ITEM 1: BUSINESS
Business History
Effective September 30, 2006, Photonics Corporation ("Photonics"), a California corporation, merged into Small Cap Strategies, Inc. ("SCPS", the "Company", "we" or "us"), a Nevada corporation, with SCPS being the surviving entity. The effect of this corporate action was to change the Company's state of incorporation from the State of California to the State of Nevada and to increase the number of shares of common stock authorized from 200,000,000 to 2,000,000,000. All common shares of Photonics were exchanged on a one-for-one basis for stock in SCPS. As discussed below, Photonics had 50,000,000 shares of $.001 par value preferred stock authorized, of which 400,000 shares had been designated Series A Convertible Preferred Stock. At September 30, 2006, immediately prior to the merger, Photonics had no preferred stock issued or outstanding. SCPS did not authorize any preferred stock in its articles of incorporation in Nevada. Accordingly, there is no preferred stock authorized, issued or outstanding after the merger on September 30, 2006. In addition, the shareholders authorized the board of directors to effect a reverse stock split with-in the next twelve months. On December 5, 2006, the board of directors authorized a reverse stock split of one share for each twenty shares outstanding, to be effective December 21, 2006. On May 15, 2007, the board of directors authorized a second reverse stock split of one share for each twenty shares outstanding, to be effective the dated filed with the Nevada Secretary of State, May 21, 2007. Accordingly, all share transactions and disclosures have been restated as if the reverse stock split occurred before all periods presented.
Photonics, d/b/a DTC Data Technology, was formed from a merger of Photonics Corporation with DTC Data Technology in March of 1996. The Company designed, developed, and marketed Integrated Device Electronics (IDE) and Small Computer Systems Interface (SCSI) disk controller cards and Input/Output (I/O) products for personal computers. However, as a result of recurring significant operating losses, in June 1999, the board of directors voted to shut down business operations and attempt to sell the Company or its assets. Since that date, the Company had been inactive in its original business operations.
Consequently, during late January and into the first few days of February 2000, days before the Company planned to file Chapter 11, the Company was contacted by and reached an initial, non-binding agreement to acquire RealEstate4Sale.com (RE4S). Since this acquisition agreement is superior to the filing of a bankruptcy proceeding, the Company deferred the Chapter 11 filing; and was actively pursuing the acquisition of RE4S and, following the termination of that transaction, the acquisition of REpipeline.com, Inc.
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The initial, non-binding agreement to acquire RE4S was terminated as of May 31, 2000. The Agreement, executed as of June 30, 2000, was executed with a majority of the same group of principals who represented RE4S but with their newly formed company REpipeline.com, Inc. (Texas).
On November 28, 2000, the Company approved the merger and merged with REpipeline.com, a Texas Corporation, an Internet vertical service provider to the commercial real estate industry, by issuing 45,320 common stock shares valued at $18,128 in exchange for all of the outstanding common stock of REpipeline.com, Inc. ("REP").
The transaction was accounted for as a reverse merger using the purchase method of accounting with REP acquiring Photonics for financial reporting purposes. The purchase price of Photonics was allocated among its net assets based on their relative fair market values. Because Photonics did not have any assets or business operations, no portion of the purchase price was allocated to goodwill. Instead, the excess of the purchase price over the fair value of net assets acquired was charged against operations.
REpipeline.com, Inc. was incorporated in the state of Texas on June 8, 2000. On July 10, 2000, the REpipeline.com, Inc., a Texas corporation, agreed to purchase the assets and assume certain liabilities and the shareholder's equity of RealEstate4Sale.com. RealEstate4Sale.com ("RE4S") was incorporated in Colorado on August 17, 1999, and its purpose was to provide commercial real estate listings on the Internet. Subsequent to the acquisition of RealEstate4Sales.com, the Company reincorporated REpipeline.com, Inc. into a Delaware corporation and made it a wholly owned subsidiary. However, the concept was deemed to be too narrow for the marketplace and was subsequently abandoned.
In the fourth quarter of 2001, we purchased all the outstanding shares of The Sarasota Group, Inc. ("SGI"), a Florida Corporation, and made it a wholly owned subsidiary. The Company's then current board resigned while simultaneously electing new officers and directors for the Company.
In the fourth quarter of 2005 we went through another change in management. The new management team is currently implementing the new business strategy that is outlined below.
On March 7, 2006 we filed a notification under Form N54a with the U.S. Securities and Exchange Commission, (the "SEC") indicating our election to be regulated as a business development company under the Investment Company Act of 1940 (the "1940 Act"). In connection with this election, we have adopted corporate resolutions and intend to operate as a closed-end management investment company as such a business development company (a "BDC").
As of December 31, 2007 we had 1 employee. Various aspects of due diligence of prospective portfolio companies and monitoring the activities of portfolio companies will be subcontracted to consultants. We may require additional employees in the areas of administration, sales and marketing, etc. in the future and as additional portfolio companies are added. There is intense competition for capable, experienced personnel and there is no assurance we will be able to obtain new qualified employees when required. We believe our relationship with our employee is good.
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Business Summary
Under the recent election to be governed as a business development company under the 1940 Act, we have been organized to provide investors with the opportunity to participate, with a modest amount in venture capital, in investments that are generally not available to the public and that typically require substantially larger financial commitments. In addition, we will provide professional management and administration that might otherwise be unavailable to investors if they were to engage directly in venture capital investing. We have decided to be regulated as a business development company under the 1940 Act, and will operate as a non-diversified company as that term is defined in Section 5(b)(2) of the 1940 Act. We will, at all times, conduct our business so as to retain our status as a BDC. We may not change the nature of our business so as to cease to be, or withdraw our election as, a BDC without the approval of the holders of a majority of our outstanding voting stock as defined under the 1940 Act.
As a business development company, we are required to invest at least 70% of our total assets in qualifying assets, which, generally, are securities of private companies or securities of public companies whose securities are not eligible for purchase on margin (which includes many companies with thinly traded securities that are quoted in the pink sheets or the NASD Electronic Quotation Service.) We must also offer to provide significant managerial assistance to these portfolio companies. Qualifying assets may also include:
o cash, o cash equivalents, o U.S. Government securities, or o high-quality debt investments maturing in one year or less from the date of investment.
We may invest a portion of the remaining 30% of our total assets in debt and/or equity securities of companies that may be larger or more stabilized than target portfolio companies.
Nature of a BDC
The 1940 Act defines a BDC as a closed-end management investment company that provides small businesses that qualify as an eligible portfolio company with investment capital and also significant managerial assistance. A BDC is required under the 1940 Act to invest at least 70% of its total assets in qualifying assets consisting of eligible portfolio companies as defined in the 1940 Act and certain other assets including cash and cash equivalents.
An eligible portfolio company generally is a United States company that is not an investment company and that:
o does not have a class of securities registered on an exchange or included in the Federal Reserve Board's over-the-counter margin list; o is actively controlled by a BDC and has an affiliate of a BDC on its board of directors; or o meets such other criteria as may be established by the SEC.
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Control under the 1940 Act is presumed to exist where a BDC owns more than 25% of the outstanding voting securities of the eligible portfolio company. We may or may not control our portfolio companies.
An example of an eligible portfolio company is a new start up company or a privately owned company that has not yet gone public by selling its shares in the open market and has not applied for having its shares listed on a nationally recognized exchange such as the NYSE the American Stock Exchange, National Association of Securities Dealers' Automated Quotation System, or the National Market System. An eligible portfolio company can also be one which is subject to filing, has filed, or has recently emerged from reorganization protection under Chapter 11 of the Bankruptcy Act.
A BDC may invest the remaining 30% of its total assets in non-qualifying assets, including companies that are not eligible portfolio companies. The foregoing percentages will be determined, in the case of financings in which a BDC commits to provide financing prior to funding the commitment, by the amount of the BDC's total assets represented by the value of the maximum amount of securities to be issued by the borrower or lessee to the BDC pursuant to such commitment. As a BDC, we must invest at least 70% of our total assets in qualifying assets but may invest more in such qualifying assets.
Primary Strategy
We will have significant relative flexibility in selecting and structuring our investments. We will not be subject to many of the regulatory limitations that govern traditional lending institutions such as banks. We will seek to structure our investments so as to take into account the uncertain and potentially variable financial performance of our portfolio companies. This should enable our portfolio companies to retain access to committed capital at different stages in their development and eliminate some of the uncertainty surrounding their capital allocation decisions. We will calculate rates of return on invested capital based on a combination of up-front commitment fees, current and deferred interest rates and residual values, which may take the form of common stock, warrants, equity appreciation rights or future contract payments. We believe that this flexible approach to structuring investments will facilitate positive, long-term relationships with our portfolio companies and enable us to become a preferred source of capital to them. We also believe our approach should enable debt financing to develop into a viable alternative capital source for funding the growth of target companies that wish to avoid the dilutive effects of equity financings for existing equity holders.
Longer Investment Horizon - We will not be subject to periodic capital return requirements. These requirements, which are standard for most private equity and venture capital funds, typically require that these funds return to investors the initial capital investment after a pre-agreed time, together with any capital gains on such capital investment. These provisions often force such funds to seek the return of their investments in portfolio companies through mergers, public equity offerings or other liquidity events more quickly than they otherwise might, which can result in a lower overall return to investors and adversely affect the ultimate viability of the affected portfolio companies. Because we may invest in the same portfolio companies as these funds, we are subject to these risks if these funds demand a return on their investments in the portfolio companies. We believe that our flexibility to take a longer-term
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view should help us to maximize returns on our invested capital while still meeting the needs of our portfolio companies.
Established Deal Sourcing Network - We believe that, through our management and directors, we have solid contacts and sources from which to generate investment opportunities. These contacts and sources include:
o public and private companies, o investment bankers , o attorneys, o accountants, o consultants, and o commercial bankers. However, we cannot assure you that such relationships will lead to the origination of debt or other investments.
Investment Criteria
As a matter of policy, we will not purchase or sell real estate or interests in real estate or real estate investment trusts except that we may:
o purchase and sell real estate or interests in real estate in connection with the orderly liquidation of investments, or in connection with foreclosure on collateral; o own the securities of companies that are in the business of buying, selling or developing real estate; or o finance the purchase of real estate by our portfolio companies.
We will limit our investments in more traditional securities (stock and debt instruments) and will not, as a matter of policy:
o sell securities short except with regard to managing the risks associated with publicly-traded securities issued by our portfolio companies; o Purchase securities on margin (except to the extent that we may purchase securities with borrowed money); or o engage in the purchase or sale of commodities or commodity contracts, including futures contracts except where necessary in working out distressed loan; or o investment situations or in hedging the risks associated with interest rate fluctuations, and, in such cases, only after all necessary registrations or exemptions from registration with the Commodity Futures Trading Commission have been obtained.
Prospective Portfolio Company Characteristics - We have identified several criteria that we believe will prove important in seeking our investment objective with respect to target companies. These criteria will provide general guidelines for our investment decisions; however, we caution readers that not all of these criteria will be met by each prospective portfolio company in which we choose to invest.
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Experienced Management - We will generally require that our portfolio companies have an experienced president or management team. We will also require the portfolio companies to have in place proper incentives to induce management to succeed and to act in concert with our interests as investors, including having significant equity interests. We intend to provide assistance in this area either supervising management or providing management for our portfolio companies.
Products or Services - We will seek companies that are involved in products or services that do not require significant additional capital or research expenditures. In general, we will seek target companies that make innovative use of proven technologies or methods.
Proprietary Advantage - We expect to favor companies that can demonstrate some kind of proprietary sustainable advantage with respect to their competition. Proprietary advantages include, but are not limited to:
o patents or trade secrets with respect to owning or manufacturing its products, and o a demonstrable and sustainable marketing advantage over its competition
Marketing strategies impose unusual burdens on management to be continuously ahead of its competition, either through some kind of technological advantage or by being continuously more creative than its competition.
Profitable or Nearly Profitable Operations Based on Cash Flow from Operations - We will focus on target companies that are profitable or nearly profitable on an operating cash flow basis. Typically, we would not expect to invest in start-up companies unless there is a clear exit strategy in place.
Potential for Future Growth - We will generally require that a prospective target company, in addition to generating sufficient cash flow to cover its operating costs and service its debt, demonstrate an ability to increase its revenues and operating cash flow over time. The anticipated growth rate of a prospective target company will be a key factor in determining the value that we ascribe to any warrants or other equity securities that we may acquire in connection with an investment in debt securities.
Exit Strategy - Prior to making an investment in a portfolio company, we will analyze the potential for that company to increase the liquidity of its common equity through a future event that would enable us to realize appreciation, if any, in the value of our equity interest. Liquidity events may include:
o an initial public offering, o a private sale of our equity interest to a third party, o a merger or an acquisition of the portfolio company, or o a purchase of our equity position by the portfolio company or one of its stockholders.
We may acquire warrants to purchase equity securities and/or convertible preferred stock of the eligible portfolio companies in connection with providing financing. The terms of the warrants, including the expiration date, exercise price and terms of the equity security for which the warrant may be exercised,
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will be negotiated individually with each eligible portfolio company, and will likely be affected by the price and terms of securities issued by the eligible portfolio company to other venture capitalists and other holders. We anticipate that most warrants will be for a term of five to ten years, and will have an exercise price based upon the price at which the eligible portfolio company most recently issued equity securities or, if a new equity offering is imminent, equity securities. The equity securities for which the warrant will be exercised generally will be common stock of which there may be one or more classes or convertible preferred stock. Substantially all the warrants and underlying equity securities will be restricted securities under the 1933 Act at the time of the issuance. We will generally negotiate for registration rights with the issuer that may provide:
o "piggyback" registration rights, which will permit us under certain circumstances, to include some or all of the securities owned by us in a registration statement filed by the eligible portfolio company, or o in circumstances, "demand" registration rights permitting us under certain circumstances, to require the eligible portfolio company to register the securities under the 1933 Act, in some cases at our expense. We will generally negotiate net issuance provisions in the warrants, which will allow us to receive upon exercise of the warrant without payment of any cash a net amount of shares determined by the increase in the value of the issuer's stock above the exercise price stated in the warrant.
Liquidation Value of Assets - Although we do not intend to operate as an asset-based lender, the prospective liquidation value of the assets, if any, collateralizing any debt securities that we hold will be an important factor in our credit analysis. We will emphasize both tangible assets, such as:
o accounts receivable, o inventory, and o equipment,
and intangible assets, such as:
o intellectual property, o customer lists, o networks, and o databases.
Investment Process
Due Diligence - If a target company generally meets the characteristics described above, we will perform initial due diligence, including:
o company and technology assessments, o existing management team, o market analysis, o competitive analysis, o evaluation of management, risk analysis and transaction size, o pricing, and
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o structure analysis.
Much of this work will be done by management and professionals who are well known by management. The criteria delineated above provide general parameters for our investment decisions. We intend to pursue an investment strategy by further imposing such criteria and reviews that best insures the value of our investments. As unique circumstances may arise or be uncovered, not all of such criteria will be followed in each instance but the process provides a guideline by which investments can be prudently made and managed. Upon successful completion of the preliminary evaluation, we will decide whether to deliver a non-binding letter of intent and move forward towards the completion of a transaction.
In our review of the management team, we look at the following:
o Interviews with management and significant shareholders, including any financial or strategic sponsor; o Review of financing history; o Review of management's track record with respect to: o product development and marketing, o mergers and acquisitions, o alliances, o collaborations, o research and development outsourcing and other strategic activities; o Assessment of competition; and o Review of exit strategies.
In our review of the financial conditions, we look at the following:
o Evaluation of future financing needs and plans; o Detailed analysis of financial performance; o Development of pro forma financial projections; and o Review of assets and liabilities, including contingent liabilities, if any, and legal and regulatory risks.
In our review of the products and services of the portfolio company, we look at the following:
o Evaluation of intellectual property position; o Review of existing customer or similar agreements and arrangements; o Analysis of core technology; o Assessment of collaborations; o Review of sales and marketing procedures; and o Assessment of market and growth potential.
Upon completion of these analyses, we will conduct on-site visits with the target company's management team. Also, in cases in which a target company is at
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a mature stage of development and if other matters that warrant such an evaluation, we will obtain an independent appraisal of the target company.
Ongoing Relationships with Portfolio Companies
Monitoring - We will continuously monitor our portfolio companies in order to determine whether they are meeting our financing criteria and their respective business plans. We may decline to make additional investments in portfolio companies that do not continue to meet our financing criteria. However, we may choose to make additional investments in portfolio companies that do not do so, but we believe that we will nevertheless perform well in the future.
We will monitor the financial trends of each portfolio company to assess the appropriate course of action for each company and to evaluate overall portfolio quality. Our management team and consulting professionals, who are well known by our management team, will closely monitor the status and performance of each individual company on at least a quarterly and, in some cases, a monthly basis.
We will use several methods of evaluating and monitoring the performance and fair value of our debt and equity positions, including but not limited to the following:
o Assessment of business development success, including product development, financings, profitability and the portfolio company's overall adherence to its business plan; o Periodic and regular contact with portfolio company management to discuss financial position, requirements and accomplishments; o Periodic and regular formal update interviews with portfolio company management and, if appropriate, the financial or strategic sponsor; o Attendance at and participation in board meetings; o Review of monthly and quarterly financial statements and financial projections for portfolio companies.
Managerial Assistance - As a business development company, we will offer, and in many cases may provide, significant managerial assistance to our portfolio companies. This assistance will typically involve:
o monitoring the operations of our portfolio companies, o participating in their board and management meetings, o consulting with and advising their officers, and o providing other organizational and financial guidance.
Diversification
As a BDC, we must invest at least 70% of our total assets in qualifying assets consisting of investments in eligible portfolio companies and certain other assets including cash and cash equivalents. In order to receive favorable pass-through tax treatment on its distributions to our shareholders, we intend to diversify our pool of investments in such a manner so as to qualify as a
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diversified closed end management investment company. However, because of the limited size of the funding which is likely to be available to us, we will likely be classified as a non-diversified closed end investment company under the 1940 Act. Until we qualify as a registered investment company, we will not be subject to the diversification requirements applicable to RICs under the Internal Revenue Code. Therefore, we will not receive favorable pass through tax treatment on distributions to our shareholders. In the future, we will seek to increase the diversification of our portfolio so as to make it possible to meet the RIC diversification requirements, as described below. We cannot assure you, however, that we will ever be able to meet those requirements.
To qualify as a RIC, we must meet the issuer diversification standards under the Internal Revenue Code that require that, at the close of each quarter of our taxable year,
o not more than 25% of the market value of our total assets is invested in the securities of a single issuer, and o at least 50% of the market value of our total assets is represented by cash, cash items, government securities, securities of other RICs, and other securities.
Each investment in these other securities is limited so that not more than 5% of the market value of our total assets is invested in the securities of a single issuer and we do not own more than 10% of the outstanding voting securities of a single issuer. For purposes of the diversification requirements under the Internal Revenue Code, the percentage of our total assets invested in securities of a portfolio company will be deemed to refer, in the case of financings in which we commit to provide financing prior to funding the commitment, to the amount of our total assets represented by the value of the securities issued by the eligible portfolio company to us at the time each portion of the commitment is funded.
Investment Amounts
The amount of funds committed to a portfolio company and the ownership percentage received will vary depending on the maturity of the portfolio company, the quality and completeness of the portfolio company's management team, the perceived business opportunity, the capital required compared to existing capital, and the potential return. Although investment amounts will vary considerably, we expect that the average investment, including follow-on investments, will be between $25,000 and $1,000,000.
Competition
Our primary competitors to provide financing to target companies will include private equity and venture capital funds, other equity and non-equity based investment funds and investment banks and other sources of financing, including traditional financial services companies such as commercial banks and specialty finance companies. Many of these entities have substantially greater financial and managerial resources than we will have. We believe that our competitive advantage with regard to quality target companies relates to our ability to negotiate flexible terms and to complete our review process on a timely basis. We cannot assure you that we will be successful in implementing our strategies.
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Current Portfolio Companies
On December 16, 2005, we entered into a stock purchase agreement to acquire all issued and outstanding shares of the capital stock of ACL Consulting Corporation (ACL), a Texas corporation majority owned by a former officer and director of the Company providing business consulting services to companies that desire to go public.
The purchase price of the shares was $1,593,000. The consideration for the acquisition was comprised of three components: (1) $735,000 in cash paid at closing, (2) a $458,000 secured promissory note delivered at closing, and (3) 400,000 shares of Series A Redeemable Convertible Preferred Stock of the Company with a value at issuance of $400,000 (Notes 3, 4 and 5).
During 2007 we liquidated our investment in ACL and transferred by dividend the securities owned by ACL, net of ACL obligations assumed by the Company.
We currently own 100% of ACL Consulting and plan to dissolve the company during 2008.
HealthSport, Inc. is a fully integrated developer, manufacturer and marketer of unique and proprietary branded and private label edible film strip nutritional supplements and over-the-counter drugs. We acquired out investment when we liquidated our investment in ACL.
We also own an investment in three portfolio companies with a cost basis of $393 on which we have placed no value.
Valuation Methodology
As an investment company under the Investment Company Act of 1940, all of the Company's investments must be carried at market value or fair value as determined by Management for investments which do not have readily determinable market values. Prior to this conversion, only marketable debt and equity securities and certain derivative securities were required to be carried at market value.
Beginning December 16, 2005, portfolio assets for which market prices are available are valued at those prices. Securities that are traded in the over-the-counter market or on a stock exchange generally will be valued at the prevailing bid price on the valuation date. However, our current investments were acquired in privately negotiated transactions and may have no readily determinable market values. These securities are carried at fair value as determined by Management and outside professionals as necessary under our valuation policy. Currently, the valuation policy provides for Management's review of the management team, financial conditions, and products and services of the portfolio company. In situations that warrant such an evaluation, an independent business valuation may be obtained.
Value, as defined in Section 2(a)(41) of 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by Management. There is no single standard for determining fair value in good
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faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment. We must determine the fair value of each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where realization of an equity security is doubtful. Conversely, we will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, our investment has also appreciated in value, where appropriate.
As an investment company, we invest primarily in illiquid securities including equity securities of private companies. The structure of each equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We generally include many terms governing ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. Our investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation.
ITEM 1A:
ITEM 1A: RISK FACTORS
In the normal course of business in an effort to keep our shareholders and the public informed about our operations and portfolio of investments, we may from time-to-time issue certain statements, either in writing or orally, that contain or may contain forward-looking information. Generally, these statements relate to our business plans or strategies or portfolio companies, projected or anticipated benefits or consequences of such plans or strategies, projected or anticipated benefits of new or follow-on investments made by or to be made by us, or projections involving anticipated purchases or sales of securities or other aspects of our operating results. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially. As noted elsewhere in this report, our operations and portfolio of investments are subject to a number of uncertainties, risks, and other influences, many of which are outside our control, and any one of which, or a combination of which, could materially affect the results of our operations, or our NAV, the market price of our common stock, and whether any forward-looking statements made by us ultimately prove to be accurate.
Investing in SCPS involves a number of significant risks relating to our business and investment objective. As a result, there can be no assurance that we will achieve our investment objective. In addition, the following risk factors are applicable to an investment in our common stock.
GENERAL RISK FACTORS
Investments in the Company by new shareholders will be diluted immediately.
Some of our present shareholders may have acquired an interest in our common stock at a total cost less than the total cost that newer investors will pay for their shares. Therefore, the newer investors may bear a greater proportion of the risk of loss (measured by the cost of shares). As of December 31, 2007,
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there were 100,000,000 shares of common stock authorized and after the reverse split of one share for each twenty shares outstanding in May 2007 there were 687,770 common shares outstanding.
We may sell additional equity in the future that may further dilute the value of existing shareholders' investment.
Reductions in the price of our stock resulting from the performance of our portfolio or other market conditions might result in stock being sold to new investors, including management, at prices below the price paid by existing shareholders. Senior management may be granted the right, and others may have the right, under certain circumstances, to acquire additional shares of our common stock at a price equal to the market price as it exists at a point in the future. If such a grant of a right occurred at a time when the price of the stock has fallen relative to the current market value and falls below the price paid by existing shareholders, management might be given the right to purchase stock at a price below existing shareholders' cost. In either of these cases, the value of existing shareholders' investment would be further diluted.
Limitation of liability and indemnification of management.
While limitations of liability and indemnification are themselves limited, we have instituted provisions in our bylaws indemnifying, to the extent permitted, against and not making management liable for, any loss or liability incurred in connection with our affairs, so long as such loss or liability arose from acts performed in good faith and not involving any fraud, gross negligence or willful misconduct. Therefore, to the extent that these provisions provide any protection to management, that protection may limit the right of a shareholder to collect damages from members of management. Management is accountable to the shareholder as a fiduciary and, consequently, members of management are required to exercise good faith and integrity in handling our affairs.
Our business may become subject to extensive regulation at the federal and state levels. The value of securities we own may be adversely impacted by subsequent regulatory changes.
Our operations are and will be affected by current and future legislation and by the policies established from time to time by various federal and state regulatory authorities. It is not possible to predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. Our current investment strategy includes the purchase of unregistered securities in both private companies as well as private placements offered by public companies. We are able to purchase securities pursuant to exemptions to the registration requirements of United States Federal securities laws. Changes in such laws or their interpretation could adversely impact our ability to resell such securities which would have a negative effect on the value of such securities as well as impact our overall investment strategy and the liquidity of our investments. In such an event, we may need to reformulate our investment strategy or we may choose to liquidate.
We cannot guarantee paying dividends to our stockholders.
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We are allowed by our articles of incorporation and/or by-laws to pay dividends to our stockholders. However, there can be no guarantee we will have sufficient revenues to pay dividends during any period. We intend to make distributions on a quarterly basis to our stockholders out of assets legally available for distribution. We cannot assure you that we will achieve investment results or maintain a tax status that will allow or require any specified level of cash distributions or year-to-year increases in cash distributions. In addition, due to the asset coverage test applicable to us as a business development company, we may be limited in our ability to make distributions. Investors in need of liquidity through the payment of dividends should refrain from common stock which does not have a dividend requirement.
Investing in our shares may involve a high degree of risk.
The investments we make in accordance with our investment objective may result in a higher amount of risk than alternative investment options and volatility or loss of principal. Our investments in portfolio companies may be speculative and aggressive, and therefore, an investment in our shares may not be suitable for someone with low risk tolerance.
The market price of our common stock may fluctuate significantly.
The market price and liquidity of the market for shares of our common stock may be significantly affected by numerous factors, some of which are beyond our control and may not be directly related to our operating performance. These factors, may adversely affect our ability to raise capital through future equity financings. These factors include:
o significant volatility in the market price and trading volume of securities of business development companies, which are not necessarily related to the operating performance of these companies;
o changes in regulatory policies or tax guidelines, particularly with respect to RICs or business development companies;
o our common stock is unlikely to be followed by any market analysts, and there may be few institutions acting as market makers for the common stock which can adversely affect its price;
o loss of or inability to qualify for RIC status or BDC status;
o changes in earnings or variations in operating results;
o changes in the value of our portfolio of investments;
o any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts;
o departure of one or more of our key personnel;
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o operating performance of companies comparable to us;
o potential legal and regulatory matters;
o changes in prevailing interest rates;
o general economic trends and other external factors; and
o loss of a major funding source.
Sales of substantial amounts of our common stock in the public market may have an adverse effect on the market price of our common stock.
As of December 31, 2007, we have 687,770 shares of common stock outstanding. We plan to raise funds in the future through sales of our common stock pursuant to Regulation E, which provides in part for issuance of freely trading shares. Sales of substantial amounts of our common stock or the availability of such shares for sale could adversely affect the prevailing market price for our common stock. If this occurs and continues, it could impair our ability to raise additional capital through the sale of equity securities should we desire to do so.
Our Board of Directors also has authority, without action or vote of the shareholders, to issue all or part of our authorized but unissued shares. Any such issuance will dilute the percentage ownership of shareholders and may, subject to the regulations pertaining to the minimum prices for which shares may be sold, further dilute the book value of the common stock. These issuances may also serve to enhance existing management's ability to maintain control of the Company.
We have the right, but do not intend to issue senior securities in the future, including debt. If we were to reverse that decision and offer for sale and/or issue senior securities, you will be exposed to additional risks, including the typical risks associated with leverage.
You will be exposed to increased risk of loss if we incur debt to make investments. If we do incur debt, a decrease in the value of our investments would have a greater negative impact on the value of our common stock than if we did not use debt.
o Our ability to pay dividends would be restricted if our asset coverage ratio were not at least 200% and any amounts that we use to service our indebtedness would not be available for dividends to our common stockholders.
o It is likely that any debt we incur will be governed by an indenture or other instrument containing covenants restricting our operating flexibility.
o We and you as shareholders will bear the cost of issuing and servicing our senior securities.
o Any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock.
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Our investments may require us to raise additional capital on different terms.
We will require additional capital in the future. For additional requirements, we may raise capital by issuing equity or convertible debt securities, and when we do, the percentage ownership of our existing stockholders will be diluted. In addition, any new securities we issue could have rights, preferences and privileges senior to our existing equity (although we do not intend to sell debt or preferred equity interests).
Our ability to raise capital as a BDC is limited by the requirement that we not sell shares below the NAV/S without approval of a majority of our shareholders. While we do not anticipate that the NAV/S calculation will ever result in a negative number or a nominally positive number, the Company would be severely limited in its ability to sell shares if such a negative number or a nominally positive number were to be the result of a NAV/S calculation.
Increases in market interest rates may both reduce the value of our portfolio investments and increase our cost of capital.
We expect that we may offer loans to our portfolio companies with interest at fixed rates and the value of these investments could be negatively affected by increases in market interest rates. In addition, an increase in interest rates would make it more expensive to use debt to finance our investments. As a result, a significant increase in market interest rates could both reduce the value of our portfolio investments and increase our cost of capital, which would reduce our net investment income.
The lack of liquidity in our investments may adversely affect our business.
We will generally make investments in private companies. Substantially all of these securities will be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly traded securities. The illiquidity of our investments may make it difficult for us to sell such investments if the need arises. In addition, if we are required to liquidate all or a portion of our portfolio quickly, due to changes in capital needs or otherwise, we may realize significantly less than the value at which we have previously recorded our investments. In addition, we may face other restrictions on our ability to liquidate an investment in a portfolio company to the extent that we or our investment adviser has material non-public information regarding such portfolio company.
We may experience fluctuations in our quarterly and annual results.
We could experience fluctuations in our quarterly and annual operating results due to a number of factors, including the interest or dividend rates payable on the debt or equity securities we acquire, performance and/or default rate on securities we acquire, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, the degree to which we encounter competition in our markets and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods.
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We may not realize gains or income from our investments.
We seek to generate both current income and capital appreciation. However, the securities, in which we invest, may not appreciate and, in fact, may decline in value, and the issuers of debt securities, in which we invest, may default on interest and/or principal payments. Accordingly, we may not be able to realize gains from our investments, and any gains that we do realize may not be sufficient to offset any losses we experience.
Your influence in matters requiring shareholder action will be subject to the probability that most shareholders will follow management's direction.
There is only one major shareholder with an interest of more than ten percent and no consortium of shareholders has been identified with a block of control or who would likely exercise voting control over all matters that may be submitted for approval by our shareholders. Without such a controlling block, management positions will be the most likely to be presented to shareholders and more likely to influence shareholder decisions (assuming a fact that shareholders will likely "vote with" management). Therefore, while the number of shares controlled by the officers and directors is less than a majority, their position of control is material and significant.
Pursuant to our articles of incorporation, our Board of Directors has the authority to issue shares of stock without any further vote or action by the stockholders. The issuance of stock under certain circumstances could have the effect of delaying or preventing a change in control of the Company or may deter takeover attempts.
Our articles of incorporation contain provisions that may have the effect of discouraging, delaying or making more difficult a change in control and preventing the removal of incumbent directors. The existence of these provisions may reduce any premiums over market price that a potential acquirer would offer to shareholders for their shares of our common stock and may discourage attempts to gain control without the consent of the Board of Directors. While shares must be sold for cash or other securities, the Board of Directors might choose to sell shares to a party with views consistent with those of management further limiting the likelihood of a change in control.
GENERAL RISKS ASSOCIATED WITH BUSINESS DEVELOPMENT COMPANIES
BDCs generally require substantial amounts of time to realize the benefits from investments.
Venture capital investments typically take from four to eight years from the date of initial investment to reach a state of maturity at which liquidation can be considered practical. We have not completed funding of our current portfolio company and we anticipate that there may be an additional period of time ranging from three to six months before we have obtained funding and completed investing that funding in our portfolio companies for our first round of equity investments. In light of the foregoing, it is unlikely that any significant distributions of the proceeds from the liquidation of equity investments will be made for several years after inception, if at all.
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Our present senior management team has limited experience managing a business development company under the Investment Company Act of 1940.
The 1940 Act imposes numerous constraints on the operations of business development companies. For example, business development companies are required to invest at least 70% of their total assets primarily in securities of privately held or thinly traded U.S. public companies, cash, cash equivalents, U.S. government securities and other high quality debt investments that mature in one year or less. The lack of experience of our senior management team in managing a portfolio of assets under such constraints may hinder their ability to take advantage of attractive investment opportunities and, as a result, achieve our investment objective. Within the BDC format, the information about deals and deal flow generated by our senior management in connection with their investment and portfolio management activities will have a significant impact on our future success as a BDC. The senior management team will evaluate, structure, negotiate terms and close investments on those terms, monitor and service our investments and their abilities to perform these functions as members of a BDC will also have a significant impact on our future success as a BDC.
We will be wholly dependent for the selection, structuring, closing and monitoring of all of our investments on the diligence and skill of our management, acting under the supervision of our Board of Directors. None of these individuals has substantial experience, within or under a BDC investment and management format, in acquiring and investing in growth stage companies, the negotiation of the terms of such investments and the monitoring of such investments after they are made. In addition, we will engage outside consultants and professionals known to management to assist in evaluating and monitoring portfolio companies and maintaining regulatory compliance.
While we believe that our management possesses certain fundamental business skills that will increase our likelihood to succeed, our management team has limited experience operating a BDC and must be considered as inexperienced when it comes to the both the day to day operations of an investment company and the management of investments. We intend to rely on the general skills and business acumen of our management team as well as engaging other professionals and consultants from time to time to insure that it gains the expertise to manage a BDC.
We may change our investment policies without further shareholder approval.
Although we are limited by the 1940 Act with respect to the percentage of our assets that must be invested in qualified portfolio companies, we are not limited with respect to the minimum standard that any investment company must meet, nor the industries in which those investment companies must operate. We may make investments without shareholder approval and such investments may deviate significantly from our historic operations. Any change in our investment policy or selection of investments could adversely affect our stock price, liquidity, and the ability of our shareholders to sell their stock.
We may allocate the net proceeds from stock sales in ways with which you may not agree.
We will have significant flexibility in investing the net proceeds of our stock sales. We may use the net proceeds in ways with which you may not agree or for investments other than those contemplated at the time we sell the stock, unless
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such change in the use of proceeds is subject to stockholders' approval or prohibited by law.
Our investments may not generate sufficient income to cover our operations.
While we intend to make investments into those qualified companies that will provide the greatest overall return on our investment, we are required to make investments into those companies which, whether due to lack of experience or financial instability (including insolvency), may present the greatest risk. This is in conformity with the Small Business Investment Incentive Act of 1980 which amended the 1940 Act and permitted the creation of BDC's. However, certain of those investments may fail, in which case we will not receive any return on our investment. In addition, our investments may not generate income, either in the immediate future, or at all. As a result, we may have to sell additional stock, or borrow money, to cover our operating expenses. The effect of such actions could cause our stock price to decline or, if we are not successful in raising additional capital, we could cease to continue as a going concern. It should be noted that our operational costs are higher as a result of our having elected to be governed as a BDC.
Shares in a BDC will likely trade at a discount.
Shares of many closed-end investment companies and most BDC's frequently trade at a discount to their net asset value. This characteristic is separate and distinct from the risk that our net asset value could decrease as a result of investment activities. This likely discount in share pricing in the market may pose a greater risk to investors expecting to sell their shares in a relatively short period after purchase. We cannot predict whether our shares will trade at prices above, at or below our net asset value.
Regulations governing our operation as a business development company affect our ability to raise, and the way in which we raise, additional capital.
We have the right to issue debt securities or preferred stock and/or borrow money from banks or other financial institutions, which we refer to collectively as "senior securities," only in amounts such that our asset coverage, as defined in the 1940 Act, equals at least 200% after each issuance of senior securities, the maximum amount permitted by the 1940 Act. If the value of our assets declines, we may be unable to satisfy this test. If that happens, we may be required to sell a portion of our investments or sell additional shares of common stock and, depending on the nature of our leverage, to repay a portion of our indebtedness at a time when such sales may be disadvantageous. In addition, any future issuance of additional shares of our common stock could dilute the percentage ownership of our current stockholders in us.
As a business development company regulated under provisions of the 1940 Act, we are not generally able to issue and sell our common stock at a price below net asset value per share. We may, however, sell our common stock, or warrants, options or rights to acquire our common stock, at a price below the current net asset value of our common stock (1) if our Board of Directors determines that such sale is in the best interests of us and our stockholders, and (2) our stockholders approve such sale. In any such case, the price at which our
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securities are to be issued and sold may not be less than a price which, in the determination of our Board of Directors, closely approximates the market value of such securities (less any sales load).
In addition, we may in the future seek to securitize or hypothecate loans previously made by us to generate cash for funding new investments. To securitize or hypothecate these loans, we may contribute a pool of such loans to a wholly-owned subsidiary. This could include the sale of interests in the subsidiary on a non-recourse basis to purchasers who we would expect to be willing to accept a lower interest rate to invest in investment grade loan pools although we would expect to retain a portion of the equity in the securitized pool of loans. An inability to successfully securitize and sell all of part of such a loan portfolio could limit our ability to grow our business, fully execute our business strategy and decrease our earnings, if any. Moreover, the successful securitization of our loan portfolio might expose us to losses because the residual loans in which we do not sell interests will tend to be those that are riskier and more likely to generate losses.
Our election to be governed as a BDC will require us to comply with significant regulatory requirements.
We elected to be regulated as a Business Development Company under the 1940 Act and be subject to Sections 54 through 65 of said Act. As a result of this election, the Company is subject to the provisions of 1940 Act as it applies to BDCs as of the date of such election. Being subject to the BDC provisions requires us to meet significant numbers of regulatory and financial requirements. Compliance with these regulations is expensive and may create financial problems for us in the future. These laws and regulations, as well as their interpretation, may be changed from time to time. Accordingly, any change in these laws or regulations could have a material adverse effect on our business.
Specifically, it must be noted that there are increased costs associated with compliance with the 1940 Act as a result of our election to become a BDC. These costs include costs associated with the increased demand for compliance including oversight by our Chief Compliance Officer and counsel to the Company as well as increased costs due to accounting methodology and valuations which increase the time and work required of both our accounting service providers and independent auditors. These costs require us to expend capital and resources that might otherwise be used to meet the needs or opportunities relating to investments and/or our portfolio companies or other income-producing assets.
If we do not remain a business development company, we might continue to be regulated as a closed-end investment company under the 1940 Act, which would decrease our operating flexibility. We cannot assure you that we will successfully retain our BDC status.
If our primary investments are deemed not to be qualifying assets, we could lose our status as a business development company or be precluded from investing according to our current business plan.
Under the 1940 Act, in order to maintain our status as a business development company, we must not acquire any assets other than "qualifying assets" unless, at the time of and after giving effect to such acquisition, at least 70% of our total assets are qualifying assets. If we acquire mezzanine loans or
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dividend-paying equity securities from an issuer that has outstanding marginable securities at the time we make an investment, these acquired assets cannot be treated as qualifying assets since the issuer might not be considered an "eligible portfolio company" under the 1940 Act. "Marginable securities" include any non-equity security, pursuant to certain 1998 amendments to Regulation T under the Securities Exchange Act of 1934, as amended, which raises the question as to whether a private company that has outstanding debt securities would qualify as an eligible portfolio company.
We operate in a highly competitive market for investment opportunities.
A large number of entities will compete with us to make the types of investments that we plan to make in target portfolio companies. We will compete with other business development companies, public and private funds, commercial and investment banks and commercial financing companies. Many of our competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more relationships than us. Furthermore, many of our competitors are not subject to the regulatory restrictions that the 1940 Act imposes on us as a business development company. We cannot assure you that the competitive pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as a result of this competition, we may not be able to take advantage of attractive investment opportunities from time to time, and we can offer no assurance that we will be able to identify and make investments that are consistent with our investment objective.
We may never be able to qualify for the income tax benefits offered to RICs.
We will be classified as a non-diversified investment company under the 1940 Act. Until we achieve a threshold level of diversification, we will not be subject to the applicable provisions for RICs under the Internal Revenue Code. Therefore, we will not receive favorable pass through tax treatment on distributions to our shareholders. This means that we will be taxed as an ordinary corporation on our taxable income even if that income is distributed to shareholders, and all distributions out of our earnings and profits will be taxable to shareholders as dividends. Thus, this income will be subject to a double layer of taxation.
RISKS ASSOCIATED WITH INVESTMENTS AND PORTFOLIO COMPANIES
There are costs associated with the purchase and sale of securities.
While the general approach of a BDC may suggest a long-term holding position of the securities of its portfolio companies, some of our strategies may include purchases of different classes of securities or frequent trading to maximize profits and, as a consequence, risks related to turnover and costs such as brokerage commissions may be greater than for an investment in a single entity for a single class of security held for a longer period of time. Our operating expenses, including, but not limited to, fees paid to accountants, attorneys, fees to execute trades, manage investments and fees paid to any investment advisor may, in the aggregate, constitute a high percentage relative to the
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expenses and fees than for an investment in a single entity for a single class of security held for a longer period of time.
There are numerous risks arising from investing in securities.
The securities industry is generally competitive and methods of investment strategy involve a degree of risk. We will compete with firms, including many of the larger securities and investment banking firms, which have substantially greater financial resources and research staffs. Where we purchase securities in portfolio companies for appreciation, our profitability substantially depends upon our ability to correctly assess the future price movements of stocks. There can be no assurance that we will be able to accurately predict price movements of securities purchased.
Security investments generally involve a high degree of risk. The performance of securities in which we may invest are subject to numerous factors which are neither within the control of nor predictable by us. Such factors can include a wide range of economic, political, competitive and other conditions which may affect investments in general or specific industries or companies. In recent years, the securities markets have become increasingly volatile and this volatility has increased the degree of risk.
Our investments in prospective portfolio companies may be risky and you could lose all or part of your investment.
We will invest in companies that have relatively short or no operating histories. These companies will be subject to all of the business risk and uncertainties associated with any new business enterprise, including the risk that these companies may not reach their investment objective and the value of our investment in them may decline substantially or fall to zero. Most of the portfolio companies into which we intend to invest will be considered "growth stage" companies.
Investments in growth stage companies offer the opportunity for significant gains. However, each investment involves a high degree of business and financial risk that can result in substantial losses. Among these are the risks associated with:
o these companies may have limited financial resources and may be unable to meet their obligations under their securities that we hold, which may be accompanied by a deterioration in the value of their equity securities or of any collateral with respect to debt securities and a reduction in the likelihood of us realizing on any guarantees we may have obtained in connection with our investment;
o they may have shorter operating histories, narrower product lines and smaller market shares than larger businesses, which tend to render them more vulnerable to competitors' actions and market conditions, as well as general economic downturns;
o because many of these companies are privately held companies, public information is generally not available about these companies. As a result, we will depend on the ability of our investment adviser to obtain adequate information to evaluate these companies in making investment decisions. If our investment adviser is unable to uncover all material information about these companies, it may not make a
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fully informed investment decision, and we may lose money on our investments;
o they are more likely to depend on the management talents and efforts of a small group of persons; therefore, the death, disability, resignation or termination of one or more of these persons could have a material adverse impact on our portfolio company and, in turn, on us;
o companies operating at a loss or with substantial variations in operating results from period to period, with the need for, but generally limited ability to provide for internally, substantial additional capital to support expansion or to achieve or maintain a competitive position;
o these companies may face intense competition, including competition from companies with greater financial resources, more extensive development, manufacturing, marketing, and service capabilities, and larger number of qualified managerial and technical personnel; and
o they may have less predictable operating results, may from time to time be parties to litigation, may be engaged in changing businesses with products subject to a risk of obsolescence and may require substantial additional capital to support their operations, finance expansion or maintain their competitive position. In addition, our executive officers, directors and our investment adviser could, in the ordinary course of business, be named as defendants in litigation arising from our investments in the portfolio companies.
Economic recessions or downturns could impair our portfolio companies and harm our operating results.
Our portfolio companies will generally be affected by the conditions and overall strength of the national, regional and local economies, including interest rate fluctuations, changes in markets and changes in the prices of their primary commodities and products. These factors could adversely impact the customer base of potential portfolio companies. As a result, many of our portfolio companies may be susceptible to economic slowdowns or recessions and may be unable to repay loans or meet other obligations during these periods. Therefore, our non-performing assets are likely to increase, and the value of our portfolio is likely to decrease, during these periods. Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us. These events could prevent us from increasing investments and harm our operating results.
A portfolio company's failure to satisfy financial or operating covenants imposed by us or other investors or lenders could lead to defaults and, potentially, termination of loans and foreclosure on secured assets, which could trigger cross-defaults under other agreements and jeopardize our portfolio company's ability to meet its obligations under the debt or equity securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms, which may include the waiver of certain financial covenants, with a defaulting portfolio company. In addition, if one of
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our portfolio companies were to go bankrupt, even though we may have structured our interest as senior debt or preferred equity, depending on the facts and circumstances, including the extent to which we actually provided managerial assistance to that portfolio company, a bankruptcy court might recharacterize our debt or equity holding and subordinate all or a portion of our claim to those of other creditors.
Our portfolio companies may incur debt or issue equity securities that rank equally with, or senior to, our investments in such companies.
We intend to invest primarily in mezzanine debt and dividend-paying equity securities issued by our portfolio companies. Our portfolio companies usually will have, or may be permitted to incur, other debt, or issue other equity securities, that rank equally with, or senior to, the securities in which we invest. By their terms, such instruments may provide that the holders are entitled to receive payment of dividends, interest or principal on or before the dates on which we are entitled to receive payments in respect of the securities in which we invest. Also, in the event of insolvency, liquidation, dissolution, reorganization or bankruptcy of a portfolio company, holders of securities ranking senior to our investment in that portfolio company would typically be entitled to receive payment in full before we receive any distribution in respect of our investment. After repaying the senior security holders, the portfolio company may not have any remaining assets to use for repaying its obligation to us. In the case of securities ranking equally with securities in which we invest, we would have to share on an equal basis any distributions with other security holders in the event of an insolvency, liquidation, dissolution, reorganization or bankruptcy of the relevant portfolio company. In addition, we may not be in a position to control any portfolio company in which we invest. As a result, we are subject to the risk that a portfolio company in which we invest may make business decisions with which we disagree and the management of such company, as representatives of the holders of their common equity, may take risks or otherwise act in ways that do not serve our interests as debt or preferred equity investors.
We may not be able to fully realize the value of any collateral securing any debt investments made into portfolio companies.
Although we expect that a substantial amount of our debt investments will be protected by holding security interests in the assets of the portfolio companies, we may not be able to fully realize the value of the collateral securing any such investments due to one or more of the following factors:
o since these debt investments will be primarily made in the form of unsecured or wrap-loans, the liens on the collateral, if any, will be subordinated to those of the senior secured debt of the portfolio companies, if any. As a result, we may not be able to control remedies with respect to the collateral;
o the collateral may not be valuable enough to satisfy all of the obligations under our secured loan, particularly after giving effect to the repayment of secured debt of the portfolio company that ranks senior to our loan;
o bankruptcy laws may limit our ability to realize value from the collateral and may delay the realization process;
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o our rights in the collateral may be adversely affected by the failure to perfect security interests in the collateral;
o how effectively the collateral would be liquidated and the value received could be impaired or impeded by the need to obtain regulatory and contractual consents; and
o by its nature, some or all of the collateral may be illiquid and may have no readily ascertainable market value. The liquidity and value of the collateral could be impaired as a result of changing economic conditions, competition, and other factors, including the availability of suitable buyers.
Our success will depend upon the success of the portfolio companies and, in great part, upon the abilities of their management.
Although our management expects to provide portfolio companies with assistance (particularly with regard to capital formation, major personnel decisions, and strategic planning), the day-to-day operations will be controlled by the management of the portfolio companies. As the portfolio companies have not all been identified, investors must rely upon our management to select portfolio companies that have, or can obtain, the necessary management resources. We will depend on the diligence, skill and network of business contacts of the senior management of each of the portfolio companies in which we invest and the professionals chosen by them, subject to the oversight of our senior management, and the information and interaction between management of the portfolio companies and our management. Our future success will depend to a significant extent on the continued service of the senior management team of each portfolio company, the departure of any of whom, could have a material adverse effect on our ability to achieve our investment objective. Problems may arise at portfolio companies that local management do not recognize or cannot resolve. In addition, the management of portfolio companies may conceal the existence of problems from us.
Many of our portfolio investments will be recorded at fair value as determined in good faith by our board of directors and, as a result, there will be uncertainty as to the value of our portfolio investments.
A large percentage of our portfolio investments will consist of securities of privately held or thinly traded public companies. The fair value of these securities may not be readily determinable. We will value these securities quarterly at fair value as determined in good faith by our Board of Directors based on input from our audit committee with or without the benefit of an opinion from a third party independent valuation firm. We may also be required to value any publicly traded securities at fair value as determined in good faith by our Board of Directors to the extent necessary to reflect significant events affecting the value of those securities. Our Board of Directors may, to the extent circumstances warrant it, utilize the services of an independent valuation firm to aid it in determining the fair value of any securities. The types of factors that may be considered in fair value pricing of our investments include the nature and realizable value of any collateral, the portfolio company's ability to make payments and its earnings, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow and other relevant factors. Because such valuations, and
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particularly valuations of private securities and private companies, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, the determinations of fair value by our Board of Directors may differ materially from the values that would have been used if a ready market for these securities existed. Our net asset value could be adversely affected if the determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon the disposal of such securities.
Limitations on availability of investment capital may adversely affect other investments.
We may be reliant on the availability of capital to generate profits under our investment strategy and such availability will depend, in part, on our ability to timely liquidate existing positions in order to reinvest the proceeds thereof. To the extent that we own securities which are not subject to a valid registration statement or otherwise available for trading under applicable securities laws, our ability to liquidate our position in such securities may be limited. We intend to require some of our portfolio companies to use their best efforts to cause a registration statement covering the resale of the securities purchased by us to be filed and declared effective by the SEC or become otherwise freely tradeable. However, there can be no guarantee that the SEC or other regulating body will declare such a registration statement effective or permit such security to become free of restrictions within such period and, until such securities become freely tradable, we will likely be unable to freely liquidate such interests in restricted securities in the manner and at the prices desired. This resulting lack of liquidity could impair our ability to generate the cash flow from these positions to timely pay our liabilities or obtain funds for the purpose of reinvestment. Although we intend to maintain adequate liquidity to achieve our future investment objectives, there can be no assurance this can be accomplished in all circumstances.
Portfolio companies are likely to need additional funding.
We expect that many portfolio companies will require additional financing to satisfy their working capital requirements. The amount of additional financing needed will depend upon the maturity and objectives of the particular company. Each round of venture financing, whether from us or other investors is typically intended to provide a portfolio company with enough capital to reach the next major valuation milestone. If the funds provided are not sufficient, a portfolio company may have to raise additional capital at a price unfavorable to us and the other existing investors. The availability of capital is generally a function of capital market conditions that are beyond our control or the control of any portfolio company. We cannot assure you that our management or the managements of portfolio companies will be able to predict accurately the future capital requirements necessary for success or that additional funds will be available to portfolio companies from any source. If funding is not available, some portfolio companies may be forced to cease operations.
BDC investments are generally illiquid.
We anticipate that most of our holdings in portfolio companies will be securities that are subject to restrictions on resale. Generally, unless the securities are subsequently registered under the 1933 Act, we will not be able to sell these securities unless we meet all of the conditions of Rule 144 or another rule under the 1933 Act that permits limited sales under specified
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conditions. When restricted securities are sold to the public, we may be deemed an underwriter, or possibly a controlling person, with respect thereto for the purpose of the Securities Act and may be subject to liability as such under the 1933 Act. These restrictions could require us to hold securities or refrain from sale and be unable to liquidate a position even at a loss.
Even if we meet all of the conditions of the 1933 Act, there may be no market for the securities that we hold. These limitations on liquidity of a BDC's investments could prevent a successful sale thereof, result in delay of any sale, or substantially reduce the amount of proceeds that might otherwise be realized. It is possible that one or more of the portfolio companies may not qualify to rely on such exemptions or to use a registration statement. In such event, we would end up owning "restricted" securities subject to resale under Rule 144
There are risks which result from the inherent concentration of investments prior to diversification.
While we intend to allocate our investments among different portfolio companies, it is possible that, prior to our achieving diversification, a significant amount of or all of our investments and, hence, our NAV could, at any one time, be invested in the securities of just a few portfolio companies. Thus, our success and its NAV would be dependent on the success of just a few portfolio companies and all of the risks associated with ownership of such portfolio companies including success dependent on management, success dependent on market conditions within the industry or field of such portfolio companies, success dependent on achieving the business objectives of such portfolio companies and success dependent on economic conditions and other conditions relative to the operation of such portfolio companies, would become risks borne by us.
There are risks associated with investments in companies with small capitalization.
The portfolio companies that we expect to invest in are thinly capitalized and generally will have a market capitalization below $100 million (and frequently substantially less). These companies generally do not have experience, market awareness, tracking by analysts, institutional investors and other benefits of larger companies that result in more marketability and more stability pricing of their securities. This impacts the liquidity of securities issued by those portfolio companies. It is expected that the securities of most, if not all, of the portfolio companies will be thinly traded. This could present a problem when we determine to liquidate our position. We may not be able to sell the securities in the time frame and at the price we would like. Furthermore, in certain situations, as a result of a security being thinly traded, we could experience a significant loss in value should we be forced to liquidate our investment as a result of rapidly changing market conditions or other factors.
There are risks associated with investments in companies with securities that are not readily marketable.
We may invest in securities that are initially, or that later become, not readily marketable. For example, we may acquire restricted securities of an issuer in a private placement pursuant to an arrangement whereby the issuer agrees to register the resale of those securities, or, in the case of an investment in convertible or exchangeable securities, the securities underlying such securities, within a certain period of time. Such registration requires
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compliance with United States Federal and state securities laws and the approval of the SEC. Unless and until such registration or compliance with applicable regulation occurs, there is likely to be no market for the restricted securities. No assurance can be given that issuers will not breach their obligation to obtain or meet such registration or other compliance obligation. Similarly, securities that are at one time marketable may become unmarketable (or more difficult to market) for a number of reasons. For example, securities traded on a securities exchange or quotation system may become unmarketable if delisted from such exchange or quotation system for among other reasons, failing to satisfy the requirements for continued listing, which may include minimum price requirements. In addition, we may acquire restricted securities, for which no market exists, which are convertible or exchangeable into common stock of the issuer. No assurances can be given that a portfolio company which has sold a convertible security requiring exchange or conversion, will not breach its obligation to convert or exchange such securities upon demand, in which case our liquidity may be adversely affected. In general, the stability and liquidity of the securities in which we invest will depend in large part on the creditworthiness of the issuers. Issuers' creditworthiness will be monitored on an ongoing basis by us. If there is a default by the issuer, we may have contractual remedies under the applicable transaction documents. However, exercising such contractual rights may involve delays in liquidating our position and the incurrence of additional costs.
Portfolio companies in which investments are made may have publicly-traded securities but those companies or their securities may become subject to restrictions due to non-compliance. Our ability to generate profits from our investment activities may be adversely affected by a failure of portfolio companies to comply with registration, conversion, exchange or other obligations under the agreements pursuant to which such securities have been sold to us. The failure of an issuer to register the resale of its securities sold to us may decrease the amount of available capital with which we may pursue other investment opportunities or meet current liabilities. We may invest in securities that are convertible into or exchangeable for common stock of the issuer, the resale of which by us is (or is to be) registered. If an issuer refuses, is unable to, or delays in timely honoring its obligation to issue conversion or exchange securities, our ability to liquidate our position will be adversely affected, and our profits may be adversely affected.
We have not yet identified all of the potential investments for our portfolio.
We have not yet identified all of the potential investments for our portfolio, and, thus, you will not be able to evaluate all of our potential investments prior to purchasing shares of our common stock. This factor will increase the uncertainty, and thus the risk, of investing in our shares.
We may sustain losses from fraud within our portfolio companies.
The risk of fraud losses on our assets varies with, among other things, the effectiveness of security procedures utilized. Management anticipates that fraud losses, if any, will be unlikely as controls and other security measures will have been adopted by each portfolio company as a condition to our investment to protect against fraudulent misappropriation of cash and other assets. However, although our management believes that any loss due to fraud will be unlikely, there can be no assurance that fraud loss experience will not become material in amount. Fraud at the BDC level is far less likely as BDC's are required to have and to have tested controls to limit this possibility. It must be noted that, in addition to basic controls as to financial data, BDC's are required to have in
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place certain safeguards which may render risks to investment assets from fraud to be nominal but these risks do exist and even requirements such as holding physical certificates of shares in portfolio companies in a safe do not, in and of themselves, eliminate the possibility of fraud.
Our investments in foreign securities may involve significant risks in addition to the risks inherent in U.S. investments.
Our investment strategy contemplates potential investments in securities of foreign companies. Investing in foreign companies may expose us to additional risks not typically associated with investing in U.S. companies. These risks include changes in exchange control regulations, political and social instability, expropriation, imposition of foreign taxes, less liquid markets and less available information than is generally the case in the U.S., higher transaction costs, less government supervision of exchanges, brokers and issuers, less developed bankruptcy laws, difficulty in enforcing contractual obligations, lack of uniform accounting and auditing standards and greater price volatility. Although we expect that most of our investments will be U.S. dollar-denominated, our investments that are denominated in a foreign currency will be subject to the risk that the value of a particular currency will change in relation to one or more other currencies. Among the factors that may affect currency values are trade balances, the level of short-term interest rates, differences in relative values of similar assets in different currencies, long-term opportunities for investment and capital appreciation, and political developments.
We may employ hedging techniques to minimize these risks, but we can offer no assurance that such strategies will be effective. If we engage in hedging transactions, we may expose ourselves to risks associated with such transactions. We may utilize instruments such as forward contracts, currency options and interest rate swaps, caps, collars and floors to seek to hedge against fluctuations in the relative values of our portfolio positions from changes in currency exchange rates and market interest rates. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, such hedging can establish other positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transaction may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, it may not be possible to hedge against an exchange rate or interest rate fluctuation that is so generally anticipated that we are not able to enter into a hedging transaction at an acceptable price. The success of our hedging transactions will depend on our ability to correctly predict movements, currencies and interest rates. Therefore, while we may enter into such transactions to seek to reduce currency exchange rate and interest rate risks, unanticipated changes in currency exchange rates or interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. In addition, the degree of correlation between price movements of the instruments used in a hedging strategy and price movements in the portfolio positions being hedged may vary. Moreover, for a variety of reasons, we may not seek to establish a perfect correlation between such hedging instruments and the portfolio holdings being hedged. Any such imperfect correlation may prevent us from achieving the intended hedge and expose us to risk of loss. In addition, it may not be possible to hedge fully or perfectly against currency fluctuations affecting the value of securities denominated in non-U.S. currencies because the value of those securities is likely to fluctuate as a result of factors not related to currency fluctuations.
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RISKS OF THE COMPANY AT ITS PRESENT STAGE
Although we have been in existence for a number of years, we may still be considered to have a limited operating history as a BDC. We are a relatively new business development company with limited resources and sources of revenues.
We were formed in March of 1996 and we have commenced investment operations but the extent of our investment activities may characterize us as a newer investment company. We made our election to become a BDC on March 7, 2006, and, as we have made an investment in only one portfolio company within our targeted industry, we have limited experience relating to the identification, evaluation and acquisition of target businesses and, accordingly, there is only a limited basis upon which to evaluate our prospects for achieving our intended business objectives. We have limited resources and have realized limited revenues to date. In addition, we will not achieve any revenues until, at the earliest, we are able to obtain funding, make investments and sell our position of securities in an underlying portfolio company for a profit. We will be wholly dependent for the selection, structuring, closing and monitoring of all of our investments on the diligence and skill of our management, acting under the supervision of our Board of Directors. None of these individuals has substantial experience, within the BDC business format, in acquiring and investing in growth stage companies, the negotiation of the terms of such investments and the monitoring of such investments after they are made. We cannot assure you that we will attain our investment objective.
We are subject to all of the business risks and uncertainties associated with any new business enterprise, including the risk that we will not achieve our investment objective and that the value of your investment in us could decline substantially or fall to zero.
We will be confronted by competition from entities having substantially greater resources and experience.
Other entities and individuals compete for investments similar to those proposed to be made by us, many of whom will have greater financial and management resources than we do. Furthermore, we must comply with provisions of the 1940 Act pertaining to BDCs and, if we qualify as a RIC, provisions of the Internal Revenue Code pertaining to RICs might restrict our flexibility as compared with our competitors. The need to compete for investment opportunities may make it necessary for us to offer portfolio companies more attractive transaction terms than otherwise might be the case. These factors may prevent us from ever becoming profitable.
We have historically incurred losses and losses may continue in the future.
We have historically lost money. Accordingly, we may experience significant liquidity and cash flow problems if we are not able to raise additional capital as needed and on acceptable terms. No assurances can be given that we will be successful in reaching or maintaining profitable operations.
Distributions to shareholders may never equal the amount invested by the shareholders.
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We cannot assure you that any distributions to shareholders will be made by us or that aggregate distributions, if any, will equal or exceed the shareholders' investment in us. Sales of portfolio company securities will be a principal source of distributable cash to shareholders. The Board of Directors has absolute discretion in the timing of distributions to shareholders. Securities acquired by us through equity investments will be held by us and will be sold or distributed at the sole discretion of the Board of Directors.
There are significant potential conflicts of interest, which could impact our investment returns
Our executive officer(s) and Director(s) serve or may serve as officers and directors of entities who operate in the same or related line of business as we do. Accordingly, they may have obligations to investors in those entities, the fulfillment of which might not be in the best interests of us or our stockholders. It is possible that new investment opportunities that would otherwise meet our investment objective may come to the attention of one these entities, and, if so, such opportunity might not be offered, or otherwise made available, to us. However, our executive officer(s) and Director(s) do have fiduciary obligations to act in our best interests and must, in such a circumstance or conflict, endeavor to allocate investment opportunities in a fair and equitable manner over time so as not to discriminate one company against another, where equal fiduciary obligations are owed. In addition, they may not be available to us if there are time conflicts involving other entities.
Our common stock is subject to the "Penny Stock" rules of the SEC and the trading market in our securities is limited, which makes transactions in our stock cumbersome and may reduce the value of an investment in our stock.
The Securities and Exchange Commission has adopted Rule 15g-9 which establishes the definition of a "penny stock," for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or option to acquire any equity security with an exercise price of less than $5.00 per share, subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require:
o that a broker or dealer approve a person's account for transactions in penny stocks; and
o the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny stocks, the broker or dealer must:
o obtain financial information and investment experience objectives of the person; and
o make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the Commission relating to the penny stock market, which, in highlight form:
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o sets forth the basis on which the broker or dealer made the suitability determination; and
o that the broker or dealer received a signed, written agreement from the investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities subject to the "penny stock" rules. This may make it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.
Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading and about the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.
We have limited operating history upon which to base your investment decision.
While we started operations in March of 1996, we have a limited operating history available to evaluate the likelihood of the success of our business. We became a BDC on March 7, 2006. Our prospects should be considered in light of the risks, expenses and uncertainties that may be encountered by development stage companies. Among other things, we must build our customer base, respond to competitive developments, attract, retain and motivate qualified employees and establish and maintain our technologies, products, and services on an ongoing basis. There can be no assurance that we will be successful in addressing such risks and implementing our business strategy.
As a result of our lack of operating history, and the other risks described herein, we are unable to accurately forecast our revenues. Our future expense levels are based predominately on our operating plans and estimates of future revenues, and to a large extent are fixed. We may be unable to adjust spending in a timely manner to compensate for revenues that do not materialize. Accordingly, any significant shortfall in revenues or lack of revenue would likely have an immediate material adverse effect on our business, operating results and financial condition.
Our ability to generate revenues will depend upon many factors. We will be required to build our business by implementing operational systems, hiring additional employees, developing and implementing a marketing and sales strategy and implementing our technology applications. Our expenses will initially exceed our revenues and no assurances can be made that we will become profitable or provide positive cash flows.
We cannot assure you that we will be successful in selling the common shares or, if sold, at what price. We have limited assets without the sale of these common shares and we cannot assure you that we will attain our investment objective.
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As of the date of filing of our Form 10K, we have minimal cash or other assets and net worth from which to invest in successful portfolio companies to insure our success. Our success will depend, in part, upon raising the necessary funds to fund investments.
Restrictions imposed upon the resale of our capital stock may require you to hold your stock for an indefinite period of time.
None of the securities to be issued based upon future sales will be registered under the Securities Act. The common stock to be sold is intended to be exempt from registration pursuant to Regulation E which permits, in conformity therewith, issuance of shares without restriction on further transfer. While we do not anticipate such an adverse decision or determination on the part of the Securities and Exchange Commission, the SEC has the right, even after permitting the offering to become effective, to enjoin the sale of securities or determine that such sales are not exempt under Regulation E. While we will make every effort to insure our compliance with the requirements under Regulation E, there can be no assurance of such exemption; as the SEC does not, as a matter of policy, affirmatively indicate the effectiveness of the notification under Regulation E.
CERTAIN GOVERNMENT REGULATIONS
We operate in a highly regulated environment. The following discussion generally summarizes certain government regulations.
BUSINESS DEVELOPMENT COMPANY. A business development company is defined and regulated by the 1940 Act. A business development company must be organized in the United States for the purpose of investing in or lending to primarily private companies and making managerial assistance available to them. A business development company may use capital provided by public shareholders and from other sources to invest in long-term, private investments in businesses.
As a business development company, we may not acquire any asset other than "qualifying assets" unless, at the time we make the acquisition, the value of our qualifying assets represent at least 70% of the value of our total assets. The principal categories of qualifying assets relevant to our business are:
(1) Securities purchased in transactions not involving any public offering from the issuer of such securities, which issuer (subject to certain limited exceptions) is an eligible portfolio company, or from any person who is, or has been during the preceding 13 months, an affiliated person of an eligible portfolio company, or from any other person, subject to such rules as may be prescribed by the SEC. An "eligible portfolio company" is defined in the 1940 Act 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 (other than a small business investment company wholly owned by the business development company) or a company that would be an investment company but for certain exclusions under the 1940 Act; and
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(c) satisfies any of the following:
o does not have any class of securities with respect to which a broker or dealer may extend margin credit; o is controlled by a business development company or a group of companies including a business development company and the business development company has an affiliated person who is a director of the eligible portfolio company; or o 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.
(2) Securities of any eligible portfolio company which we control.
(3) Securities purchased in a private transaction from a U.S. issuer that is not an investment company or from an affiliated person of the issuer, or in transactions incident thereto, if the issuer is in bankruptcy and subject to reorganization or if the issuer, immediately prior to the purchase of its securities was unable to meet its obligations as they came due without material assistance other than conventional lending or financing arrangements.
(4) Securities of an eligible portfolio company purchased from any person in a private transaction if there is no ready market for such securities and we already own 60% of the outstanding equity of the eligible portfolio company.
(5) Securities received in exchange for or distributed on or with respect to securities described in (1) through (4) above, or pursuant to the exercise of warrants or rights relating to such securities.
(6) Cash, cash equivalents, U.S. Government securities or high-quality debt maturing in one year or less from the time of investment.
To include certain securities described above as qualifying assets for the purpose of the 70% test, a business development company must make available to the issuer of those securities significant managerial assistance such as providing significant guidance and counsel concerning the management, operations, or business objectives and policies of a portfolio company, or making loans to a portfolio company. We offer to provide managerial assistance to each of our portfolio companies.
As a business development company, we are entitled to issue senior securities in the form of stock or senior securities representing indebtedness, including debt securities and preferred stock, as long as each class of senior security has an asset coverage ratio of at least 200% immediately after each such issuance. See "Risk Factors." We may also be prohibited under the 1940 Act from knowingly participating in certain transactions with our affiliates without the prior approval of our Independent Directors and, in some cases, prior approval by the SEC.
As with other companies regulated by the 1940 Act, a business development company must adhere to certain other substantive ongoing 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 business development company. Furthermore, as a
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business development company, we are prohibited from protecting any director or officer against any liability to the company 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.
We maintain a code of ethics that establishes procedures for personal investment and restricts certain transactions by our personnel. Our code of ethics generally does not permit investment by our employees in securities that may be purchased or held by us. Our code of ethics is attached as Exhibit 14.
We may not change the nature of our business so as to cease to be, or withdraw our election as, a business development company unless authorized by vote of a "majority of the outstanding voting securities," as defined in the 1940 Act, of our shares. A majority of the outstanding voting securities of a company is defined by the 1940 Act as the lesser of: (i) 67% or more of such company's shares present at a meeting if more than 50% of the outstanding shares of such company are present and represented by proxy, or (ii) more than 50% of the outstanding shares of such company.
We are periodically examined by the SEC for compliance with the 1940 Act.
ITEM 2:
ITEM 2: PROPERTIES
Our chief executive officer is providing our corporate office at 3651 Lindell Road, Suite D #146, Las Vegas, Nevada 89103 at no cost. The fair value of this rental space is not material. We believe these facilities, which are in good physical condition, are adequate for our needs for the next 12 to 24 months.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
We are not currently subject to any legal proceedings, nor, to our knowledge, is any legal proceeding threatened against us.
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter.
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PART II
ITEM 5:
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND PURCHASES OF EQUITY SECURITIES MARKET
Our Common Stock trades on the Over the Counter Bulletin Board ("OTCBB") under the symbol: SMCA.OB.
HISTORICAL MARKET PRICE DATA FOR THE COMMON STOCK OF SMALL CAP STRATEGIES, INC.
These prices represent prices between broker-dealers and do not include retail markups and markdowns or any commission to broker-dealers. In addition, these prices do not reflect prices in actual transactions.
The following table sets forth the range of high and low closing sales prices (as adjusted for the one for twenty stock split which was effective December 21, 2006 and the reverse stock split of one for twenty shares which was effective May 21, 2007) for our Common Stock for the periods indicated:
High Low
Fiscal Year Ending December 31, 2007
First Quarter $ 1.80 $ 0.40 Second Quarter $ 0.80 $ 0.16 Third Quarter $ 0.25 $ 0.25 Fourth Quarter $ 0.55 $ 0.16
Fiscal Year Ending December 31, 2006
First Quarter $ 3.60 $ 2.00 Second Quarter $ 5.60 $ 2.04 Third Quarter $ 3.00 $ 1.80 Fourth Quarter $ 2.40 $ 1.00
NUMBER OF SHAREHOLDERS AND TOTAL OUTSTANDING SHARES
As of December 31, 2007, there were approximately 1,936 holders of record of our common stock and we had 687,770 common shares issued and outstanding after the one share for twenty share reverse split effective May 21, 2007.
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DIVIDENDS
The Company has not historically paid cash dividends. The Company does not anticipate paying any cash dividends in the foreseeable future.
MERGER Effective September 30, 2006, Photonics Corporation ("Photonics"), a California corporation, merged into Small Cap Strategies, Inc. ("SCPS", the "Company", "we" or "us"), a Nevada corporation, with SCPS being the surviving entity. The effect of this corporate action was to change the Company's state of incorporation from the State of California to the State of Nevada and to increase the number of shares of common stock authorized from 200,000,000 to 2,000,000,000. All common shares of Photonics were exchanged on a one-for-one basis for stock in SCPS. As discussed below, Photonics had 50,000,000 shares of $.001 par value preferred stock authorized, of which 400,000 shares had been designated Series A Convertible Preferred Stock. At September 30, 2006, immediately prior to the merger, Photonics had no preferred stock issued or outstanding. SCPS did not authorize any preferred stock in its articles of incorporation in Nevada. Accordingly, there is no preferred stock authorized, issued or outstanding after the merger on September 30, 2006. In addition, the shareholders authorized the board of directors to effect a reverse stock split with-in the next twelve months. On December 5, 2006, the board of directors authorized a reverse stock split of one share for each twenty shares outstanding, to be effective December 21, 2006. On May 15, 2007, the board of directors authorized a second reverse stock split of one share for each twenty shares outstanding, to be effective the dated filed with the Nevada Secretary of State, May 21, 2007. Accordingly, all share transactions and disclosures have been restated as if the reverse stock split occurred before all periods presented.
OPTIONS
As of December 31, 2007, there are 21,698 common shares reserved for the exercise of options held by a former management team at an exercise price of $4.00 per share. The former management team is G. Thomas Bailey (18,385), Joseph "Chip" Langston (1,750), and Michael Craven (1,563). All other options and option agreements have been cancelled.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The Company's stock option plan (the 1997 Stock Option Plan) allows for the issuance of incentive and nonqualified stock options to employees and consultants of the Company. Options granted under the Plan are generally for periods not to exceed ten years and generally must be at prices not less than 100% and 85%, for incentive and nonqualified stock options, respectively, of the estimated fair value of the stock on the date of grant as determined by the Board of Directors. Options granted to shareholders who own greater than 10% of the outstanding stock are established at the estimated fair value of the stock on the date of grant. Stock options granted by the Company to others are primarily for legal and investment banking services.
In connection with the Company's acquisition of SGI in 2001, the Company renegotiated the stock options previously granted to former members of management. These options for 21,698 common stock shares were considered a new
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PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
At December 31, 2006, we had a stock subscription receivable from Shocker Index 100 LP with a balance of $361,627. We had substantial doubt about the ability of Shocker to make payment on the obligation in a reasonable period of time. Accordingly, on March 20, 2007, our Board of Directors agreed to exchange our note receivable from Shocker, for the return of 113,009 shares of our common stock. The transaction was recorded effective December 31, 2006.
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ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The following table sets forth selected financial data as of and for each of the three fiscal years ended December 31, 2007, 2006 and 2005, and is derived from our audited financial statements. The data set forth below should be read in conjunction with "Item 8: Financial Statements" and related Notes to Financial Statements appearing elsewhere herein and "Item 7:
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Management's Analysis of Business
We will have significant relative flexibility in selecting and structuring our investments. We will not be subject to many of the regulatory limitations that govern traditional lending institutions such as banks. We will seek to structure our investments so as to take into account the uncertain and potentially variable financial performance of our portfolio companies. This should enable our portfolio companies to retain access to committed capital at different stages in their development and eliminate some of the uncertainty surrounding their capital allocation decisions. We will calculate rates of return on invested capital based on a combination of up-front commitment fees, current and deferred interest rates and residual values, which may take the form of common stock, warrants, equity appreciation rights or future contract payments. We believe that this flexible approach to structuring investments will facilitate positive, long-term relationships with our portfolio companies and enable us to become a preferred source of capital to them. We also believe our approach should enable debt financing to develop into a viable alternative capital source for funding the growth of target companies that wish to avoid the dilutive effects of equity financings for existing equity holders.
Longer Investment Horizon - We will not be subject to periodic capital return requirements. These requirements, which are standard for most private equity and venture capital funds, typically require that these funds return to investors the initial capital investment after a pre-agreed time, together with any capital gains on such capital investment. These provisions often force such funds to seek the return of their investments in portfolio companies through mergers, public equity offerings or other liquidity events more quickly than they otherwise might, which can result in a lower overall return to investors and adversely affect the ultimate viability of the affected portfolio companies. Because we may invest in the same portfolio companies as these funds, we are subject to these risks if these funds demand a return on their investments in the portfolio companies. We believe that our flexibility to take a longer-term view should help us to maximize returns on our invested capital while still meeting the needs of our portfolio companies.
Established Deal Sourcing Network - We believe that, through our management and directors, we have solid contacts and sources from which to generate investment opportunities. These contacts and sources include:
o public and private companies, o investment bankers, o attorneys, o accountants, o consultants, and o commercial bankers.
However, we cannot assure you that such relationships will lead to the origination of debt or other investments.
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Investment Criteria
As a matter of policy, we will not purchase or sell real estate or interests in real estate or real estate investment trusts except that we may:
o purchase and sell real estate or interests in real estate in connection with the orderly liquidation of investments, or in connection with foreclosure on collateral; o own the securities of companies that are in the business of buying, selling or developing real estate; or o finance the purchase of real estate by our portfolio companies.
We will limit our investments in more traditional securities (stock and debt instruments) and will not, as a matter of policy:
o sell securities short except with regard to managing the risks associated with publicly-traded securities issued by our portfolio companies; o Purchase securities on margin (except to the extent that we may purchase securities with borrowed money); or o engage in the purchase or sale of commodities or commodity contracts, including futures contracts except where necessary in working out distressed loan; or o investment situations or in hedging the risks associated with interest rate fluctuations, and, in such cases, only after all necessary registrations or exemptions from registration with the Commodity Futures Trading Commission have been obtained.
Prospective Portfolio Company Characteristics - We have identified several criteria that we believe will prove important in seeking our investment objective with respect to target companies. These criteria will provide general guidelines for our investment decisions; however, we caution readers that not all of these criteria will be met by each prospective portfolio company in which we choose to invest.
Experienced Management - We will generally require that our portfolio companies have an experienced president or management team. We will also require the portfolio companies to have in place proper incentives to induce management to succeed and to act in concert with our interests as investors, including having significant equity interests. We intend to provide assistance in this area either supervising management or providing management for our portfolio companies.
Products or Services - We will seek companies that are involved in products or services that do not require significant additional capital or research expenditures. In general, we will seek target companies that make innovative use of proven technologies or methods.
Proprietary Advantage - We expect to favor companies that can demonstrate some kind of proprietary sustainable advantage with respect to their competition. Proprietary advantages include, but are not limited to:
o patents or trade secrets with respect to owning or manufacturing its products, and o a demonstrable and sustainable marketing advantage over its competition
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Marketing strategies impose unusual burdens on management to be continuously ahead of its competition, either through some kind of technological advantage or by being continuously more creative than its competition.
Profitable or Nearly Profitable Operations Based on Cash Flow from Operations - We will focus on target companies that are profitable or nearly profitable on an operating cash flow basis. Typically, we would not expect to invest in start-up companies unless there is a clear exit strategy in place.
Potential for Future Growth - We will generally require that a prospective target company, in addition to generating sufficient cash flow to cover its operating costs and service its debt, demonstrate an ability to increase its revenues and operating cash flow over time. The anticipated growth rate of a prospective target company will be a key factor in determining the value that we ascribe to any warrants or other equity securities that we may acquire in connection with an investment in debt securities.
Exit Strategy - Prior to making an investment in a portfolio company, we will analyze the potential for that company to increase the liquidity of its common equity through a future event that would enable us to realize appreciation, if any, in the value of our equity interest. Liquidity events may include:
o an initial public offering, o a private sale of our equity interest to a third party, o a merger or an acquisition of the portfolio company, or o a purchase of our equity position by the portfolio company or one of its stockholders.
We may acquire warrants to purchase equity securities and/or convertible preferred stock of the eligible portfolio companies in connection with providing financing. The terms of the warrants, including the expiration date, exercise price and terms of the equity security for which the warrant may be exercised, will be negotiated individually with each eligible portfolio company, and will likely be affected by the price and terms of securities issued by the eligible portfolio company to other venture capitalists and other holders. We anticipate that most warrants will be for a term of five to ten years, and will have an exercise price based upon the price at which the eligible portfolio company most recently issued equity securities or, if a new equity offering is imminent, equity securities. The equity securities for which the warrant will be exercised generally will be common stock of which there may be one or more classes or convertible preferred stock. Substantially all the warrants and underlying equity securities will be restricted securities under the 1933 Act at the time of the issuance. We will generally negotiate for registration rights with the issuer that may provide:
o "piggyback" registration rights, which will permit us under certain circumstances, to include some or all of the securities owned by us in a registration statement filed by the eligible portfolio company, or
o in circumstances, "demand" registration rights permitting us under certain circumstances, to require the eligible portfolio company to register the securities under the 1933 Act, in some cases at our expense. We will generally negotiate net issuance provisions in the warrants, which will allow us to receive upon exercise of the warrant without payment of any cash a net amount of shares determined by the
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increase in the value of the issuer's stock above the exercise price stated in the warrant.
Liquidation Value of Assets - Although we do not intend to operate as an asset-based lender, the prospective liquidation value of the assets, if any, collateralizing any debt securities that we hold will be an important factor in our credit analysis. We will emphasize both tangible assets, such as:
o accounts receivable, o inventory, and o equipment,
and intangible assets, such as:
o intellectual property, o customer lists, o networks, and o databases.
Investment Process
Due Diligence - If a target company generally meets the characteristics described above, we will perform initial due diligence, including:
o company and technology assessments, o existing management team, o market analysis, o competitive analysis, o evaluation of management, risk analysis and transaction size, o pricing, and o structure analysis.
Much of this work will be done by management and professionals who are well known by management. The criteria delineated above provide general parameters for our investment decisions. We intend to pursue an investment strategy by further imposing such criteria and reviews that best insures the value of our investments. As unique circumstances may arise or be uncovered, not all of such criteria will be followed in each instance but the process provides a guideline by which investments can be prudently made and managed. Upon successful completion of the preliminary evaluation, we will decide whether to deliver a non-binding letter of intent and move forward towards the completion of a transaction.
In our review of the management team, we look at the following:
o Interviews with management and significant shareholders, including any financial or strategic sponsor; o Review of financing history; o Review of management's track record with respect to:
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o product development and marketing, o mergers and acquisitions, o alliances, o collaborations, o research and development outsourcing and other strategic activities; o Assessment of competition; and o Review of exit strategies.
In our review of the financial conditions, we look at the following:
o Evaluation of future financing needs and plans; o Detailed analysis of financial performance; o Development of pro forma financial projections; and o Review of assets and liabilities, including contingent liabilities, if any, and legal and regulatory risks.
In our review of the products and services of the portfolio company, we look at the following:
o Evaluation of intellectual property position; o Review of existing customer or similar agreements and arrangements; o Analysis of core technology; o Assessment of collaborations; o Review of sales and marketing procedures; and o Assessment of market and growth potential.
Upon completion of these analyses, we will conduct on-site visits with the target company's management team. Also, in cases in which a target company is at a mature stage of development and if other matters that warrant such an evaluation, we will obtain an independent appraisal of the target company.
Ongoing Relationships with Portfolio Companies
Monitoring - We will continuously monitor our portfolio companies in order to determine whether they are meeting our financing criteria and their respective business plans. We may decline to make additional investments in portfolio companies that do not continue to meet our financing criteria. However, we may choose to make additional investments in portfolio companies that do not do so, but we believe that we will nevertheless perform well in the future.
We will monitor the financial trends of each portfolio company to assess the appropriate course of action for each company and to evaluate overall portfolio quality. Our management team and consulting professionals, who are well known by our management team, will closely monitor the status and performance of each individual company on at least a quarterly and, in some cases, a monthly basis.
We will use several methods of evaluating and monitoring the performance and fair value of our debt and equity positions, including but not limited to the following:
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o Assessment of business development success, including product development, financings, profitability and the portfolio company's overall adherence to its business plan; o Periodic and regular contact with portfolio company management to discuss financial position, requirements and accomplishments; o Periodic and regular formal update interviews with portfolio company management and, if appropriate, the financial or strategic sponsor; o Attendance at and participation in board meetings; o Review of monthly and quarterly financial statements and financial projections for portfolio companies.
Managerial Assistance - As a business development company, we will offer, and in many cases may provide, significant managerial assistance to our portfolio companies. This assistance will typically involve:
o monitoring the operations of our portfolio companies, o participating in their board and management meetings, o consulting with and advising their officers, and o providing other organizational and financial guidance.
Investment Amounts
The amount of funds committed to a portfolio company and the ownership percentage received will vary depending on the maturity of the portfolio company, the quality and completeness of the portfolio company's management team, the perceived business opportunity, the capital required compared to existing capital, and the potential return. Although investment amounts will vary considerably, we expect that the average investment, including follow-on investments, will be between $25,000 and $1,000,000.
Competition
Our primary competitors to provide financing to target companies will include private equity and venture capital funds, other equity and non-equity based investment funds and investment banks and other sources of financing, including traditional financial services companies such as commercial banks and specialty finance companies. Many of these entities have substantially greater financial and managerial resources than we will have. We believe that our competitive advantage with regard to quality target companies relates to our ability to negotiate flexible terms and to complete our review process on a timely basis. We cannot assure you that we will be successful in implementing our strategies.
FORWARD LOOKING STATEMENTS
Certain statements contained in this report that are not historical fact are "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995. The words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "believes," "estimates," "projects" or similar expressions are intended to identify these forward-looking
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statements. These statements are subject to risks and uncertainties beyond our reasonable control that could cause our actual business and results of operations to differ materially from those reflected in our forward-looking statements. The safe harbor provisions provided in the Securities Litigation Reform Act do not apply to forward-looking statements we make in this report. Forward-looking statements are not guarantees of future performance. Our forward-looking statements are based on trends which we anticipate in our industry and our good faith estimate of the effect on these trends of such factors as industry capacity, product demand and product pricing. The inclusion of projections and other forward-looking statements should not be regarded a representation by us or any other person that we will realize our projections or that any of the forward-looking statements contained in this prospectus will prove to be accurate.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2007 COMPARED TO YEAR ENDED DECEMBER 31, 2006 AND TO YEAR ENDED DECEMBER 31, 2005
REVENUES
During the year ended December 31, 2007, we received a dividend from our wholly owned portfolio company, ACL in the amount of $231,131 and had interest income from cash investments of $823. During the year ended December 31, 2006, we received a cash dividend from our wholly owned portfolio company, ACL in the amount of $562,146.
The Company did not produce any revenue in the period ended December 31, 2005 inasmuch as it had ceased operations in contemplation of a significant change in its business model. With no operations under its old model and the fact that it had not commenced acting as a BDC, save the acquisition of a portfolio company, there were no opportunities for revenue during 2005.
COSTS AND EXPENSES
We had total costs and expenses in the amount of $174,680, $246,694, and ($80,835) during the years ended December 31, 2007, 2006 and 2005, respectively. The 2005 period included a gain on extinguishment of debt of $174,133. Accordingly, our actual expenses were $93,298.
The 2007 period decreased $72,014 (29%) from the 2006 period. The primary decreases were $48,923 of legal, audit and consulting fees and $28,000 in director fees. The increase in compensation and benefits of $15,647 was mostly offset by miscellaneous income of $11,564.
The 2006 period increased $153,396 (164%) from the 2005 period. The primary increases were $56,535 in legal, audit and professional fees, $57,950 in compensation and benefits and $30,000 in director fees. The increase in professional fees was the result of increased accounting and audit costs associated with the acquisition of ACL and the conversion to a BDC. These costs decreased in 2007. The increase in compensation and benefits and director fees is the result of converting from an inactive holding company to a BDC.
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NET REALIZED AND UNREALIZED GAINS AND LOSSES
As an investment company under the Investment Company Act of 1940, all of our investments must be carried at market value or fair value as determined by management for investments which do not have readily determinable market values. Prior to this conversion, only marketable debt and equity securities and certain derivative securities were required to be carried at market value.
Beginning December 16, 2005, portfolio assets for which market prices are available are valued at those prices. Securities that are traded in the over-the-counter market or on a stock exchange generally will be valued at the prevailing bid price on the valuation date. However, our current investments were acquired in privately negotiated transactions and may have no readily determinable market values. These securities are carried at fair value as determined by management and outside professionals as necessary under our valuation policy. Currently, the valuation policy provides for management's review of the management team, financial conditions, and products and services of the portfolio company. In situations that warrant such an evaluation, an independent business valuation may be obtained.
Value, as defined in Section 2(a)(41) of 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by management. There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment. We must determine the fair value of each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where realization of an equity security is doubtful. Conversely, we will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and, therefore, its investment has also appreciated in value, where appropriate.
As an investment company, we invest primarily in illiquid securities including equity securities of private companies. The structure of each equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We generally include many terms governing ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. Our investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation.
During the year ended December 31, 2007, we recognized a realized loss of $4,952 and an unrealized loss of $447,580. Both the realized loss and unrealized loss arose principally from our investment in Healthsport, Inc. During the year ended December 31, 2006, we recognized a realized loss of $5,000 and an unrealized gain of $188,835. The realized loss arose from our investment in Elitegroup Ventures Nevada, Inc. We made this investment early in 2006; however, Elitegroup was unable to raise sufficient capital to implement its business plan. Accordingly, we wrote off our investment. The unrealized gain of $188,835 is from our investment in ACL. At December 31, 2006, ACL had cash of $20,571 and investments in marketable equity securities valued at $589,100, for total assets
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of $609,671. ACL had liabilities of $105,107 and equity in net assets of $504,564, which is the amount we used to value our investment. At December 31, 2005, our carrying value in our investment in ACL was our net cost of $315,729. The increase in value of $188,835 to $504,564 accounts for the unrealized appreciation. We applied the same methodology in valuing the ACL investments that would have been used had we owned the investments directly. All ACL assets have now been transferred to the Company along with assumption of any remaining ACL debt, all of which was paid by December 31, 2007. We plan to dissolve ACL in 2008.
CAPITAL EXPENDITURES
We plan to raise funds to be used in making investments in other as yet unidentified portfolio companies.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2007, we had net assets of $161,593 as compared to net assets of $415,515 at December 31, 2006. This decrease of $253,922 consisted of earnings from operations of $95,213, sales of common stock for $30,000, the contribution to capital of liabilities in the amount of $73,396 and less the net decrease in net assets from stock transactions of $452,532.
During the year ended December 31, 2007, total assets declined $324,443, which includes a decrease in investments of $367,544 offset by an increase in income tax refund receivable of $37,939, an increase in cash of $3,327 and an increase in office equipment, net of $1,835. During this same period, liabilities decreased $70,521; the major components of the decrease were a decrease in accounts payable of $6,751, a decrease in amounts due related parties of $59,355 and a decrease in accrued expenses of $4,414. The combination of the decline in assets along with the decline in liabilities resulted in the decrease in net assets.
We currently have sufficient value in marketable equity securities which could be sold and the proceeds to cover our planned 2008 expenses of operation. We would expect to raise additional funds in the event we purchase any additional investments.
NET ASSET VALUE
As a Business Development Company, certain of our activities and disclosures are made in reference to Net Asset Value which is the value of our portfolio assets less debt and preferred stock. This may be viewed, simply and generalized, as the value of our assets to our common shareholders. As of the date of the financial information in this report, the value of our portfolio of assets including investments in equity securities and cash is $180,447 and from this, are subtracted liabilities and debts of $18,854. There are no shares of preferred stock outstanding but the rights of preferred stockholders would be included if there were. The Net Asset Value is therefore $161,593. We have 687,770 common shares outstanding at December 31, 2007; therefore, the Net Asset Value per Share is $0.2350.
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RECENT ACCOUNTING PRONOUNCEMENTS
There are several new accounting pronouncements issued by the Financial Accounting Standards Board ("FASB") which are not yet effective. Each of these pronouncements, as applicable, has been or will be adopted by the Company. Management does not believe any of these accounting pronouncements has had or will have a material impact on the Company's financial position or operating results.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measures". This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, expands disclosures about fair value measurements, and applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 does not require any new fair value measurements. However, the FASB anticipates that for some entities, the application of SFAS No. 157 will change current practice. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, which for the Company would be its fiscal year beginning January 1, 2008. The Company is currently evaluating the impact of SFAS No. 157 but does not expect that it will have a material impact on its financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities ("SFAS 159"). SFAS 159 expands opportunities to use fair value measurements in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 will be effective for us on January 1, 2008. We are currently evaluating the impact of adopting SFAS 159 on our financial statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160"). SFAS 160 establishes accounting and reporting standards for the noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective on January 1, 2009 for the Company. The Company is currently evaluating the impact of adopting SFAS 160.
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ITEM 7A:
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in market rates and prices. We are primarily exposed to equity price risk. The following is a discussion of our equity market risk.
Equity price risk arises from exposure to securities that represent an ownership interest in our portfolio companies. The value of our equity securities and our other investments are based on quoted market prices or our Board of Directors' good faith determination of their fair value (which is based, in part, on quoted market prices). Market prices of common equity securities, in general, are subject to fluctuations, which could cause the amount to be realized upon sale or exercise of the instruments to differ significantly from the current reported value. The fluctuations may result from perceived changes in the underlying economic characteristics of our portfolio companies, the relative price of alternative investments, general market conditions and supply and demand imbalances for a particular security.
Basis of presentation
The preparation of financial statements in conformity with Generally Accepted Accounting Principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
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ITEM 8:
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SCHEDULES OF FINANCIAL RATIOS
SMALL CAP STRATEGIES, INC. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.......................55
STATEMENTS OF NET ASSETS......................................................56
STATEMENTS OF OPERATIONS......................................................57
STATEMENTS OF CASH FLOWS...................................................58-59
STATEMENTS OF CHANGES IN NET ASSETS...........................................60
SCHEDULES OF INVESTMENTS...................................................61-62
NOTES TO FINANCIAL STATEMENTS..............................................63-75
SCHEDULES OF FINANCIAL RATIOS.................................................76
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Report of Independent Registered Public Accounting Firm
Board of Directors Small Cap Strategies, Inc. Las Vegas, Nevada
We have audited the accompanying statements of net assets of Small Cap Strategies, Inc. (the "Company") at December 31, 2007 and 2006, including the schedules of investments as of December 31, 2007 and 2006, and the related statements of operations, cash flows and changes in net assets for the years ended December 31, 2007 and 2006, the period December 16, 2005 through December 31, 2005 and the period January 1, 2005 through December 15, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Small Cap Strategies, Inc., as of December 31, 2007 and 2006, and the results of its operations, its cash flows and changes in net assets for the above referenced periods in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the financial statements, certain accounting principles used in the preparation of the financial statements beginning December 16, 2005 (upon becoming an investment company under the Investment Company Act of 1940) are different than those of prior periods and therefore are not directly comparable.
/s/ Turner, Stone & Company, LLP - -------------------------------- Turner, Stone & Company, LLP
Certified Public Accountants Dallas, Texas April 14, 2008
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See accompanying notes to financial statements.
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See accompanying notes to financial statements.
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See accompanying notes to financial statements.
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See accompanying notes to financial statements.
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See accompanying notes to financial statements.
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See accompanying notes to financial statements.
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SMALL CAP STRATEGIES, INC. NOTES TO FINANCIAL STATEMENTS
NOTE 1: GENERAL ORGANIZATION AND BUSINESS
Effective September 30, 2006, Photonics Corporation ("Photonics"), a California corporation, merged into Small Cap Strategies, Inc. ("SCPS", the "Company"), a Nevada corporation, with SCPS being the surviving entity. The effect of this corporate action was to change the Company's state of incorporation from the State of California to the State of Nevada and to increase the number of shares of common stock authorized from 200,000,000 to 2,000,000,000. All common shares of Photonics were exchanged on a one-for-one basis for stock in SCPS. Photonics also had 50,000,000 shares of $.001 par value preferred stock authorized, of which 400,000 shares had been designated Series A Convertible Preferred Stock. At September 30, 2006, immediately prior to the merger, Photonics had no preferred stock issued or outstanding. SCPS did not authorize any preferred stock in its articles of incorporation in Nevada. Accordingly, there is no preferred stock authorized, issued or outstanding after the merger on September 30, 2006. In addition, the shareholders authorized the board of directors to effect a reverse stock split with-in the next twelve months. On December 5, 2006, the board of directors authorized a reverse stock split of one share for each twenty shares outstanding, to be effective December 21, 2006. On May 15, 2007, the board of directors authorized a second reverse stock split of one share for each twenty shares outstanding, to be effective the date filed with the Nevada Secretary of State, May 21, 2007. Accordingly, all share transactions and disclosures have been restated as if the reverse stock split occurred before all periods presented. The Company is currently traded on the OTCBB under the symbol SMCA.OB.
Photonics Corporation formerly dba DTC Data Technology, a California corporation, began from a merger of Photonics Corp. with DTC Data Technology in March of 1996. The Company designed, developed, and marketed Integrated Device Electronics (IDE), Small Computer Systems Interface (SCSI) disk controller cards, and Input/Output (I/O) products for personal computers. However, as a result of recurring significant operating losses, in June 1999, the board of directors voted to shut down business operations and attempt to sell the Company or its assets. Since that date and through December 15, 2005, the Company was inactive and in the development stage (see below).
On November 28, 2000, the Company merged with REPipeline.com, a Texas corporation, an Internet vertical service provider to the commercial real estate industry, by issuing 45,320 common stock shares valued at $18,128 in exchange for all of the outstanding common stock of REPipeline.com, Inc. (REP). Immediately after the merger, the Company transferred the net assets and business operations to REPipeline.com, Inc., a Delaware corporation, incorporated on June 8, 2000 as a wholly owned subsidiary of the Company.
Prior to this merger on July 10, 2000, REPipeline.com, Inc., a Texas corporation, also incorporated on June 8, 2000, agreed to purchase the assets and assume the certain liabilities and shareholder's equity of RealEstate4Sale.com. RealEstate4Sale.com (RE4S) was incorporated in Colorado on August 17, 1999, and its purpose was to provide commercial real estate listings on the Internet. However, the concept was deemed to be too narrow for the marketplace, which requires a wider variety of services to the commercial real
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estate market over the Internet, which is best addressed by the expanded concept of REP.
The transaction was accounted for as a reverse merger using the purchase method of accounting with REP acquiring Photonics for financial reporting purposes. The purchase price of Photonics was allocated among its net assets based on their relative fair values. Because Photonics did not have any assets and only liabilities and had no business operations, no portion of the purchase price was allocated to goodwill. Instead, the excess of the purchase price over the fair value of net assets acquired was charged against operations.
In October 2001, the Company acquired all of the outstanding common stock of The Sarasota Group, Inc. (SGI), a Florida corporation, in exchange for the issuance of 1,000,000 convertible preferred stock shares and 35,500 common stock shares. At the same time, the Company's then current officers and directors resigned and the Company elected new officers and directors. Since then, the preferred shares of stock have been cancelled.
SGI was incorporated on November 13, 2001, and both prior to and after the acquisition had no assets, liabilities or business operations. The purchase price, which exceeded the fair value of net assets acquired, has been charged against operations and reflected in the accompanying financial statements as an acquisition cost.
In December 2005, the Company entered into a Stock Purchase Agreement with ACL Consulting Corporation (ACL), an entity majority owned by an officer of the Company. The Stock Purchase Agreement has rights of rescission that can be exercised by the Seller. The Stock Purchase Agreement was effective on December 16, 2005.
Upon acquisition of ACL on December 16, 2005, the Company became a non-diversified internally managed, closed-end investment company under the Investment Company Act of 1940, as amended, and no longer considered itself as being in the development stage.
During 2007, the Company liquidated its investment in ACL and transferred by dividend the securities owned by ACL, net of ACL obligations assumed by the Company. The Company plans to dissolve ACL during 2008.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principles of Consolidation - ----------------------------------------------------- Beginning December 16, 2005, the accompanying financial statements reflect the separate accounts of Small Cap Strategies, Inc., and the related results of operations. In accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and the Securities Exchange Act of 1934, the Company does not consolidate portfolio company investments in which the Company has a controlling interest.
Prior to December 16, 2005, the accompanying consolidated financial statements included the accounts of the Company and those of its wholly owned subsidiary,
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The Sarasota Group, Inc., a Florida corporation. All intercompany transactions, accounts, and balances have been eliminated in the consolidation. There were no material intercompany transactions during the periods presented. SGI did not have any assets, liabilities, or business operations at the time the Company became an investment company, therefore, there was no cumulative effect recognition in the accompanying financial statements upon becoming an investment company.
Although the nature of the Company's operations and its reported financial position, results of operations, and its cash flows are dissimilar for the periods prior to and subsequent to its becoming an investment company, its financial position for the years ended December 31, 2007 and 2006 and its operating results, cash flows and changes in net assets for each of the years ended December 31, 2007, 2006 and 2005 (separated as indicated above) are presented in the accompanying financial statements pursuant to Article 6 of Regulation S-X. In addition, the accompanying footnotes, although different in nature as to the required disclosures and information reported therein, are also presented as they relate to each of the above referenced periods.
Conversion to an Investment Company - ----------------------------------- The Company's results of operations for 2005 are divided into two periods. The period from January 1, 2005 to December 15, 2005 reflects the Company's results prior to becoming an investment company under the Investment Company Act of 1940, as amended. The period from December 16, 2005 to December 31, 2005 and the years ended December 31, 2007 and 2006, reflect the Company's results as an investment company under the Investment Company Act of 1940, as amended. Accounting principles used in the preparation of the financial statements beginning December 16, 2005 are different than those of prior periods and, therefore, the financial position and results of operations of these periods are not directly comparable. The primary differences in accounting principles relate to the carrying value of investments - see corresponding sections below for further discussions.
Development Stage Activities - ---------------------------- Through December 15, 2005, the Company was inactive and considered to be in the development stage. Accordingly, all of the Company's operating results and cash flows reported in the accompanying financial statements for periods prior to this date were considered to be those related to development stage activities pursuant to Statements of Financial Accounting Standards (SFAS) No. 7, Accounting and Reporting by Development Stage Enterprises. With the Company's acquisition of ACL Consulting Corporation, the Company is no longer considered a development stage company.
Management Estimates - -------------------- The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Net Increase (Decrease) in Net Assets from Operations per Share - --------------------------------------------------------------- Basic net increase (decrease) in net assets from operations per share is computed by dividing the net earnings (loss) amount adjusted for cumulative dividends on preferred stock (numerator) by the weighted average number of
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common shares outstanding during the period (denominator). Diluted net increase (decrease) in net assets from operations per share amounts reflect the maximum dilution that would have resulted from the assumed exercise of stock options and from the assumed conversion of the Series A Convertible Preferred Stock. Diluted net increase (decrease) in net assets from operations per share is computed by dividing the net earnings (loss) amount adjusted for cumulative dividends on preferred stock by the weighted average number of common and potentially dilutive securities outstanding during the period. For all periods presented the above potentially dilutive securities are excluded from the computation as their effect is anti-dilutive.
Income Taxes - ------------ The Company has not elected to be a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended. Accordingly, the Company will be subject to U.S. federal income taxes on sales of investments for which the sales prices are in excess of their tax basis.
Income taxes are accounted for using an asset and liability approach for financial reporting. The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial statement carrying amount and the tax basis of assets and liabilities and net operating loss and tax credit carry forwards. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Cash and Cash Equivalents - ------------------------- For purposes of the statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity date of three months or less to be cash equivalents. None of the Company's cash is restricted.
Valuation of Investments (as an Investment Company) - --------------------------------------------------- As an investment company under the Investment Company Act of 1940, all of the Company's investments must be carried at market value or fair value. The value is determined by management for investments which do not have readily determinable market values. Prior to this conversion, only marketable debt and equity securities and certain derivative securities were required to be carried at market value.
Beginning December 16, 2005, portfolio assets for which market prices are available are valued at those prices. Securities that are traded in the over-the-counter market or on a stock exchange generally will be valued at the prevailing bid price on the valuation date. However, some of the Company's current investments were acquired in privately negotiated transactions and may have no readily determinable market values. These securities are carried at fair value as determined by management and outside professionals as necessary under the Company's valuation policy. Currently, the valuation policy provides for management's review of the management team, financial conditions, and products and services of the portfolio company. In situations that warrant such an evaluation, an independent business valuation may be obtained.
Value, as defined in Section 2(a)(41) of 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by management. There is no single standard for determining fair value in good
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faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment. The Company must determine the fair value of each individual investment on a quarterly basis. The Company will record unrealized depreciation on investments when it believes that an investment has become impaired, including where realization of an equity security is doubtful. Conversely, the Company will record unrealized appreciation if the Company believes that the underlying portfolio company has appreciated in value and, therefore, its investment has also appreciated in value, where appropriate.
As an investment company, the Company invests primarily in illiquid securities including equity securities of private companies. The structure of each equity security is specifically negotiated to enable the Company to protect its investment and maximize its returns. The Company generally includes many terms governing ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. The Company's investments are generally subject to some restrictions on resale and generally have no established trading market. Because of the type of investments that the Company makes and the nature of its business, the Company's valuation process requires an analysis of various factors. The Company's fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition and market changing events that impact valuation.
Comprehensive Income - -------------------- SFAS No. 130, Reporting Comprehensive Income, establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. It requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS No. 130 requires that an enterprise (a) classify items of other comprehensive income by their nature in financial statements and (b) display the accumulated balance of other comprehensive income separately in the equity section of the balance sheet for all periods presented. The Company's comprehensive income (loss) does not differ from its reported net income (loss).
As an investment company, the Company must report changes in the fair value of its investments outside of its operating income on its statement of operations and reflect the accumulated appreciation or depreciation in the fair value of its investments as a separate component of its stockholders' deficit. This treatment is similar to the treatment required by SFAS No. 130.
Stock Based Incentive Program - ----------------------------- SFAS No. 123R, Share-Based Payment, a revision to SFAS No. 123, Accounting for Stock-Based Compensation and superseding APB Opinion No. 25, Accounting for Stock Issued to Employees, establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, including obtaining employee services in share-based payment transactions. SFAS No. 123R applies to all awards granted after the required effective date and to awards modified, purchased, or canceled after that date. The Company adopted SFAS No. 123R effective January 1, 2006, with no impact on financial position or results of operations.
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Recent Accounting Pronouncements - -------------------------------- There are several new accounting pronouncements issued by the Financial Accounting Standards Board ("FASB") which are not yet effective. Each of these pronouncements, as applicable, has been or will be adopted by the Company. Management does not believe any of these accounting pronouncements has had or will have a material impact on the Company's financial position or operating results.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measures". This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, expands disclosures about fair value measurements, and applies under other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 does not require any new fair value measurements. However, the FASB anticipates that for some entities, the application of SFAS No. 157 will change current practice. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, which for the Company would be its fiscal year beginning January 1, 2008. The Company is currently evaluating the impact of SFAS No. 157 but does not expect that it will have a material impact on its financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 expands opportunities to use fair value measurements in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 will be effective for us on January 1, 2008. We are currently evaluating the impact of adopting SFAS 159 on our financial statements.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51" ("SFAS 160"). SFAS 160 establishes accounting and reporting standards for the noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective on January 1, 2009 for the Company. The Company is currently evaluating the impact of adopting SFAS 160.
NOTE 3: INVESTMENTS AND VALUATION
On December 16, 2005, the Company entered into a stock purchase agreement to acquire all issued and outstanding shares of the capital stock of ACL Consulting Corporation (ACL), a Texas corporation majority owned by a former officer and director of the Company providing business consulting services to companies that desire to go public.
The purchase price of the shares was $1,593,000. The consideration for the acquisition was comprised of three components: (1) $735,000 in cash paid at closing, (2) $458,000 secured promissory note delivered at closing, and (3) 400,000 shares of Series A Convertible Preferred Stock of the Company with a value at issuance of $400,000 (Notes 3, 4 and 5).
During 2007 the Company liquidated its investment in ACL and transferred by dividend the securities owned by ACL, net of ACL obligations to the Company. Accordingly, no value is placed on the investment in ACL by the board of directors at December 31, 2007.
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The Company acquired an investment in HealthSport, Inc. from ACL. HealthSport is a fully integrated developer, manufacturer and marketer of unique and proprietary branded and private label edible film strip nutritional supplements and over-the-counter drugs. The board of directors of the Company valued the 263,500 shares of HealthSport owned at December 31, 2007 at the market closing price of $0.52 per share.
The Company also acquired an interest in three other portfolio companies from ACL, which the board of directors is valuing at $0.
The Company acquired 240,000 shares of HealthSport in May 2007 in exchange for its 8% promissory note payable in the amount of $535,200. In September 2007, both parties agreed to rescind the transaction. The Company returned the shares to the note holder and the note was returned to the Company and cancelled.
NOTE 4: CAPITAL STRUCTURE
Merger Effective September 30, 2006, Photonics Corporation, a California corporation, merged into Small Cap Strategies, Inc., a Nevada corporation, with SCPS being the surviving entity. The effect of this corporate action was to change the Company's state of incorporation from the State of California to the State of Nevada and to increase the number of shares of common stock authorized from 200,000,000 to 2,000,000,000. All common shares of Photonics were exchanged on a one-for-one basis for stock in SCPS. Photonics also had 50,000,000 shares of $.001 par value preferred stock authorized, of which 400,000 shares had been designated Series A Convertible Preferred Stock. At September 30, 2006, immediately prior to the merger, Photonics had no preferred stock issued or outstanding. SCPS did not authorize any preferred stock in its articles of incorporation in Nevada. Accordingly, there is no preferred stock authorized, issued or outstanding after the merger on September 30, 2006. In addition, the shareholders authorized the board of directors to effect a reverse stock split with-in the next twelve months. On December 5, 2006, the board of directors authorized a reverse stock split of one share for each twenty shares outstanding, to be effective December 21, 2006. On May 15, 2007, the board of directors authorized a second reverse stock split of one share for each twenty shares outstanding, to be effective the date filed with the Nevada Secretary of State, May 21, 2007. Accordingly, all share transactions and disclosures have been restated as if the reverse stock split occurred before all periods presented.
Common Stock The Company is now authorized to issue 100,000,000 shares of common stock with a par value of $.001 and each share having one voting right. There are 687,770 and 387,770 common shares outstanding at December 31, 2007 and 2006, respectively.
Preferred Stock As noted above, at September 30, 2006, immediately prior to the merger, Photonics had no preferred stock issued or outstanding. SCPS did not authorize any preferred stock in its articles of incorporation in Nevada. Accordingly, there is no preferred stock authorized, issued or outstanding after the merger on September 30, 2006.
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In April 2001, the Company amended its articles of incorporation to increase the number of preferred stock shares authorized from 6,000,000 shares to 50,000,000 shares, reduced the par value of the preferred stock from $1.00 to $.001 and eliminated its previous rights and preferences.
On October 18, 2001, in connection with the Company's merger with SGI, the Company issued 1,000,000 convertible preferred shares. The shares were convertible into common stock in an amount such that, when added to the common shares already issued to SGI, SGI would own 70% of the outstanding common shares of the Company. No other rights or privileges exist, with respect to these shares. These shares were cancelled on May 8, 2003.
On December 15, 2005, the Company amended its articles of incorporation to designate 400,000 shares of the 50,000,000 shares of preferred stock authorized as Series A Convertible Preferred Stock with a par value of $.001 per share.
Series A Convertible Preferred Stock - prior to September 30, 2006 On December 16, 2005, in connection with the acquisition of ACL Consulting Corporation, the Company issued 400,000 shares of Series A Convertible Preferred Stock (Series A Shares) (as noted above) with a par value of $.001 per share. A 6% distribution per share was payable per annum, at the Company's fiscal year end, on a cumulative basis based upon the specified redemption value of each share of Series A Shares. If any dividend or other distribution was declared on the common stock, each holder of shares of Series A Stock on record on the date of declaration would be entitled to receive the equivalent dividend or other distribution as if the shares had been converted into common stock at the declaration date. All Series A Shares had equal voting rights with common stock. The shares could have been converted, at any time, into shares of common stock as specified by the "conversion ratio" that was in effect at the time of conversion. The initial "conversion ratio" for the entire class of Series A Shares was equal to 12.5% of the total outstanding shares of common stock. The Company had the right, at any time, to call for mandatory redemption of all the Series A Shares at a set redemption price of $1.25 per share.
The Company's Series A Convertible Preferred Stock (here and after referred to as Series A Shares) is redeemable at the option of the holder and therefore falls outside of the scope of Statement on Financial Accounting Standards (SFAS) No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. Accordingly, they are subject to Rule 5-02 of Regulation S-X.
Pursuant to Rule 5-02 of Regulation S-X, the Series A shares are considered mandatorily redeemable and as such would be presented in the balance sheet outside of stockholders' deficit. The initial carrying amount of these shares was recorded at its fair value at the date of issuance, which was determined on a per share basis to equal the value at which these shares were redeemed in January 2006. In addition, the carrying value was increased by the amount of accrued cumulative dividends at December 31, 2005.
At December 31, 2005, $1,315 was accrued as dividends payable on the Company's Series A Shares.
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On January 24, 2006, the Company exercised its redemption right and redeemed 320,000 of the outstanding 400,000 shares at the redemption price of $1.25 per share, totaling $400,000 for which the officer received a cash payment. The remaining 80,000 shares were redeemed through the issuance of a $100,000 note to the officer.
Purchase of the Company's common stock At December 31, 2006, the Company had a stock subscription receivable from Shocker Index 100 LP with a balance of $361,627. The Company had substantial doubt about the ability of Shocker to make payment on the obligation in a reasonable period of time. Accordingly, on March 20, 2007, the Board of Directors of the Company agreed to exchange the Company's note receivable from Shocker, for the return of 113,009 shares of its common stock. The transaction was recorded effective December 31, 2006.
Stock appreciation rights On May 26, 2006, the Shareholders and the Board of Directors approved a plan to provide additional compensation to its executive officers. Each executive officer shall receive a stock appreciation rights contract ("SAR") on each one-year anniversary date of his or her employment with the Company based upon the value of the common stock of the Company using the closing price on the date of the award and the number of shares of common stock which could be purchased for the amount of money paid to such executive employee during the previous 12 months of employment. The SAR contract shall entitle such executive employee to be paid the value, in cash, of the appreciation, if any, of such shares immediately following the two-year anniversary of the granting of each such SAR contract. In the event that any executive officer leaves or terminates his or her employment prior to said two year anniversary of such award, except for cause, the value shall be calculated as of the last date of his or her employment. No executive officer shall have any right to receive any payment under such SAR if terminated for cause. No SARs have been awarded as of December 31, 2007.
NOTE 5: RELATED PARTY TRANSACTIONS
The officers and directors of the Company are involved in other business activities and may, in the future, become involved in other business opportunities as they become available. The officers and directors may face a conflict in selecting between the Company and their other business interests. The Company has not formulated a policy for the resolution of such conflicts.
At December 31, 2005, the Company had received $108,595 in non-interest bearing advances from director/shareholders. During 2006, $35,199 of this amount was repaid. During 2007, the remaining balance of $73,396 was contributed to the Company's capital.
At December 31, 2007, the Company owes its CEO $14,041 in accrued compensation.
On April 18, 2006, the Company issued 169,227 shares of common stock with a par value of $.001 to Shocker, a limited partnership in which ACL owned a 42.9% limited partnership interest at the time, and a related party, for a purchase price of $541,527, based on the Company's net asset value per share. The consideration consisted of $35,381 cash, a $406,146 stock subscription
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receivable, and extinguishment of the Company's $100,000 note payable to Shocker. The note was unsecured with an interest rate of 8% per annum and was payable as Shocker might from time to time designate in writing. The Company received a cash payment of $36,146 in October 2006 and total accrued interest in the amount of $8,373 was also applied to reduce the stock subscription receivable. The stock subscription receivable may be summarized as follows:
Original amount $ 406,146 Cash payment received (36,146) Accrued interest owed Shocker which was offset (8,373) -----------
Stock subscription receivable $ 361,627 ===========
Effective December 31, 2006, the Company exchanged with Shocker, its note receivable with a balance of $361,627 for 113,009 shares of its common stock.
On December 16, 2005, in conjunction with the stock purchase of ACL Consulting Corporation, the Company issued a secured promissory note in the amount of $458,000 to an officer of the Company. Quarterly payments of $114,500 were due on the 1st day of the third month for a period of 360 days, beginning on January 1, 2006. Interest on the note was 6% per annum and payable in full on the maturity date. In accordance with the stock purchase agreement entered into on December 16, 2005 (Note 3), the seller had the right to rescind the purchase agreement and maintain 100% ownership of ACL Consulting Corporation in the event the Company failed to make any required payments pursuant to the terms of this secured promissory note. At December 31, 2005, accrued interest expense payable totaled $1,144. On January 25, 2006, a payment of $458,000 plus accrued interest of $2,931 was made to the officer to retire the note.
On December 16, 2005, in conjunction with the stock purchase of ACL Consulting Corporation, the Company indirectly acquired a majority owned interest in Interim Capital Corp (ICC), the general partner of Shocker, at the time. At December 31, 2005, ACL Consulting Corporation's interest consisted of a 72.35% share of Interim Capital Corporation. On December 31, 2005, a majority of the limited partners removed ICC as general partner and appointed FGT Consultants, Inc., a Texas corporation wholly owned by a former officer of the Company, as general partner.
On June 14, 2006, the Company repaid the $100,000 note issued to a former officer as part of the Series A Convertible Preferred Stock redemption. The note was non-interest bearing until June 1, 2006, at which point interest commenced to accrue on the outstanding principal at a rate of 8% per annum. The officer waived the interest related to the note upon repayment, thus no interest expense was recorded during 2006.
Officer's compensation and director's fees related to the services provided by Bryce Knight, President and Director of the Company, are paid directly to Knight Enterprises, Inc., a Nevada corporation 100% owned by Bryce Knight.
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As of December 31, 2007, the Company has approximately $69,000 of capital loss available to offset future capital gains, which expire through the year 2011.
At December 31, 2007 and 2006, significant components of the Company's deferred tax assets (benefits) are summarized below.
2007 2006 --------- --------- Deferred Tax Assets: Net Capital Loss Carry Forward $ 23,700 $ 33,400 Investments 88,000 (64,200) Tax liability of portfolio company -- 47,500 Less Valuation Allowance (111,700) (16,700) --------- --------- Total deferred tax assets -- --
Deferred Tax Liabilities -- -- --------- ---------
Net Deferred Tax Assets $ -- $ -- ========= =========
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The tax refund of $37,939 from carryback of the 2007 net operating loss to 2006 was received in April 2008.
NOTE 7: STOCK OPTION AND EMPLOYEE BENEFIT PLANS
STOCK OPTION PLANS The Company's stock option plan (the 1997 Stock Option Plan) allows for the issuance of incentive and nonqualified stock options to employees and consultants of the Company. Options granted under the Plan are generally for periods not to exceed ten years and generally must be at prices not less than 100% and 85%, for incentive and nonqualified stock options, respectively, of the estimated fair value of the stock on the date of grant as determined by the Board of Directors. Options granted to shareholders who own greater than 10% of the outstanding stock are established at the estimated fair value of the stock on the date of grant. Stock options granted by the Company to others are primarily for legal and investment banking services. In connection with the Company's acquisition of SGI in 2001, the Company renegotiated the stock options previously granted to former members of management. These options for 21,698 common shares were considered a new grant pursuant to SFAS No. 123(R). These options are fully vested, do not expire and are exercisable at $4.00 per share, the adjusted closing bid price of the Company's common stock on the date of grant. Accordingly, no compensation was charged to income using the intrinsic value method of accounting. These options were granted under the 1997 Stock Option Plan. On February 24, 2004, the Company established the 2004 Stock Plan (the Plan). The plan registers, via an S8 registration statement, up to 2,250 shares of common stock to be issued to qualified recipients. Eligible participants in the Plan shall be such key employees, non-employee directors, and consultants of the Company and its subsidiaries, whether or not members of the Board, as the Committee, in its sole discretion, may designate from time to time. The Committee's designation of a participant in any year shall not require the Committee to designate such person to receive awards in any other year. The designation of a participant to receive an award under one portion of the Plan does not require the Committee to include such participant under other portions of the Plan. The Committee shall consider such factors as it deems pertinent in selecting participants and in determining the types and amounts of their respective awards.
During the year ended December 31, 2005, the Company issued 1,250 shares of common stock, under the 2004 Stock Plan, as payment for $40,000 of legal and consulting services, reducing the shares of common stock available for future awards under the stock plan to 1,000 shares at December 31, 2007 and 2006.
EMPLOYEE BENEFIT PLANS The Company adopted a Shared Savings Plan (the SSP) covering substantially all of its employees. The SSP allows employees to defer from 2% to 12% of their compensation to the maximum amount permitted by law. Employee and Company contributions are considered tax deferred under Section 401(k) of the Internal
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Revenue Code. Under the terms of the SSP, the Company can contribute, on a quarterly basis, shares of its common stock to each employee's account equal in value to 40% of the employee's contributions, limited, however to $2,000 or 6% of compensation per calendar year, whichever is less. The Company's contributions vest at the rate of 25% for each full year of service, as defined, but become 100% vested upon normal retirement, disability or death. Neither the Company nor any of its employees have made any contributions to this plan.
EXECUTIVE PROFIT SHARING
On May 26, 2006, the Shareholders and Board of Directors approved a profit sharing plan for its executive officers. The Company will pay each executive officer a bonus pursuant to the following cash-distribution profit sharing plan, payable on a quarterly basis.
1. At the end of each quarter, a profit sharing pool will be determined based on the Company's performance during that quarter and calculated to be twenty percent (20%) of the net profits achieved during that quarter. 2. The sum to be paid to each executive officer shall equal his or her proportional percentage of the total base salaries paid to all executive officers during the quarter multiplied by the amount of the profit sharing pool and shall be paid with all mandatory deductions, including Federal withholding calculated at the flat IRS bonus rate of 27%. 3. This plan is a cash-distribution plan and is not intended as nor should it be treated as a deferred compensation plan. The Company will not take any steps to cause the profit-sharing plan described in this section to comply with the Employee Retirement Income Security Act of 1974 or any provision of the Internal Revenue Code of 1986 nor will the Company seek any tax-advantaged treatment of the payments made pursuant to the profit-sharing plan.
None of the above may be used or interpreted in any manner inconsistent with the Investment Company Act of 1940 and any limitations imposed by such Act or the rules and regulations promulgated thereunder shall govern and control this additional compensation.
Compensation in the amount of $43,597 was due from the profit sharing plan for 2007 to the Chief Executive Officer, Mr. Knight.
NOTE 8: COMMITMENTS AND CONTINGENCIES
Leases The Company currently maintains its corporate office at 3651 Lindell Road, Suite D#146, Las Vegas, Nevada 89103 on a month-to-month basis. Our chief executive officer is providing the space at no cost.
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ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T):
ITEM 9A(T): CONTROLS AND PROCEDURES
1. Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2007 (the "Evaluation Date"). Based upon that evaluation, the chief executive officer concluded that, as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms and (ii) is accumulated and communicated to our management, including its chief executive officer, as appropriate to allow timely decisions regarding required disclosure.
2. Internal Control over Financial Reporting
(a) Management's Annual Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by the SEC, internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company's principal executive and principal financial officers and effected by the Company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company's internal control over financial reporting is supported by written policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company's assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company's management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
The Company's internal control system was designed to provide reasonable assurance to the Company's management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations which may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to
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financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management conducted an evaluation of the effectiveness of the Company's internal control over financial reporting as of December 31, 2007. In making this assessment, management used the framework set forth in the report entitled "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a company's internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on this evaluation, management concluded that the Company's internal control over financial reporting was not effective as of December 31, 2007, primarily due to a lack of segregation of duties.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permits us to provide only management's report in this annual report.
(b) Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) identified in connection with the evaluation required by Rules 13a-15(d) or 15d-15(d) that occurred during the fiscal quarter ended December 31, 2007 that has materially affected, or is likely to materially affect, our internal control over financial reporting.
ITEM 9B:
ITEM 9B: OTHER INFORMATION
None.
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PART III
ITEM 10:
ITEM 10: DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table includes the names, ages and positions of our directors and executive officers as of December 31, 2007. There are no family relationships between the officer and directors. A summary of the background and experience of each of these individuals immediately follows the table.
NAME AGE POSITION OFFICER OR DIRECTOR SINCE - --------------------------------------------------------------------------------
Bryce Knight 24 President, CEO, CFO 2005 and Director
Paul Johnson 59 Director 2005
Joel Holt 77 Director 2006
Bryce Knight serves as President, CEO, CFO and Director of the Company. Mr. Knight also served as Vice-President and Chief Financial Officer of Global Beverage Solutions, Inc. (OTCBB: GBVS) until February 23, 2007. He is the President of Knight Enterprises, Inc. and Knight Consulting Corporation, corporate strategy and financial consulting firms, as well. Previously Mr. Knight worked with General Electric as a financial analyst for its consumer products division and with Robert Bosch Tool Corporation in the marketing department. Mr. Knight graduated with honors from Bellarmine University with a Business Administration degree and a Master's of Business Administration.
Paul Johnson serves as a Director for the Company. He specializes in designing and directing the implementation of new and innovative business strategies and in recruiting the best talent to develop and grow businesses. Over the past 20 years his companies have created major innovations in rapid business development strategies, knowledge management, and software interface design.
Mr. Johnson is President of Homeland Safety International and is responsible for the strategic planning and business development for the Company. In addition, he serves as an executive consultant to several developing companies in the Dallas/Ft. Worth, Texas area. Mr. Johnson is an active participant in strategic planning and business development in each of these companies. Over the past 15 years he has founded seven technology-related companies, the largest of which was Multimedia Learning, Inc. (ranked 154th on the "Inc. 500" in 1996). From 1991-1998, Mr. Johnson served as CEO of Multimedia Learning, Inc. Mr. Johnson is a graduate of City College of New York and is a veteran of the Vietnam war.
Joel Holt serves as a Director for the Company. He holds a B.S. degree from the Medical College of Virginia in both Physical Therapy and Biology. He served in various and progressively more responsible sales and marketing positions for Proctor and Gamble Company for 35 years. In 1987, he was instrumental in the
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formation of Keystone Laboratories, Inc., a forensic drug-testing laboratory, where he served as President for 12 years.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act requires our officers and directors, and persons who own more than 10% of a registered class of our equity securities, to file reports of ownership and change in ownership with the SEC. Our officers, directors and greater than 10% stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. We believe our directors did not make their Form 3 filings when they became directors and the Form 5's for the three directors were filed late.
CODE OF ETHICS
SCPS has adopted a code of ethics for its officers and directors, which is attached as Exhibit 14 to the March 31, 2007 Form 10-Q.
AUDIT COMMITTEE
On March 6, 2006 the Company formerly chartered an audit committee to provide guidance and direction in matters relating to the accounting of the Corporation and review and preparation of independent accounting statements and other matters relating to financial accounting all for the best governance of the Corporation.
The Audit Committee is comprised of two members, Joel Holt and Paul Johnson, both of whom are independent directors of the Company. The Company has determined that Joel Holt qualifies as the Audit Committee Financial Expert.
The Audit Committee has received and discussed the audited financial statements with management; has discussed with the independent auditors the matters required to be discussed by the statement on Auditing Standards No. 61, as amended; has received the written disclosure and the letter from the independent accountants required by Independence Standards Board Standard No. 1 and has discussed with the independent accountant the independent accountant's independence; and based on the forgoing reviews and discussions, has recommended to the board of directors that the audited financial statements be included in the Company's annual report on Form 10-K.
NOMINATING COMMITTEE
Our independent directors serve as the nominating committee.
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(a) The bonus to Mr. Knight includes $29,556 which was paid and $14,041 which was accrued pursuant to the executive profit sharing plan.
Mr. Knight's compensation is paid to Knight Enterprises, Inc., which is wholly owned by Mr. Knight.
Required columns for bonus, stock awards, option awards, non-entity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings and all other compensation are omitted from the table above as the amounts are all zero.
Narrative discussion of compensation
Compensation for our officers and directors is based on comparative compensation levels for similar positions and time.
The Company does not have any current employment agreements with its officers and directors. The company intends to pay its Executives and Directors salaries, wages, or fees commensurate with experience and industry standards in relationship to the success of the company.
Stock appreciation rights On May 26, 2006, the Shareholders and the Board of Directors approved a plan to provide additional compensation to its executive officers. Each executive officer shall receive a stock appreciation rights contract ("SAR") on each one-year anniversary date of his or her employment with the Company based upon the value of our common stock using the closing price on the date of the award and the number of shares of common stock which could be purchased for the amount
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of money paid to such executive employee during the previous 12 months of employment. The SAR contract shall entitle such executive employee to be paid the value, in cash, of the appreciation, if any, of such shares immediately following the two-year anniversary of the granting of each such SAR contract. In the event that any executive officer leaves or terminates his or her employment prior to said two year anniversary of such award, except for cause, the value shall be calculated as of the last date of his or her employment. No executive officer shall have any right to receive any payment under such SAR if terminated for cause. No SARs have been awarded as of December 31, 2007.
Executive profit sharing
On May 26, 2006, the Shareholders and Board of Directors approved a profit sharing plan for its executive officers. The Company will pay each executive officer a bonus pursuant to the following cash-distribution profit sharing plan, payable on a quarterly basis.
1. At the end of each quarter, a profit sharing pool will be determined based on the Company's performance during that quarter and calculated to be twenty percent (20%) of the net profits achieved during that quarter. 2. The sum to be paid to each executive officer shall equal his or her proportional percentage of the total base salaries paid to all executive officers during the quarter multiplied by the amount of the profit sharing pool and shall be paid with all mandatory deductions, including Federal withholding calculated at the flat IRS bonus rate of 27%. 3. This plan is a cash-distribution plan and is not intended as nor should it be treated as a deferred compensation plan. The Company will not take any steps to cause the profit-sharing plan described in this section to comply with the Employee Retirement Income Security Act of 1974 or any provision of the Internal Revenue Code of 1986 nor will the Company seek any tax-advantaged treatment of the payments made pursuant to the profit-sharing plan.
None of the above may be used or interpreted in any manner inconsistent with the Investment Company Act of 1940 and any limitations imposed by such Act or the rules and regulations promulgated thereunder shall govern and control this additional compensation.
Compensation in the amount of $43,597 was due Mr. Knight from the profit sharing plan for 2007.
(b) Grants of plan-based awards table
There were no grants of plan-based awards during the year for the named individuals.
(c) Outstanding equity awards at fiscal year-end table
There were no outstanding equity awards at fiscal year-end for the named individuals.
(d) Option exercises and stock vested table
There were no option exercises during the year and no stock vested at fiscal year-end for the named individuals.
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(e) Pension benefits
There are no pension plans.
(f) Nonqualified defined contribution and other nonqualified deferred compensation plans
There are no nonqualified defined contribution or other nonqualified deferred compensation plans.
(g) Potential payments upon termination or change-in-control
There are no potential payments upon termination or change-in-control for the named individuals.
(h) Compensation of directors
Directors Fee Earned or Paid Name In Cash ($) - ---- -----------
Paul Johnson $ 1,000
Joel Holt $ 1,000
Director compensation paid to executive officers is included in the summary compensation table above.
Directors, including executive officers, are compensated $1,000 for each meeting during the year. There was one meeting during 2007.
The columns for stock awards, option awards, non-equity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings and all other compensation are omitted as there was no other form of compensation for the directors.
(i) Compensation committee interlocks and insider participation
The outside directors serve as the compensation committee.
(j) Compensation committee report
Based on the compensation discussion and analysis required by Item 402(b) between the compensation committee and management, the compensation committee recommended to the Board of Directors that the compensation discussion and analysis be included in the 10-K, see Item 11(a) above.
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ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth, as of December 31, 2007, certain information concerning the beneficial ownership of each class of our voting stock held by:
- each beneficial owner of 5% or more of our voting stock, based on reports filed with the SEC and certain other information;
- each of our directors;
- each of our executive officers; and
- all of our executive officers and directors as a group.
There were 687,770 shares of our common stock issued and outstanding at December 31, 2007.
NAME AND ADDRESS (1) COMMON (2) % COMMON -------------------- ---------- --------
Shocker 100 Index LP 56,219 8.2%
Bryce Knight 300,000 43.6%
Paul Johnson - -
Joel Holt - -
Officers and Directors as a group 300,000 43.6%
(1) The address of all parties listed is C/O Small Cap Strategies, Inc., 3651 Lindell Road, Suite D#146, Las Vegas, Nevada 89103.
(2) Unless otherwise indicated, we believe that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them. A person is deemed to be the beneficial owner of securities which may be acquired by such person within 60 days from the date on which beneficial ownership is to be determined upon the exercise of options, warrants or convertible securities. Shares are as of December 31, 2007.
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ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The officers and directors of the Company are involved in other business activities and may, in the future, become involved in other business opportunities as they become available. The officers and directors may face a conflict in selecting between the Company and their other business interests. The Company has not formulated a policy for the resolution of such conflicts.
At December 31, 2005, the Company had received $108,595 in non-interest bearing advances from director/shareholders. During 2006, $35,199 of this amount was repaid. During 2007, the remaining balance of $73,396 was contributed to the Company's capital.
At December 31, 2007, the Company owes its CEO $14,041 in accrued compensation.
On April 18, 2006, the Company issued 169,227 shares of common stock with a par value of $.001 to Shocker, a limited partnership in which ACL owned a 42.9% limited partnership interest at the time, and a related party, for a purchase price of $541,527, based on the Company's net asset value per share. The consideration consisted of $35,381 cash, a $406,146 stock subscription receivable, and extinguishment of the Company's $100,000 note payable to Shocker. The note was unsecured with an interest rate of 8% per annum and was payable as Shocker might from time to time designate in writing. The Company received a cash payment of $36,146 in October 2006 and total accrued interest in the amount of $8,373 was also applied to reduce the stock subscription receivable. The balance of the stock subscription receivable of $361,627 was exchanged with Shocker for 113,009 shares of our common stock effective December 31, 2006.
On December 16, 2005, in conjunction with the stock purchase of ACL, the Company issued a secured promissory note in the amount of $458,000 to an officer of the Company. Quarterly payments of $114,500 were due commencing on the 1st day of the third month for a period of 360 days, beginning on January 1, 2006. Interest on the note was 6% per annum and payable in full on the maturity date. On January 25, 2006, a payment of $458,000 plus accrued interest of $2,931 was made to the officer to retire the note.
On December 16, 2005, in conjunction with the stock purchase of ACL, the Company indirectly acquired a majority interest in Interim Capital Corp (ICC). On March 30, 2006, the Company's Board of Directors approved the sale of ACL's interest in ICC. The Company entered into a Stock Purchase Agreement with Shocker 200 Index, LP, a related party through a common director, on March 31, 2006. $76,000 was exchanged in consideration for 7,600,000 shares of ICC, representing 72.35% of ICC's outstanding common stock.
On June 14, 2006, the Company repaid the $100,000 note issued to an officer as part of the Series A Convertible Preferred Stock redemption. The note was non-interest bearing until June 1, 2006, at which point interest commenced to accrue on the outstanding principal at a rate of 8% per annum. The officer waived the interest related to the note upon repayment, thus no interest expense was recorded during the nine months ended September 30, 2006.
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Officer's compensation and director's fees related to the services provided by Bryce Knight, President and Director of the Company, are paid directly to Knight Enterprises, Inc., a Nevada corporation 100% owned by Bryce Knight.
ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees. The aggregate fees billed for professional services rendered by our current principal accountants for the audit of our annual financial statements and review of our quarterly financial statements were $11,756 and $49,032 for the years ended December 31, 2007 and 2006, respectively, including billings received through January 31, 2008. The 2007 amount includes only the quarterly reviews.
Audit-Related Fees: None
Tax Fees - None by current auditor.
All Other Fees - None.
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PART IV
ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
1. Financial Statements - The following financial statements of Small Cap Strategies, Inc. are contained in Item 8 of this Form 10-K:
o Report of Independent Registered Public Accountant o Statements of Net Assets at December 31, 2007 and 2006 o Statements of Operations - For the fiscal years ended December 31, 2007, 2006 and 2005 o Statements of Cash Flows - For the fiscal years ended December 31, 2007, 2006 and 2005 o Statements of Changes in Net Assets - For the fiscal years ended December 31, 2007, 2006 and 2005 o Schedule of Investments - At December 31, 2007 and 2006 o Notes to the Financial Statements o Financial Highlights - For the fiscal years ended December 31, 2007, 2006 and 2005
2. Financial Statement Schedules were omitted, as they are not required or are not applicable, or the required information is included in the Financial Statements.
3. Exhibits - The following exhibits are filed with this report or are incorporated herein by reference to a prior filing, in accordance with Rule 12b-32 under the Securities Exchange Act of 1934.
Exhibit Description - ------- -----------
31.1 Certificate of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1 Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
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SIGNATURE
Pursuant to the requirements of Section 3 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DATE: April 14, 2008 SMALL CAP STRATEGIES, INC.
/s/ Bryce Knight ---------------- Bryce Knight President, Chief Executive Officer and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
DATE SIGNATURE/TITLE
April 14, 2008 /s/ Bryce Knight -------------------------- Bryce Knight President, Chief Executive Officer, Chief Financial Officer and Director
April 14, 2008 /s/ Paul Johnson -------------------------- Paul Johnson Director
April 14, 2008 /s/ Joel Holt ----------------------------------- Joel Holt Director
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ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth, as of December 31, 2007, certain information concerning the beneficial ownership of each class of our voting stock held by:
- each beneficial owner of 5% or more of our voting stock, based on reports filed with the SEC and certain other information;
- each of our directors;
- each of our executive officers; and
- all of our executive officers and directors as a group.
There were 687,770 shares of our common stock issued and outstanding at December 31, 2007.
NAME AND ADDRESS (1) COMMON (2) % COMMON -------------------- ---------- --------
Shocker 100 Index LP 56,219 8.2%
Bryce Knight 300,000 43.6%
Paul Johnson - -
Joel Holt - -
Officers and Directors as a group 300,000 43.6%
(1) The address of all parties listed is C/O Small Cap Strategies, Inc., 3651 Lindell Road, Suite D#146, Las Vegas, Nevada 89103.
(2) Unless otherwise indicated, we believe that all persons named in the table have sole voting and investment power with respect to all shares of common stock beneficially owned by them. A person is deemed to be the beneficial owner of securities which may be acquired by such person within 60 days from the date on which beneficial ownership is to be determined upon the exercise of options, warrants or convertible securities. Shares are as of December 31, 2007.
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ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The officers and directors of the Company are involved in other business activities and may, in the future, become involved in other business opportunities as they become available. The officers and directors may face a conflict in selecting between the Company and their other business interests. The Company has not formulated a policy for the resolution of such conflicts.
At December 31, 2005, the Company had received $108,595 in non-interest bearing advances from director/shareholders. During 2006, $35,199 of this amount was repaid. During 2007, the remaining balance of $73,396 was contributed to the Company's capital.
At December 31, 2007, the Company owes its CEO $14,041 in accrued compensation.
On April 18, 2006, the Company issued 169,227 shares of common stock with a par value of $.001 to Shocker, a limited partnership in which ACL owned a 42.9% limited partnership interest at the time, and a related party, for a purchase price of $541,527, based on the Company's net asset value per share. The consideration consisted of $35,381 cash, a $406,146 stock subscription receivable, and extinguishment of the Company's $100,000 note payable to Shocker. The note was unsecured with an interest rate of 8% per annum and was payable as Shocker might from time to time designate in writing. The Company received a cash payment of $36,146 in October 2006 and total accrued interest in the amount of $8,373 was also applied to reduce the stock subscription receivable. The balance of the stock subscription receivable of $361,627 was exchanged with Shocker for 113,009 shares of our common stock effective December 31, 2006.
On December 16, 2005, in conjunction with the stock purchase of ACL, the Company issued a secured promissory note in the amount of $458,000 to an officer of the Company. Quarterly payments of $114,500 were due commencing on the 1st day of the third month for a period of 360 days, beginning on January 1, 2006. Interest on the note was 6% per annum and payable in full on the maturity date. On January 25, 2006, a payment of $458,000 plus accrued interest of $2,931 was made to the officer to retire the note.
On December 16, 2005, in conjunction with the stock purchase of ACL, the Company indirectly acquired a majority interest in Interim Capital Corp (ICC). On March 30, 2006, the Company's Board of Directors approved the sale of ACL's interest in ICC. The Company entered into a Stock Purchase Agreement with Shocker 200 Index, LP, a related party through a common director, on March 31, 2006. $76,000 was exchanged in consideration for 7,600,000 shares of ICC, representing 72.35% of ICC's outstanding common stock.
On June 14, 2006, the Company repaid the $100,000 note issued to an officer as part of the Series A Convertible Preferred Stock redemption. The note was non-interest bearing until June 1, 2006, at which point interest commenced to accrue on the outstanding principal at a rate of 8% per annum. The officer waived the interest related to the note upon repayment, thus no interest expense was recorded during the nine months ended September 30, 2006.
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Officer's compensation and director's fees related to the services provided by Bryce Knight, President and Director of the Company, are paid directly to Knight Enterprises, Inc., a Nevada corporation 100% owned by Bryce Knight.
ITEM 14:
ITEM 14: PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees. The aggregate fees billed for professional services rendered by our current principal accountants for the audit of our annual financial statements and review of our quarterly financial statements were $11,756 and $49,032 for the years ended December 31, 2007 and 2006, respectively, including billings received through January 31, 2008. The 2007 amount includes only the quarterly reviews.
Audit-Related Fees: None
Tax Fees - None by current auditor.
All Other Fees - None.
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PART IV
ITEM 15:
ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this report:
1. Financial Statements - The following financial statements of Small Cap Strategies, Inc. are contained in Item 8 of this Form 10-K:
o Report of Independent Registered Public Accountant o Statements of Net Assets at December 31, 2007 and 2006 o Statements of Operations - For the fiscal years ended December 31, 2007, 2006 and 2005 o Statements of Cash Flows - For the fiscal years ended December 31, 2007, 2006 and 2005 o Statements of Changes in Net Assets - For the fiscal years ended December 31, 2007, 2006 and 2005 o Schedule of Investments - At December 31, 2007 and 2006 o Notes to the Financial Statements o Financial Highlights - For the fiscal years ended December 31, 2007, 2006 and 2005
2. Financial Statement Schedules were omitted, as they are not required or are not applicable, or the required information is included in the Financial Statements.
3. Exhibits - The following exhibits are filed with this report or are incorporated herein by reference to a prior filing, in accordance with Rule 12b-32 under the Securities Exchange Act of 1934.
Exhibit Description - ------- -----------
31.1 Certificate of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1 Certificate of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
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SIGNATURE
Pursuant to the requirements of Section 3 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DATE: April 14, 2008 SMALL CAP STRATEGIES, INC.
/s/ Bryce Knight ---------------- Bryce Knight President, Chief Executive Officer and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
DATE SIGNATURE/TITLE
April 14, 2008 /s/ Bryce Knight -------------------------- Bryce Knight President, Chief Executive Officer, Chief Financial Officer and Director
April 14, 2008 /s/ Paul Johnson -------------------------- Paul Johnson Director
April 14, 2008 /s/ Joel Holt ----------------------------------- Joel Holt Director
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