WATERSIDE CAPITAL CORPORATION
1999 ANNUAL REPORT
TABLE OF CONTENTS
LETTER TO STOCKHOLDERS .................
FIVE-YEAR SUMMARY OF SELECTED
FINANCIAL DATA .........................
MANAGEMENT'S DISCUSSION AND ANALYSIS ...
INDEPENDENT AUDITORS' REPORT ...........
FINANCIAL STATEMENTS ...................
CORPORATE INFORMATION .................. Inside Back Cover
WATERSIDE CAPITAL CORPORATION
A Small Business Investment Company
Letter to Stockholders
Fiscal 1999 marked the first full year of operations subsequent to our
successful IPO in February 1998. We feel we made tremendous progress in 1999 and
look forward to continuing to grow in 2000.
We are a specialty finance company that invests in equity and debt securities of
small primarily privately held businesses to finance their growth and expansion.
We evaluate potential investments for credit quality through a due diligence
process that assesses traditional criteria such as profit history, cash flow,
debt service coverage and collateral. As a Small Business Investment Corporation
(SBIC) which primarily invests in equity securities, our due diligence also
includes a thorough evaluation of the prospect's products, market size, growth
potential, a thorough review of management abilities and experience and
determination of the best and most likely exit strategy. Our typical investment
is currently structured as a preferred stock security generally ranging in size
from $500,000 to $1,500,000 although we have invested as much as $2.5 million in
one company.
To enhance the overall due diligence process necessary with our emphasis on
future growth we added Mr. Martin N. Speroni as Director of Research during
fiscal 1999. Mr. Speroni has extensive experience as a trader in fixed income
securities as well as being a Financial Analyst with a New York based
international conglomerate. Mr. Speroni also holds a MBA from Columbia
University. With our current professional staff we believe that we are now
positioned for solid growth. We aggressively monitor the status and quality of
the investments in our current portfolio, which enables us to take quick
responsive action when necessary to protect any of our investments.
The theme for the Company's financial performance has been continuing growth and
diversification. Due to the successful completion of its IPO and the Company's
initiation of its growth strategy using those proceeds, results for the year
ended June 30, 1999 do not offer a meaningful comparison with the financial
performance for fiscal 1998. We originated $18.5 million in new financing during
fiscal 1999 compared to $6.5 million during 1998. We currently have investments
in 20 companies compared to 11 companies the previous year. Net operating income
reflected tremendous growth to $1.0 million for fiscal 1999 compared to the $218
thousand for fiscal 1998 reflecting a 377% increase. Per share net operating
income of $.70 for 1999 compared to the $.23 generated during fiscal 1998. This
significant growth in per share earnings is extremely gratifying in light of the
56% increase in average number of shares outstanding due to the IPO completed in
February 1998. We paid our first 5% stock dividend in March 1999.
Our only significant disappointment during 1999 was a stock price that we do not
believe reflects the true value of our company given our earnings growth and
potential. We believe market perceptions and valuations often tend to lag
underlying realities and true valuations especially in small capitalization
stocks. With our current infrastructure and growth potential, we believe total
returns can improve dramatically. Our job is to tell our story to the market so
that our stock price can better approach its true value.
For fiscal 2000, we will continue the course currently established with quality
controlled growth. We will continue diversification of the investment portfolio
and emphasize current pay income instruments. Our top priority will be to
continue to leverage our return on equity, which should equate to a positive
driver for our stock market valuation.
We are grateful for the loyalty of our staff and their dedication to the
achievement of our goals. We thank our shareholders for their continued interest
and support.
/s/ J. Alan Lindauer
- ---------------------
J. Alan Lindauer
President & CEO
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 1999 financial statements and the notes
thereto and the other information included 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
historical financial performance is indicative of its future
results of operations.
o General
Waterside Capital Corporation ("Waterside" or the "Company") is a
specialty finance company headquartered in Norfolk, Virginia. The
Company invests in equity 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
Corporation. Through June 30, 1996 the Company operated as a
development stage company focused primarily on preparation to
commence operation. The Company was licensed in 1996 by the Small
Business Administration (SBA) as a Small Business 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 operating
income comes from interest earned on cash equivalents. The
Company's operating expenses primarily consist of payroll and
other expenses incidental to operation. Waterside currently has 8
full time employees and 2 offices from which it operates - Norfolk
and Richmond, Virginia.
o Portfolio Composition
The Company's primary business is investing in and lending to
privately owned businesses through investments in subordinated
debt with detachable common stock warrants, preferred stock and
common stock. The portfolio composition at June 30, 1999 and 1998
is shown in the following table at fair value:
JUNE 30,
-----------------------------------
1999 1998 1999 1998
% % $ $
---- ---- ------- -----
Subordinated debt 28.3% 18.5% $ 6,894 $1,575
Preferred stock 66.3 70.7 16,146 6,014
Common stock warrants 1.6 2.4 377 207
Common stock 3.8 8.4 925 710
----- ---- --------- --------
Total 100% 100% $24,342 $8,506
The weighted average effective interest rate on the Investment
Portfolio was 11.26% at June 30, 1999 and 11.45% at June 30, 1998.
The following tables show the Portfolio Composition by geographic
region and industry grouping:
JUNE 30,
-------------
GEOGRAPHIC REGION 1999 1998
---- ----
Mid-Atlantic 66% 86%
Midwest 16 14
Southeast 9 0
Northeast 7 0
West 2 0
--------------------------------------------
Total 100% 100%
JUNE 30,
-------------
INDUSTRY 1999 1998
---- ----
Business Services 44% 23%
Manufacturing 25 35
Telecommunications 15 32
Education 7 5
Publishing 5 0
Retail 2 5
High Tech (software) 2 0
--------------------------------------------
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.
o Results of Operations
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.
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 the
growth in the Company's investment portfolio. The 1999 operating
income consisted of dividends of $1.1 million, fee income of $947
thousand, interest on loans of $717 thousand and interest on cash
equivalents of $161 thousand.
Total operating expenses for the year ended June 30, 1999 were
$1.8 million, 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 operating expenses compared
to the $636 thousand expended during 1998. Net operating income of
$1.0 million for the year ended June 30, 1999 compared favorably
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 appreciation on investments, net of taxes, was $325
thousand for the year 1998 due primarily to the change in stock
price of our publicly traded portfolio company.
The Company declared and paid a 5% stock dividend during the
quarter ended March 31, 1999.
1998 Compared to 1997
During the fiscal year ended June 30, 1998, the Company generated
$807 thousand in operating income compared to the $265 thousand
generated during the fiscal year ended June 30, 1997. The largest
component of the change in operating income relates to an increase
in dividends earned to $299 thousand in fiscal 1998 from $51
thousand in fiscal 1997. Another component of the change in
operating income related to the increase in fee income, consisting
of a combination of application and closings fees, to $272
thousand in fiscal 1998 from $37 thousand in fiscal 1997. The
increases in dividends and fee income were derived from the new
investments and loans made during fiscal year 1998 of $6.5 million
as compared to $1.5 million for fiscal year 1997. The remainder of
the increase in operating income can be primarily attributed to an
increase in interest income from cash equivalents due to the
investment of proceeds from the IPO.
Operating expenses for the year ended June 30, 1998 were $636
thousand as compared to the $215 thousand reported for the year
ended June 30, 1997. The significant increase in expenses is a
function of the growth of the Company through increased investment
activity and the related accompanying increases in payroll, legal
and accounting costs, and other general operating expenses. The
work force grew from three employees at June 30, 1997 to eight
full time equivalents at June 30, 1998. The increase in employees
primarily consisted of three additional business development
officers necessary to sustain the Company's growth strategy. The
remaining two additional employees handle administrative and
financial management functions.
The Company reported $325 thousand, net of taxes, of unrealized
appreciation on investments for the year ended June 30, 1998 as
compared to the $212 thousand reported for the year ended June 30,
1997. The increase can be primarily attributed to the growth in
value of a publicly traded portfolio company, as well as
appreciation measured by the sale of one of its investments in
July 1998.
o Financial Condition, Liquidity And Capital Resources
During the year ended June 30, 1999, the Company made $12.9
million in new equity investments and $5.6 million in loans as
compared to the $5.2 million of equity investments and $1.3
million of loans made during the fiscal year ended June 30, 1998.
To fund these investments and loans, the Company borrowed $12.3
million from the SBA from a leverage commitment previously granted
on June 8, 1998. The notes are due on March 1, 2009 for the $6
million draw and on September 1, 2009 for the $6.3 million draw
and bear interest at a blended rate of 5.879% plus a 1.35% fee
annually on the outstanding balance. The Company received a
commitment letter on May 26, 1999 from the SBA reserving
additional leverage in an amount equal to $16.1 million that will
expire on September 30, 2003. The Company anticipates drawing the
entire $16.1 million in leverage during fiscal year 2000. The
Company has an additional tier of leverage (representing
approximately $15 million) that it may borrow from the SBA based
on its current regulatory capital position. Management believes
that these sources of capital will be sufficient to fund the
company's operations and grow its portfolio in fiscal 2000.
During the year ended June 30, 1999, cash provided by operating
activities was $988 thousand as compared to the $125 thousand
provided during the year ended June 30, 1998, primarily due to the
growth in the Company's net operating income. The Company used
$15.9 million in investing activities during the year ended June
30, 1999 as compared to the $6.0 million used in the comparable
period of 1998. This increase is primarily attributable to the
growth in the investment portfolio described above, net of the
cash generated from the liquidation of the Company's investment in
four portfolio companies. The Company generated $11.8 million in
cash from financing activities for the year ended June 30, 1999
primarily representing the proceeds from the borrowings from the
SBA described above. The Company generated $8.0 million in cash
from financing activities during the year ended June 30, 1998
primarily representing the proceeds from the IPO consummated in
January 1998.
o The Year 2000
State of readiness:
The Company has identified and addressed the potential impact of
the Year 2000 issue on its operations. This process has identified
three primary areas in which the Company could be affected:
financial and administrative programs, service providers, and
portfolio companies.
First, the Company has assessed its financial and administrative
software programs. As part of this process, the Company has
contacted its software vendors, who have indicated that their
programs either are or will be Year 2000 compliant. The Company
will continue to work with these vendors to ensure that necessary
upgrades and testing are completed. Due to the nature of the
Company's business, management does not expect a significant
impact associated with non-information technology systems.
Second, the Company is assessing its key relationships with
suppliers and other third parties, including its principal bank,
to determine the potential impact of Year 2000 on these parties,
and in turn on the Company. The Company is not aware of any
critical service provider that will not be Year 2000 compliant.
However, the Company cannot give any assurance that the service
providers will be Year 2000 compliant and that no interruption of
business will occur as a result of their non-compliance.
Finally, the Company is investigating the impact of Year 2000
issues on its portfolio companies. Because of the relatively small
size of its portfolio companies and their lack of sophisticated
operating systems, their readiness represents the Company's most
significant risk with regards to the Year 2000. The Company sent
Year 2000 questionnaires to each of its portfolio companies to
assess their awareness and to evaluate their Year 2000 readiness.
The Company is not aware of any significant deficiencies in the
Year 2000 readiness of its portfolio companies. In addition, the
Company evaluates each new portfolio company's Year 2000 readiness
as part of the due diligence process when making a new investment.
Although the Company is currently unaware of any significant Year
2000 issues related to its portfolio companies, the failure of one
or more of the portfolio companies to properly prepare for the
Year 2000 could have a material adverse impact on the Company's
business, results of operations and financial condition.
Based on the assessment performed to date, the Company does not
believe that the cost of its Year 2000 remediation activities will
exceed $50,000. This includes time allocated to this task by
Company personnel and costs incurred in the testing phase.
The Company believes it has taken the necessary steps to be Year
2000 compliant; however, it is difficult to fully predict the
impact on the Company of non-compliance in any of the above
mentioned areas. Significant non-compliance could result in a
material adverse effect on the Company's financial condition and
results of operations. The Company believes that the worst-case
Year 2000 scenarios may include the inability of the Company to
access or transfer cash needed to pay its bills or fund new
investments or a disruption of a portfolio company's business that
results in a loss of the Company's investment.
o 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-annual shareholder letters, filings with the
Commission, news releases and investor presentations, are
forward-looking statements about business objectives and
strategies, market potential, the Company's ability to expand the
geographic scope of its investments, the quality of the Company's
due diligence efforts, its financing plans, the impact of Year
2000 issues on itself, its vendors, suppliers, and portfolio
companies, future financial performance and other matters that
reflect management's expectations as of the date made. Without
limiting the foregoing, the words "believes", "anticipates",
"plans", "expects", "seeks" and similar expressions are intended
to identify forward-looking statements. Future events and the
Company's actual results could differ materially from the results
reflected in these forward-looking statements. Please refer to a
discussion of these and other factors in this Report and the
Company's other Commission filings. The Company disclaims any
intent or obligation to update these forward-looking statements,
whether as a result of new information, future events, or
otherwise.
WATERSIDE CAPITAL CORPORATION
FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1999
(WITH INDEPENDENT AUDITORS' REPORT THEREON)
Independent Auditors' Report
The Stockholders and Board of Directors
Waterside Capital Corporation:
We have audited the accompanying balance sheets of Waterside
Capital Corporation, including the schedule of portfolio
investments, as of June 30, 1998 and 1999 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,
1999. 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 generally accepted
auditing standards. Those standards require that we plan and
perform the audit 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
Waterside Capital Corporation as of June 30, 1998 and 1999, and the
results of its operations and cash flows for each of the years in
the three-year period ended June 30, 1999 in conformity with
generally accepted accounting principles.
/s/ KPMG LLP
August 5, 1999
Norfolk, Virginia
FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
YEAR ENDED JUNE 30,
INCEPTION (JULY 13, 1993) ------------------------------------------------
TO JUNE 30, 1995(1) 1996(1) 1997 1998 1999
------------------------- ------- ---- ---- ----
SUMMARY OF EARNINGS INFORMATION:
Operating Income:
Interest on loans $ -- $ -- $ 9,430 $ 24,290 $ 717,437
Dividends -- -- 51,425 299,080 1,071,899
Interest on cash equivalents 8,955 42,262 166,573 211,440 160,889
Fee and other income -- 17,255 37,450 271,714 947,013
-------- ------- -------- -------- ----------
Total operating income 8,955 59,517 264,878 806,524 2,897,238
Total operating expenses 36,025 59,777 214,667 635,519 1,805,130
-------- ------- -------- -------- ----------
Net operating income (loss) before
income taxes (27,070) (260) 50,211 171,005 1,092,108
Income tax expense (benefit) 1,880 (7,346) (12,370) (47,220) 51,000
-------- ------- -------- -------- ----------
Net operating income (loss) (28,950) 7,086 62,581 218,225 1,041,108
Realized gain on investments, net of
income taxes(2) -- -- -- -- 234,312
Change in unrealized appreciation on
investments, net of income taxes (3) -- -- 211,700 325,110 (238,376)
Net increase (decrease) in stockholders' equity
resulting from operations $(28,950) $ 7,086 $274,281 $543,335 $1,037,044
-------- ------- -------- -------- ----------
Net operating income per share -
basic and diluted -- -- $ .11 $ .23 $ .70
Net increase in stockholders' equity
resulting from operations per share -
basic and diluted -- -- $ .46 $ .57 $ .70
Weighted average number of shares
outstanding -- -- 590,223 955,749 1,491,937
JUNE 30,
1995(1) 1996(1) 1997 1998 1999
------- ------- ---- ---- ----
BALANCE SHEET INFORMATION:
Investments in portfolio companies, at fair value(5):
Equity securities $ -- $ -- $1,142,410 $ 6,724,337 $17,070,782
Loans -- -- -- 1,575,264 6,894,468
Options and warrants -- -- 388,890 206,624 377,000
------- ---------- ---------- ----------- -----------
Total investments -- -- 1,481,300 8,506,225 24,342,250
Cash and cash equivalents 409,869 3,595,766 2,329,148 4,393,501 1,269,409
Total assets 420,012 3,655,018 3,963,648 13,374,729 27,109,870
Debentures payable -- -- -- -- 12,300,000
Total stockholders' equity 319,850 3,512,636 3,856,417 13,034,288(4) 14,071,269
(1) Through June 30, 1996, the Company operated as a development stage
enterprise. 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.
(3) Amounts have been presented net of deferred income tax expense (benefit) of
$129,600, $198,920 and (145,000), respectively, for the years ended
June 30, 1997, 1998 and 1999.
(4) 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.
(5) The Company's portfolio investments are presented at fair value, as
determined 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 elsewhere herein. The cost of the portfolio investments was
$1,140,000, $7,640,893 and $23,860,295 at June 30, 1997, 1998 and 1999,
respectively.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is quoted on the NASDAQ Stock Market under the symbol
WSCC. As of August 23, 1999 the Company had 120 stockholders of record and
approximately 650 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, 1999.
Bid Price
Net Asset ---------------------------------
Value Per Share(1) High Low Close
------------------ ------- -------- -------
1998
Third Quarter $8.67 $ 11.750 $ 10.750 $10.875
Fourth Quarter 8.74 11.375 10.125 11.125
1999
First Quarter $8.74 $ 11.375 $ 9.000 $ 9.250
Second Quarter 8.87 10.620 7.500 8.500
Third Quarter 9.24 8.750 6.500 7.250
Fourth Quarter 9.43 7.875 6.000 6.750
- -----------------
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 paid on March 15,
1999.
WATERSIDE CAPITAL CORPORATION
Balance Sheets
June 30, 1998 and 1999
- --------------------------------------------------------------------------------
1998 1999
---------------- ----------------
Assets:
Investments in portfolio companies, at fair value (notes 2 and 16):
Equity securities $ 6,724,337 17,070,782
Loans 1,575,264 6,894,468
Options and warrants 206,624 377,000
---------------- ----------------
Total investments, cost of $7,640,893 and $23,860,295
at June 30, 1998 and 1999, respectively 8,506,225 24,342,250
---------------- ----------------
Current assets:
Cash and cash equivalents 4,393,501 1,269,409
Dividend receivable 172,842 311,737
Interest receivable 21,272 228,438
Note receivable (note 3) - 150,000
Refundable income taxes - 43,322
Prepaid expenses and other current assets 45,137 77,916
---------------- ----------------
Total current assets 4,632,752 2,080,822
Property and equipment, net (note 4) 112,002 118,961
Deferred financing costs, net 123,750 567,837
---------------- ----------------
Total assets $ 13,374,729 27,109,870
================ ================
Liabilities and Stockholders' Equity:
Current liabilities:
Accounts payable $ 15,616 57,142
Accrued expenses (note 5) 66,825 372,828
Deferred revenue - 113,631
---------------- ----------------
Total current liabilities 82,441 543,601
Deferred income taxes (note 7) 258,000 195,000
Debentures payable (note 6) - 12,300,000
---------------- ----------------
Total liabilities 340,441 13,038,601
---------------- ----------------
Stockholders' equity (note 8):
Common stock, $1 par value, 10,000,000 shares authorized,
1,420,900 and 1,491,937 issued and outstanding at
June 30, 1998 and 1999, respectively 1,420,900 1,491,937
Preferred stock, $1 par value, 25,000 shares authorized,
no shares issued and outstanding - -
Additional paid-in capital 12,272,636 12,769,895
Net unrealized appreciation on investments, net of income taxes 536,810 298,434
Undistributed accumulated earnings 258,942 966,003
Stockholders' notes receivable (1,455,000) (1,455,000)
---------------- ----------------
Total stockholders' equity 13,034,288 14,071,269
Commitments and contingencies (notes 2, 11, 12 and 13)
---------------- ----------------
Total liabilities and stockholders' equity $ 13,374,729 27,109,870
================ ================
Net asset value per common share (note 8) $ 8.74 9.43
================ ================
See accompanying notes to financial statements.
2
WATERSIDE CAPITAL CORPORATION
Statements of Operations
Years ended June 30, 1997, 1998 and 1999
- --------------------------------------------------------------------------------
1997 1998 1999
--------------- -------------- --------------
Operating income:
Interest on loans $ 9,430 24,290 717,437
Dividends 51,425 299,080 1,071,899
Interest on cash equivalents 166,573 211,440 160,889
Fee and other income 37,450 271,714 947,013
--------------- -------------- --------------
Total operating income 264,878 806,524 2,897,238
--------------- -------------- --------------
Operating expenses:
Management fees (note 10) 52,000 39,000 -
Salary and benefits 41,965 326,261 913,786
Legal and accounting 41,128 90,592 122,080
Interest expense - - 417,605
Other operating expenses (note 10) 79,574 179,666 351,659
--------------- -------------- --------------
Total operating expenses 214,667 635,519 1,805,130
--------------- -------------- --------------
Net operating income before income taxes 50,211 171,005 1,092,108
Income tax expense (benefit) (note 7) (12,370) (47,220) 51,000
--------------- -------------- --------------
Net operating income 62,581 218,225 1,041,108
Realized gain on investments, net of income taxes of $144,000 - - 234,312
Change in unrealized appreciation on investments, net of income
tax expense (benefit) of $129,600, $198,920 and $(145,000)
for 1997, 1998 and 1999, respectively (note 16) 211,700 325,110 (238,376)
--------------- -------------- --------------
Net increase in stockholders' equity resulting from operations $ 274,281 543,335 1,037,044
=============== ============== ==============
Net increase in stockholders' equity resulting from operations per share -
basic and diluted (notes 8 and 9) $ 0.46 0.57 0.70
=============== ============== ==============
See accompanying notes to financial statements.
3
WATERSIDE CAPITAL CORPORATION
Statements of Changes in Stockholders' Equity (Note 8)
Years ended June 30, 1997, 1998 and 1999
- --------------------------------------------------------------------------------
Common Stock Additional
--------------------------------------------------------------
Shares Shares paid-in
------------------------------ ------------------------------
Subscribed Amount Issued Amount capital
---------------------------------------------------------------------------
Balance at June 30, 1996 26,000 $ 26,000 537,400 $ 537,400 4,987,100
Common stock issued pursuant to
private placement (26,000) (26,000) 31,500 31,500 54,000
Repayment of stockholders' notes receivable - - - - -
Net operating income - - - - -
Increase in net unrealized appreciation on
investments - - - - -
-------- ---------- ----------- ----------- ------------
Balance at June 30, 1997 - - 568,900 568,900 5,041,100
Common stock issued pursuant to
initial public offering - - 852,000 852,000 7,231,536
Repayment of stockholders' notes receivable - - - - -
Net operating income - - - - -
Increase in net unrealized appreciation on
investments - - - - -
-------- ---------- ----------- ----------- -----------
Balance at June 30, 1998 - - 1,420,900 1,420,900 12,272,636
5% stock dividend - - 71,037 71,037 497,259
Net operating income - - - - -
Net realized gain on investments - - - - -
Decrease in net unrealized appreciation on
investments - - - - -
--------- ---------- ----------- ----------- ------------
Balance at June 30, 1999 - $ - 1,491,937 $ 1,491,937 12,769,895
========= =========== =========== ============ ============
Net unrealized Undistributed
appreciation accumulated Stockholders' Total
(depreciation) earnings notes stockholders'
on investments (deficit) receivable equity
---------------------------------------------------------------
Balance at June 30, 1996 $ - (21,864) (2,016,000) 3,512,636
Common stock issued pursuant to
private placement - - - 59,500
Repayment of stockholders' notes receivable - - 10,000 10,000
Net operating income - 62,581 - 62,581
Increase in net unrealized appreciation on
investments 211,700 - - 211,700
----------- ------------ ------------- -------------
Balance at June 30, 1997 211,700 40,717 (2,006,000) 3,856,417
Common stock issued pursuant to
initial public offering - - - 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 325,110 - - 325,110
---------- ----------- ------------ ------------
Balance at June 30, 1998 536,810 258,942 (1,455,000) 13,034,288
5% stock dividend - (568,359) - (63)
Net operating income - 1,041,108 - 1,041,108
Net realized gain on investments - 234,312 - 234,312
Decrease in net unrealized appreciation on
investments (238,376) - - (238,376)
---------- ------------ ------------- -------------
Balance at June 30, 1999 $ 298,434 966,003 (1,455,000) 14,071,269
=========== ============ ============ =============
See accompanying notes to financial statements.
4
- --------------------------------------------------------------------------------
WATERSIDE CAPITAL CORPORATION
Statements of Cash Flows
Years ended June 30, 1997, 1998 and 1999
- --------------------------------------------------------------------------------
1997 1998 1999
--------------- ------------- ------------
Cash flows from operating activities:
Net increase in stockholders' equity resulting from operations $ 274,281 543,335 1,037,044
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 on investments (341,300) (524,030) 383,376
Realized gain on investments - - (378,312)
Accretion of preferred stock and loan investments - - (71,823)
Depreciation and amortization 15,346 38,634 42,185
Deferred income tax expense (benefit) 117,230 151,700 (63,000)
Changes in assets and liabilities increasing (decreasing) cash
flows from operating activities:
Dividend receivable (51,425) (121,417) (138,895)
Interest receivable (5,730) (15,542) (207,166)
Refundable income taxes (16,752) 16,752 (43,322)
Prepaid expenses and other current assets - (45,137) (32,779)
Other assets (390) (750) -
Accounts payable and accrued expenses (114,058) 81,510 347,529
Deferred revenue - - 113,631
Income taxes payable (1,823) - -
------------ ------------- ----------------
Net cash provided by (used in) operating activities (124,621) 125,055 988,468
------------ ------------- ----------------
Cash flows from investing activities:
Investments made (1,140,000) (5,175,893) (12,872,180)
Loans made (400,000) (1,325,000) (5,633,270)
Principal collected on loans made 400,000 - 66,163
Issuance of note receivable - - (150,000)
Proceeds from repayment of stockholders' notes receivable 10,000 551,000 -
Proceeds from sales of investments - - 2,670,021
Acquisition of property and equipment (52,997) (71,345) (24,731)
------------ ------------- ----------------
Net cash used in investing activities (1,182,997) (6,021,238) (15,943,997)
------------ ------------- ----------------
Cash flows from financing activities:
Proceeds from notes payable - - 12,300,000
Payment of deferred financing costs - (123,000) (468,500)
Proceeds from issuance of common stock 59,500 8,083,536 -
Payment related to fractional shares associated with stock dividend - - (63)
Repayment of short-term debt (18,500) - -
------------ ------------- ----------------
Net cash provided by financing activities 41,000 7,960,536 11,831,437
------------ ------------- ----------------
Net increase (decrease) in cash and cash equivalents (1,266,618) 2,064,353 (3,124,092)
Cash and cash equivalents, beginning of year 3,595,766 2,329,148 4,393,501
------------ ------------- ----------------
Cash and cash equivalents, end of year $ 2,329,148 4,393,501 1,269,409
============= ============= ================
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ - - 196,462
============= ============= ================
Cash paid during the year for income taxes $ 10,180 - 160,000
============= ============= ================
See accompanying notes to financial statements.
5
WATERSIDE CAPITAL CORPORATION
Notes to Financial Statements
June 30, 1998 and 1999
- --------------------------------------------------------------------------------
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Waterside Capital Corporation (the "Company") was incorporated in the
Commonwealth 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 November 1996.
On September 10, 1997, the Company authorized a common stock split of
100 to 1. This increased the authorized number of common shares to
10,000,000 and the issued and outstanding common shares to 568,900.
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 proceeds, after $1,288,464 of offering costs, were
$8,083,536.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid securities purchased with
insignificant 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, 1998 and 1999:
1998 1999
---- ----
Cash $ 193,501 269,409
Repurchase agreements 4,200,000 1,000,000
--------- -------------
Total $ 4,393,501 1,269,409
========= =============
(Continued)
6
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
Committee 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 acquired 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 valued 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 guidelines. 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 range from 0% to 40% for investment size and market liquidity
concerns. Discounts for restriction on the sale of the investments are
15% in accordance with the provisions of the Policy. The Company
maintains custody of its investments as permitted by the Investment
Company Act of 1940.
REALIZED AND UNREALIZED GAIN OR LOSS ON INVESTMENTS
Realized gains or losses recorded upon disposition of investments are
calculated 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.
(Continued)
7
FEE INCOME
Portfolio investment processing fees are recognized as income upon
consummation 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 estimated useful lives of the assets ranging from 5 to 7
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 amortized over the life of the debentures using the
straight-line method, which approximates the effective interest method.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences 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 expected to be recovered or settled.
The effect on deferred tax assets and liabilities 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
The Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 128, EARNINGS PER SHARE, for the year ended June
30, 1998. Basic earnings per share as calculated in accordance with
SFAS No. 128 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 potential dilution that could occur assuming the inclusion
of common share equivalents 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 method. All
share and per share data in the financial statements and the
accompanying notes have been retroactively adjusted to reflect the
implementation of SFAS No. 128.
8
STOCK OPTION PLAN
The Company accounts for stock options issued to employees under the
provisions of Statement of Financial Accounting Standards (SFAS) No.
123, ACCOUNTING FOR STOCK BASED COMPENSATION, which permits entities to
recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS No. 123
also allows entities to continue to apply the provisions of Accounting
Principles Board (APB) Opinion No. 25 and provide pro forma net income
and pro forma net income per common share disclosures for employee
stock option grants made in 1995 and future years as if the
fair-value-based method defined in SFAS No. 123 had been applied. The
Company has elected to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure provisions of SFAS No. 123.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 and 1998
financial statements to conform to 1999 financial statement
presentation.
USE OF ESTIMATES
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.
(2) INVESTMENTS
Investments consist primarily of preferred stock obtained from and
loans made to portfolio companies under SBIC investment and loan
regulations. The financial statements include securities valued at
$8,506,225 and $24,342,250 at June 30, 1998 and 1999 (63.6% and 89.8%
of assets), respectively. Investments are recorded at fair value as
determined by the Executive Committee of the Board of Directors or by
current market prices, if available, in accordance with the Company's
valuation policy. 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.
Since December 4, 1998, Diversified Telecom, Inc. has not made required
dividend payments to the Company. As a result, the Company has
discontinued accruing dividends on the investment. Certain changes have
been made at the portfolio company level and management does not
believe that the underlying investment is impaired.
(Continued)
9
(3) NOTE RECEIVABLE
The Company has a note receivable due from the chief executive officer
of one of its investees. The note earns interest at 9% per annum and
matures on June 30, 2000. Interest payments are due monthly, and a
final installment in the amount of all outstanding principal, plus
accrued and unpaid interest, is due upon maturity.
(4) PROPERTY AND EQUIPMENT
Property and equipment at June 30, 1998 and 1999 consists of the
following:
1998 1999
---- ----
Furniture and fixtures $ 66,189 80,479
Computer equipment 30,226 37,296
Leasehold improvements 27,927 31,298
------------ -----------
124,342 149,073
Less accumulated depreciation and amortization 12,340 30,112
------------ -----------
Property and equipment, net $ 112,002 118,961
============ =========
(5) ACCRUED EXPENSES
Accrued expenses at June 30, 1998 and 1999 consist of the following:
1998 1999
---- ----
Accrued accounting and legal expense $ 45,500 37,932
Accrued salaries and benefits 21,325 114,766
Accrued interest payable - 196,730
Other accrued expenses - 23,400
------------ ----------
Total accrued expenses $ 66,825 372,828
============ =========
(6) DEBENTURES PAYABLE
At June 30, 1999, the Company had drawn down debentures totaling
$12,300,000 payable to the SBA. The $6,000,000 drawn down during the
second quarter of 1999 bears interest at a fixed interest rate of
6.240% and matures March 1, 2009. Interest on the $6,300,000 drawn down
in the fourth quarter of 1999 is payable at an interim interest rate of
5.535% which is expected to be fixed in September 1999, and matures on
September 1, 2009. The debentures require semi-annual interest-only
payments, with all principal due upon maturity. The SBA debentures are
subject to a prepayment penalty.
10
In May 1999, the Company was granted approval for additional SBA
debentures totaling up to $16,100,000. The debentures will accrue
interest at an interim rate to be set at the time of each draw against
the facility. The interest rate on any outstanding amounts is fixed in
the March or September following the draw down. At June 30, 1999 none
of these debentures had been drawn upon.
(7) INCOME TAXES
The Company's provision for income taxes for the years ended June 30,
1997, 1998 and 1999 was allocated as follows:
1997 1998 1999
---- ---- ----
Income tax expense (benefit) attributable to
operations $ (12,370) (47,220) 51,000
Deferred tax expense (benefit) attributable
to change in unrealized appreciation
on investments 129,600 198,920 (145,000)
Current tax expense attributable to realized
gain on investments - - 144,000
---------- ----------- -----------
Total income tax expense $ 117,230 151,700 50,000
========== =========== ===========
The Company's income tax expense (benefit) attributable to operations
for the years ended June 30, 1997, 1998 and 1999 is as follows:
1997 1998 1999
---- ---- ----
Current:
Federal $ - - (25,000)
State - - (6,000)
---------- ----------- -----------
Total current taxes - - (31,000)
---------- ----------- -----------
Deferred:
Federal (10,370) (39,720) 68,000
State (2,000) (7,500) 14,000
---------- ----------- -----------
Total deferred taxes (12,370) (47,220) 82,000
---------- ----------- -----------
Total income tax expense (benefit) attributable
to operations $ (12,370) (47,220) 51,000
========== =========== ===========
(Continued)
11
The 1997, 1998 and 1999 actual tax expense (benefit) attributable to
operations differs from the amount which would be provided by applying
the statutory federal rate to net operating income before income taxes
as follows:
1997 1998 1999
---- ---- ----
Computed "expected" tax expense $ 17,000 58,000 371,000
State taxes, net of federal impact (1,320) (5,000) 5,000
Nontaxable dividend income (17,500) (102,000) (348,000)
Other (10,550) 1,780 23,000
------- ----------- -----------
Total income tax expense (benefit) attributable
to operations $ (12,370) (47,220) 51,000
======= =========== ===========
The Company's deferred tax assets and liabilities at June 30, 1998 and
1999 are as follows:
1998 1999
---- ----
Deferred tax assets:
Net operating loss carryforward $ 53,000 -
Organization costs, due to the differing amortization
methods and implementation of SOP 98-5 23,000 15,000
----------- -----------
Total deferred tax assets 76,000 15,000
----------- -----------
Deferred tax liabilities:
Property and equipment, due to differing
depreciation methods (5,000) (9,000)
Investments, due to recognition of unrealized
appreciation and accretion for financial
statement purposes (329,000) (201,000)
----------- -----------
Total deferred tax liabilities (334,000) (210,000)
----------- -----------
Net deferred tax liabilities $ (258,000) (195,000)
=========== ===========
(Continued)
12
(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 subscription price paid in cash and the balance financed by a
non-interest bearing demand recourse promissory note. The Company holds
the issued shares as collateral for the note until the note is paid in
full. Other investors that purchased shares in this private placement
elected to pay all cash for their shares at the time of issuance. As of
June 30, 1998 and 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.
STOCK DIVIDEND
On February 5, 1999, the Company declared a 5% stock dividend to
shareholders 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 capitalized as common stock and additional
paid-in capital. Historical earnings per share and weighted average
shares outstanding and net asset value per share have been restated to
reflect the 5% stock dividend.
UNDISTRIBUTED ACCUMULATED EARNINGS
Undistributed accumulated earnings at June 30, 1998 and 1999 consist of
the following:
1998 1999
---- ----
Undistributed accumulated investment income $ 258,942 731,691
Undistributed accumulated net realized gains - 234,312
---------- -------
Undistributed accumulated earnings $ 258,942 966,003
========== =======
(Continued)
13
STOCK OPTION PLAN
During 1998, the Company adopted the Waterside Capital Corporation 1998
Employee Stock Option Plan (the "Plan") pursuant to which the Company
may grant stock options to officers and key employees. The Plan
authorizes the grant of options to purchase up to 105,000 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. There was no
plan in effect during 1997. During 1998 and 1999, 81,375 and 21,000
options, respectively, were granted under the Plan. At June 30, 1998
and 1999, there were 23,625 and 2,625 additional shares available for
future grant under the Plan, respectively.
The per share weighted-average fair value of all stock options granted
is $2.94. The fair value of each grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
assumptions: expected 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 and expected life of five years,
expected volatility of 17.3%, expected dividend yield of 0% and
risk-free interest rate of 6.01% for options granted in fiscal 1999.
Under the Plan, the employee stock options are dividend protected. As a
result, 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 dividend described above, all options outstanding were
adjusted in accordance with the Plan.
The Company applies APB Opinion No. 25 in accounting for its Plan and,
accordingly, 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 indicated below:
1998 1999
---- ----
Net increase in stockholders'
equity resulting from operations As reported $ 543,335 1,037,044
Pro forma 515,587 855,516
Net increase in stockholders'
equity resulting from operations
per share - basic and diluted As reported $ 0.57 0.70
Pro forma 0.54 0.57
(Continued)
14
Stock option activity during the periods indicated is as follows:
Number of Weighted-Average
Shares Exercise Price
------ --------------
Balance at June 30, 1997 - $ -
Granted 81,375 10.49
Exercised - -
Forfeited - -
Expired - -
---------- ----------
Balance at June 30, 1998 81,375 10.49
Granted 21,000 8.21
Exercised - -
Forfeited - -
Expired - -
---------- ----------
Balance at June 30, 1999 102,375 $ 10.02
========== ==========
At June 30, 1998 and 1999, 9,450 and 75,425 options, respectively, were
exercisable. The difference between the weighted average exercise
prices for all outstanding options and those exercisable on June 30,
1999 was not significant.
The weighted average remaining contractual life of outstanding options
at June 30, 1999 is 8.9 years.
(Continued)
15
(9) NET INCREASE IN STOCKHOLDERS' EQUITY RESULTING FROM OPERATIONS PER
SHARE
The following table sets forth the calculation of basic and diluted net
increase in stockholders' equity resulting from operations per share
for the years ended June 30, 1997, 1998 and 1999:
1997 1998 1999
---- ---- ----
Basic net increase in stockholders' equity
resulting from operations per share:
Net increase in stockholders' equity
resulting from operations $ 274,281 543,335 1,037,044
============ =========== ===========
Weighted average number of
common shares outstanding $ 590,223 955,749 1,491,937
============ =========== ===========
Basic net increase in stockholders'
equity resulting from operations
per share $ 0.46 0.57 0.70
============ =========== ===========
Diluted net increase in stockholders' equity
resulting from operations per share:
Net increase in stockholders' equity
resulting from operations $ 274,281 543,335 1,037,044
============ =========== ===========
Weighted average number of common
shares outstanding 590,223 955,749 1,491,937
Dilutive effect of stock options (as
determined by using the treasury
stock method) - 1,456 -
------------ ----------- -----------
Adjusted weighted average number
of common shares outstanding $ 590,223 957,205 1,491,937
============ =========== ===========
Diluted net increase in
stockholders' equity resulting
from operations per share $ 0.46 0.57 0.70
============ =========== ===========
(10) RELATED PARTY TRANSACTIONS
During the fiscal years ended June 30, 1997 and 1998, the Company paid
management fees and expenses to a company owned by an officer and
director of the Company of $52,000 and $39,000, respectively. In
addition, for the fiscal years ended June 30, 1998 and 1999, the
Company paid fees of $14,000 and $88,000, respectively, 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.
(Continued)
16
On February 1, 1997, the Company entered into a sublease agreement with
a company in which it has invested. The sublease agreement provides for
the same term as the prime lease, except that the sublease may be
terminated by either party on 90 days notice. As of June 30, 1999, the
Company no longer has an investment in this entity.
(11) LEASES
The Company has four noncancelable operating leases, primarily for
office space, that expire over the next four 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, 1999 are:
Year ending June 30,
2000 $ 62,907
2001 64,241
2002 65,370
2003 33,326
------------
Total minimum lease payments $ 225,844
============
Net rental expense for operating leases for the years ended June 30,
1997, 1998 and 1999 was $20,919, $34,834 and $68,376, respectively.
Sublease income for the years ended June 30, 1997, 1998 and 1999 was
$3,500, $10,900 and $4,900, respectively.
(12) COMMITMENTS AND CONTINGENCIES
EMPLOYMENT AGREEMENTS
The Company has employment agreements with five active members of
management. 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 purchase 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 $65,000 to $130,000. The
terms for these agreements range from one year to five years and expire
between December 1999 and December 2002. If the employees are
terminated by the Executive Committee due to disability 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 employee
will be paid for a period of two years from termination date. The
Company's commitment for termination benefits is approximately
$276,000.
(Continued)
17
LINE OF CREDIT
The Company has an open line of credit with a financial institution for
$1,500,000. The interest rate on the line is the bank's prime rate.
There were no outstanding borrowings under the line of credit at June
30, 1999.
(13) CONCENTRATION OF CREDIT RISK
Most of the Company's portfolio investment companies are located in the
Mid-Atlantic region of the United States. As a result, any adverse
impact on the economy of that region could 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, 1998 and 1999:
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
balance sheets. The fair value of portfolio investments is determined
by the Executive Committee of the Board of Directors or by current
market prices, if available, in accordance with the Company's valuation
policy (see note 2).
DEBENTURES PAYABLE:
The carrying amounts approximate fair value as the interest rate on the
$6,000,000 draw down was fixed in March 1999 and the $6,300,000 draw
down received an interim rate on April 22, 1999. In addition, interest
rates did not materially change between March and June 30, 1999.
(Continued)
18
STOCKHOLDERS' NOTES RECEIVABLE:
The fair value of stockholders' notes receivable is estimated by
discounting 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, 1998 and 1999 is estimated to be $1,279,000
and $1,394,000, respectively.
(15) EMPLOYEE BENEFIT PLAN
Effective July 1, 1998, the Company adopted the Waterside Capital
Corporation Defined Contribution Plan and Trust. The plan is available
to all employees of the Company, regardless of age, who have completed
at least three months of service. Eligible employees may contribute up
to 8% of their compensation 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 resolution of
the Board of Directors. Total employer expense for the plan for the
year ended June 30, 1999 was $21,708.
(16) CHANGE IN ESTIMATE
In the fourth quarter of 1999, the Company changed its estimate of the
liquidity discount used to calculate the fair value of investments in
publicly traded companies. The change in estimate provides a more
reasonable basis to determine the actual liquidity discount based on
the amount of shares held and the average daily trading volume. The
change resulted in additional unrealized appreciation on investments of
approximately $66,000, net of income taxes, for the fourth quarter of
1999.
(Continued)
19
WATERSIDE CAPITAL CORPORATION
Schedule of Portfolio Investments
JUNE 30, 1998 AND 1999
- --------------------------------------------------------------------------------
The Company's investment portfolio at June 30, 1998, consisted of the
following:
Cost or
contributed Fair
Loans: Maturity value value
------ -------- ----- -----
Avery Communications,
Inc. Convertible Note 12/10/02 $ 350,000 600,264
Divaris Consolidated
Investments, Inc. 6/29/04 975,000 975,000
------------ ------------
Total loans 1,325,000 1,575,264
------------ ------------
Cost or Fair
Number contributed market
Equity Investments: of shares value value
------------------- --------- ----- -----
PUBLICLY-TRADED COMPANY -
Avery Communications, Inc. Common
Stock 245,000 $ 249,900 568,033
EQUITY INVESTMENTS IN PRIVATE COMPANIES:
Real Time Data Management Services, Inc.
Preferred Stock 700 585,000 710,247
Mid-Atlantic Small Business Finance, Inc.
Preferred Stock 500 140,000 140,000
Coddle Roasted Meats, Inc. Preferred
Stock 125 125,000 93,750
Election Products, Inc. Preferred Stock 500 875,000 875,000
Election Products, Inc. Common Stock 223 4 140,518
NKL Industries, Inc. Preferred Stock 900 900,000 900,000
NKL Industries, Inc. Common Stock 989 989 989
Delta Education Systems, Inc. Preferred
Stock 425 398,600 398,600
Diversified Telecom, Inc. Preferred
Stock 1,500 1,500,000 1,500,000
Crispies, Inc. Preferred Stock 400 397,200 397,200
Triangle Biomedical Sciences Preferred
Stock 1,000 1,000,000 1,000,000
------------ ------------
Total equity investments 6,171,693 6,724,337
------------ ------------
(Continued)
20
WATERSIDE CAPITAL CORPORATION
Schedule of Portfolio Investments (continued)
- --------------------------------------------------------------------------------
Cost or Fair
Number of Percentage contributed market
Stock Options and Warrants: shares ownership value value
--------------------------- ------ --------- ----- -----
PUBLICLY-TRADED COMPANY:
Avery Communications, Inc. * 91,000 0.00% $ - 53,424
PRIVATE COMPANIES:
Real Time Data Management
Services, Inc. 125 29.41 115,000 124,000
Coddle Roasted Meats, Inc. 1,177 15.00 - -
Delta Education Systems, Inc. 176 15.00 26,400 26,400
Diversified Telecom, Inc. 3,611 10.74 - -
Crispies, Inc. 524 6.37 2,800 2,800
Triangle Biomedical Sciences 23,260 6.57 - -
------------ -------------
Total options and warrants 144,200 206,624
------------ -------------
Total investments $ 7,640,893 8,506,225
============ =============
The Company's investment portfolio at June 30, 1999 consisted of the
following:
Cost or
contributed Fair
Loans: Maturity value 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 Worldwide, 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
MilleCom, Inc. 3/31/04 900,000 900,000
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 loans 6,894,468 6,894,468
------------ -------------
(Continued)
21
WATERSIDE CAPITAL CORPORATION
Schedule of Portfolio Investments (continued)
- --------------------------------------------------------------------------------
Cost or Fair
Number contributed market
Equity Investments: of 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 * 165,000 237,000 427,425
Triangle Imaging Group, Inc. Preferred
Stock 150,000 1,321,500 1,321,500
Triangle Imaging Group, Inc. Convertible
Preferred Stock 700 700,000 700,000
Triangle Imaging Group, Inc. Common
Stock * 500,000 225,000 273,500
EQUITY INVESTMENTS IN 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 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 North America, 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
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 investments 16,669,927 17,070,782
-------------- --------------
(Continued)
22
WATERSIDE CAPITAL CORPORATION
Schedule of Portfolio Investments (continued)
Cost or Fair
Number of Percentage contributed market
Stock Options and Warrants: shares ownership value value
-------------------------- ------ --------- ------ ------
PUBLICLY-TRADED COMPANIES:
Avery Communications, Inc. 126,000 0.00% $ - -
Netplex Group, Inc. * 75,000 0.70 - 74,100
Triangle Imaging Group, Inc. * 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 North America, 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 - -
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
============= =============
* Represents Rule 144A restricted securities
- --------------------------------------------------------------------------------
23
SHAREHOLDER INFORMATION
CORPORATE OFFICES
Norfolk,Virginia -- Headquarters
300 E. Main Street, Suite 1380
Norfolk, VA 23510
Telephone: 757-626-1111
Facsimile: 757-626-0114
RICHMOND, VIRGINIA
707 E. Main Street, Suite 700
Richmond, VA 23219
Telephone: 804-225-5500
Facsimile: 804-225-5501
STOCK TRANSFER AGENT AND
REGISTRAR
Investors with questions
concerning account
information, replacing
lost or stolen certificates,
transferring securities
or processing a change
of address should contact:
RELIANCE TRUST COMPANY
3295 Northcrest Road N.E.
Atlanta, GA 30340-4099
Telephone: 770-938-6400
Facsimile: 770-908-7066
INVESTOR RELATIONS
Investors requiring
information about
the Company should
contact:
GERALD T. MCDONALD
Chief Financial Officer
Telephone: 757-626-1111
Facsimile: 757-626-0114
ANNUAL MEETING OF
SHAREHOLDERS
The annual shareholder's
meeting will be held
Monday, October 25, 1999
at 10:00 a.m. at Nauticus,
One Waterside Drive,
Norfolk, Virginia.
All shareholders are invited to attend.
STOCK LISTING
WATERSIDE CAPITAL CORPORATION
common stock is traded on the
NASDAQ Stock Market under the symbol WSCC.
INDEPENDENT PUBLIC
ACCOUNTANTS
KPMG LLP
Norfolk, Virginia
CORPORATE COUNSEL
WILLIAMS, MULLEN, CLARK & DOBBINS, P.C.
Virginia Beach, Virginia
DIRECTORS AND OFFICERS
DIRECTORS
Peter M. Meredith, Jr.1,3
Chairman of the Board
President
Meredith Construction Co. Inc.
J. Alan Lindauer1
President and Chief Executive Officer
James E. Andrews
Principal Owner
Anzell Automotive, Inc.
Donna C. Bennett2
Vice President
First Union National Bank
J.W. Whiting Chisman, Jr.1,3
President
Dare Investment Company
Jeffrey R. Ellis
Private Investor
Marvin S. Friedberg
Chief Executive Officer
Virginia Commonwealth
Trading Company
Eric L. Fox
Portfolio Manager
Paine Webber
Roger L. Frost2
Retired
Ernest F. Hardee1,3
President and Chief
Executive Officer
Hardee Realty Corporation
Henry U. Harris, III
President
Virginia Investment
Counselors, Inc.
Robert I. Low1,2
Senior Partner
Goodman & Company
Harold J. Marioneaux, Jr.
Dental Surgeon
Charles H. Merriman, III1
Manager, Corporate Finance Department
Scott & Stringfellow, Inc.
Augustus C. Miller
President and Chief
Executive Officer
Miller Oil Co., Inc.
Paul F. Miller
Director of Planning and
Development
City of Newport News
Juan M. Montero, II
General and Thoracic
Surgery
R. Scott Morgan, Sr.1
Executive Vice President
Branch Bank & Trust Corp.
James W. Noel, Jr.
Executive Director
York County Industrial Dev. Authority
Richard G. Ornstein1
Real Estate Management and Development
Jordan E. Slone
Chairman and Chief
Executive Officer
Harbor Group Companies
OFFICERS
J. Alan Lindauer
President and Chief
Executive Officer
Robert P. Louthan
Vice President and Business Development Officer
Gerald T. McDonald
Secretary and Chief
Financial Officer
Mark A. Sommer, III
Controller
Martin N. Speroni
Director of Research
Lex W. Troutman
Business Development
Officer
1 Executive Committee
2 Audit Committee
3 Compensation/Stock Option Committee