WATERSIDE CAPITAL CORPORATION
2000 Annual Report
1
Table of Contents
Letter to Stockholders............................... 3
Five-Year Summary of Selected
Financial Data ..................................... 4
Management's Discussion And Analysis................. 5
Independent Auditors' Report......................... 10
Financial Statements................................. 11
Corporate Information................................ Inside Back Cover
2
Waterside Capital Corporation
A Small Business Investment Company
Letter to Stockholders
Fiscal 2000 proved to be a very successful year of operation, with quality
controlled growth, continued diversification of the investment portfolio, and
current-pay investment origination. Our original business plan has not
changed, and we are generating strong net operating income from current pay
investments.
We originated $16.9 million in new financings during Fiscal 2000, compared
with $18.5 million during Fiscal 1999. We currently have investments in twen-
ty-five portfolio companies, compared with twenty the previous year. Of these
twenty-five portfolio companies, three are publicly traded, and twenty-two are
privately held. As we discussed in our various quarterly reporting over the
year, the publicly traded companies experienced extreme volatility in the mar-
ket place with the significant market adjustment that materialized during the
March--April timeframe.
Our net operating income increased from $1.0 million for Fiscal 1999 to $1.4
million for Fiscal 2000, representing a 34% increase. On a per-share basis,
net operating income was $.66 per share for Fiscal 1999 and $.88 per share for
Fiscal 2000.
We continued with our disappointment during 2000 with a stock price that we do
not believe reflects the true value of our company, given our earnings growth
and potential. We continue to believe that market perceptions and valuations
often tend to lag underlying realities and true valuations especially in small
capitalization stocks. We experienced significant improvement in our net asset
value per common share, increasing from $8.90 at June 30, 1999, to $10.65 at
June 30, 2000. This 20% improvement in net asset value per share was due to a
combination of earnings and the repayment of the stockholders' notes receiv-
able. With our current operating performance and growth potential we believe
total returns can improve dramatically.
For Fiscal 2001 we will continue the course currently established with quali-
ty, controlled growth, and improved operating efficiency. We will again con-
tinue diversification of the investment portfolio and emphasize current pay
investment origination. Our top priority will be to continue to leverage our
return on equity, which should equate to a positive driver for our stock mar-
ket valuation.
It has been a very good year at Waterside Capital. We are grateful for the
loyalty of our staff and their dedication to the achievement of our goals. On
behalf of all directors, managers and employees, we thank you for your contin-
ued support.
/s/ J. Alan Lindauer
J. Alan Lindauer
President & CEO
300 East Main Street . Suite 1380 . Norfolk, Virginia 23510
(757) 626-1111 . (757) 626-0114 Fax . E-mail to
waterside@watersidecapital.com
NASDAQ Symbol WSCC
3
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
Year Ended June 30,
-----------------------------------------------------
1996(1) 1997 1998 1999 2000
------- -------- ---------- ---------- ----------
Summary of Earnings
Information:
Operating income:
Dividends.............. $ -- $ 51,425 $ 299,080 $1,071,899 $2,189,862
Interest on debt
securities............ -- 9,430 24,290 717,437 1,009,744
Interest on cash
equivalents........... 42,262 166,573 211,440 160,899 37,203
Fee and other income... 17,255 37,450 271,714 947,013 677,205
------- -------- ---------- ---------- ----------
Total operating
income............... 59,517 264,878 806,524 2,897,238 3,914,014
Operating expenses:
Interest expense....... -- -- -- 417,605 1,224,066
Other.................. 59,777 214,667 635,519 1,387,525 1,645,318
------- -------- ---------- ---------- ----------
Net operating income
(loss) before income
taxes................ (260) 50,211 171,005 1,092,108 1,044,630
Income tax expense
(benefit).............. (7,346) (12,370) (47,220) 51,000 (352,000)
------- -------- ---------- ---------- ----------
Net operating income... 7,086 62,581 218,225 1,041,108 1,396,630
Realized gain on
investments, net of
income taxes (2)....... -- -- -- 234,312 1,426,474
Change in unrealized
appreciation
(depreciation) on
investments, net of
income taxes (3)....... -- 211,700 325,110 (238,376) (1,514,791)
------- -------- ---------- ---------- ----------
Net increase in
stockholders' equity
resulting from
operations........... $ 7,086 $274,281 $ 543,335 $1,037,044 $1,308,313
======= ======== ========== ========== ==========
Net operating income per
share-basic and
diluted................ $ 0.86 $ 0.10 $ 0.22 $ 0.66 $ 0.88
Net increase in
stockholders' equity
resulting from
operations per share--
basic and diluted...... $ 0.86 $ 0.44 $ 0.54 $ 0.66 $ 0.83
Weighted average number
of shares outstanding.. 8,220 625,636 1,013,094 1,581,430 1,581,430
At June 30,
------------------------------------------------------------
1996(1) 1997 1998 1999 2000
---------- ---------- ----------- ----------- -----------
Balance Sheet
Information:
Investments in portfolio
companies, at fair
value (4):
Equity securities...... $ -- $1,142,410 $ 6,724,337 $17,070,782 $23,237,050
Debt securities........ -- -- 1,575,264 6,894,468 8,877,766
Options and warrants... -- 388,890 206,624 377,000 3,752,744
---------- ---------- ----------- ----------- -----------
Total investments..... -- 1,481,300 8,506,225 24,342,250 35,867,560
Cash and cash
equivalents............ 3,595,766 2,329,148 4,393,501 1,269,409 118,314
Total assets............ 3,655,018 3,963,648 13,374,729 27,109,870 39,098,743
Debentures payable...... -- -- -- 12,300,000 19,300,000
Total stockholders'
equity................. 3,512,636 3,856,417 13,034,288(5) 14,071,269 16,834,391
- -------
(1) Through June 30, 1996, the Company operated as a development stage enter-
prise. The Company made its first portfolio investment during the year
ended June 30, 1997.
(2) Amount presented net of income tax expense of $144,000 for 1999 and
$873,000 for 2000.
(3) Amounts have been presented net of deferred income tax expense (benefit)
of $129,600, $198,920, ($145,000) and ($926,000), respectively , for the
years ended June 30, 1997, 1998, 1999, and 2000.
(4) The Company's portfolio investments are presented at fair value, as deter-
mined by the Executive Committee of the Board of Directors, using the
Model Valuation Policy as published by the Small Business Administration
(SBA).
The valuation policy includes estimates made by management in the absence
of readily ascertainable market values. These estimated values may differ
from those that would have been used had a ready market for the securities
existed. See the Notes to the Company's Financial Statements included else-
where herein. The cost of the portfolio investments was $1,140,000,
$7,640,893, $23,860,295, and $37,826,396 at June 30, 1997, 1998, 1999 and
2000, respectively.
(5) In January 1998, the Company completed an initial public offering of
852,000 shares of common stock at $11 per share. The net proceeds for the
offering , after $1,288,464 of expenses, were $8,083,536.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following analysis of the financial condition and results of operations
of the Company should be read in conjunction with the Company's fiscal year
2000 financial statements and the notes thereto and the other information in-
cluded elsewhere in this report. Because of the very limited operating results
and history of the Company there can be no assurance that the Company's his-
torical financial performance is indicative of its future results of opera-
tions.
General
Waterside Capital Corporation ("Waterside" or the "Company") is a specialty
finance company headquartered in Norfolk, Virginia. The Company invests in eq-
uity and debt securities to finance the growth, expansion and modernization of
small private businesses, primarily in the Mid-Atlantic Region. The Company
was formed in 1993 as the Eastern Virginia Small Business Investment Corpora-
tion. Through June 30, 1996, the Company operated as a development stage com-
pany focused primarily on preparation to commence operation. The Company was
licensed in 1996 by the Small Business Administration (SBA) as a Small Busi-
ness Investment Company (SBIC) under the Small Business Investment Act of
1958. In October 1996, the Company made its first portfolio investment. In
January 1998, the Company completed its Initial Public Offering (IPO) to raise
additional equity to support its growth strategy.
The majority of the Company's operating income is derived from dividend and
interest income on portfolio investments and application and processing fees
related to investment originations. The remaining portion of the Company's op-
erating income comes from interest earned on cash equivalents. The Company's
operating expenses primarily consist of payroll, interest expense on SBA de-
bentures and the Company's lines of credit and other expenses incidental to
the operation. Waterside currently has 7 full time employees and 2 offices
from which it operates: Norfolk and Reston, Virginia.
Portfolio Composition
The Company's primary business is investing in and lending to privately
owned businesses through investments in subordinated debt, preferred stock and
common stock. Substantially all of the Company's investments in subordinated
debt securities and preferred stock also include detachable warrants or con-
version features. The portfolio composition at June 30, 2000 and 1999 is shown
in the following table at fair value:
June 30,
-----------------------------
1999 2000 1999 2000
% % $ $
----- ----- ------- -------
Subordinated debt............................ 28.3% 24.8% $ 6,894 $ 8,878
Preferred stock.............................. 66.3 63.7 16,146 22,863
Common stock warrants........................ 1.6 10.5 377 3,753
Common stock................................. 3.8 1.0 925 374
----- ----- ------- -------
Total...................................... 100.0% 100.0% $24,342 $35,868
======= =======
The weighted average effective yield on the investment portfolio was 11.21%
at June 30, 2000 and 11.26% at June 30, 1999.
The following tables show the Portfolio Composition by geographic region and
industry grouping:
June 30,
----------
1999 2000
Geographic region ---- ----
Mid Atlantic.............................................. 66% 57%
Southeast................................................. 9 15
Midwest................................................... 16 12
Northeast................................................. 7 12
West...................................................... 2 4
--- ---
Total.................................................... 100% 100%
5
June 30,
----------
1999 2000
Industry ---- ----
Manufacturing........................................... 25% 27%
Business Services....................................... 44 22
Information Technologies................................ 2 16
Telecommunications...................................... 15 11
Education............................................... 7 5
Other................................................... 7 19
--- ---
Total.................................................. 100% 100%
Management intends to continue to diversify the portfolio and will explore
new investment opportunities in a variety of industries as market conditions
permit.
Results of Operations
2000 Compared to 1999
For the year ended June 30, 2000, total operating income was $3.9 million
compared to the $2.9 million generated during the same period of fiscal 1999.
The increase in total operating income is due to increased dividends and in-
terest income as a result of the growth in the company's investment portfolio.
The 2000 operating income consisted of dividends of $2.2 million, interest on
debt securities of $1.0 million, fee and other income of $677,000 and interest
on cash equivalents of $37,000.
Total operating expenses for the year ended June 30, 2000, were $2.9 mil-
lion, an increase of $1.1 million or 61.1% from the $1.8 million for fiscal
1999. The increase in operating expenses is primarily attributable to an ap-
proximate $800 thousand increase in interest expense due to additional
borrowings necessary to fund the growth in the investment portfolio. The re-
mainder of the increase is attributable to other expenses necessary to support
the growth in the investment portfolio such as legal and travel. Total operat-
ing expenses (excluding interest expense) as a percentage of total operating
revenue declined to 42% for fiscal 2000 from 48% in the previous year.
Net operating income for the year 2000 was $1.4 million, which compared fa-
vorably to the $1.0 million generated during fiscal 1999 for the reasons dis-
cussed above.
The realized gain on investments, net of income taxes, of $1.4 million for
the year ended June 30, 2000 was primarily due to the sale of a significant
block of stock in one of the publicly held securities (The Netplex Group,
Inc.). This significant gain was partially offset by a realized loss of $527
thousand in one of our privately held companies.
The decrease in unrealized appreciation / depreciation on investments, net
of taxes was $1.5 million for the year ended June 30, 2000 as compared to $238
thousand for the year ended June 30, 1999. The decrease of $1.5 million, net
of taxes for the year ended June 30, 2000 was due to a combination of the neg-
ative impact of the weakness in the high tech sector of the stock market be-
tween March and June, 2000 causing an unrealized decline in the value of the
company's publicly traded investments as well as a write down in two portfolio
companies who had operational performance below expectations and had not made
the required dividend payments to the Company on a timely basis. The decrease
in unrealized appreciation on investments, net of taxes, of $238 thousand for
the year ended June 30, 1999 was due primarily to the changing stock price of
two publicly traded portfolio companies.
The company issued a 6% stock dividend during the quarter ended March 31,
2000.
1999 Compared to 1998
Due to the successful completion of its IPO in January 1998 and the
Company's initiation of its growth strategy using the proceeds from its IPO,
results from the year ended June 30, 1999 do not offer a meaningful comparison
with the performance for the year ended June 30, 1998.
6
For the year ended June 30, 1999 total operating income was $2.9 million
compared to the $807 thousand generated during the same period of 1998. The
increase in operating income is due to increased dividends and interest income
as a result of the growth in the Company's investment portfolio. The 1999 op-
erating income consisted of dividends of $1.1 million, fee and other income of
$947 thousand, interest on debt securities of $717 thousand, and interest on
cash equivalents of $161 thousand.
Total operating expenses for the year ended June 30, 1999, were $1.8 mil-
lion, consisting primarily of salary and benefits of $914 thousand, interest
expense on SBA borrowings of $418 thousand, legal and accounting expenses of
$122 thousand, and other operating expenses of $352 thousand. These total op-
erating expenses compared to the $636 thousand expended during 1998. Net oper-
ating income of $1.0 million for the year ended June 30, 1999 compared favor-
ably to the $218 thousand generated during 1998.
The realized appreciation on investments, net of taxes, of $234 thousand for
the year ended June 30, 1999 was due to the sale of our equity investments in
four private companies. There were no realized gains during 1998. The decrease
in unrealized appreciation on investments, net of taxes, of $238 thousand for
the year ended June 30, 1999, was due primarily to the changing stock price of
two publicly traded portfolio companies. The increase in unrealized apprecia-
tion on investments, net of taxes, was $325 thousand for the year 1998, due
primarily to the changing stock price of our publicly traded portfolio compa-
ny.
The company declared and issued a 5% stock dividend during the quarter ended
March 31, 1999.
Financial Condition, Liquidity, and Capital Resources
The Company utilizes cash flow from operations, proceeds from borrowings un-
der its lines of credit and approved SBA leverage and proceeds from investment
repayments and redemptions to fund its operations and grow its investment
portfolio. Based on its current regulatory capital, the SBA has approved the
issuance of up to $28.4 million of debentures for the Company, of which $19.3
million have been issued as of June 30, 2000. The Company also maintains two
short term line of credit agreements, which allowed for maximum borrowings of
$4.0 million at June 30, 2000. Borrowings against the lines at June 30, 2000
were $2.2 million. The remaining $9.1 million of approved SBA leverage is ex-
pected to be issued in fiscal 2001. Under the regulations governing the SBIC
program, available SBA leverage is determined based on the SBIC's regulatory
capital and investment portfolio mix. Therefore, additional SBA leverage will
most likely not be available to the Company unless it raises additional capi-
tal. Without additional SBA leverage or other alternative sources of capital,
the Company will not be able to continue to grow its investment portfolio at
the rate maintained for the last two years. Management is in the process of
evaluating various strategic alternatives for the Company, including but not
limited to raising additional equity capital through public or private sourc-
es, exploring other sources of financing or managing the existing investment
portfolio and reinvesting proceeds from repayments and liquidations.
During the year ended June 30, 2000, the Company funded $10.8 million in new
equity investments and $6.1 million in debt securities as compared to the
$12.9 million of equity investments and $5.6 million in debt securities made
during the fiscal year ended June 30, 1999. To partially fund the new invest-
ments, the company borrowed $7 million from the SBA in debentures with a
blended interest rate of 7.64% plus a 1.00% annual fee on the outstanding bal-
ance. The Company also received $1.5 million in proceeds from the repayment of
stockholders' notes receivable and $5.5 million from the repayment or redemp-
tion from certain of its investments during the year ended June 30, 2000.
These proceeds compared to the $2.7 million received from the repayment or re-
demption of certain of its investments during the year ended June 30, 1999.
Net asset value per common share increased to $10.65 per share at June 30,
2000 from $8.90 per share at June 30, 1999 of which $.83 per share ($1.3 mil-
lion) resulted from operations and $.92 per share resulted from repayment of
stockholders notes receivable of $1.5 million.
During the year ended June 30, 2000 cash used in operating activities was
$143 thousand as compared to the $1.0 million provided during the year ended
June 30, 1999. Although net operating income increased for the year ended June
30, 2000, the income taxes on realized gain on investments also increased and
the changes in operating assets and liabilities have resulted in the decrease
in cash provided by operating activities. The company used $10.0 million in
investing activities during the year ended June 30, 2000 as compared to the
$15.9 million used during the year ended June 30,1999. The decrease is due to
a slight reduction in investment originations as well as the repayment of both
stockholder notes and investee loans. Cash flows provided by financing activi-
ties for the year ended June 30, 2000 were $9.0 million compared to $11.8 mil-
lion for the year ended June 30, 1999. Both amounts resulted primarily from
net borrowings necessary to finance the growth in the company's investment
portfolio.
7
Quantitative and Qualitative Disclosure About Market Risk
The Company's business activities contain elements of risk. The company con-
siders the principal types of market risk to be: risk of lending and investing
in small privately owned companies, valuation risk of portfolio, risk of illi-
quidity of portfolio investments, and the competitive market for investment
opportunities. The Company considers the management of risk essential to con-
ducting its businesses and to maintaining profitability. Accordingly, the
Company's risk management systems and procedures are designed to identify and
analyze the Company's risks, to set appropriate policies and limits, and to
continually monitor these risks and limits by means of reliable administrative
and information systems and other policies and programs.
The Company manages its market risk by maintaining a portfolio of equity in-
terests that is diverse by industry, geographic area, size of individual in-
vestment and borrower. The Company is exposed to a degree of risk of public
market price fluctuations as three of the Company's twenty-five investments
are in thinly traded, small public companies, whose stock prices have been
volatile. The other twenty-two investments are in private business enter-
prises. Since there is typically no public market for the equity interest of
the small companies in which the Company invests, the valuation of the equity
interests in the Company's portfolio of private business enterprises is sub-
ject to the estimate of the Company's Executive Committee. In the absence of a
readily ascertainable market value, the estimated value of the company's port-
folio of equity interests may differ significantly from the values that would
be placed on the portfolio if a ready market for the equity interests existed.
Any changes in estimated value are recorded in the Company's statement of op-
erations as "Net unrealized gains (losses)." Each hypothetical 1% increase or
decrease in value of the Company's portfolio of equity securities of $35.9
million at June 30, 2000, and $23.9 million at June 30, 1999, would have re-
sulted in unrealized gains or losses and would have changed net increase in
stockholders' equity resulting from operations for the year by 17% and less
than 15% respectively.
The Company's sensitivity to changes in interest rates is regularly moni-
tored and analyzed by measuring the characteristics of assets and liabilities.
The Company utilizes various methods to assess interest rate risk in terms of
the potential effect of interest income net of interest expense, the market
value of net assets, and the value at risk in an effort to ensure that the
Company is insulated from any significant adverse effects from changes in in-
terest rates. Based on the model used for the sensitivity of interest income
net of interest expense, if the balance sheet were to remain constant and no
actions were taken to alter the existing interest rate sensitivity, a hypo-
thetical immediate 100 basis point change in interest rates would have af-
fected net increase in stockholders' equity resulting from operations by less
than 4% over a twelve month horizon. Although management believes that this
measure is indicative of the Company's sensitivity to interest rate changes,
it does not adjust for potential changes in credit quality, size and composi-
tion of the balance sheet and other business developments that could affect
operating results. Accordingly, no assurances can be given that actual results
would not differ materially from the potential outcome simulated by this esti-
mate.
Forward Looking Statements
Included in this report and other written and oral information by management
from time to time, including reports to shareholders, quarterly and semi-an-
nual shareholder letters, filings with the Commission, news releases and in-
vestor presentations, are forward-looking statements about business objective
and strategies, market potential, the Company's ability to expand the geo-
graphic scope of its investments, the quality of the Company's due diligence
efforts, its financing plans, its vendors, suppliers, and portfolio companies,
future financial performance, and other matters that reflect management's ex-
pectations as of the date made.
Except for historical information, all of the statements, expectations, and
assumptions contained in the foregoing are "forward-looking statements"
(within the meaning of the Private Securities Litigation Reform Act of 1995)
that involve a number of risks and uncertainties. It is possible that the as-
sumptions made by management--including , but not limited to, the average ma-
turity of our investments, the potential to realize investment gains, as these
investments mature, investment opportunities, results, performance or expecta-
tions--may not materialize. Actual results may differ materially from those
projected or implied in any forward-looking statements. In addition to the
above factors, other important factors that may effect the company's perfor-
mance include: the risks associated with the performance of the Company's
portfolio companies, dependencies on key employees, interest rates, the level
of economic activity, and competition, as well as other risks described from
time to time in the Company's filings with the Securities Exchange Commission,
press releases, and other communications. The Company disclaims any intent or
obligation to update these forward-looking statements, whether as a result of
new information, future events, or otherwise.
8
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is quoted on the NASDAQ Stock Market under the
symbol WSCC. As of August 22, 2000, the Company had 106 stockholders of record
and approximately 550 beneficial owners. The following table sets forth the
range of high and low bid prices of the Company's common stock as reported on
the NASDAQ stock market for the period from February 2, 1998, when public
trading of the common stock commenced pursuant to the IPO, through June 30,
2000.
Bid Price
-----------------------
Net Asset
Value Per Share(1) High Low Close
------------------ ------- ------- -------
1998
Third Quarter............... $8.18 $11.750 $10.750 $10.875
Fourth Quarter.............. 8.24 11.375 10.125 11.125
1999
First Quarter............... $8.25 $11.375 $ 9.000 $ 9.250
Second Quarter.............. 8.37 10.620 7.500 8.500
Third Quarter............... 8.72 8.750 6.500 7.250
Fourth Quarter.............. 8.90 7.875 6.000 6.750
2000
First Quarter............... $8.98 $ 7.063 $ 6.625 $ 6.875
Second Quarter.............. 11.13 9.438 6.625 9.000
Third Quarter............... 12.16 10.750 7.563 8.375
Fourth Quarter.............. 10.65 8.500 6.500 6.500
- -------
(1) Net asset value per share is determined as of the last day in the calendar
quarter and therefore may not reflect the net asset value per share on the
date of the high or low sales prices for that specific quarter. The net
asset values shown are based on outstanding shares at the end of each
quarter and the previously reported values have been restated to reflect
the 5% stock dividend declared on February 5, 1999 and the 6% stock divi-
dend declared on December 7, 1999.
9
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Waterside Capital Corporation:
We have audited the accompanying balance sheets of Waterside Capital Corpo-
ration, including the schedule of portfolio investments, as of June 30, 1999
and 2000 and the related statements of operations, changes in stockholders'
equity and cash flows for each of the years in the three-year period ended
June 30, 2000. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these fi-
nancial statements based on our audits.
We conducted our audits in accordance with auditing standards generally ac-
cepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the finan-
cial statements are free of material misstatement. An audit includes examin-
ing, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting princi-
ples used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits pro-
vide 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 Waterside Capital Corpora-
tion as of June 30, 1999 and 2000, and the results of its operations and its
cash flows for each of the years in the three-year period ended June 30, 2000
in conformity with accounting principles generally accepted in the United
States of America.
/s/ KPMG LLP
July 28, 2000
Norfolk, Virginia
10
BALANCE SHEETS
JUNE 30, 1999 AND 2000
1999 2000
----------- -----------
ASSETS:
Investments in portfolio companies, at fair value
(note 2):
Equity securities.................................. $17,070,782 $23,237,050
Debt securities.................................... 6,894,468 8,877,766
Options and warrants............................... 377,000 3,752,744
----------- -----------
Total investments, cost of $23,860,295 and
$37,826,396
at June 30, 1999 and 2000, respectively......... 24,342,250 35,867,560
----------- -----------
Current assets:
Cash and cash equivalents.......................... 1,269,409 118,314
Dividends receivable............................... 311,737 654,767
Interest receivable................................ 228,438 222,517
Note receivable (note 3)........................... 150,000 237,550
Refundable income taxes............................ 43,322 323,322
Prepaid expenses and other current assets.......... 77,916 140,403
----------- -----------
Total Current Assets.............................. 2,080,822 1,696,873
Property and equipment, net (note 4)................ 118,961 167,919
Deferred income taxes (note 7)...................... -- 650,000
Deferred financing costs, net....................... 567,837 716,391
----------- -----------
Total Assets...................................... $27,109,870 $39,098,743
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Lines of credit.................................... $ -- $ 2,200,000
Accounts payable................................... 57,142 31,310
Accrued expenses (note 5).......................... 372,828 733,042
Deferred revenue................................... 113,631 --
----------- -----------
Total Current Liabilities......................... 543,601 2,964,352
Deferred income taxes (note 7)...................... 195,000 --
Debentures payable (note 6)......................... 12,300,000 19,300,000
----------- -----------
Total Liabilities................................. 13,038,601 22,264,352
----------- -----------
Stockholders' Equity (note 8):
Common stock, $1 par value, 10,000,000 shares
authorized, 1,581,430 issued and outstanding at
June 30, 1999 and 2000, adjusted for stock
dividends......................................... 1,491,937 1,581,430
Preferred stock, $1 par value, 25,000 shares
authorized,
no shares issued and outstanding.................. -- --
Additional paid-in capital......................... 12,769,895 14,618,719
Net unrealized appreciation (depreciation) on
investments, net of income taxes.................. 298,434 (1,216,357)
Undistributed accumulated earnings................. 966,003 1,850,599
Stockholders' notes receivable..................... (1,455,000) --
----------- -----------
Total Stockholders' Equity........................ 14,071,269 16,834,391
Commitments and contingencies (notes 2, 11, 12 and
13)
Total Liabilities and Stockholders' Equity........ $27,109,870 $39,098,743
=========== ===========
Net asset value per common share (note 8)......... $8.90 $10.65
=========== ===========
See accompanying notes to financial statements.
11
STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 1998, 1999 AND 2000
1998 1999 2000
-------- ---------- -----------
Operating Income:
Dividends.................................. $299,080 $1,071,899 $ 2,189,862
Interest on debt securities................ 24,290 717,437 1,009,744
Interest on cash equivalents............... 211,440 160,889 37,203
Fee and other income....................... 271,714 947,013 677,205
-------- ---------- -----------
Total Operating Income.................... 806,524 2,897,238 3,914,014
-------- ---------- -----------
Operating Expenses:
Management fees (note 10).................. 39,000 -- --
Salaries and benefits...................... 326,261 913,786 994,717
Legal and accounting....................... 90,592 122,080 167,580
Interest expense........................... -- 417,605 1,224,066
Other operating expenses (note 10)......... 179,666 351,659 483,021
-------- ---------- -----------
Total Operating Expenses.................. 635,519 1,805,130 2,869,384
-------- ---------- -----------
Net operating income before income taxes.. 171,005 1,092,108 1,044,630
Income tax expense (benefit) (note 7)....... (47,220) 51,000 (352,000)
-------- ---------- -----------
Net Operating Income...................... 218,225 1,041,108 1,396,630
Realized gain on investments, net of income
taxes of $144,000 and $873,000 for 1999 and
2000, respectively......................... -- 234,312 1,426,474
Change in unrealized appreciation
(depreciation) on investments, net of
income tax expense (benefit) of $198,920,
$(145,000) and $(926,000) for 1998, 1999
and 2000, respectively..................... 325,110 (238,376) (1,514,791)
-------- ---------- -----------
Net Increase in Stockholders' Equity
Resulting From Operations................ $543,335 $1,037,044 $ 1,308,313
======== ========== ===========
Net increase in stockholders' equity
resulting from operations per share --
basic and diluted (notes 8 and 9).......... $ 0.54 $ 0.66 $ 0.83
======== ========== ===========
See accompanying notes to financial statements.
12
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (NOTE 8)
YEARS ENDED JUNE 30, 1998, 1999 AND 2000
Net unrealized
Common Stock Additional appreciation Undistributed Stockholders' Total
-------------------- paid-in (depreciation) on accumulated notes stockholders'
Shares Amount capital investments earnings receivable equity
--------- ---------- ----------- ----------------- ------------- ------------- -------------
Balance at June 30, 1997 568,900 $ 568,900 $ 5,041,100 $ 211,700 $ 40,717 $(2,006,000) $ 3,856,417
Common stock issued
pursuant to initial
public offering.......... 852,000 852,000 7,231,536 -- -- -- 8,083,536
Repayment of stockholders'
notes receivable......... -- -- -- -- -- 551,000 551,000
Net operating income...... -- -- -- -- 218,225 -- 218,225
Increase in net unrealized
appreciation on
investments, net of
income taxes............. -- -- -- 325,110 -- -- 325,110
--------- ---------- ----------- ----------- ----------- ----------- -----------
Balance at June 30, 1998.. 1,420,900 $1,420,900 $12,272,636 $ 536,810 $ 258,942 $(1,455,000) $13,034,288
5% stock dividend......... 71,037 71,037 497,259 -- (568,359) -- (63)
Net operating income...... -- -- -- -- 1,041,108 -- 1,041,108
Net realized gain on
investments, net of
income taxes............. -- -- -- -- 234,312 -- 234,312
Decrease in net unrealized
appreciation on
investments, net of
income taxes............. -- -- -- (238,376) -- -- (238,376)
--------- ---------- ----------- ----------- ----------- ----------- -----------
Balance at June 30, 1999.. 1,491,937 $1,491,937 $12,769,895 $ 298,434 $ 966,003 $(1,455,000) $14,071,269
6% stock dividend......... 89,493 89,493 648,824 -- (738,508) -- (191)
Capitalization of
undistributed accumulated
earnings................. -- -- 1,200,000 -- (1,200,000) -- --
Repayment of stockholders'
notes receivable......... -- -- -- -- -- 1,455,000 1,455,000
Net operating income...... -- -- -- -- 1,396,630 -- 1,396,630
Net realized gain on
investments, net of
income taxes............. -- -- -- -- 1,426,474 -- 1,426,474
Increase in net unrealized
depreciation on
investments, net of
income taxes............. -- -- -- (1,514,791) -- -- (1,514,791)
--------- ---------- ----------- ----------- ----------- ----------- -----------
Balance at June 30, 2000.. 1,581,430 $1,581,430 $14,618,719 $(1,216,357) $ 1,850,599 $ -- $16,834,391
========= ========== =========== =========== =========== =========== ===========
See accompanying notes to financial statements.
13
STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1998, 1999 AND 2000
1998 1999 2000
---------- ----------- -----------
Cash flows from operating activities:
Net increase in stockholders' equity
resulting from operations.............. $ 543,335 $ 1,037,044 $ 1,308,313
Adjustments to reconcile net increase in
stockholders' equity resulting from
operations to net cash provided by
(used in) operating activities:
Decrease (increase) in unrealized
appreciation (depreciation) on
investments... ....................... (524,030) 383,376 2,440,791
Realized gain on investments........... -- (378,312) (2,299,474)
Accretion of preferred stock and loan
investments........................... -- (71,823) (356,423)
Depreciation and amortization.......... 38,634 42,185 66,959
Deferred income tax expense (benefit).. 151,700 (63,000) (845,000)
Loss on disposal of property and
equipment............................. -- -- 828
Changes in assets and liabilities
increasing (decreasing) cash flows
from operating activities:
Dividends receivable................. (121,417) (138,895) (343,030)
Interest receivable.................. (15,542) (207,166) 5,921
Refundable income taxes.............. 16,752 (43,322) (280,000)
Prepaid expenses and other current
assets.............................. (45,137) (32,779) (62,487)
Other assets......................... (750) -- --
Accounts payable and accrued
expenses............................ 81,510 347,529 334,382
Deferred revenue..................... -- 113,631 (113,631)
---------- ----------- -----------
Net cash provided by (used in)
operating activities............... 125,055 988,468 (142,851)
---------- ----------- -----------
Cash flows from investing activities:
Investments in equity securities made... (5,175,893) (12,872,180) (10,778,709)
Investments in debt securities made..... (1,325,000) (5,633,270) (6,074,509)
Principal collected on debt securities.. -- 66,163 1,254,587
Issuance of note receivable............. -- (150,000) (727,500)
Proceeds from collection of note
receivable............................. -- -- 639,950
Proceeds from collection of
stockholders' notes receivable......... 551,000 -- 1,455,000
Proceeds from sales of investments...... -- 2,670,021 4,288,427
Acquisition of property and equipment... (71,345) (24,731) (92,299)
Proceeds from sale of property and
equipment.............................. -- -- 2,000
---------- ----------- -----------
Net cash used in investing
activities......................... (6,021,238) (15,943,997) (10,033,053)
---------- ----------- -----------
Cash flows from financing activities:
Proceeds from lines of credit........... -- -- 2,200,000
Proceeds from debentures payable........ -- 12,300,000 7,000,000
Payment of deferred financing costs..... (123,000) (468,500) (175,000)
Proceeds from issuance of common stock.. 8,083,536 -- --
Payments in lieu of fractional shares
associated with stock dividends........ -- (63) (191)
---------- ----------- -----------
Net cash provided by financing
activities......................... 7,960,536 11,831,437 9,024,809
---------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents............................. 2,064,353 (3,124,092) (1,151,095)
Cash and cash equivalents, beginning of
year.................................... 2,329,148 4,393,501 1,269,409
---------- ----------- -----------
Cash and cash equivalents, end of year... $4,393,501 $ 1,269,409 $ 118,314
========== =========== ===========
Supplemental disclosure of cash flow
information:
Cash paid during the year for interest $ -- $ 196,462 $ 908,775
========== =========== ===========
Cash paid during the year for income
taxes $ -- $ 160,000 $ 720,000
========== =========== ===========
See accompanying notes to financial statements.
14
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1999 AND 2000
1. Summary of Significant Accounting Policies
Description of Business
Waterside Capital Corporation (the "Company") was incorporated in the Com-
monwealth of Virginia on July 13, 1993 and is a closed-end investment company
licensed by the Small Business Administration (the "SBA") as a Small Business
Investment Corporation ("SBIC"). The Company makes equity investments in, and
provides loans to, small business concerns to finance their growth, expansion
and development. Under applicable SBA regulations, the Company is restricted
to investing only in qualified small business concerns as contemplated by the
Small Business Investment Act of 1958. The Company made its first loan to a
small business concern in October 1996 and its first equity investment in No-
vember 1996.
In January 1998, the Company completed an Initial Public Offering ("IPO") of
852,000 shares of common stock at a price of $11.00 per share. The net pro-
ceeds, after $1,288,464 of offering costs, were $8,083,536.
Cash and Cash Equivalents
The Company considers all highly liquid securities purchased with insignifi-
cant interest rate risk and original maturities of three months or less at the
acquisition date to be cash equivalents. Cash and cash equivalents consisted
of the following at June 30, 1999 and 2000:
1999 2000
---- ----
Cash.................................................. $ 269,409 $ 118,314
Repurchase agreements................................. 1,000,000 --
---------- ---------
Total.............................................. $1,269,409 $ 118,314
========== =========
The repurchase agreements reflected above consist of overnight agreements
collateralized by U.S. Government securities. Due to the short-term nature of
the agreements, the securities are held for the Company by a bank.
Investment Valuation
Investments are carried at fair value, as determined by the Executive Com-
mittee of the Board of Directors. The Company, through its Board of Directors,
has adopted the Model Valuation Policy, as published by the SBA, in Appendix
III to Part 107 of Title 12 of the Code of Federal Regulations (the "Policy").
The Policy, among other things, presumes that loans and investments are ac-
quired with the intent that they are to be held until maturity or disposed of
in the ordinary course of business. Except for interest-bearing securities
which are convertible into common stock, interest-bearing securities are val-
ued at an amount not greater than cost, with unrealized depreciation being
recognized when value is impaired. Equity securities of private companies are
presumed to represent cost unless the performance of the portfolio company,
positive or negative, indicates otherwise in accordance with the Policy guide-
lines. The fair value of equity securities of publicly traded companies are
generally valued at their quoted market price discounted due to the investment
size or market liquidity concerns and for the effect of restrictions on the
sale of such securities. Discounts can range from 0% to 40% for investment
size and market liquidity concerns. Actual liquidity discounts in the portfo-
lio at June 30, 2000 ranged from 11% to 40%. Discounts for restriction on the
sale of the investments are 15% in accordance with the provisions of the Poli-
cy. The Company maintains custody of its investments as permitted by the In-
vestment Company Act of 1940.
Realized and Unrealized Gain or Loss on Investments
Realized gains or losses recorded upon disposition of investments are calcu-
lated on the difference between the net proceeds and the cost basis determined
using the specific identification method. All other changes in the value of
investments, including any provision for losses, are included as changes in
the unrealized appreciation or depreciation in the statement of operations.
Recognition of Interest and Dividend Income
Interest income is recorded on the accrual basis. In the case of dividends
on preferred stock investments where the Company has an agreement stipulating
dividends payable, the Company accrues the dividends in income on a pro-rata
basis during the year. Otherwise, dividends are recorded as income on the ex-
dividend date. The Company ceases to accrue dividends and interest income if
the investee is more than 120 days delinquent in their payments. Accretion of
loans and preferred stock investments are recorded as a component of interest
and dividend income in the statement of operations.
15
NOTES TO FINANCIAL STATEMENTS -- Continued
1. Summary of Significant Accounting Policies -- Continued
Fee Income
Portfolio investment processing fees are recognized as income upon consumma-
tion of the related investment transaction.
Property and Equipment
Property and equipment is stated at cost. Depreciation and amortization of
property and equipment is calculated on the straight-line method over the es-
timated useful lives of the assets ranging from five to seven years. Property
and equipment held under leasehold improvements are amortized on a straight-
line basis over the shorter of the lease term or estimated useful life of the
asset.
Deferred Financing Costs
Deferred financing costs consist of origination and processing fees paid in
connection with SBA debentures. The origination and processing fees are amor-
tized using the effective interest method. Accumulated amortization was
$24,412 and $50,859 at June 30, 1999 and 2000, respectively.
Income Taxes
Income taxes are accounted for under the asset and liability method. De-
ferred tax assets and liabilities are recognized for the future tax conse-
quences attributable to differences between the financial carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are ex-
pected to be recovered or settled. The effect on deferred tax assets and lia-
bilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
Net Increase in Stockholders' Equity Resulting From Operations per Share
Basic earnings per share has been computed by dividing net increase in
stockholders' equity resulting from operations by the weighted average number
of common shares outstanding. Diluted earnings per share reflects the poten-
tial dilution that could occur assuming the inclusion of common share equiva-
lents and has been computed by dividing net increase in stockholders' equity
resulting from operations by the weighted average number of common shares and
common share equivalents outstanding. Common share equivalents include all
outstanding stock options and warrants after applying the treasury stock meth-
od.
Stock Option Plan
As permitted under Statement of Financial Accounting Standards (SFAS) No.
123, Accounting for Stock Based Compensation, the Company has chosen to ac-
count for stock-based compensation using the intrinsic value method prescribed
in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (APB Opinion No. 25), and related interpretations. Accordingly, com-
pensation cost for stock options is measured as the excess, if any, of the es-
timated fair value of the Company's stock at the date of grant over the amount
an employee must pay to acquire the stock.
Use of Estimates
The preparation of financial statements in conformity with generally ac-
cepted accounting principles requires management to make estimates and assump-
tions that affect the reported amounts of assets and liabilities and disclo-
sure of contingent assets and liabilities at the date of the financial state-
ments and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
2. Investments
Investments consist primarily of preferred stock and debt securities ob-
tained from portfolio companies in accordance with SBIC investment regula-
tions. The financial statements include securities valued at $24,342,250 and
$35,867,560 at June 30, 1999 and 2000 (89.8% and 91.7% of assets), respective-
ly. The valuation process completed by management includes estimates made by
management and the Executive Committee in the absence of readily ascertainable
market values. These estimated values may differ significantly from the values
that would have been used had a ready market for the securities existed, and
those differences could be material.
16
NOTES TO FINANCIAL STATEMENTS -- Continued
3. Note Receivable
At June 30, 1999, the Company had a note receivable from the chief executive
officer of one of its investees. The note earned interest at 9% per annum and
matured on June 30, 2000. Interest payments were due monthly and a final in-
stallment in the amount of all outstanding principal, plus accrued and unpaid
interest, due upon maturity. This note was fully repaid as of June 30, 2000.
At June 30, 2000, the Company has a note receivable due from a guarantor of
one of its liquidated investments. The note earns interest at 9.25% per annum
and is due on demand.
4. Property and Equipment
Property and equipment at June 30, 1999 and 2000 consists of the following:
1999 2000
---- ----
Furniture and fixtures............................... $ 80,479 $ 86,895
Computer equipment and software...................... 37,296 119,818
Leasehold improvements............................... 31,298 31,298
--------- ---------
149,073 238,011
Less accumulated depreciation and amortization....... 30,112 70,092
--------- ---------
Property and equipment, net......................... $ 118,961 $ 167,919
========= =========
5. Accrued Expenses
Accrued expenses at June 30, 1999 and 2000 consist of the following:
1999 2000
---- ----
Accrued accounting and legal expense............... $ 37,932 $ 40,856
Accrued salaries and benefits...................... 114,766 163,502
Accrued interest payable........................... 196,730 485,574
Other accrued expenses............................. 23,400 43,110
--------- ---------
Total accrued expenses............................ $ 372,828 $ 733,042
========= =========
6. Debentures Payable
Based on its existing regulatory capital, the SBA has approved the issuance
of up to $28.4 million of debentures for the Company. All debentures, if and
when issued, bear interest payable semi-annually at a fixed rate and are due
at maturity, which is generally 10 years from the date the interest rate is
fixed. The debentures are subject to a prepayment penalty for the first five
years they are outstanding. During 1999, the Company utilized $12,300,000 of
the available facility, $6,000,000 which bears interest at 7.24% and matures
on March 1, 2009 and $6,300,000 which bears interest at 8.22% and matures on
September 1, 2009. During fiscal 2000, the Company has drawn an additional
$7,000,000, which bears interest at 8.64% and matures on March 1, 2010.
7. Income Taxes
The Company's provision for income taxes for the years ended June 30, 1998,
1999 and 2000 was allocated as follows:
1998 1999 2000
---- ---- ----
Income tax expense (benefit)
attributable to operations.......... $ (47,220) $ 51,000 $(352,000)
Deferred tax expense (benefit)
attributable to change in unrealized
appreciation on investments......... 198,920 (145,000) (926,000)
Current tax expense attributable to
realized gain on investments........ -- 144,000 873,000
--------- --------- -----------
Total income tax expense
(benefit)........................ $ 151,700 $ 50,000 $(405,000)
========= ========= ===========
17
NOTES TO FINANCIAL STATEMENTS -- Continued
7. Income Taxes -- Continued
The Company's income tax expense (benefit) attributable to operations for
the years ended June 30, 1998, 1999 and 2000 is as follows:
1998 1999 2000
---- ---- ----
Current:
Federal................................ $ -- $(25,000) $(364,500)
State.................................. -- (6,000) (68,500)
--------- -------- ---------
Total current taxes................... -- (31,000) (433,000)
--------- -------- ---------
Deferred:
Federal................................ (39,720) 68,000 67,000
State.................................. (7,500) 14,000 14,000
--------- -------- ---------
Total deferred taxes.................. (47,220) 82,000 81,000
--------- -------- ---------
Total income tax expense (benefit)
attributable to operations........... $(47,220) $51,000 $(352,000)
========= ======== =========
The 1998, 1999 and 2000 actual tax expense (benefit) attributable to opera-
tions differs from the amount which would be provided by applying the statu-
tory federal rate to net operating income before income taxes as follows:
1998 1999 2000
---- ---- ----
Computed "expected" tax expense......... $ 58,000 $371,000 $ 355,000
State taxes, net of federal impact...... (5,000) 5,000 (36,000)
Nontaxable dividend income.............. (102,000) (348,000) (674,000)
Other................................... 1,780 23,000 3,000
--------- -------- ----------
Total income tax expense (benefit)
attributable to operations............. $(47,220) $ 51,000 $(352,000)
========= ======== ==========
The Company's deferred tax assets and liabilities at June 30, 1999 and 2000
are as follows:
1999 2000
---- ----
Deferred tax assets:
Investments, due to recognition of unrealized
depreciation and accretion for financial
statement purposes............................... $ -- $ 645,000
Organization costs, due to the differing
amortization methods and implementation of SOP
98-5............................................. 15,000 8,000
--------- ---------
Total deferred tax assets....................... 15,000 653,000
--------- ---------
Deferred tax liabilities:
Property and equipment due to differing
depreciation methods............................. (9,000) (3,000)
Investments, due to recognition of
unrealized appreciation and accretion for
financial statement purposes..................... (201,000) --
--------- ---------
Total deferred tax liabilities.................. (210,000) (3,000)
--------- ---------
Net deferred tax assets (liabilities)........... $(195,000) $ 650,000
========= =========
18
NOTES TO FINANCIAL STATEMENTS -- Continued
7. Income Taxes -- Continued
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred
tax assets will not be realized. The ultimate realization of deferred tax as-
sets is dependent upon the generation of future taxable income during the pe-
riods in which those temporary differences become deductible. Management con-
siders the estimated reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment. Based
upon the level of historical taxable income and projections for future taxable
income over the periods which the deferred tax assets are deductible, manage-
ment believes it is more likely than not the Company will realize the benefits
of these deductible differences at June 30, 2000. The amount of the deferred
tax asset considered realizable, however, could be reduced in the near term if
estimates of future taxable income are reduced.
8. Stockholders' Equity
Stockholders' Notes Receivable
In 1996, the Company completed a private placement under which the Company
sold shares of common stock to accredited investors for 50% of the subscrip-
tion price paid in cash and the balance financed by a non-interest bearing de-
mand recourse promissory note. The Company held the issued shares as collat-
eral for the note until the note was repaid in full. Other investors that pur-
chased shares in this private placement elected to pay all cash for their
shares at the time of issuance. As of June 30, 1999, $1,455,000 of these notes
were outstanding.
On December 3, 1997, the Board of Directors of the Company authorized the
officers of the Company to demand that the stockholders repay the notes on or
before December 31, 1999. Notice of this demand was sent to the stockholders
on December 31, 1997. All notes were repaid during the year ended June 30,
2000.
Stock Dividend
On February 5, 1999, the Company declared a 5% stock dividend to sharehold-
ers of record as of February 26, 1999. On March 15, 1999, the Company issued
71,037 shares of common stock in conjunction with this dividend. Accordingly,
amounts equal to the fair market value (based on quoted market prices) of the
additional shares issued have been charged to retained earnings and capital-
ized as common stock and additional paid-in capital. Historical earnings per
share, weighted average shares outstanding and net asset value per share have
been restated to reflect the 5% stock dividend.
On December 7, 1999, the Company declared a 6% stock dividend to sharehold-
ers of record as of January 14, 2000. On January 31, 2000, the Company issued
89,493 shares of common stock in conjunction with this dividend. Accordingly,
amounts equal to the fair market value (based on quoted market prices) of the
additional shares issued have been charged to retained earnings and capital-
ized as common stock and additional paid-in capital. Historical earnings per
share, weighted average shares outstanding and net asset value per share have
been restated to reflect the 6% stock dividend.
Undistributed Accumulated Earnings
Undistributed accumulated earnings at June 30, 1999 and 2000 consist of the
following:
1999 2000
--------- -----------
Undistributed accumulated investment income........ $ 731,691 $ 1,389,813
Undistributed accumulated net realized gains....... 234,312 460,786
--------- -----------
Undistributed accumulated earnings................. $ 966,003 $ 1,850,599
========= ===========
Effective December 7, 1999, the Executive Committee of the Company's Board
of Directors and the SBA approved the capitalization of $1,200,000 of the
Company's undistributed accumulated earnings, which reduced the undistributed
accumulated net realized gains disclosed above.
Stock Option Plan
During 1998, the Company adopted the Waterside Capital Corporation 1998 Em-
ployee Stock Option Plan (the "Plan") pursuant to which the Company may grant
stock options to officers and key employees. The Plan, as amended, authorizes
the grant of options to purchase up to 212,000 shares of authorized but
unissued common stock. Stock options are granted with an exercise price equal
to the stock's fair market value at the date of grant. All stock options have
ten-year terms and vest on a graded schedule, at which time they become fully
exercisable. At June 30, 2000, there were 45,425 additional shares available
for future grant under the Plan.
19
NOTES TO FINANCIAL STATEMENTS -- Continued
8. Stockholders' Equity -- Continued
The per share weighted-average fair value of all stock options granted is
$3.6307. The fair value of each grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions: ex-
pected life of five years, expected volatility of 18.2%, expected dividend
yield of 0% and risk-free interest rate of 5.55% for options granted in fiscal
1998; expected life of five years, expected volatility of 17.3%, expected div-
idend yield of 0% and risk-free interest rate of 6.01% for options granted in
fiscal 1999; and expected life of five years, expected volatility of 51.01%,
expected dividend yield of 0% and risk-free interest rate of 6.23% for options
granted in fiscal 2000.
Under the Plan, the employee stock options are dividend protected. As a re-
sult, the exercise price of the outstanding options was adjusted downward and
the number of options increased so as to equalize the holder's value before
and after a stock dividend or split. As a result of the stock dividends de-
scribed above, all options outstanding were adjusted in accordance with the
Plan.
The Company applies APB Opinion No. 25 in accounting for its Plan and, ac-
cordingly, no compensation cost has been recognized for its stock options in
the financial statements. Had the Company determined compensation cost based
on the fair value at the grant date for its stock options under SFAS No. 123,
the Company's net income would have been reduced to the pro forma amounts in-
dicated below:
1998 1999 2000
---- ---- ----
Net increase in stockholders' equity
resulting As reported $543,335 $1,037,044 $1,308,313
from operations.................... Pro Forma 515,587 855,516 1,154,537
Net increase in stockholders' equity $ 0.54 $ 0.66 $ 0.83
resulting As reported
from operations per share--basic
and diluted....................... Pro Forma 0.51 0.54 0.73
Stock option activity during the periods indicated is as follows:
Weighted-
Average
Number of Exercise
shares Price
--------- ---------
Balance at June 30, 1997.............................. -- $ --
Granted............................................... 86,258 9.90
Exercised............................................. -- --
Forfeited............................................. -- --
Expired............................................... -- --
-------
Balance at June 30, 1998.............................. 86,258 9.90
Granted............................................... 22,260 7.75
Exercised............................................. -- --
Forfeited............................................. -- --
Expired............................................... -- --
-------
Balance at June 30, 1999.............................. 108,518 9.46
Granted............................................... 83,100 8.19
Exercised............................................. -- --
Forfeited............................................. (25,043) 9.88
Expired............................................... -- --
-------
Balance at June 30, 2000.............................. 166,575 8.76
=======
At June 30, 1998, 1999 and 2000, 10,017, 79,951 and 96,715 options, respec-
tively, were exercisable. The difference between the weighted average exercise
prices for all outstanding options and those exercisable on June 30, 2000 was
not significant.
The weighted average remaining contractual life of outstanding options at
June 30, 2000 is 8.9 years.
20
NOTES TO FINANCIAL STATEMENTS -- Continued
9. Net Increase in Stockholders' Equity Resulting From Operations per Share
The following table sets forth the calculation of basic and diluted net in-
crease in stockholders' equity resulting from operations per share for the
years ended June 30, 1998, 1999 and 2000:
1998 1999 2000
--------- ---------- ----------
Basic net increase in stockholders' equity
resulting from operations per share:
Net increase in stockholders' equity resulting
from operations.............................. $543,335 $1,037,044 $1,308,313
========= ========== ==========
Weighted average number of common shares
outstanding.................................. 1,013,094 1,581,430 1,581,430
========= ========== ==========
Basic net increase in stockholders' equity
resulting from operations per share.......... $0.54 $0.66 $0.83
========= ========== ==========
Diluted net increase in stockholders' equity
resulting from operations per share:
Net increase in stockholders' equity resulting
from operations.............................. $543,335 $1,037,044 $1,308,313
========= ========== ==========
Weighted average number of common shares
outstanding.................................. 1,013,094 1,581,430 1,581,430
Dilutive effect of stock options (as
determined by using the treasury stock
method)...................................... 1,456 -- 1,677
--------- ---------- ----------
Weighted average number of common shares and
dilutive common shares outstanding........... 1,014,550 1,581,430 1,583,107
========= ========== ==========
Diluted net increase in stockholders' equity
resulting
from operations per share.................. $0.54 $0.66 $0.83
========= ========== ==========
10. Related Party Transactions
During the fiscal year ended June 30, 1998, the Company paid management fees
and expenses to a company owned by an officer and director of the Company of
$39,000. In addition, for the fiscal years ended June 30, 1998, 1999 and 2000,
the Company paid fees of approximately $14,000, $88,000 and $126,000, respec-
tively, to an officer and director of the Company and to a partnership owned
by an officer and director of the Company for the use of an airplane.
11. Leases
The Company has three noncancelable operating leases, primarily for office
space, that expire over the next three years. The Company nets rent expense
with sublease income.
Future minimum lease payments under noncancelable operating leases (with
initial or remaining lease terms in excess of one year) as of June 30, 2000
are:
Year ending June 30,
2001........................................................ $ 65,241
2002........................................................ 65,370
2003........................................................ 33,324
---------
Total minimum lease payments............................... $ 163,935
=========
Net rental expense for operating leases for the years ended June 30, 1998,
1999 and 2000 was $34,834, $68,376 and $62,468, respectively. Sublease income
for the years ended June 30, 1998, 1999 and 2000 was $10,900, $4,900 and
$5,400, respectively.
12. Commitments and Contingencies
Employment Agreements
The Company has employment agreements with five active members of manage-
ment. These agreements provide for a specified annual base salary and certain
discretionary and performance-based bonuses. The contracts also provide for
stock options to be granted to the executives, where the executives may pur-
chase common shares of the Company at the fair value of the Company's common
stock at the time of grant. Annual base salaries under these agreements range
from $80,000 to $150,000. The terms for these agreements range from one year
to five years and expire on various dates through December
21
NOTES TO FINANCIAL STATEMENTS -- Continued
12. Commitments and Contingencies -- Continued
2002. If the employees are terminated by the Executive Committee due to dis-
ability or without cause, the compensation of four employees will be paid for
a period of 90 days from the termination date, and the compensation of one em-
ployee will be paid for a period of two years from termination date. The
Company's commitment for termination benefits is approximately $408,000.
Lines of Credit
The Company has open lines of credit with two financial institutions with a
total availability of $4,000,000. The interest rate on the lines is the bank's
prime rate. The outstanding borrowings under the lines of credit at June 30,
2000 was $2,200,000. The $2,500,000 and $1,500,000 lines of credit expire on
November 1, 2000 and August 30, 2000, respectively.
13. Concentration of Credit Risk
Most of the Company's portfolio investment companies are located in the Mid-
Atlantic region of the United States. In addition, three of the Company's
portfolio investment companies are in the telecommunications industry. As a
result, any adverse impact on the economy of that region or the telecommunica-
tions industry could adversely impact the Company's results of operations and
financial position.
14. Fair Value of Financial Instruments
The following summary disclosures are made in accordance with the provisions
of SFAS No. 107, Disclosures About Fair Value of Financial Instruments. Fair
value is defined in the statement as the amount at which an instrument could
be exchanged in a current transaction between willing parties.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments at June 30, 1999 and 2000:
Cash and cash equivalents, dividends receivable, interest receivable, note
receivable, accounts payable and accrued expenses:
The carrying amounts approximate fair value because of the short maturity of
these instruments.
Investments in portfolio companies:
The Company's investments are reflected at fair value in the Company's bal-
ance sheets. The fair value of portfolio investments is determined by the Ex-
ecutive Committee of the Board of Directors or by current market prices, if
available, in accordance with the Company's valuation policy (see note 2).
Debenture payable:
The fair value of the debentures payable is estimated by discounting the fu-
ture cash flows using current interest rates at which similar notes would be
made to borrowers with similar credit ratings. At June 30, 1999, the carrying
value of the debentures estimated the fair value as the fixed interest rates
approximated market interest rates at that time. The fair value of the
$12,300,000 debentures issued in fiscal 1999 was estimated to be $11,612,743
at June 30, 2000. The remaining $7,000,000 in debentures bears an interim rate
which approximates current interest rates.
Stockholders' notes receivable:
The fair value of the stockholders' notes receivable is estimated by dis-
counting the future cash flows using current interest rates at which similar
notes would be made to borrowers with similar credit ratings. The fair value
at June 30, 1999 was estimated to be $1,394,000.
15. Employee Benefit Plan
Effective July 1, 1998, the Company adopted the Waterside Capital Corpora-
tion Defined Contribution Plan and Trust. The plan is available to all employ-
ees of the Company, regardless of age, who have completed at least three
months of service. Eligible employees may contribute up to 8% of their compen-
sation annually with the Company providing contributions of 50% of the first
6% of participating employees' contributions. In addition, the Company has the
ability to make discretionary contributions which will be determined by a res-
olution of the Board of Directors. Total employer expense for the plan for the
years ended June 30, 1999 and 2000 was $21,708 and $20,721, respectively.
22
SCHEDULE OF PORTFOLIO INVESTMENTS
JUNE 30, 1999 AND 2000
The Company's investment portfolio at June 30, 1999 consisted of the follow-
ing:
Cost or
Number of Contributed Fair Market
Equity Securities: Shares Value Value
------------------ --------- ----------- -----------
Publicly Traded Companies:
Avery Communications, Inc. Common Stock..... 245,000 $ 249,900 $ 223,685
Netplex Group, Inc. Preferred Stock......... 1,500,000 1,500,000 1,500,000
Netplex Group, Inc. Common Stock (a)........ 165,000 237,000 427,425
Electronic Business Systems, Inc. (formerly
Triangle Imaging Group, Inc.) Preferred
Stock...................................... 150,000 1,321,500 1,321,500
Electronic Business Systems, Inc. (formerly
Triangle Imaging Group, Inc.) Convertible
Preferred Stock............................ 700 700,000 700,000
Electronic Business Systems, Inc. (formerly
Triangle Imaging Group, Inc.) Common Stock
(a)........................................ 500,000 225,000 273,500
Private Companies:
Real Time Data Management Services, Inc.
Preferred Stock............................ 400 369,334 557,479
Coddle Roasted Meats, Inc. Common Stock..... 1,200 120 120
Delta Education Systems, Inc. Preferred
Stock...................................... 1,625 1,584,643 1,584,643
Diversified Telecom, Inc. Preferred Stock
(c)........................................ 1,500 1,500,000 1,500,000
Crispies, Inc. Preferred Stock.............. 400 397,760 397,760
Triangle Biomedical Sciences Preferred
Stock...................................... 1,000 1,000,000 1,000,000
JMS Worldwide, Inc. Preferred Stock......... 1,500 1,500,000 1,500,000
EPM Development Systems Corp. Preferred
Stock...................................... 1,500 1,490,527 1,490,527
Fire King International Preferred Stock..... 2,000 2,000,000 2,000,000
QuesTech Packaging, Inc. Preferred Stock.... 600 600,000 600,000
SECC (formerly MilleCom, Inc.) Common Stock. 60 60 60
Eton Court Asset Management, Ltd. Preferred
Stock...................................... 1,000 966,457 966,457
Fairfax Publishing Co., Inc. Preferred
Stock...................................... 1,100 1,027,626 1,027,626
---------- ----------
Total equity securities................... 16,669,927 17,070,782
---------- ----------
Cost or
Contributed
Debt Securities: Maturity Value Fair Value
---------------- --------- ----------- -----------
Avery Communications, Inc. Convertible Note. 12/10/02 $ 350,000 $ 350,000
Divaris Consolidated Investments, Inc....... 6/29/04 1,100,000 1,100,000
Extraction Technologies of VA, LLC.......... 7/22/03 900,000 900,000
JMS Wordwide, Inc........................... 7/31/03 1,000,000 1,000,000
Diversified Telecom, Inc.................... Demand 133,837 133,837
Diversified Telecom, Inc.................... 5/19/02 152,145 152,145
The Netplex Group, Inc...................... 2/25/04 758,319 758,319
SECC (formerly MilleCom, Inc.).............. 3/31/04 900,000 900,000
SECC (formerly MilleCom, Inc.).............. 5/11/04 360,000 360,000
DigitalSquare.com Convertible Note.......... 12/31/99 500,000 500,000
ISR Solutions, Inc.......................... 6/30/04 740,167 740,167
---------- ----------
Total debt securities..................... 6,894,468 6,894,468
---------- ----------
23
SCHEDULE OF PORTFOLIO INVESTMENTS -- Continued
Number Cost or
of Percentage Contributed Fair Market
Stock Options and Warrants Shares Ownership Value Value
-------------------------- ------- ---------- ----------- -----------
Public Traded Companies:
Avery Communications, Inc............ 126,000 0.00 $ -- $ --
Netplex Group, Inc. (a).............. 75,000 0.70 -- 74,100
Electronic Business Systems, Inc.
(formerly Triangle Imaging Group,
Inc.) (a)........................... 20,000 0.14 -- --
Private Companies:
Real Time Data Management Services,
Inc................................. 125 29.41 115,000 122,000
Delta Education Systems, Inc......... 639 39.00 48,200 48,200
Diversified Telecom, Inc............. 8,998 15.00 -- --
Crispies, Inc........................ 524 6.37 2,800 2,800
Triangle Biomedical Sciences......... 23,260 6.57 -- --
Extraction Technologies of VA, LLC... -- 15.00 -- --
JMS Wordwide, Inc.................... 199 5.00 -- --
EPM Development Systems Corp......... 87 8.00 11,600 11,600
Fire King International.............. -- 3.75 -- --
QuesTech Packaging, Inc.............. -- 12.50 -- --
SECC (formerly MilleCom, Inc.)....... 150,000 3.15 -- --
Eton Court Asset Management, Ltd..... 14,943 13.00 34,700 34,700
Fairfax Publishing Co., Inc.......... 526 16.50 73,600 73,600
ISR Solutions, Inc................... 476,951 6.00 10,000 10,000
----------- -----------
Total options and warrants.......... 295,900 377,000
----------- -----------
Total investments................... $23,860,295 $24,342,250
=========== ===========
The Company's investment portfolio at June 30, 2000 consisted of the follow-
ing:
Cost or Fair
Number of Contributed Market
Equity Securities: Shares Value Value
------------------ --------- ----------- ----------
Publicly Traded Companies:
Avery Communications, Inc. Common Stock...... 245,000 $ 249,900 $ 156,310
Netplex Group, Inc. Common Stock (a)......... 66,400 464,800 129,281
Netplex Group, Inc. Preferred Stock.......... 2,300,000 1,151,784 1,151,784
Electronic Business Systems, Inc. (formerly
Triangle Imaging Group, Inc.) Convertible
Preferred Stock (b) (c)..................... 700 2,046,004 1,346,004
Electronic Business Systems, Inc. (formerly
Triangle Imaging Group, Inc.) Common Stock
(b) (c)..................................... 500,000 225,000 28,000
Electronic Business Systems, Inc. (formerly
Triangle Imaging Group, Inc.) Common Stock
(b) (c)..................................... 1,080,071 60,484 60,484
24
SCHEDULE OF PORTFOLIO INVESTMENTS -- continued
Cost or
Number of Contributed Fair Market
Shares Value Value
--------- ----------- -----------
Private Companies:
Real Time Data Management Services, Inc.
Preferred Stock............................ 300 $ 286,859 $ 463,500
Delta Education Systems, Inc. Preferred
Stock...................................... 1,625 1,594,283 1,594,283
Diversified Telecom, Inc. Preferred Stock
(c)........................................ 1,500 1,500,000 750,000
Crispies, Inc. Preferred Stock.............. 400 398,320 398,320
Triangle Biomedical Sciences Preferred
Stock...................................... 2,000 1,988,481 1,988,481
JMS Worldwide, Inc. Preferred Stock......... 1,500 1,500,000 1,500,000
EPM Development Systems Corp. Preferred
Stock...................................... 1,500 1,492,847 1,492,847
Fire King International Preferred Stock..... 2,000 2,000,000 2,000,000
SECC (formerly MilleCom, Inc.) Common Stock. 60 60 60
Eton Court Asset Management, Ltd. Preferred
Stock...................................... 1,000 973,397 973,397
Fairfax Publishing Co., Inc. Preferred
Stock...................................... 1,100 1,042,347 1,042,347
DigitalSquare.com Preferred Stock........... 1,210,739 1,513,425 1,513,425
Answernet, Inc. Preferred Stock............. 550 303,194 303,194
Answernet, Inc. Preferred Stock............. 700 376,926 376,926
ISR Solutions, Inc. Preferred Stock......... 500 497,407 497,407
Capital Markets Group, Inc. Preferred Stock. 1,500 1,500,000 1,500,000
Jubilee Tech International, Inc. Convertible
Preferred Stock............................ 2,444,444 1,971,000 1,971,000
VentureCom, Inc. Preferred Stock............ 278,164 2,000,000 2,000,000
---------- ----------
Total equity securities................... 25,136,518 23,237,050
---------- ----------
Cost or
Contributed
Debt Securities: Maturity Value Fair Value
---------------- --------- ----------- -----------
Avery Communications, Inc. Convertible Note. 12/10/02 $ 350,000 $ 350,000
Extraction Technologies of VA, LLC.......... 7/22/03 900,000 900,000
Extraction Technologies of VA, LLC.......... 8/31/04 202,316 202,316
Extraction Technologies of VA, LLC.......... 11/2/04 373,711 373,711
Extraction Technologies of VA, LLC.......... 2/7/05 263,742 263,742
Extraction Technologies of VA, LLC.......... 2/25/05 97,409 97,409
Extraction Technologies of VA, LLC.......... 3/14/05 95,584 95,584
JMS Wordwide, Inc........................... 7/31/03 950,000 950,000
Diversified Telecom, Inc.................... Demand 84,250 84,250
Diversified Telecom, Inc.................... 5/19/02 156,387 156,387
SECC (formerly MilleCom, Inc.).............. 3/31/04 900,000 900,000
SECC (formerly MilleCom, Inc.).............. 5/11/04 360,000 360,000
ISR Solutions, Inc.......................... 6/30/04 742,167 742,167
Fire King International..................... Demand 550,000 550,000
TABET Manufacturing Co., Inc................ 12/31/04 283,230 283,230
National Assisted Living, LP................ 12/31/04 1,408,689 1,408,689
Electronic Business Systems, Inc. (formerly
Triangle Imaging Group, Inc.) (b).......... 1/31/05 424,931 424,931
New Dominion Pictures LLC................... 4/30/06 735,350 735,350
---------- ----------
Total debt securities..................... 8,877,766 8,877,766
---------- ----------
25
SCHEDULE OF PORTFOLIO INVESTMENTS -- Continued
Cost or
Number of Percentage Contributed Fair Market
Stock Options and Warrants: Shares Ownership Value Value
--------------------------- --------- ---------- ----------- -----------
Publicly Traded Companies:
Avery Communications, Inc........... 126,000 0.00 $ -- $ --
Netplex Group, Inc. (a)............. 300,000 2.10 900,000 171,600
Electronic Business Systems, Inc.
(formerly Triangle Imaging Group,
Inc.) (a)(b)....................... 56,000 0.39 -- --
Private Companies:
Real Time Data Management Services,
Inc................................ 125 29.41 115,000 139,573
Delta Education Systems, Inc........ 639 39.00 48,200 69,546
Diversified Telecom, Inc. .......... 8,998 15.00 -- --
Crispies, Inc. ..................... 524 6.37 2,800 3,235
Triangle Biomedical Sciences........ 50,743 11.70 127,449 127,449
Extraction Technologies of VA, LLC.. -- 39.00 337,567 337,567
JMS Wordwide, Inc................... 199 5.00 -- --
EPM Development Systems Corp........ 87 8.00 11,600 634,278
Fire King International............. 4 4.00 -- --
SECC (formerly MilleCom, Inc.)...... 150,000 3.15 -- --
Eton Court Asset Management, Ltd.... 14,943 13.00 34,700 34,700
Fairfax Publishing Co., Inc......... 526 16.50 73,600 73,600
ISR Solutions, Inc.................. 550,973 7.20 12,936 12,936
DigitalSquare.com................... 81,074 5.70 -- --
Answernet, Inc...................... 69,837 17.64 268,615 268,615
TABET Manufacturing Co., Inc........ 500,000 20.00 175,400 175,400
National Assisted Living, LP........ -- 15.00 667,000 667,000
Capital Markets Group, Inc.......... 2,294,118 15.00 -- --
Jubilee Tech International, Inc..... 400,000 1.60 240,000 240,000
Signius Investment Corporation...... 12 11.67 332,595 332,595
VentureCom, Inc..................... 38,943 0.37 -- --
New Dominion Pictures LLC........... -- 9.00 464,650 464,650
----------- -----------
Total options and warrants........ 3,812,112 3,752,744
----------- -----------
Total investments................. $37,826,396 $35,867,560
=========== ===========
(a) Rule 144A restricted securities
(b) The Company is an affiliate of this entity at June 30, 2000.
(c) Entity is in default with respect to dividend/interest payments.
26
Shareholder Information
Stock Transfer Agent and
Corporate Offices Registrar
Norfolk, Virginia Investors with questions
Headquarters concerning account information,
300 E. Main Street, Suite 1380 replacing lost or stolen certificates,
Norfolk, VA 23510 transferring securities or
Telephone: 757-626-1111 processing a change of address
Facsimile: 757-626-0114 should contact:
waterside@watersidecapital.com
Registrar and Transfer Company
Reston, Virginia 10 Commerce Drive
11921 Freedom Dr., Suite 920 Cranford, New Jersey 07016-3572
Reston, VA 20190 Telephone: 800-368-5948
Telephone: 703-481-4537 Facsimile: 908-497-2310
Facsimile: 703-481-4538
jlong@watersidecapital.com
Investor Relations Stock Listing
Investors requiring information about Waterside Capital Corporation
the Company should contact: Common Stock is traded on the
NASDAQ Stock Market
Gerald T. McDonald under the symbol WSCC
Chief Financial Officer
Telephone: 757-626-1111
Facsimile: 757-626-0114 Independent Public Accountants
gmcdonald@watersidecapital.com
KPMG LLP
Annual Meeting of Shareholders Norfolk, Virginia
The annual shareholders' meeting will Corporate Counsel
be held Monday, October 23, 2000 at
11:00 a.m. at Nauticus, One Waterside Williams, Mullen, Clark, &
Drive, Norfolk, Virginia Dobbins, P.C.
All shareholders are invited to attend Virginia Beach, Virginia
Directors and Officers
Directors
Peter M. Meredith, Jr.(1,3) Eric L. Fox Augustus C. Miller
Chairman of the Board Portfolio Manager President and Chief
President Paine Webber Executive Officer
Meredith Construction Co. Inc. Miller Oil Co, Inc.
Roger L. Frost(2)
J. Alan Lindauer(1) Retired Juan M. Montero, II
President and Chief Executive General and Thoracic
Officer Ernest F. Hardee(1,3) Surgery
President and Chief Executive
James E. Andrews Officer R. Scott Morgan, Sr.(1)
Principal Owner Hardee Realty Corporation President
Anzell Automotive, Inc. TowneBank
Henry U. Harris, III
J. W. Whiting Chisman, Jr.(1,3) President Richard G. Ornstein(1)
President Virginia Investment Real Estate Management and
Dare Investment Company Counselors, Inc. Development
Jeffrey R. Ellis Robert I. Low(1,2) Jordan E. Sloan
Private Investor Senior Partner Chairman and Chief
Goodman & Company Executive Officer
Harbor Group Companies
Marvin S. Friedberg Harold J. Marioneaux, Jr.
Chief Executive Officer Dental Surgeon
Virginia Commonwealth
Trading Company Charles H. Merriman, III(1)
Manager, Corporate Finance
Department
Scott & Stringfellow, Inc.
Officers
J. Alan Lindauer
President and Chief Executive
Officer
Gerald T. McDonald
Secretary and Chief Financial
Officer
Martin N. Speroni
Vice President and Director of
Research
Lex W. Troutman
Vice President and Business
Development Officer
James S. Long
Vice President and Business
Development Officer
1. Executive Committee
2. Audit Committee
3. Compensation/Stock
Option Committee
27
WATERSIDE CAPITAL CORPORATION
300 East Main Street . Suite 1380 . Norfolk, Virginia 23510
www.waterside@watersidecapital.com
28