Form 10-Q for SOVEREIGN EXPLORATION ASSOCIATES INTERNATIONAL, INC.
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14-Nov-2005
Quarterly Report
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion will assist in the understanding of the Companys position and results of operations. The information below should be read in conjunction with the financial statements, the Companys report on Form 10Q and the Companys recently filed Form 8K describing the October 20, 2005 definitive agreement with Sovereign Exploration Associates International, Inc. (SEAI).
Among other material items, the October 20, 2005 agreement required CALI Holdings, Inc. to divest all its portfolio companies in existence at the time of the execution of the agreement, with the sole exception of Gulf Coast Records, which shall be divested upon the filing of a Form SB-2. The agreement also required a full release from any and all liability from Gulf Coast Records.
The reader of this discussion and related Form 10Q for September 30, 2005 and the recently filed Form 8K should understand that the Portfolio companies, the Senior Management team, and the Board of Directors have all materially changed.
Overview
On January 5, 2004 the Company shareholders approved the proposal to allow the Company to adopt business development company (BDC) status under the Investment Company Act of 1940 (1940 Act). A BDC is a specialized type of Investment Company under the 1940 Act. A BDC may primarily be engaged in the business of furnishing capital and managerial expertise to companies that do not have ready access to capital through conventional financial channels; such companies are termed eligible portfolio companies. The Company as a BDC, may invest in other securities, however such investments may not exceed 30% of the Companys total asset value at the time of such investment. The Company filed its BDC election with the SEC (Form N-54A) on January 13, 2004.
The Company is a financial service company providing financing and advisory services to small and medium-sized companies throughout the United States. Effective January 5, 2004 the Company shareholders approved the proposal to allow the Company to convert to a business development company (BDC) under the Investment Company Act of 1940 (1940 Act).
The Companys investments in portfolio companies typically range from $100,000 to $1,000,000. The Company invests either directly in the equity of a company through equity shares or through a debt instrument. The Companys debt instruments usually do not have a maturity of more than five years. Interest is either currently paid or deferred.
Investment opportunities are identified for the Company by the management team. Investment proposals may, however, come to the Company from many sources, and may include unsolicited proposals from the public and from referrals from banks, lawyers, accountants and other members of the financial community. The management team brings an extensive network of investment referral relationships.
The Companys principal offices are located at 7658 Municipal Drive, Orlando, Florida. The office is equipped with an integrated network of computers for word processing, financial analysis, accounting and loan services. The Company believes its office space is suitable for its needs for the foreseeable future.
On October 26, 2005 the Company changed its name from CALI Holdings, Inc. to Sovereign Exploration Associates International (SEAI), Inc. (the Company). The Company provides equity and long-term debt financing to small and medium-sized private companies in a variety of industries throughout the United States. The companys investment objective is to achieve long-term capital appreciation in the value of its investments and to provide current income primarily from interest, dividends and fees paid by its portfolio companies.
Portfolio Investments
The Company has investments in 5 controlled (portfolio) companies as of September 30, 2005.
1. Sports Nation, Inc.
Sports Nation, Inc. is involved in all aspects of the sports memorabilia merchandising industry. Sports Nations management has over 50 years of combined experience in product development, licensing, mass merchandise, retail, and direct marketing & sales. Through years of specializing in sourcing and selling the finest caliber sports memorabilia and collectible products, Sports Nation has forged numerous strategic relationships with companies and individuals in sports marketing, including agents and athletes, manufacturers, authenticators, and retailers.
Sports Nation, Inc. is a Nevada Corporation, which is owned 100% by the Company.
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Table of Contents
2. TSB Financial Services, Inc.
TSB Financial Services, Inc. obtains financing for various commercial real estate transactions through strategic relationships with outside funding sources and provides professional consulting services to portfolio companies and other outside companies. TSB Financial Services, Inc. serves customers nationally from its headquarters in Orlando, Florida.
TSB Financial Services, Inc. is a Florida Corporation, which is owned 100% by the Company.
3. Wellstone Acquisition Corporation
Wellstone Acquisition Corporation is a non-reporting Securities & Exchange Commission registrant. This Company had no business activity for the three months ended September 30, 2005.
Wellstone Acquisition Corporation is a Delaware corporation that is owned 66% by the Company.
4. TS&B Gaming and Entertainment Corporation
TS&B Gaming and Entertainment Corporation was formed on March 18, 2004 to invest in gaming, entertainment and other such ventures. TS&B Gaming and Entertainment had no business activity through September 30, 2005.
TS&B Gaming & Entertainment Corporation is a Florida corporation that is 100% owned by the Company.
5. TS&B Ventures, Inc.
TS&B Ventures, Inc. was formed on April 16, 2004 to seek private investment into the Companys various portfolio companies. TS&B Ventures, Inc. had no business activity through September 30, 2005.
TS&B Ventures, Inc. is a Florida corporation that is 100% owned by the Company.
Other Investments
The Company has investments in three other companies as of September 30, 2005.
1. Gulf Coast Records, LLC
Gulf Coast Records, LLC, a Florida Limited Liability Company, is an independent record label. Currently, Gulf Coast Records is developing recording artist Glenn Cummings. Gulf Coast Records has released Glenn Cummings debut single and album entitled BIG and second hit single Good Old Days.
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Table of Contents The Gulf Coast Records team includes Bryan Switzer, former manager of a major record label and H.L. Voelker who acted as production consultant on Glenn's album.
On June 30, 2004 Gulf Coast Records formed Hare Scramble, LLC. Hare Scramble, LLC is a Florida Limited Liability Company involved in music publishing and is 100% owned by Gulf Coast Records, LLC.
On July 27, 2005, the Company retained a legal firm to assist in filing a selling stockholder registration statement for its to-be-formed portfolio company Gulf Coast Records, Inc. and its to-be-wholly-owned subsidiary Gulf Coast Records, LLC. The purpose of the offering is to make Gulf Coast a separate SEC reporting company and to secure a qualification for quotation of its securities on the Over the Counter Bulletin Board.
On July 28, 2005 Gulf Coast Records entered into a joint venture with Brick Agency, LLC which was recently formed by Bryan Switzer. Brick Agency is a stand alone artist management company that will sign Glenn Cummings and other established artists into management contracts.
2. KMA Capital Partners, Ltd.
KMA Capital Partners, Ltd. provides business consulting and financial services to the Company and to small and mid-cap companies.
KMA Capital Partners, Ltd. is a Florida Limited Partnership in which the Company has a 25% limited partnership interest.
3. NEX2U, Inc.
NEX2U is in the multimedia catalog industry. Through the new patent-pending STM(TM) Technology, NEX2U takes existing print catalogs and transforms them into highly interactive, highly profitable direct mail experiences.
The Company owns less than 7% of the outstanding stock of NEX2U.
Dispositions of Investments
On September 21, 2005, the company sold its 51% interest in Buehler Earth and Waterworks, LLC for $110,000 to Buehlers managing member.
As referenced in Note L, the company on October 17, 2005 divested all of its portfolio companies at the time of the agreement with Sovereign Exploration Associates International, Inc. with the exception of Gulf Coast Records, LLC which shall be divested upon the filing of Form SB-2.
Valuation of Investments
The most significant estimate inherent in the preparation of the Companys financial statements is the valuation of its investments and the related unrealized appreciation or depreciation.
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Table of Contents Upon the Companys conversion to a business development company, the Company employed independent business valuation experts to value selected portfolio companies. The Board of Directors determined all other portfolio companies and investments at fair market value under a good faith standard. The Company analyzes and values each individual investment on a quarterly basis and records unrealized depreciation for an investment that it believes has become impaired, including where collection of a loan or realization of an equity security is doubtful. Conversely, the Company will record unrealized appreciation if it believes that the underlying portfolio company has appreciated in value.
Investments in Private Companies
The Company provides privately negotiated long-term debt and equity investment capital. The Company provides capital in the form of debt with or without equity features, such as warrants or options, often referred to as mezzanine financing. In certain situations the Company may choose to take a controlling equity position in a company. The Companys private financing is generally used to fund growth, buyouts and acquisitions and bridge financing.
The Companys private finance portfolio currently includes investments in a variety of industries including record company, publishing company and financial services and sports memorabilia.
The Company funds new investments using cash through the issuance of common stock. The Company intends to reinvest accrued interest, dividends and management fees into its various investments. When the Company acquires a controlling interest in a company, the Company may have the opportunity to acquire the companys equity with its common stock. The issuance of its stock as consideration may provide the Company with the benefit of raising equity without having to access the public markets in an underwritten offering, including the added benefit of the elimination of any underwriting commission.
As a business development company, the Company is required to provide significant managerial assistance available to the companies in its investment portfolio. In addition to the interest and dividends received from the Companys private finance investments, the Company will often generate additional fee income for the structuring, due diligence, transaction and management services and guarantees we provide to its portfolio companies.
Governmental Regulation
Business Development Company
A business development company is defined and regulated by the 1940 Act. Although the 1940 Act exempts a business development company from registration under the Act, it contains significant limitations on the operations of a business development company.
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Table of Contents A business development company must be organized in the United States for the purpose of investing in or lending to primarily private companies and making managerial assistance available to them. A business development company may use capital provided by public shareholders and from other sources to invest in long-term, private investments in businesses. A business development company provides shareholders the ability to retain the liquidity of a publicly traded stock, while sharing in the possible benefits, if any, of investing in primarily privately owned companies. To qualify as a business development company, a company must:
· Have registered a class of its equity securities or have filed a registration statement with the Securities and Exchange Commission pursuant to Section 12 of the Securities and Exchange Act of 1934;
· Operate for the purpose of investing in securities of certain types of portfolio companies, namely emerging companies and businesses suffering or just recovering from financial distress;
· Extend significant managerial assistance to such portfolio companies and;
· Have a majority of disinterested directors (as defined in the 1940 Act).
Generally, a business development company must be primarily engaged in the business of furnishing capital and providing managerial expertise to companies that do not have ready access to capital through conventional financial channels. An eligible portfolio company is generally a domestic company that is not an investment company (other than a small business investment company wholly owned by a business development company), and that:
· Does not have a class of securities registered on an exchange or included in the Federal Reserve Boards over-the-counter margin list; or
· Is actively controlled by a business development company and has an affiliate of a business development company on its board of directors; or
· Meets such other criteria as may be established by the Securities and Exchange Commission.
Control under the 1940 Act is presumed to exist where a business development Company beneficially owns more than 25% of the outstanding voting securities of the portfolio company.
The 1940 Act prohibits or restricts companies subject to the 1940 Act from investing in certain types of companies such as brokerage firms, insurance companies, investment banking firms and investment companies.
As a business development company, the Company may not acquire any asset other than "qualifying assets" unless, at the time the Company makes the acquisition, the value of its qualifying assets represent at least 70% of the value of its total assets. The principal categories of qualifying assets relevant to our business are:
· Securities purchased in transactions not involving any public offering, the issuer of which is an eligible portfolio company;
· Securities received in exchange for or distributed with respect to securities described in the bullet above or pursuant to the exercise of options, warrants or rights relating to such securities;
· Securities of bankrupt or insolvent companies that were eligible at the time of the business development companys initial acquisition of their securities but are no longer eligible, provided that the business development company has maintained a substantial portion of its initial investment in those companies; and
· Cash, cash items, government securities or high quality debt securities (within the meaning of the 1940 Act), maturing in one year or less from the time of investment.
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Table of Contents A business development company is permitted to invest in the securities of public companies and other investments that are not qualifying assets, but those kinds of investments may not exceed 30% of the business development companys total asset value at the time of the investment.
As a business development company, the Company is entitled to issue senior securities in the form of stock or senior securities representing indebtedness, including debt securities and preferred stock, as long as each class of senior security has asset coverage of at least 200% immediately after each such issuance.
The Company is also prohibited under the 1940 Act from knowingly participating in certain transactions with its affiliates without the prior approval of its board of directors who are not interested persons and, in some cases, prior approval by the Securities and Exchange Commission.
A business development company must make significant managerial assistance available to the issuers of eligible portfolio securities in which it invests. Making available significant managerial assistance means among other things, any arrangement whereby the business development company, through its directors, officers or employees, offers to provide and, if accepted does provide, significant guidance and counsel concerning the management, operation or business objectives and policies of a portfolio company.
The Company may be periodically examined by the Securities and Exchange Commission for compliance with the 1940 Act. As of the date of this filing the Company has not been examined by the Securities and Exchange Commission and has not been notified of a pending examination.
As with other companies regulated by the 1940 Act, a business development company must adhere to certain substantive regulatory requirements. A majority of its directors must be persons who are not interested persons, as that term is defined in the 1940 Act. Additionally, the Company is required to provide and maintain a bond issued by a reputable fidelity insurance company to protect it against larceny and embezzlement.
Furthermore, as a business development company, the Company is prohibited from protecting any director or officer against any liability to the Company or its shareholders arising from willful malfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of such person's office.
The Company maintains a Code of Ethics that establishes procedures for personal investment and restricts certain transactions by its personnel. The Companys Code of Ethics generally does not permit investment by its employees in securities that may be purchased or held by the Company. The Code of Ethics is filed as an exhibit to this 10Q, which will be on file at the SEC.
The Company may not change the nature of its business so as to cease to be, or withdraw its election as, a business development company unless authorized by vote of a "majority of the outstanding voting securities," as defined in the 1940 Act, of its shares. A majority of the outstanding voting securities of a company is defined under the 1940 Act as the lesser of: (i) 67% or more of such company's shares present at a meeting if more than 50% of the outstanding shares of such company are present and represented by proxy or (ii) more than 50% of the outstanding shares of such company. Since the Company elected to become a business development company, it has not made any substantial change in the nature of its business.
Regulated Investment Company
The Company has not elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986.
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Table of Contents Compliance with the Sarbanes-Oxley Act of 2002 and NYSE Corporate Governance Regulations.
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"). The Sarbanes-Oxley Act imposes a wide variety of new regulatory requirements on publicly held companies and their insiders. Many of these requirements will affect the Company. For example:
· The Companys chief executive officer and chief financial officer must now certify the accuracy of the financial statements contained in its periodic reports;
· The Companys periodic reports must disclose conclusions about the effectiveness of its disclosure controls and procedures;
· The Companys periodic reports must disclose whether there were significant changes in its internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses; and
· The Company may not make any loan to any director or executive officer and may not materially modify any existing loans.
The Sarbanes-Oxley Act has required the Company to review its current policies and procedures to determine whether it complies with the Sarbanes-Oxley Act and the new regulations promulgated thereunder. The Company will continue to monitor its compliance with all future regulations that are adopted under the Sarbanes-Oxley Act and will take actions necessary to ensure that we are in compliance.
Employees
As of September 30, 2005 the Company had five employees.
Risk Factors and Other Considerations
Investing in the Companys common stock involves a high degree of risk. Careful consideration should be given to the risks described below and all other information contained in this Annual Report, including the financial statements and the related notes and the schedules as exhibits to this Annual Report.
Limited Operating History as a Business Development Company Which May Impair Your Ability to Assess Our Prospects.
Prior to January 2004 the Company had not operated as a business development company under the Investment Company Act of 1940. As a result the Company has limited operating results under this regulatory framework that can demonstrate either its effect on its business or managements ability to manage the Company under these frameworks. In addition, the Companys management has no prior experience managing a business development company. The Company cannot assure that management will be able to operate successfully as a business development company.
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Table of Contents Because there is generally no established market for which to value its investments, the Companys board of directors determination of the value of its investments may differ materially from the values that a ready market or third party would attribute to these investments.
Under the 1940 Act the Company is required to carry its portfolio investments at market value, or, if there is no readily available market value, at fair value as determined by the board. The Company is not permitted to maintain a general reserve for anticipated loan losses. Instead, the Company is required by the 1940 Act to specifically value each individual investment and to record any unrealized depreciation for any asset that has decreased in value. Since there is typically no public market for the loans and equity securities of the companies in which it invests, the Companys board will determine the fair value of these loans and equity securities pursuant to its valuation policy. These determinations of fair value may necessarily be somewhat subjective. Accordingly, these values may differ materially from the values that would be determined by a party or placed on the portfolio if there existed a market for our loans and equity securities.
Investing in Private Companies Involves a High Degree of Risk.
The Companys portfolio consists of primarily long-term loans to and investments in private companies. Investments in private businesses involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative. There is generally no publicly available information about the companies in which the Company invests, and the Company relies significantly on the due diligence of its employees and agents to obtain information in connection with its investment decisions. If the Company is unable to uncover all material information about these companies, it may not make a fully informed investment decision and the Company may lose money on its investments.
In addition, some smaller businesses have narrower product lines and market shares than their competition, and may be more vulnerable to customer preferences, market conditions or economic downturns, which may adversely affect the return on, or the recovery of, the Companys investment in such business.
The Lack of Liquidity of the Companys Privately Held Investments may Adversely Affect Our Business.
Substantially all of the investments the Company expects to acquire in the future will be, subject to restrictions on resale, including in some instances, legal restrictions, or will otherwise be less liquid than publicly traded securities. The illiquidity of these investments may make it difficult for the Company to quickly obtain cash equal to the value at which it records its investments if the need arises. This could cause the Company to miss important business opportunities. In addition, if the Company were required to quickly liquidate all or a portion of its portfolio, it may realize significantly less than the value at which it had previously recorded its investments.
If the Industry Sectors in which the Companys Portfolio is Concentrated Experience Adverse Economic or Business Conditions, Our Operating Results may be Negatively Impacted.
The Companys customer base is primarily in the Manufacturing and Distribution; Product Marketing and Sales; Financial Services; and Sports, Entertainment & Gaming; and Management Services industry sectors. These customers can experience adverse business conditions or risks related to their industries. Accordingly, if the Companys customers suffer due to these adverse business conditions or risks or due to economic slowdowns or downturns in these industry sectors the Company will be more vulnerable to losses in its portfolio and our operating results may be negatively impacted.
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Table of Contents Some of these companies may be unable to obtain financing from public capital markets or from traditional credit sources, such as commercial banks. Accordingly, advances made to these types of customers may entail a higher degree of risk than advances made to customers who are able to utilize traditional credit sources. These conditions may also make it difficult for us to obtain repayment of our loans.
Economic downturns or recessions may impair the Companys customers ability to repay its loans, harm its operating results.
Many of the companies in which the Company has made or will make investments may be susceptible to economic slowdowns or recessions. An economic slowdown may affect the ability of a company to engage in a liquidity event. The Companys non-performing assets are likely to increase and the value of its portfolio is likely to decrease during these periods. These conditions could lead to financial losses in its portfolio and a decrease in its revenues, net income and assets.
The Companys business of making private equity investments and positioning them for liquidity events also may be affected by current and future market conditions. The absence of an active senior lending environment may slow the amount of private equity investment activity generally. As a result, the pace of the Companys investment activity may slow. In addition, significant changes in the capital markets could have an effect on the valuations of private companies and on the potential for liquidity events involving such companies. This could affect the amount and timing of gains realized on its investments.
The Companys Borrowers May Default on Their Payments, Which May Have an Effect on Financial Performance.
Some of these companies may be unable to obtain financing from public capital markets or from traditional credit sources, such as commercial banks. . . . |
