Form 10KSB for GREENSHIFT CORP
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17-Apr-2006
Annual Report
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION
In addition to historical information, this Reports contains forward-looking statements, which are generally identifiable by use of the words "believes," "expects," "intends," "anticipates," "plans to," "estimates," "projects," or similar expressions. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in these forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the sections entitled "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements.
OVERVIEW
We are a business development company that provides long-term debt and equity investment capital to companies and technologies that facilitate the efficient use of natural resources and catalyze transformational environmental gains. Our financing is generally used to fund growth, acquisitions, buyouts, recapitalizations, note purchases, bridge financings, and other types of financings. We generally invest in private companies and companies that are public but that lack access to additional public capital or whose securities may not be marginable.
Our earnings depend primarily on the level of interest and dividend income, fee and other income, and net gains or losses earned on our investment portfolio after deducting interest expense on borrowed capital and operating expenses. Interest income results from the stated interest rate earned on a loan or debt security and the amortization of loan origination fees and discounts. The level of interest income is directly related to the balance of the interest-bearing investment portfolio outstanding during the period multiplied by the weighted average yield. Our ability to generate interest income is dependent on economic, regulatory, and competitive factors that influence new investment activity, the amount of loans and debt securities for which interest is not accruing and our ability to secure debt and equity capital for our investment activities.
Because we are a regulated investment company for tax purposes, we intend to distribute substantially all of our annual taxable income as dividends to our shareholders.
PORTFOLIO AND INVESTMENT ACTIVITY
The total portfolio at value, investment activity, and the yield on
interest-bearing investments at and for the nine months ended December 31, 2005,
were as follows:
12/31/05
--------------
Portfolio at value $ 14,175,517
Investments funded 11,902,694
Change in accrued or reinvested interest 122,596
Principal collections related to investment repayments or sales --
Yield on interest-bearing investments 8.00%
The level of investment activity for investments funded and principal repayments for our investments can vary substantially from period to period depending on many factors, including the amount of debt and equity capital available to middle market companies, the level of merger and acquisition activity for such companies, the general economic environment, and the competitive environment for the types of investments we make. We believe that merger and acquisition activity in the middle market was strong during 2005, which when combined with a lower interest rate environment resulted in an increase in private finance investments funded, as well as increased repayments. The first quarter of the year tends to be a seasonally slower period for deal closings as the industry recovers from what is typically an active fourth quarter closing schedule.
Investments funded for the nine months ended December 31, 2005 consisted of the following:
12/31/05
----------------
Companies more than 25% owned $ 8,459,847
Companies 5% to 25% owned 1,160,430
Companies less than 5% owned 5,000
Notes receivable 2,277,417
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Total $ 11,902,694
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION
PORTFOLIO AND INVESTMENT ACTIVITY (continued)
We intend to continue a balanced approach to private finance investing that emphasizes a complementary mix of non-control investments and buyout investments, subject to regulatory diversity requirements. The combination of these two types of investments provides current interest and related portfolio income and the potential for future capital gains. Our current strategy is to focus on buyout and recapitalization transactions where we can control a portfolio company to manage risk and where we can potentially realize more attractive total returns from both current interest and fee income and future capital gains. In addition to our mezzanine investing, we are also focusing on smaller strategically compatible middle market companies for non-control transactions where we can provide either or both equity and/or debt financing.
We generally fund new investments using cash. In addition, we may acquire securities in exchange for our common equity. Also, we may acquire new securities through the reinvestment of previously accrued interest and dividends in debt or equity securities, or the current reinvestment of interest and dividend income through the receipt of a debt or equity security (payment-in-kind income). From time to time we may opt to reinvest accrued interest receivable in a new debt or equity security in lieu of receiving such interest in cash.
At December 31, 2005, we had an outstanding investment commitments to Aerogel Composite, Inc. and TerraPass, Inc., totaling $440,000.
The Company's largest investments at December 31, 2005, were in Veridium Corporation ("Veridium") (OTC Bulletin Board: VRDM), INSEQ Corporation ("INSEQ") (OTC Bulletin Board: INSQ), GreenWorks Corporation ("GreenWorks"), Sterling Planet, Inc. ("Sterling Planet"), and Ovation Products Corporation ("Ovation"), accounting for 27.2%, 21.4%, 20.5%, 5.1%, and 6.8% respectively, of our total portfolio value.
Veridium Corporation
At December 31, 2005 our investment in Veridium totaled $5,746,692 at cost and $4,040,171 at value, or 27.2% of our total assets. Total interest and related portfolio income earned from our investment in Veridium for nine months ended December 31, 2005, was $17,697. Net change in unrealized appreciation or depreciation for nine months ended December 31, 2005, includes $1,706,521 of unrealized depreciation related to Veridium.
Veridium (OTC Bulletin Board: VRDM) is a publicly traded environmental management company. Veridium is currently implementing a restructuring plan which includes the cessation of operations of Veridium's industrial waste recycling facility and is planned to include the reorganization of its services business. Veridium expects that these initiatives will enhance operating results in the immediate term and enable Veridium to grow its business more effectively.
Our chairman and chief executive officer, Kevin Kreisler, is also the chairman, chief executive officer and president of Veridium Corporation. As the controlling shareholder of the Company, who is in turn the controlling shareholder of Veridium, Mr. Kreisler has unconditionally guaranteed certain of Veridium's debts with its creditors.
INSEQ Corporation
At December 31, 2005, our investment in INSEQ totaled $1,988,967 at cost and $3,149,671 at value, or 21.4% of our total assets. Total interest and related portfolio income earned from our investment in INSEQ for the nine months ended December 31, 2005, was $151,928 which includes management fees of $150,000 and interest income of $1,928. Net change in unrealized appreciation or depreciation for the nine months ended December 31, 2005, includes $1,160,704 unrealized appreciation related to INSEQ.
INSEQ is a publicly traded corporation whose mission is to directly facilitate the efficient utilization of natural resources including metals, chemicals, fuels and plastics.
Our chairman and chief executive officer, Kevin Kreisler, is also the chairman of INSEQ, and our president and chief financial officer, James Grainer, is also the president and chief financial officer of INSEQ. As the controlling shareholder of the Company, who is in turn the controlling shareholder of INSEQ, Mr. Kreisler and the Company have unconditionally guaranteed certain of INSEQ's debts with its creditors.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION
PORTFOLIO AND INVESTMENT ACTIVITY (continued)
GreenWorks Corporation
At December 31, 2005, our investment in GreenWorks totaled $1,002,124 at cost and $3,236,514 at value, or 20.5% of our total assets. Total related portfolio income earned from our investment in GreenWorks for the nine months ended December 31, 2005, was $112,500. Net change in unrealized appreciation or depreciation for the nine months ended December 31, 2005, includes $2,234,390 unrealized appreciation related to GreenWorks.
GreenWorks is an environmental engineering services company that provides consulting, technical and engineering services to alleviate the environmental problems of its clients. GreenWorks' clients include Fortune 100 and other industrial companies, commercial firms, engineering and construction contractors, law firms, utilities, real estate developers and government entities.
Our chairman and chief executive officer, Kevin Kreisler, is also the chairman of GreenWorks, and our president and chief financial officer, James Grainer, is also the president and chief financial officer of GreenWorks.
Sterling Planet, Inc.
At December 31, 2005, our investment in Sterling totaled $750,000 at cost and $750,000 at value, or 5.1% of our total assets. Total interest and related portfolio income earned from our investment in Sterling for the nine months ended December 31, 2005, was about $17,389. Net change in unrealized appreciation or depreciation for the nine months ended December 31, 2005, includes no unrealized appreciation related to Sterling.
Sterling Planet is the nation's leading retail renewable energy provider through the sourcing and sale of renewable energy certificates ("RECs"). RECs, or green tags, enable retail residential and non-residential consumers to purchase green, or environmentally friendly, energy through their existing utility and offset reliance on power generated from fossil fuel sources. RECs represent all of the positive environmental attributes of renewable power generation from sources such as solar, wind and organic bioenergy power and can be purchased and used by consumers regardless of whether or not their local utility has access to green power generation.
Ovation Products Corporation
At December 31, 2005, our investment in Ovation totaled $1,000,000 at cost and $1,000,000 at value, or 6.8% of our total assets. We did not realize any interest or related portfolio income from our investment in Ovation for the nine months ended December 31, 2005. Net change in unrealized appreciation or depreciation for the nine months ended December 31, 2005, includes no unrealized appreciation related to Ovation.
Ovation is a development stage company with patented and proprietary technologies involving new implementations of vapor compression distillation. Ovation has invested over $9 million developing technology that offers dramatic price and performance advantages over competing clean water technologies. Ovation is finalizing the development of its initial product, the Clean Water Appliance - a fire-hydrant sized appliance that can generate 25 gallons of pure water per hour from a variety of dirty water input sources at a cost of approximately $0.004 per gallon, or about 1.2% of the cost of traditional home distillation methods. Ovation expects that its Clean Water Appliance will be available in 2006 and will sell for a fraction of the price of commercial distillation systems. Our chairman and chief executive officer, Kevin Kreisler, is a board member of Ovation.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION
RESULTS OF OPERATIONS
Total Interest and Related Portfolio Equity Income
Total interest and related portfolio income includes interest and dividend
income, loan payments, and fees and other income. We generated $57,272 in
interest and dividend income during the nine months ended December 31, 2005.
Fees and other income for the nine months ended December 31, 2005, was composed
of the following:
12/31/05
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Management services provided to portfolio companies ............... $556,250
Transactional and other services provided to portfolio companies .. --
Structuring and diligence services provided for portfolio companies 87,500
Other income ...................................................... --
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Total .......................................................... $643,750
Fees and other income are generally related to specific transactions or services and therefore may vary substantially from period to period depending on the level and types of services provided.
Operating Expenses
Operating expenses include interest, employee, and administrative expenses. Our interest expense is mostly associated with our various convertible debentures, and totaled $231,698 during the nine months ended December 31, 2005. Employee expenses include salaries and employee benefits and the individual performance award and bonuses, and totaled $87,361 during the nine months ended December 31, 2005. Administrative expenses include legal and accounting fees, valuation assistance fees, insurance premiums, the cost of leases for our offices, stock record expenses, directors' fees, and various other expenses, and totaled $714,466 during nine months ended December 31, 2005. Change in the fair market value of derivatives relate to the conversion features of certain of our debentures and totaled $265,679 for the nine months ended December 31, 2005.
Realized Gains and Losses
Net realized gains primarily result from the sale of equity securities associated with certain investments, and the sale of debt, bonds and preferred shares. Net realized gains for the nine months ended December 31, 2005, were $0. When we exit an investment and realize a gain or loss, we make an accounting entry to reverse any unrealized appreciation or depreciation, respectively, we had previously recorded to reflect the appreciated or depreciated value of the investment. For the nine months ended December 31, 2005, we made no such reversals.
Change in Unrealized Appreciation or Depreciation
We determine the value of each investment in our portfolio on a quarterly basis, and changes in value result in unrealized appreciation or depreciation being recognized in our statement of operations. Value, as defined in Section 2(a)(41) of the Investment Company Act of 1940, is (i) the market price for those securities for which a market quotation is readily available and (ii) for all other securities and assets, fair value is as determined in good faith by the Board of Directors. Since there is typically no readily available market value for the investments in our portfolio, we value substantially all of our portfolio investments at fair value as determined in good faith by the Board of Directors pursuant to a valuation policy and a consistently applied valuation process.
The Company relies on the services of an independent third party valuation company, Business Valuation Center of Reston, Virginia ("BVC"), to provide an independent assessment of the fair market value of the Company's investments. The Company's financial statements for the nine months ended December 31, 2005 have been prepared in connection with BVC's conclusions, which conclusions were based on a variety of conventionally accepted valuation methods.
At December 31, 2005, portfolio investments recorded at fair value constituted greater than 96% of our total assets. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our investments determined in good faith by the Board of Directors may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION
RESULTS OF OPERATIONS (continued)
There is no single standard for determining fair value in good faith. As a result, determining fair value requires that judgment be applied to the specific facts and circumstances of each portfolio investment while employing a consistently applied valuation process for the types of investments we make. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. Instead, we are required to specifically value each individual investment on a quarterly basis. We will record unrealized depreciation on investments when we believe that an investment has become impaired, including where collection of a loan or realization of an equity security is doubtful, or when the enterprise value of the portfolio company does not currently support the cost of our debt or equity investment. Enterprise value means the entire value of the company to a potential buyer, including the sum of the values of debt and equity securities used to capitalize the enterprise at a point in time. We will record unrealized appreciation if we believe that the underlying portfolio company has appreciated in value and our equity security has also appreciated in value. Changes in fair value are recorded in the statement of operations as net change in unrealized appreciation or depreciation.
As a business development company, we have invested in illiquid securities including debt and equity securities of companies, and preferred shares. The structure of each private finance debt and equity security is specifically negotiated to enable us to protect our investment and maximize our returns. We include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. Our investments are generally subject to restrictions on resale and generally have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation process requires an analysis of various factors. Our fair value methodology includes the examination of, among other things, the underlying investment performance, financial condition, and market changing events that impact valuation.
Valuation Methodology
Our process for determining the fair value of a private finance investment begins with determining the enterprise value of the portfolio company. The fair value of our investment is based on the enterprise value at which the portfolio company could be sold in an orderly disposition over a reasonable period of time between willing parties other than in a forced or liquidation sale. The liquidity event whereby we exit a private finance investment is generally the sale, the recapitalization or, in some cases, the initial public offering of the portfolio company.
There is no one methodology to determine enterprise value and, in fact, for any one portfolio company, enterprise value is best expressed as a range of fair values, from which we derive a single estimate of enterprise value. To determine the enterprise value of a portfolio company, we analyze its historical and projected financial results. We generally require portfolio companies to provide annual audited and quarterly unaudited financial statements, as well as annual projections for the upcoming fiscal year. Typically in the private equity business, companies are bought and sold based on multiples of EBITDA, cash flow, net income, revenues or, in limited instances, book value.
The private equity industry uses financial measures such as EBITDA or EBITDAM (Earnings Before Interest, Taxes, Depreciation, Amortization and, in some instances, Management fees) in order to assess a portfolio company's financial performance and to value a portfolio company. EBITDA and EBITDAM are not intended to represent cash flow from operations as defined by U.S. generally accepted accounting principles and such information should not be considered as an alternative to net income, cash flow from operations, or any other measure of performance prescribed by U.S. generally accepted accounting principles. When using EBITDA to determine enterprise value, we may adjust EBITDA for non-recurring items. Such adjustments are intended to normalize EBITDA to reflect the portfolio company's earnings power. Adjustments to EBITDA may include compensation to previous owners, acquisition, recapitalization, or restructuring related items or one-time non-recurring income or expense items.
In determining a multiple to use for valuation purposes, we generally look to private merger and acquisition statistics, discounted public trading multiples or industry practices. In estimating a reasonable multiple, we consider not only the fact that our portfolio company may be a private company relative to a peer group of public comparables, but we also consider the size and scope of our portfolio company and its specific strengths and weaknesses. In some cases, the best valuation methodology may be a discounted cash flow analysis based on future projections. If a portfolio company is distressed, a liquidation analysis may provide the best indication of enterprise value.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS AND PLAN OF OPERATION
RESULTS OF OPERATIONS (continued)
Change in Unrealized Appreciation or Depreciation (continued)
Valuation Methodology (continued)
If there is adequate enterprise value to support the repayment of our debt, the fair value of our loan or debt security normally corresponds to cost unless the borrower's condition or other factors lead to a determination of fair value at a different amount. The fair value of equity interests in portfolio companies is determined based on various factors, including the enterprise value remaining for equity holders after the repayment of the portfolio company's debt and other preference capital, and other pertinent factors such as recent offers to purchase a portfolio company, recent transactions involving the purchase or sale of the portfolio company's equity securities, or other liquidation events. The determined equity values are generally discounted when we have a minority position, restrictions on resale, specific concerns about the receptivity of the capital markets to a specific company at a certain time, or other factors.
As a participant in the private equity business, we invest primarily in private middle market companies for which there is generally no publicly available information. Because of the private nature of these businesses, there is a need to maintain the confidentiality of the financial and other information that we have for the private companies in our portfolio. We believe that maintaining this confidence is important, as disclosure of such information could disadvantage our portfolio companies and could put us at a disadvantage in attracting new investments. Therefore, we do not intend to disclose financial or other information about our portfolio companies, unless required, because we believe doing so may put them at an economic or competitive disadvantage, regardless of our level of ownership or control.
To balance the lack of publicly available information about our private portfolio companies, we will continue to work with independent third-party consultants to obtain assistance in determining fair value for a portion of the private finance portfolio each quarter. We work with these consultants to obtain assistance as additional support in the preparation of our internal valuation analysis for a portion of the portfolio each quarter (for all investments with a cost or value greater than $250,000). In addition, we may receive independent assessments of a particular private finance portfolio company's value in the ordinary course of business, most often in the context of a prospective sale transaction or in the context of a bankruptcy process. The valuation analysis prepared by management using these independent valuation resources is submitted to our Board of Directors for its determination of fair value of the portfolio in good faith.
At December 31, Business Valuation Center, Inc. ("BVC") assisted us by reviewing our valuations of our portfolio companies. For the remaining quarters in 2005, we intend to continue to obtain valuation assistance from BVC and possibly other third parties. We currently anticipate that we will generally obtain assistance for all companies in the portfolio that are more than 50% owned for each of the remaining quarters in 2005 and that we will generally obtain assistance for companies that are equal to or less than 50% owned at least once during the course of the year. Valuation assistance may not be obtained for new companies that enter the portfolio after September 30 of any calendar year during that year. Professional fees for valuation assistance for all of 2005 was approximately $57,500.
OTHER MATTERS
Per Share Amounts
All per share amounts included in the Management's Discussion and Analysis of Financial Condition and Results of Operations section have been computed using the weighted average common shares outstanding to compute basic earnings per share, which were $0.03 with 63.5 million weighted average common shares outstanding for the nine months ended December 31, 2005.
FINANCIAL CONDITIONS, LIQUIDITY AND CAPITAL RESOURCES
Our portfolio is expected to generate cash flow from which we plan to pay dividends to shareholders and fund new investment activity. Cash generated from the portfolio includes cash flow from net investment income and net realized gains and principal collections related to investment repayments or sales. Cash . . .
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