 2014
   Six Months
Ended
June 30, 2015
   Six Months
Ended
June 30, 2014
 
Investment Income                    
Interest income  $117,796    59,036   $256,322   $88,502 
Dividend income   29,285    25,979    54,603    38,277 
Total Investment Income   147,081    85,015    310,925    126,779 
                     
Operating Expenses                    
Professional fees   36,071    35,205    87,468    72,382 
Payroll expense   40,481    40,473    81,955    81,919 
Insurance expense   21,610    24,795    46,174    58,116 
Occupancy   22,819    20,795    45,618    38,201 
Directors’ fees expense   15,000    15,000    30,000    30,000 
Depreciation and amortization expense   3,212    3,136    6,424    6,234 
Other general and administrative expenses   4,368    3,595    9,163    7,445 
Total Operating Expenses   143,561    142,999    306,802    294,297 
Net Investment Income (Loss)   3,520    (57,984)   4,123    (167,518)
                     
Realized and Unrealized Gain (Loss) on Investments                    
Net realized gain on investments   139,290    -    286,143    200,903 
Net change in unrealized appreciation (depreciation) on  investments   (683,368)   (162,588)   (677,645)   520,609 
Net Realized and Unrealized Gain (Loss) on Investments   (544,078)   (162,588)   (391,502)   721,512 
                     
Net Increase (Decrease) in Net Asset Value Resulting from Operations  $(540,558)   (220,572)  $(387,379)  $553,994 
                     
Net Increase (Decrease) in Net Assets Resulting from Operations per share:                    
Basic and diluted  $(0.04)   (0.02)  $(0.03)  $0.05 
                     
Weighted-average number of common shares outstanding   12,151,493    12,169,422    12,151,493    12,169,422 

 

See accompanying notes to financial statements.

 

2 

 

  

Mill City Ventures III, Ltd.

Statements of Cash Flows

(unaudited)

 

   Six Months Ended
June 30, 2015
   Six Months Ended
June 30, 2014
 
Cash flows from operating activities:          
Net increase (decrease) in net asset value resulting from operations  $(387,379)  $553,994 
           
Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash used in operating activities:          
Net change in unrealized (appreciation) depreciation on investments   677,645    (520,609)
Net realized gain on investments   (286,143)   (200,903)
Payments for purchases of investments   (1,841,399)   (2,433,510)
Proceeds from sales of investments   1,442,595    622,894 
Depreciation and amortization expense   6,424    6,234 
           
Changes in operating assets and liabilities:          
Prepaid expenses   (36,681)   (37,607)
Receivable from sale of investments   82,103    794 
Interest and dividends receivable   (52,517)   (22,887)
Accounts payable   (23,457)   (10,748)
Deferred interest income   20,645    6,167 
Accrued royalty   -    (619)
Deferred rent   564    1,123 
           
Net cash used in operating activities   (397,600)   (2,035,407)
           
Cash flows from investing activities:          
Purchases of property and equipment   -    (3,179)
Purchases of leasehold improvements   -    (2,561)
           
Net cash used by investing activities   -    (5,740)
           
Net decrease in cash   (397,600)   (2,041,147)
           
Cash, beginning of the period   4,105,911    7,090,379 
Cash, end of the period  $3,708,311   $5,049,232 

 

See accompanying notes to financial statements.

 

3 

 

  

Mill City Ventures III, Ltd.

Financial Highlights

(unaudited)

 

   Six Months Ended
June 30, 2015
 
Per Share Data     
Net asset value at beginning of the period  $0.94 
Net investment income   0.00 
Net realized and unrealized losses   (0.03)
      
Net asset value at end of period  $0.91 
      
Ratio / Supplemental Data     
Per share market value of investments at end of period  $0.59 
Shares outstanding at end of period   12,151,493 
Average weighted shares outstanding for period   12,151,493 
Net assets at end of period  $11,086,311 
Average net assets (1)  $11,525,839 
Portfolio turnover rate (2)   12.52%
Ratio of operating expenses to average net assets (2)   (2.49)%
Ratio of net investment income to average net assets (2)   0.07%
Ratio of realized gains to average net assets (2)   5.07%

 

(1)Based on the monthly average of net assets as of the beginning and end of each period presented.
(2)Ratios are annualized.

 

See accompanying notes to financial statements.

 

4 

 

  

Mill City Ventures III, Ltd.

Schedule of Investments

As of June 30, 2015

(Unaudited)

 

Portfolio Company  Description of Securities  Cost   Fair Value 
Creative Realities Inc.  12% Convertible Promissory Note (Mat. 8/18/16 )   $1,000,000   $1,000,000 
   1,515,152 $0.38 Cashless Warrants (Exp. 2/18/20)*†   -    - 
BioLife Solutions Inc.  $4.70 Cashless Warrants (Exp. 3/20/21)*   -    - 
Combimatrix Corp.  $1.97 Cashless Warrants (Exp. 12/29/2018)*   -    - 
   $3.12 Cashless Warrants (Exp. 12/19/2018)*   -    - 
Mix 1 Life Inc.  12% Convertible Promissory Note (Mat. 2/6/16)   500,000    500,000 
   12% Promissory Note (Mat. 3/13/16)†   250,000    250,000 
   Common Stock*   -    1,460,523 
Pacific Oil & Gas, LLC  12% Promissory Note (Mat. 12/31/15)†   25,000    25,000 
Tzfat Spirits of Israel, LLC  Class A Membership Units*†   101,019    25,000 
Insite Software Solutions, Inc.  $0.01 Warrants (Change Of Control) (Exp 12/30/23)*   -    - 
MAX 4G Wireless, Inc.  Series B Convertible Preferred Stock*†   150,000    150,000 
Calamos Convertible and High Income Fund  Closed End Fund   128,357    132,900 
Powershares KBW High Dividend
Yield Financial
  ETF   253,510    241,500 
Solar Senior Capital, Ltd.  Common Stock   91,983    95,361 
DBR Phase III US Investors, LLC  Membership Units†   1,000,000    1,000,000 
The Igloo, LLC  20% Senior Secured Note (Mat. 12/31/16)†   500,000    500,000 
Discovery Communications Inc.  Common Stock Series A   149,609    166,300 
Dala Petroleum Inc.  Series A 6% Convertible Preferred Stock   500,000    500,000 
   714,286 $1.35 Cashless Warrants (Exp. 6/3/17 )*   -    - 
Northern Capital Partners I, LP  Membership Units*†   500,000    444,208 
Southern Plains Resources, Inc.  Common Stock*   730,000    150,000 
Hi-Crush Partners, LP  Limited Partnership Units   183,660    153,450 
AT&T Inc.  Common Stock   175,260    177,600 
Century Link Inc.  Common Stock   157,360    146,900 
Communications Sales & Leasing Inc.  Common Stock   65,620    49,440 
Windstream Holdings, Inc.  Common Stock   21,087    10,629 
   Total Investments  $6,482,465   $7,178,811 

 

Restricted security

* Indicates securities are not income producing

 

5 

 

  

Mill City Ventures III, Ltd.

Portfolio Investments by Industry

As of June 30, 2015

(Unaudited)

 

Security Name  Industry  Date of
Initial
Investment
  Investment  Quantity
or Face
Value
   Cost   Fair Value   % of
Net
Assets
 
                              
Creative Realities, Inc.  Advertising  2/19/2015  Promissory Note   1,000,000   $1,000,000   $1,000,000      
Creative Realities, Inc.  Advertising  2/19/2015  Warrants   1,515,152              
                  1,000,000    1,000,000    9.02%
                              
Bio Life Solutions, Inc.  Bio-technology  3/21/2014  Warrants   100,000              
Combimatrix Corporation  Bio-technology  5/6/2013  Warrants   413,934              
                  -    -    0.00%
                              
Mix 1 Life, Inc.  Consumer  2/6/2014  Promissory Note   500,000    500,000    500,000      
Mix 1 Life, Inc.  Consumer  3/9/2015  Promissory Note   250,000    250,000    250,000      
Mix 1 Life, Inc.  Consumer  8/7/2014  Common Stock   292,690        1,460,523      
Tzfat Spirits of Israel, LLC  Consumer  10/14/2013  Membership Units   55,000    101,019    25,000      
                  851,019    2,235,523    20.17%
Communication Sales & Leasing,  Inc.  Financial  4/24/2015  Common Stock   2,000    65,620    49,440    0.45%
                              
Insite Software Solutions, Inc.  Information Technology  12/30/2013  Warrants   108,960              
MAX 4G  Information Technology  6/14/2013  Preferred Stock   300,000    150,000    150,000      
                  150,000    150,000    1.35%
                              
Calamos Convertible & High Income Fund  Investment Fund  11/5/2013  Common Stock   10,000    128,357    132,900      
Powershares High Dividend Yield  Investment Fund  5/12/2014  Common Stock   10,000    253,510    241,500      
Solar Senior Capital Ltd  Investment Fund  1/16/2015  Common Stock   6,047    91,983    95,361      
                  473,850    469,761    4.24%
                              
DBR Phase III US Investors, LLC  Leisure & Hospitality  2/7/2014  LP Units   1,000,000    1,000,000    1,000,000      
The Igloo LLC  Leisure & Hospitality  12/31/2014  Promissory Note   500,000    500,000    500,000      
                  1,500,000    1,500,000    13.53%
                              
Discovery Communications Inc.  Media  1/23/2015  Common Stock   5,000    149,609    166,300    1.50%
                              
Dala Petroleum, Inc.  Oil & Gas  6/3/2014  Preferred Stock   500    500,000    500,000      
Dala Petroleum, Inc.  Oil & Gas  6/3/2014  Warrants   714,286              
HI Crush Partners  Oil & Gas  2/24/2015  Common Stock   5,000    183,660    153,450      
Northern Capital, LP  Oil & Gas  6/16/2014  Membership Units   500,000    500,000    444,208      
Pacific Oil & Gas, LLC  Oil & Gas  5/29/2015  Promissory Note   25,000    25,000    25,000      
Southern Plains Resources, Inc.  Oil & Gas  3/13/2013  Common Stock   600,000    730,000    150,000      
                  1,913,660    1,438,958    11.48%
                              
AT&T  Telecommunications  10/25/2013  Common Stock   5,000    175,260    177,600      
CenturyLink, Inc.  Telecommunications  10/28/2013  Common Stock   5,000    157,360    146,900      
Windstream Holdings Inc.  Telecommunications  11/6/2013  Common Stock   1,666    21,087    10,629      
                  353,707    335,129    3.03%
                              
Total Investments                $6,482,465   $7,178,811    64.77%

 

6 

 

  

Mill City Ventures III, Ltd.

Notes to Financial Statements

June 30, 2015

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Description of Operations and Basis of Presentation

 

Mill City Ventures III, Ltd. (the “Company”) is an investment company that was incorporated in the State of Minnesota on January 10, 2006 under the name WPP Acquisition, Inc. The Company’s name was subsequently changed to Poker Magic, Inc. Our business from January 10, 2006 (inception) through December 12, 2012 consisted primarily of marketing and licensing a new form of poker-based table game to casinos and on-line gaming facilities in the United States.

 

On December 13, 2012, we filed a Form N-8A with the SEC, notifying the SEC that we intended to convert the Company to an internally managed, non-diversified, closed-end investment company under the Investment Company Act of 1940 (the “1940 Act”). On February 7, 2013, we filed Form N-54A, notifying the SEC of our election to become a business development company (“BDC”). Subsequently, on May 13, 2013, we filed Form N-8F to deregister as a registered investment company based upon our prior filing to become a BDC. On September 25, 2013, the SEC issued an order under Section 8(f) of the Investment Company Act of 1940 declaring that the Company has ceased to be an investment company. We are regulated as a BDC and plan to be taxed as a regulated investment company, although we currently have not elected this tax status. As a BDC, we primarily focus on investing in or lending to privately held and publicly traded companies and making managerial assistance available to such companies. A BDC may provide shareholders with the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits of investing in emerging-growth or expansion-stage companies. Our future revenues will relate to the earnings we receive from the sale of securities, dividends and interest from our portfolio investments. The Company’s objective is to obtain returns from investments in securities and other investment opportunities available to business development companies under the 1940 Act. We intend to invest capital in portfolio companies for purposes of financing acquisitions, recapitalizations, buyouts, organic growth and working capital. Buyouts generally include transactions that involve the acquisition of a controlling interest in an entity, either by management or other investors. Organic growth refers to growth through the internal operations of the company, through investments in marketing initiatives, capital expenditures or other internal growth initiatives, rather than growth by means of an acquisition. We plan to identify potential investments through multiple sources, including private equity sponsors, investment bankers, brokers, and owners and operators of businesses. We will base our investment decisions on analyses of potential customers’ business operations and asset valuations as well as financing structure, utilizing risk management methods, pricing tools, due diligence methodologies and data management processes designed to help us assess risk, establish appropriate pricing, and maximize our return on investment. Subject to regulations set forth in the 1940 Act and applicable to BDCs, we plan to invest in private companies, small-cap public stocks, notes and other forms of debt, investment contracts, and other investments commonly referred to as securities.

 

On January 17, 2013, the Company amended and restated our Articles of Incorporation. The amendment and restatement included a change in our name from "Poker Magic, Inc." to "Mill City Ventures III, Ltd."

 

On February 7, 2013, the Company filed Form N-54A, Notification of Election to be Subject to Sections 55 through 65 of the Investment Company Act of 1940 notifying the SEC that we are closed-end company that will be operated for the purpose of making investments primarily in securities described in section 55(a)(1) through (3) of the Investment Company Act of 1940 and will make available significant managerial assistance with respect to issuers of such securities to the extent required by the Act.

 

Interim Financial Information

 

The balance sheet as of December 31, 2014, which has been derived from audited financial statements, and the unaudited interim condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial information. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to such rules and regulations. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 or any other period. The accompanying financial statements and related notes should be read in conjunction with our audited financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2014. The financial information furnished in this report is unaudited and reflects all adjustments which are normal recurring adjustments and, which in the opinion of management, are necessary to fairly present the results of the interim periods presented in order to make the financial statements not misleading.

 

7 

 

  

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management and our independent board members to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates.

 

Cash Deposits

 

The Company maintains its cash balances in financial institutions and with regulated financial investment brokers. Cash on deposit in excess of FDIC and similar coverage is subject to the usual banking risk of funds in excess of those limits.

 

Fair Value of Financial Instruments

 

The carrying amounts of certain of the Company’s financial instruments, including cash, receivable from sale of investments, interest and dividends receivable, prepaid expenses, accounts payable and notes payable approximate fair value due to their relatively short maturities.

 

In the normal course of business, the Company may utilize derivative financial instruments (principally options) in connection with its trading activities. The Company records its derivative activities at fair value. Gains and losses from derivative financial instruments are included in net gain (loss) on investments in the statement of operations.

 

Investment Valuation

 

Investment transactions are recorded on the trade date. Realized gains or losses on investments are measured by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment without regard to unrealized gains or losses on investments previously recognized, and include investments charged off during the period, net of recoveries. Unrealized gains or losses on investments primarily reflect the change in investment values, including the reversal of previously recorded unrealized gains or losses when gains or losses are realized.

 

Investments for which market quotations are readily available are typically valued at such market quotations. In order to validate market quotations, we look at a number of factors to determine if the quotations are representative of fair value, including the source and nature of the quotations. Debt and equity securities that are not publicly traded or whose market prices are not readily available are valued at fair value as determined in good faith by our Board of Directors or the Valuation Committee of the board, based on, among other things, the input of our executive management, audit committee and independent third-party valuation expert that may be engaged by management to assist in the valuation of our portfolio investments, but in all cases consistent with our written valuation policies and procedures.

 

Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments may fluctuate from period to period. Additionally, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that we may ultimately realize. Further, such investments are generally less liquid than publicly traded securities. If we were required to liquidate a portfolio investment in a forced or liquidation sale, we could realize significantly less than the value at which we have recorded it.

 

In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned.

 

Allocation of Net Gains and Losses

 

All income, gains, losses, deductions and credits for any investment are allocated in a manner proportionate to the shares owned.

 

8 

 

  

Income Taxes

 

The Company accounts for income taxes under the liability method. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.

 

Realized Gains and Losses, Interest and Dividend Income Recognition

 

Realized gains or losses on the sale of investments are calculated using the specific investment method.

 

Interest income is recorded on an accrual basis and includes the accretion of discounts and amortization of premiums. Discounts from and premiums to par value on securities purchased are accreted/amortized into interest income over the life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of discounts and amortization of premiums, if any.

 

Loans are generally placed on non-accrual status when principal or interest payments are past due 30 days or more or when there is reasonable doubt that principal or interest will be collected in full. Accrued and unpaid interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current. The Company may make exceptions to this if the loan has sufficient collateral value and is in the process of collection.

 

Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Dividend income on common equity securities is recorded on the record date for private portfolio companies or on the ex-dividend date for publicly traded portfolio companies.

 

Our portfolio investments at June 30, 2015 and December 31, 2014 were $7,178,811 and $7,171,509, respectively.

 

Management and Service Fees

 

The Company does not incur expenses related to management and service fees. Our executive management team manages the Company’s investments as part of their employment responsibilities.

 

Recent Accounting Pronouncements

 

No other new accounting pronouncement issued or effective during the fiscal quarter has had or is expected to have a material impact on the condensed financial statements.

 

NOTE 2—NET GAIN (LOSS) PER COMMON SHARE

 

Basic net gain (loss) per common share is computed by dividing net gain (loss) by the weighted average number of vested common shares outstanding during the period. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net gain (loss) per common share follows:

 

   For the Three Months Ended 
   June 30, 
   2015   2014 
Numerator: Net Decrease in Net Asset Value Resulting from Operations  $(540,558)  $(220,572)
Denominator: Weighted-average number of common shares outstanding   12,151,493    12,169,422 
Basic and diluted net loss per common share  $(0.04)  $(0.02)

 

   For the Six Months Ended 
   June 30, 
   2015   2014 
Numerator: Net Increase (Decrease) in Net Asset Value Resulting from Operations  $(387,379)  $553,994 
Denominator: Weighted-average number of common shares outstanding   12,151,493    12,169,422 
Basic and diluted net gain (loss) per common share  $(0.03)  $0.05 

 

9 

 

  

At June 30, 2015 and 2014, the Company did not have any options or warrants outstanding or any other dilutive common equivalent shares.

 

NOTE 3—COMMITMENTS AND CONTINGENCIES

 

The Company has an agreement to lease approximately 1,917 square feet of commercial space and two parking spots, for a period of 62 months. The 62-month lease term began October 1, 2013 and runs through November 30, 2018. The total rent expense for the three and six -month periods ended June 30, 2015 was $22,819 and $45,618.

 

The following is a schedule of the required annual minimum lease payments.

 

Year  Amount 
2015   22,125 
2016   46,179 
2017   50,311 
2018   46,988 
TOTAL  $165,603 

 

NOTE 4—SHAREHOLDERS’ EQUITY

 

Common stock

 

On August 29, 2014 we purchased and retired 2,973 shares of common stock at a per-share price of $0.83.

 

On September 3, 2014, we purchased and retired 4,510 shares of common stock at a per-share price of $0.80.

 

On December 19, 2014, we purchased and retired 10,446 shares of common stock at a per-share price of $0.84.

 

At June 30, 2015, a total of 12,151,493 shares of common stock were issued and outstanding.

 

NOTE 5—FAIR VALUE OF INVESTMENTS

 

Investment Risks

 

The Company’s investments are subject to a variety of risks. Those risks include the following:

 

Market Risk

 

Market risk represents the potential loss that can be caused by a change in the fair value of the instrument.

 

Credit Risk

 

Credit risk represents the risk that the Company would incur if the counterparties failed to perform pursuant to the terms of their agreements with the Company.

 

Fair Value Hierarchy

 

The fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels is explained below:

 

Level 1

 

Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments are not applied to Level 1 securities. Because valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant degree of judgment.

 

10 

 

  

Level 2

 

Pricing inputs are other than used in Level 1, which include the closing bid price for unlisted marketable securities, which are available in active or inactive markets for identical investments or liabilities, other direct or indirect observable inputs that can be corroborated by market data or the use of models or other valuation methodologies as of the reporting date.

 

Level 3

 

Pricing inputs are unobservable for the investment and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require significant management judgment or estimation.

 

The table below presents the balances of assets measured at fair value within respective industries.

  

   As of June 30, 2015 
   Level 1   Level 2   Level 3   Total 
AT&T  $177,600   $-   $-   $177,600 
Calamos Convertible & High Income Fund   132,900    -    -    132,900 
CenturyLink, Inc.   146,900    -    -    146,900 
Communication Sales & Leasing,Inc.   49,440    -    -    49,440 
Discovery Communications Corp.   166,300    -    -    166,300 
Hi Crush Partners, LP   153,450    -    -    153,450 
Windstream Holdings, Inc.   10,629    -    -    10,629 
Solar Senior Capital Ltd   95,361    -    -    95,361 
Powershares High Yield Dividend Fund   241,500    -    -    241,500 
Pacific Oil & Gas, Inc.   -    -    25,000    25,000 
Southern Plains Resources, Inc.   -    -    150,000    150,000 
Max 4G   -    -    150,000    150,000 
Tzfat Spirits of Israel, LLC   -    -    25,000    25,000 
DBR Phase III US Investors, LLC   -    -    1,000,000    1,000,000 
Mix 1 Life, Inc. Convertible Note   -    -    500,000    500,000 
Mix 1 Life, Inc. Promissory Note   -    -    250,000    250,000 
Mix 1 Life, Inc. Common Stock   1,460,523    -    -    1,460,523 
Dala Petroleum Inc.   -    -    500,000    500,000 
The Igloo, LLC   -    -    500,000    500,000 
Creative Realities, Inc.   -    -    1,000,000    1,000,000 
Northern Capital Partners I, LP   -    -    444,208    444,208 
                     
Total  $2,634,603   $-   $4,544,208   $7,178,811 

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:

 

   Fair Value 
Fair value, December 31, 2014  $4,225,000 
Change in unrealized appreciation   (205,792)
Net realized and unrealized loss   (205,792)
Purchases of portfolio investments   1,275,000 
Sales of portfolio investments   (750,000)
Fair value, June 30, 2015  $4,544,208 
      
Net unrealized losses included in the net increase in net assets resulting from operations relating to assets held at June 30, 2015  $(205,792)

 

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Portfolio Investments

 

At June 30, 2015, we held investments in 13 eligible portfolio investments, which had an amortized cost of $5,256,019 and a fair value of $6,004,731. At December 31, 2014, we held investments in 11 eligible portfolio investments, which had an amortized cost of $4,946,019 and a fair value of $6,265,399.

 

On March 1, 2013, we entered into a subscription agreement with Great Plains Sand, LLC through a private placement of common stock for the purchase of 1 Class A Membership Unit for $105,000. On May 24, 2013, Great Plains Sand, LLC sold its company to Fairmount Minerals, Ltd. for a sale price of $65 million subject to certain adjustments for the final working capital settlement and the retention of a limited amount of the sale consideration to pay certain post-closing expenses. After expenses, we received approximately $182,176 in cash with the potential of an additional $18,750 in escrow to be paid within 60 days of closing and a potential earnout of $18,750 to be paid within one year of closing. On February 25, 2014, $7,500 was received in satisfaction of post-closing payment rights under the acquisition agreement. On August 7, 2014 an additional $28,000 was received and on December 31, 2014 $258 was received in final satisfaction of post-closing payment rights under the acquisition agreement.

 

On March 6, 2013, we entered into a purchase and sale agreement with Mill City Ventures II, LP, wherein we purchased 400,000 shares of Southern Plains Resources, Inc. common stock from Mill City Ventures II, LP for $420,000. On July 11, 2013, the Company entered into a subscription agreement with Southern Plains Resources, Inc. through a private placement of common stock to purchase an additional 200,000 shares of common stock at $1.55 per share for $310,000. Our cost of the Southern Plains investment at June 30, 2015 was $730,000 and the fair value was $150,000.

 

On May 3, 2013, we entered into a securities purchase agreement with CombiMatrix Corporation (“CombiMatrix”) to purchase Series C Convertible Preferred Stock and warrants in two separate closings. In the May 6, 2013 closing, we purchased 200 shares of Series C preferred stock convertible into common stock at $2.86 per share and 81,967 warrants with an exercise price of $3.77 per share. In the June 28, 2013 closing, we purchased 200 shares of Series C preferred stock convertible into common stock at $2.86 per share and 81,967 warrants with an exercise price of $3.55 per share. On August 9, 2013, we converted 100 shares of the CombiMatrix 6% Series C shares to 34,994 shares of CombiMatrix common stock at $2.86 per share. An additional 207 shares of common stock were issued in lieu of accrued dividend on the converted principal amount. Our cost for the CombiMatrix investment was $400,600 and the fair value at September 30, 2013 was $400,675. On November 21, 2013, we converted 300 shares of the CombiMatrix 6% series C shares to 104,983 shares of CombiMatrix common stock at $2.86 per share. An additional 3,710 shares of common stock were issued in lieu of accrued dividend on the converted principal balance. On December 18, 2013, we purchased 515 Series D Convertible preferred shares of CombiMatrix Corporation for $1,000 per share for a total purchase price of $515,000 with a warrant to purchase 250,000 shares of common stock at $3.12. Each Series D Convertible share is convertible into common stock at $2.06 per share. The warrant has an expiration date of December 18, 2018. On December 19, we converted 515 Series D Convertible preferred shares into 250,000 shares of common stock. During the first quarter ended March 31, 2014, we sold 204,850 shares of the common stock for $615,394, resulting in a realized gain of $193,403. During the third quarter ended September 30, 2014, we sold the remaining 45,150 shares of the common stock for $61,252, resulting in a realized loss of $31,756. On February 13, 2015, CombiMatrix modified the conversion price of the 81,967 warrants at $3.77 and the 81,967 warrants at $3.55 to a $1.97 conversion price for the duration of the life of the warrants. The modification was made in accordance with anti-dilution price-protection provisions in the warrant. At June 30, 2015 the cost and fair value of the warrants was $0.

 

On May 29, 2013, we entered into a subscription and investment letter with MAX4G, Inc. to purchase 300,000 shares of MAX4G's Series B Convertible Preferred Stock, $.001 par value per share, at $0.50 per share, for a total of $150,000. At June 30, 2015, the cost and fair value of the MAX4G investment was $150,000.

 

On October 14, 2013, we entered into subscription agreement with Tzfat Spirits of Israel, LLC, to purchase 55,000 Class A Membership Units at $1.8367 per unit for a total of $101,019. At June 30, 2015, the cost and fair value of the Tzfat investment was $101,019 and $25,000, respectively.

 

On December 30, 2013, we entered into a Promissory Note and Warrant Purchase Agreement with Insite Software Solutions, Inc. and in connection therewith purchased a $750,000 promissory note and received a warrant to purchase 108,960 shares of Insite Software common stock at one cent ($0.01) per share. The warrant has a 10-year term expiring December 30, 2023. On April 27, 2015 $750,000 plus $5,825.34 in accrued interest was received in full on redemption of the promissory note. At June 30, 2015, the cost and fair value of the warrant was $0.

 

On February 6, 2014, we entered into a Senior Secured Convertible Promissory Note and Warrant Purchase Agreement with Mix 1 Life, Inc. and in connection therewith purchased a $500,000 senior secured convertible promissory note and received a warrant to purchase up to 1,600,000 shares of Mix 1 Life common stock at $0.50 per share. The note currently is convertible into shares of common stock at $1.08 per share (post split). The warrant has a five-year term expiring February 6, 2019. On August 7, 2014 we elected to exercise, on a cashless basis, our warrants into 1,121,912 shares of common stock. On September 11, 2014, a 1-for-3 reverse split on those common shares reduced our holdings to 373,971 common shares. At June 30, 2015, the cost and fair value of the promissory note was $500,000 and the cost and fair value of the common stock was $0 and $1,460,523, respectively. Our director Mr. Larson is currently the Chief Financial Officer, director and 5% shareholder of Mix 1 Life, Inc. Mr. Larson was appointed Chief Financial Officer and a director of Mix 1 on June 24, 2014, after our initial investment in Mix 1 Life.

 

On February 7, 2014, we entered into a Purchase Agreement for $1,000,000 of limited liability company interests with DBR Phase III US Investors, LLC and in connection therewith funded a first capital call of $350,000. A second capital call of $350,000 was funded on May 9, 2014 and the final capital call was funded on October 21, 2014 in the amount of $300,000. At June 30, 2015, the cost and fair value of the interests was $1,000,000.

 

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On June 3, 2014, we entered into a subscription and warrant purchase agreement with Dala Petroleum Corporation (fka Westcott Products Corporation) to purchase 500 shares of Series A 6% Convertible Preferred Stock, $.01 par value per share, at $1,000 per share, for a total of $500,000 and received a warrant to purchase up to 714,286 shares of Dala Petroleum common stock at $1.35 per share. The preferred stock converts into common stock at $0.70. The warrant has a three-year term, expiring June 3, 2017. On May 25, 2015, we entered into an agreement to defer the receipt of the quarerly dividend distribution on the preferred shares until October 1, 2015. The deferred dividend of $7,500 for the quarter ended June 30, 2015 is included in Interest and Dividends Receivable on the Balance Sheet. At June 30, 2015, the cost and fair value of the preferred stock was $500,000 and the cost and fair value of the warrant was $0.

 

On May 16, 2014, we entered into a Purchase Agreement for $500,000 of limited partnership interests with Northern Capital Partners I, LP and in connection therewith funded a first capital call of $50,000 on June 16. A second capital call of $125,000 was funded on August 26, 2014, a third capital call of $200,000 was funded on October 21, 2014 and the fourth and final capital call of $125,000 was funded on December 26, 2014. At June 30, 2015, the cost and fair value of the interests was $500,000 and $444,208, respectively.

 

On December 31, 2014, we entered into a Promissory Note Agreement for $500,000 with The Igloo, LLC and in connection therewith funded a $500,000 promissory note. At June 30, 2015, the cost and fair value of the note was $500,000.

 

On February 19, 2015, we purchased a 12% convertible note from Creative Realities, Inc. for $1,000,000 principal amount. The note bears 12% annual interest paid monthly in arrears and is due August 18, 2016. The outstanding principal amount is convertible into common stock at $0.33. In conjunction with the financing, we received a warrant to purchase 1,515,152 common shares with a conversion price of $0.38. The warrant has a cashless conversion provision and expires February 17, 2020. At June 30, 2015, the cost and fair value of the note was $1,000,000. The cost and value of the warrant is $0.

 

On March 13, 2015, we purchased a 12% senior secured promissory note from Mix 1 Life, Inc. for $250,000 principal amount. At closing, 12 months of interest was prepaid by Mix 1. The note is due on March 13, 2016. Our director Christopher Larson is also a director and the Chief Financial Officer of Mix 1 as well as a 5% shareholder in Mix 1. At June 30, 2015, the cost and fair value of the note was $250,000.

 

On June 1, 2015, we purchased a 12% promissory note from Pacific Oil & Gas, LLC for $25,000 principal amount. The note plus accrued interest is due on December 31, 2015. At June 30, 2015, the cost and fair value of the note was $25,000.

 

NOTE 6—MINIMUM ASSET COVERAGE

 

As a BDC, we are required to meet various regulator tests. Among other things, these tests will require us to invest at least 70% of our total assets in private or small-cap public U.S.-based companies, and to maintain a coverage ratio of total net assets to total senior securities and borrowings (including accrued interest payable) of at least 200%. As of June 30, 2015, approximately 84% of our investments (by fair value at that date) were in private or small-cap public U.S.-based companies and our coverage ratio was 100%.

 

NOTE 7—INCOME TAXES

 

We plan to be regulated as a regulated investment company (“RIC”) and intend to comply with the requirements of the Internal Revenue Code, applicable to regulated investment companies. Currently, we have not elected to be treated as a RIC. We are required to distribute at least 90% of our investment company taxable income and intend to distribute (or retain through a deemed distribution) all of our investment company taxable income and net capital gain to shareholders; therefore, we have made no provision for income taxes. The characterization of income and gains that we will distribute is determined in accordance with income tax regulations that may differ from GAAP. Book and tax basis differences relating to shareholder dividends and distributions and other permanent book and tax differences are reclassified to paid-in capital.

 

NOTE 8—SUBSEQUENT EVENTS

 

None.

 

13 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below should be read in conjunction with our audited financial statements, and notes thereto, contained in our Form 10-K filed with the SEC on March 31, 2015 related to our year ended December 31, 2014.

 

Forward-Looking Statements

 

Some of the statements made in this section of our report are forward-looking statements based on the current expectations of the management of our company. These expectations involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “targets,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, the availability of additional capital, and the ability to maintain certain debt-to-asset ratios. In light of these and other uncertainties, the inclusion of a projection or forward-looking statement in this report should not be regarded as a representation by us that our plans or objectives will be achieved.

 

Some of the forward-looking statements contained in this report include statements as to:

 

·our future operating results;

 

·our business prospects and the prospects of our portfolio companies;

 

·the outcome of a pending compliance inspection by the SEC Office of Compliance and Inspections;

 

·the impact of investments that we expect to make;

 

·our informal relationships with third parties;

 

·the dependence of our future success on the general economy and its impact on the industries in which we invest;

 

·the ability of our portfolio companies to achieve their objectives;

 

·our expected financings and investments;

 

·our regulatory structure and tax treatment;

 

·our ability to operate as a business development company and to be taxed as a regulated investment company;

 

·the adequacy of our cash resources and working capital; and

 

·the timing of cash flows, if any, from the operations of our portfolio companies.

 

The foregoing list is not exhaustive. In light of the foregoing, prospective investors are cautioned that the forward-looking statements included in this filing may ultimately prove to be inaccurate—even materially inaccurate. For a more complete summary of the risks and uncertainties facing our company and its business and relating to our forward-looking statements, please refer to our Annual Report on Form 10-K filed on March 31, 2015 (related to our year ended December 31, 2014) and in particular the section thereof entitled “Risk Factors.” Because of the significant uncertainties inherent in the forward-looking statements pertaining to our company, the inclusion of such information should not be regarded as a representation or warranty by us or any other person that our objectives, plans, expectations or projections that are contained in this filing will be achieved in any specified time frame, if ever. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this report. The forward-looking statements made in this report relate only to events as of the date on which the statements are made, and are excluded from the safe harbor protection provided by Section 21E of the Securities Exchange Act of 1934. 

 

14 

 

 

General Overview

 

Mill City Ventures III, Ltd. is a Minnesota corporation that was incorporated in January 2006. Until December 13, 2012, we were a development-stage company that previously focused on promoting and placing our Winner’s Pot Poker game online and into casinos and entertainment facilities nationwide, including those located in Native American tribal lands. On December 13, 2012, we filed a Form N-8A with the SEC, notifying the SEC of our intent to register as an internally managed, non-diversified, closed-end investment company under the Investment Company Act of 1940 (the “1940 Act”). On February 7, 2013, we filed Form N-54A, Notification of Election to be Subject to Sections 55 through 65 of the 1940 Act, to be regulated as a business development company (“BDC”). Subsequently, on May 13, 2013, we filed Form N-8F to deregister as a registered investment company based upon our prior filing to become a BDC. On September 25, 2013, the SEC issued an order under Section 8(f) of the Investment Company Act of 1940 declaring that we had ceased to be an investment company. We are regulated as a BDC and we plan to be taxed as a regulated investment company (“RIC”) although we have not made an election to be taxed as a RIC at this time.

 

Business Model and Strategy

 

As a BDC, we primarily focus on investing in, lending to and making managerial assistance available to privately held and publicly traded companies. A BDC may provide shareholders with the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits of investing in emerging-growth or expansion-stage companies.

 

Our future revenues will relate to the earnings we receive from our portfolio investments. Our objective is to obtain superior returns from investments in securities and other investment opportunities available to BDC’s under the 1940 Act. We intend to invest capital in portfolio companies for purposes of financing acquisitions, recapitalizations, buyouts, organic growth and working capital. Buyouts generally include transactions that involve the acquisition of a controlling interest in an entity, either by management or other investors. Organic growth refers to growth through the internal operations of the company, through investments in marketing initiatives, capital expenditures or other internal growth initiatives, rather than growth by means of an acquisition.

 

We plan to identify potential investments through multiple sources, including private equity sponsors, investment bankers, brokers, our Board of Directors, owners and operators of businesses and other persons within our professional network. We will base our investment decisions primarily on analyses of potential growth prospects of business operations and asset valuations. Subject to applicable BDC regulations set forth in the 1940 Act, we plan to invest in private companies, small-cap public stocks, notes and other forms of debt, investment contracts, and other investments commonly referred to as securities.

 

Highlights for the Six Months Ended June 30, 2015

 

Investment Transactions

 

On February 19, 2015, we purchased a 12% convertible note from Creative Realities, Inc. for $1,000,000 principal amount. The note bears 12% annual interest paid monthly in arrears and is due August 18, 2016. The outstanding principal amount is convertible into common stock at $0.33. In conjunction with the financing, we received a warrant to purchase 1,515,152 common shares with a conversion price of $0.38. The warrant has a cashless conversion provision and expires February 17, 2020.

 

On March 13, 2015, we purchased a 12% senior secured promissory note from Mix 1 Life, Inc. for $250,000 principal amount. At closing, 12 months of interest was prepaid by Mix 1. The note is due on March 13, 2016. Our director Christopher Larson is also a director and the Chief Financial Officer of Mix 1 Life as well as a 5% shareholder in Mix 1.

 

On April 27, 2015 we received $750,000 plus $5,825.34 in accrued interest in full on redemption of the promissory note purchased from Insite Software Solutions, Inc.

 

On May 25, 2015, we entered into an agreement to defer the receipt of the quarterly dividend distribution on the preferred shares of Dala Petroleum Corporation until October 1, 2015. The deferred dividend of $7,500 for the quarter ended June 30, 2015 is included in Interest and Dividends Receivable on the Balance Sheet.

 

On June 1, 2015, we purchased a 12% promissory note from Pacific Oil & Gas, LLC for $25,000 principal amount. The note plus accrued interest is due on December 31, 2015.

 

15 

 

 

Material Changes in Assets and Liabilities

 

Our prepaid expenses as of June 30, 2015 were $86,304 compared to $49,623 for the year ended December 31, 2014. The increase relates to our annual insurance and fidelity bond premiums. These premiums will be amortized ratably over the covered period.

 

Our receivable from sale of investments as of June 30, 2015 were $0 compared to $82,103 for the year ended December 31, 2014. The decrease relates to the executions of trades as of December 31, 2014 which settled in January, 2015. We had no trades executed which had not yet settled as of June 30, 2015.

 

Our accounts payable as of June 30, 2015 were $12,641 compared to $36,098 for the year ended December 31, 2014. The decrease relates to a reduction in accounting and other professional fees.

 

Our interest and dividends receivable at June 30, 2015 were $112,311 compared to $59,794 for the year ended December 31, 2014. The increase relates to our investments in DBR Phase III US Investors, LLC, The Igloo LLC, Mix 1 Life Inc., Dala Petroleum and Creative Realities Inc.

 

Our deferred interest income at June 30, 2015 was $20,645 compared to $0 at December 31, 2014. This relates to the interest received in advance on the Mix 1 Life, Inc. $250,000 promissory note entered into on March 13, 2015. The advanced interest is being amortized over the period of the note until maturity on March 16, 2016.

 

On August 7, 2014 we elected to exercise, on a cashless basis, our warrants of Mix 1 Life, Inc. into 1,121,912 shares of common stock. On September 11, 2014, a 1-for-3 reverse split on those common shares reduced our holdings to 373,971 common shares. At June 30, 2015, the cost and fair value of the warrant and common stock was $0 and $1,460,523, respectively.

 

Results of Operations for the Six Months Ended June 30, 2015 Compared to the Six Months Ended June 30, 2014

 

Operating Expenses

 

Item  For the
Six-Month
Period Ended
June 30, 2015
   For the
Six-Month
Period Ended
June 30, 2014
 
Investment Income  $310,925    126,779 
           
Operating Expenses:          
Professional fees   87,468    72,382 
Payroll expense   81,955    81,919 
Occupancy expense   45,618    38,201 
Insurance expense   46,174    58,116 
Directors’ fees expense   30,000    30,000 
Depreciation and amortization   6,424    6,234 
Other general and administrative   9,163    7,445 
Net Investment Income (Loss)  $4,123    (167,518)

 

As the table above demonstrates, we incurred operating expenses of $306,802 and $294,297 for the six-month periods ended June 30, 2015 and 2014, respectively. A discussion and analysis of the material components of our operating expenses appears below.

 

Professional fees. Our professional fees were $87,468 for the six-month period ended June 30, 2015, compared to $72,382 for the six-month period ended June 30, 2014. The increase in professional fees is due to increased legal fees associated with the preparation of the Company’s filing requirements.

 

Payroll expense and executive management compensation. During the six-month period ended June 30, 2015, we incurred $81,955 in payroll expense for our executive management compared to $81,919 incurred during the three-month period ended June 30, 2014.

 

Insurance expense. During the six-month period ended June 30, 2015, we incurred $46,174 in insurance expense compared to $58,116 for the six-month period ended June 30, 2014. Insurance expense relates to our annual director and officer insurance, fidelity bond premiums and business insurance amortized ratably over the covered period.

 

Directors’ fees expense. Our directors’ fees expense for the six-month periods ended June 30, 2015 and 2014 were $30,000.

 

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We appointed independent members (qualifying as non-interested persons under the 1940 Act) to our Board of Directors and began compensating our directors as part of our transition to a BDC.

 

Occupancy expense. Our occupancy expenses for the six-month periods ended June 30, 2015 and 2014 were $45,618 and $38,201.

 

Results of Operations for the Three Months Ended June 30, 2015 Compared to the Three Months Ended June 30, 2014

 

Operating Expenses

 

Item  For the
Three-Month
Period Ended
June 30, 2015
   For the
Three-Month
Period Ended
June 30, 2014
 
Investment Income  $147,081    85,015 
           
Operating Expenses:          
Professional fees   36,071    35,205 
Payroll expense   40,481    40,473 
Occupancy expense   22,819    20,795 
Insurance expense   21,610    24,795 
Directors’ fees expense   15,000    15,000 
Depreciation and amortization   3,212    3,136 
Other general and administrative   4,368    3,595 
Net Investment Income (Loss)  $3,520    (57,984)

 

As the table above demonstrates, we incurred operating expenses of $143,561 and $142,999 for the three-month periods ended June 30, 2015 and 2014, respectively. A discussion and analysis of the material components of our operating expenses appears below.

 

Professional fees. Our professional fees were $36,071 for the three-month period ended June 30, 2015, compared to $35,205 for the three-month period ended June 30, 2014. The increase in professional fees is due to increased legal fees associated with the preparation of the Company’s filing requirements.

 

Payroll expense and executive management compensation. During the three-month period ended June 30, 2015, we incurred $40,481 in payroll expense for our executive management compared to $40,473 incurred during the three-month period ended June 30, 2014.

 

Insurance expense. During the three-month period ended June 30, 2015, we incurred $21,610 in insurance expense compared to $24,795 for the three-month period ended June 30, 2014. Insurance expense relates to our annual director and officer insurance, fidelity bond premiums and business insurance amortized ratably over the covered period.

 

Directors’ fees expense. Our directors’ fees expense for the three-month periods ended June 30, 2015 and 2014 were $15,000. We appointed independent members (qualifying as non-interested persons under the 1940 Act) to our Board of Directors and began compensating our directors as part of our transition to a BDC.

 

Occupancy expense. Our occupancy expenses for the three-month periods ended June 30, 2015 and 2014 were $22,819 and $20,795.

 

Net Investment Income (Loss)

 

Net investment income (loss) represents the difference between investment income and operating expenses. Our net investment income (loss) for the six-month period ended June 30, 2015 and 2014 was $4,123 and ($167,518) respectively. The increase is primarily due to better results from investing activities resulting in interest and dividend income.

 

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Net Realized Gains, Increase in Net Assets from Net Changes in Unrealized Appreciation

 

Net realized gains on investments for the six-month period ended June 30, 2015 was $286,143. A net realized gain of $352,011 was due to our sale of 59,540 shares of Mix 1 Life, Inc. common stock, and a $115,308 realized loss was due to our sale of 50,000 common shares of Bio Life Solutions, Inc.

 

The net decrease in net assets from changes in unrealized appreciation or depreciation was ($677,645), primarily caused by the realizing of gains on the sale of our Mix 1 Life, Inc. common stock position.

 

Liquidity and Capital Resources

 

Summary cash flow data is as follows:

 

   Six Months Ended June 30, 
    2015    2014 
Cash flows used by :          
Operating activities  $(397,600)  $(2,035,407)
Investing activities   -    (5,740)
Financing activities   -    - 
Net decrease in cash   (397,600)   (2,041,147)
Cash, beginning of period   4,105,911    7,090,379 
Cash, end of period  $3,708,311   $5,049,232 

 

The cash used in operating activities for the six-month period June 30, 2015 was primarily from our investment transactions.

 

On February 19, 2015, we purchased a 12% convertible note from Creative Realities, Inc. for $1,000,000 principal amount. The note bears 12% annual interest paid monthly in arrears and is due August 18, 2016. The outstanding principal amount is convertible into common stock at $0.33. In conjunction with the financing, we received a warrant to purchase 1,515,152 common shares with a conversion price of $0.38. The warrant has a cashless conversion provision and expires February 17, 2020.

 

On March 13, 2015, we purchased a 12% senior secured promissory note from Mix 1 Life, Inc. for $250,000 principal amount. At closing, 12 months of interest was prepaid by Mix 1. The note is due on March 13, 2016. Our director Christopher Larson is also a director and the Chief Financial Officer of Mix 1 Life as well as a 5% shareholder in Mix 1.

 

On April 27, 2015 we received $750,000 plus $5,825.34 in accrued interest in full on redemption of the promissory note purchased from Insite Software Solutions, Inc.

 

On June 1, 2015, we purchased a 12% promissory note from Pacific Oil & Gas, LLC for $25,000 principal amount. The note plus accrued interest is due on December 31, 2015.

 

We presently expect that we will be able to invest substantially all of our available cash in portfolio investment at or prior to the end of this year.

 

Regulation as a BDC

 

As a BDC, we are regulated by the 1940 Act. A BDC must be organized in the United States for the purpose of investing in or lending to primarily private companies, or certain small-cap public companies, and, with limited exceptions, making managerial assistance available to them. A BDC may use capital provided by public shareholders and from other sources to make long-term, private investments in businesses. A BDC may provide shareholders the ability to retain the liquidity of a publicly traded stock while sharing in the possible benefits, if any, of investing in primarily privately owned or small-cap public companies.

 

We may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC unless authorized by vote of a majority of the outstanding voting securities, as required by the 1940 Act. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (a) 67% or more of such company’s voting securities present at a meeting if more than 50% of the outstanding voting securities of such company are present or represented by proxy; or (b) more than 50% of the outstanding voting securities of such company. We do not anticipate any substantial change in the nature of our business.

 

As with other companies regulated by the 1940 Act, a BDC must adhere to certain substantive regulatory requirements. A majority of our directors must be persons who are not “interested persons,” as that term is defined in the 1940 Act. Additionally, we are required to provide and maintain a bond issued by a reputable fidelity insurance company to protect the BDC. Furthermore, as a BDC, we are prohibited from protecting any director or officer against any liability to us or our shareholders arising from willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office.

 

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We are generally not able to sell our common stock at a price below net asset value per share. We may, however, sell our common stock at a price below net asset value per share (i) in connection with a rights offering to our existing shareholders, (ii) with the consent of shareholders holding a majority of our common stock, or (iii) under such other circumstances as the SEC may permit. For example, we may sell our common stock at a price below the then-current net asset value of our common stock if our Board of Directors determines that such sale is in our best interests and the best interests of our shareholders, and our shareholders approve our policy and practice of making such sales. In addition, we may generally issue new shares of our common stock at a price below net asset value in rights offerings to our existing shareholders, in payment of dividends and in certain other limited circumstances. No such offerings have occurred as of the date of this filing.

 

We will be permitted, under specified conditions, to issue multiple classes of indebtedness and one class of stock senior to our common stock, but only if our “asset coverage,” as defined in the 1940 Act, is at least equal to 200% immediately after each such issuance. In addition, while any senior securities remain outstanding, we must not make any dividend distribution to our shareholders or repurchase securities unless we meet the applicable asset-coverage ratios at the time of the dividend distribution or repurchase. We may also borrow amounts up to 5% of the value of our total assets for temporary or emergency purposes.

 

We are prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our directors who are not interested persons and, in some cases, prior approval by the SEC. Subject to certain exceptions, as a BDC, we are generally not permitted to invest in any portfolio company in which our affiliates currently have an investment or to make any co-investments with our affiliates without an exemptive order from the SEC.

 

We will be periodically examined by the SEC for compliance with the 1940 Act, the rules and regulations thereunder, and good governance practices. We will not “concentrate” our investments (i.e., invest 25% or more of our assets in any particular industry, determined at the time of investment). We will be required to provide and maintain a bond issued by a reputable fidelity insurance company to protect us against larceny and embezzlement. Furthermore, as a BDC, we are prohibited from indemnifying any director or officer against any liability to our shareholders arising from willful malfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person’s office. We are required to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws, review these policies and procedures annually for their adequacy and the effectiveness of their implementation.

 

Qualifying Assets

 

Under the 1940 Act, a BDC may not acquire any asset other than “qualifying assets” listed in Section 55(a) of the 1940 Act unless, at the time the acquisition is made, qualifying assets represent at least 70% of the BDC’s total assets. The principal categories of qualifying assets relevant to our business are the following:

 

(1) Securities of an “eligible portfolio company” purchased from the issuer of such securities or from a person who is, or who was within the prior 13 months of the date of purchase, an affiliate of the issuer or from any other person (subject to limitation by SEC rules), in any case in transactions not involving any public offering. The 1940 Act defines an “eligible portfolio company” as any issuer which:

 

(a) is organized under the laws of, and has its principal place of business in, the United States;

 

(b) is not an investment company or a company that would be an investment company but for certain exclusions under the 1940 Act; and

 

(c) satisfies one of the following:

 

  (i) does not have outstanding any class of securities with respect to which a broker or dealer may extend margin credit (or, if a broker or dealer may in fact extend or maintain margin credit to a customer with respect to such securities, then at the time of purchase of the issuer’s securities (A) the BDC owns at least 50% of the greatest number of outstanding and issuable equity securities of such issuer (i.e., 50% determined on a fully diluted basis) and the greatest amount of debt securities of such issuer), (B) the BDC is one of the 20 largest holders of record of the issuer’s outstanding voting securities);

 

  (ii) is controlled by a BDC or a group of companies acting together that includes a BDC, the BDC does in fact exercise a controlling influence over the management or policies of the issuer, and, as a result of such control, the BDC has an affiliated person serving as a director of the eligible portfolio company;

 

  (iii) is a small and solvent company having total assets of not more than $4 million and capital and surplus of not less than $2 million, subject to adjustment by SEC rules; or

 

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  (iv) by virtue of SEC Rule 2a-46, (A) does not have any class of securities listed on a national securities exchange, or (B) has a class of securities listed on a national securities exchange but an aggregate market value (as computed under such rule) of outstanding voting and non-voting common equity of less than $250 million.

 

(2) Securities of any eligible portfolio company (as defined above) that we control through having a person serving on the board of directors of the issuer.

 

(3) Securities purchased from an issuer, or from a person who is, or was in the prior 13 months of the date of purchase, an affiliate of the issuer, which issuer is organized under the laws of, and has its principal place of business in, the United States and is not an investment company (or a company that would be an investment company but for certain exclusions under the 1940 Act), and which is in bankruptcy and subject to reorganization (or where the issuance of securities is consummated pursuant to or in consummation of a bankruptcy or reorganization plan or arrangement).

 

(4) Securities of an eligible portfolio company (as defined above) purchase from any person in a transaction not involving a public offering, if there is no ready market for such securities and if immediately prior to such purchase the BDC owns at least 60% of the outstanding equity securities of such issuer, as determined on a fully diluted basis.

 

(5) Securities received in exchange for or distributed on or with respect to securities described above, or pursuant to the conversion of warrants or rights relating to such securities.

 

(6) Cash, cash equivalents, U.S. government securities or high-quality debt securities maturing in one year or less from the time of investment.

 

(7) Office furniture and equipment, interests in real estate and leasehold improvement and facilities maintained to conduct the business operations of the BDC, deferred organization and operating expenses, and other non-investment assets necessary and appropriate to its operations as a BDC, including notes of indebtedness of directors, officers, employees and general partners held by the BDC as payment for securities of such company issued in connection with an executive compensation plan described in Section 57(j) of the 1940 Act.

 

In addition to the foregoing description of “qualifying assets,” certain types of follow-on investments in issuers that no longer satisfy the definition of “eligible portfolio company” may nonetheless be “qualifying assets.”

 

Significant Managerial Assistance or Control

 

A BDC must have been organized and have its principal place of business in the United States and must be operated for the purpose of making investments in the types of securities described above. Nevertheless, to count portfolio securities as qualifying assets for the purpose of the foregoing 70% test, the BDC must either control the issuer of the securities or offer to make available to the issuer of the securities (other than small and solvent companies described above) significant managerial assistance; except that, where the BDC purchases such securities in conjunction with one or more other persons acting together, one of the other persons in the group may make available such managerial assistance. Making available significant managerial assistance means, among other things, any arrangement whereby the BDC, whether through its directors, officers or employees, offers to provide, and, if accepted, does in fact so provide, significant guidance and counsel concerning the management, operations or business objectives and policies of a portfolio company through monitoring of portfolio company operations, selective participation in board and management meetings, consulting with and advising a portfolio company’s officers or other organizational or financial guidance.

 

Temporary Investments

 

Pending investment in other types of qualifying assets, as described above, our investments may consist of cash, cash equivalents, U.S. government securities or high quality debt securities maturing in one year or less from the time of investment, which we refer to, collectively, as temporary investments, so that at least 70% of our assets are qualifying assets. We plan to invest in U.S. treasury bills or in repurchase agreements, provided that such agreements are fully collateralized by cash or securities issued by the U.S. government or its agencies. A repurchase agreement involves the purchase by an investor, such as us, of a specified security and the simultaneous agreement by the seller to repurchase it at an agreed upon future date and at a price which is greater than the purchase price by an amount that reflects an agreed-upon interest rate. There is no percentage restriction on the proportion of our assets that may be invested in such repurchase agreements. However, if more than 25% of our total assets constitute repurchase agreements from a single counterparty, we would not meet the diversification tests imposed on us by the Internal Revenue Code to qualify for tax treatment as a RIC for federal income tax purposes. Thus, we do not intend to enter into repurchase agreements with a single counterparty in excess of this limit. We will monitor the creditworthiness of the counterparties with which we enter into repurchase agreement transactions.

 

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Capital Expenditures

 

We did not have and do not plan to have any material commitments for capital expenditures in 2014 or 2015. Given our business model and status as a BDC, we do not require material investments in capital resources.

 

Certain Potential Conflicts of Interest

 

Our Company maintains a Code of Ethics and certain other policies relating to conflicts of interest and related-party transactions, as well as policies and procedures relating to what applicable BDC regulations generally describe as “affiliate transaction.” Nevertheless, from time to time we may hold investments in portfolio companies in which certain members of our management are also directly or indirectly invested. Our Board of Directors has recently adopted a policy to require our disclosure of these instances in our periodic filings with the SEC. Presently, each of Messrs. Geraci and Polinsky have direct and indirect interests in Southern Plains Resources, Inc. We invested in Southern Plains Resources in each of March and July 2013. In addition, our director Christopher Larson has a direct interest in Mix 1 Life, Inc. and served as that company’s Chief Financial Officer at the time of our investment. We invested in Mix 1 Life in February 2014 and we exercised, on a cashless basis, a warrant for the purchase of Mix 1 Life common stock in September 2014. Subsequent to our initial investment, Mr. Larson became a director of Mix 1 Life.

 

Critical Accounting Policies

 

Investment Valuation

 

Investment transactions are recorded on the trade date. Realized gains or losses are measured by the difference between the net proceeds from the repayment or sale and the amortized cost basis of the investment without regard to unrealized gains or losses previously recognized, and include investments charged off during the period, net of recoveries. Unrealized gains or losses primarily reflect the change in investment values, including the reversal of previously recorded unrealized gains or losses when gains or losses are realized.

 

Investments for which market quotations are readily available are typically valued at such market quotations. In order to validate market quotations, we look at a number of factors to determine if the quotations are representative of fair value, including the source and nature of the quotations. Debt and equity securities that are not publicly traded or whose market prices are not readily available are valued at fair value as determined in good faith by our board of directors, based on, among other things, the input of our executive management, audit committee and independent third-party valuation expert that may be engaged by management to assist in the valuation of our portfolio investments.

 

Realized Gains and Losses, Interest and Dividend Income Recognition

 

Realized gains or losses on the sale of investments are calculated using the specific investment method.

 

Interest income is recorded on an accrual basis and includes the accretion of discounts and amortization of premiums. Discounts from and premiums to par value on securities purchased are accreted/amortized into interest income over the life of the respective security using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of discounts and amortization of premiums, if any.

 

Loans are generally placed on non-accrual status when principal or interest payments are past due 30 days or more or when there is reasonable doubt that principal or interest will be collected in full. Accrued and unpaid interest is generally reversed when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as income or applied to principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current. We may make exceptions to this if the loan has sufficient collateral value and is in the process of collection.

 

Dividend income on preferred equity securities is recorded as dividend income on an accrual basis to the extent that such amounts are payable by the portfolio company and are expected to be collected. Dividend income on common equity securities is recorded on the record date for private portfolio companies or on the ex-dividend date for publicly traded portfolio companies.

 

Further information on our critical accounting policies and use of estimates can be found in our financial statements and notes thereto included in this report and in our Annual Report on Form 10-K filed with the SEC on March 31, 2015. There have been no material changes to our critical accounting policies and estimates from those disclosed in our Annual Report on Form 10-K.

 

Off-Balance Sheet Arrangements

 

During the six months ended June 30, 2015, we did not engage in any off-balance sheet arrangements set forth in Item 303(a)(4) of Regulation S-K.

 

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Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance the objectives of the control system are met.

 

As of June 30, 2015, our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures as such term is defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded our disclosure controls and procedures are effective as of June 30, 2015.

 

Changes in Internal Controls

 

There were no significant changes in our internal controls over financial reporting that occurred during the fiscal quarter covered by this report that materially affected, or were reasonably likely to materially affect such controls.

 

PART II – OTHER INFORMATION

 

Item 6. Exhibits

 

Exhibit No.   Description
31.1   Certification of Chief Executive Officer (filed herewith).
31.2   Certification of Chief Financial Officer (filed herewith).
32   Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).

 

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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.

 

  MILL CITY VENTURES III, LTD.
   
  /s/ Douglas Polinsky
  Douglas Polinsky
  Chief Executive Officer
   
  Dated: August 14, 2015
   
  /s/ Joseph A. Geraci, II
  Joseph A. Geraci, II
  Chief Financial Officer
   
  Dated: August 14, 2015

 

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