UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2005
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _____________ to _______________
Commission File Number 000-26887
FRANCHISE CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Nevada 98-0353403
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
8655 E. Via De Ventura Suite G-217
Scottsdale, AZ 85058
(Address of principal executive offices)
(480) 355-8142
(Registrant's telephone number)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares of the issuer's common equity outstanding as of April
7, 2005 was 18,927,305 shares of common stock, par value $.0001.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
INDEX TO FORM 10-Q/A FILING
FOR THE QUARTER ENDED MARCH 31, 2005
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Portfolio of Investments as of March 31, 2005 3
Statements of Assets and Liabilities at March 31, 2005 and
June 30, 2004 5
Statements of Operations for the nine month and three month periods
ended March 31, 2005 and March 31, 2004 6
Statements of Changes in Net Assets for the nine month periods ended
March 31, 2005 and March 31, 2004 7
Statements of Cash Flow for the nine month periods ended March 31,
2005 and March 31, 2004 8
Notes to Financial Statements 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 22
ITEM 4. CONTROLS AND PROCEDURES 22
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 22
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 23
ITEM 4. SUBMSISION OF MATTERS TO A VOTE OF SECURITY HOLDERS 23
ITEM 5. OTHER INFORMATION 23
ITEM 6. EXHIBITS 23
SIGNATURES 23
EXPLANATORY NOTE:
On December 23, 2004, the company elected to be regulated as a Business
Development Company (BDC) as outlined in the Investment Company Act of 1940 by
filing a Form N-54A. As a BDC, the Company is no longer eligible to report on
Form 10-QSB because it is an investment company and, therefore, does not qualify
as a small business issuer. The Company has therefore elected to file this
amended Form 10Q/A to properly present its financial information to comply with
Regulation S-X.
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FRANCHISE CAPITAL CORPORATION
PORTFOLIO OF INVESTMENTS (UNAUDITED)
March 31, 2005
Percent of
Net
Value Assets
----- ------
PORTFOLIO STRUCTURE
SHORT-TERM INVESTMENTS:
None $ -- --%
PRIVATE COMPANIES 799,244 219%
PUBLIC COMPANIES -- --%
PRIVATE UNVESTMENT FUNDS -- --%
TOTAL INVESTMENTS 799,244 219%
OTHER ASSETS & LIABILITIES (NET) (434,849) (119)%
NET ASSETS $ 364,395 100%
Notes to Financial Statements are an integral part of
these Financial Statements
3
FRANCHISE CAPITAL CORPORATION
PORTFOLIO OF INVESTMENTS MARCH 31, 2005 (UNAUDITED)
Principal Acquisition
Amount/Shares Date Value
------------- ---- -----
PRIVATE COMPANIES (1) -- 219%
Common Stocks-- 100%
Restaurant companies-- 100%
1,000,000
shares common
stock Fathom Business Systems, Inc. 12/2004 $ 337,480
INVESTMENTS IN CONTROLLED COMPANIES:
Membership 72.5% Comstock Jake's Franchise Co., LLC 12/2004 7,500
Membership 50% Cousin Vinnie's Franchise Co., LLC 12/2004 -
Membership 100% Kirby Foo's Franchise Co., LLC 12/2004 7,500
Membership 50% Kokopelli Mexican Grill Franchise Co. LLC 12/2004 250,000
ADVANCES TO CONTROLLED COMPANIES:
Fathom Business Systems, Inc. 12/2004 43,842
Comstock Jake's Franchise Co., LLC 12/2004 30,000
Cousin Vinnie's Franchise Co., LLC 12/2004 90,473
Kirby Foo's Franchise Co., LLC 12/2004 26,842
Kokopelli Mexican Grill Franchise Co. LLC 12/2004 5,607
---------
TOTAL-- PRIVATE COMPANIES (Cost $512,473) 799,244
---------
TOTAL INVESTMENTS (Cost $512,473) -- 219% 799,244
---------
OTHER ASSETS & LIABILITIES (NET) -- (119)% (434,849)
---------
NET ASSETS -- 100.00% $ 364,395
---------
Notes to Financial Statements are an integral part of
these Financial Statements
----------
1. At March 31, 2005 the Company owned 25% or more of each of the private
company's outstanding common stock thereby making each a controlled
affiliate as defined by the Investment Company Act of 1940. Total market
value of controlled affiliated securities owned at March 31, 2005 was
$799,244.
4
FRANCHISE CAPITAL CORPORATION
STATEMENT OF ASSETS AND LIABILITIES
March 31, June 30,
2005 2004
------------ ------------
(Unaudited)
ASSETS:
Controlled Affiliated Issuers at value (Cost $512,473
and $0, respectively) $ 799,244 $ --
Cash and cash equivalents 15,836 46,001
Advances receivable 3,427 --
Prepaid expenses and other assets -- 309,198
------------ ------------
TOTAL ASSETS $ 818,507 $ 355,199
LIABILITIES:
Accounts payable and accrued expenses $ 51,570 $ 281,332
Payable to shareholders 2,350 6,058
Debentures payable (See Note 4) 446,227 227,500
Debt discount (46,035) --
Minority interest -- 2,510
------------ ------------
TOTAL LIABILITIES 454,112 517,400
NET ASSETS $ 364,395 $ (162,201)
NET ASSETS CONSIST OF:
Preferred Series B, 0 and 10,000 shares outstanding $ -- $ 3,800,000
Preferred Series C, 13,187,500 and 0 shares outstanding 1,319 --
Paid-in capital, 16,289,627 shares outstanding 6,161,276 1,727,804
Accumulated deficit (5,606,200) (5,482,005)
Deferred compensation (192,000) (208,000)
------------ ------------
TOTAL NET ASSETS $ 364,395 $ (162,201)
Shares Outstanding (5,000,000,000 of $0.0001 par value
common stock authorized) 16,289,627 3,465,240
NET ASSET VALUE PER SHARE $ 0.02 $ (0.05)
============ ============
Notes to Financial Statements are an integral part of
these Financial Statements
5
FRANCHISE CAPITAL CORPORATION
STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended
March 31, March 31,
2005 2004 2005 2004
----------- ----------- ----------- -----------
INVESTMENT INCOME:
Interest income $ -- $ -- $ -- $ --
Dividend income -- -- -- --
----------- ----------- ----------- -----------
TOTAL INCOME -- -- -- --
EXPENSES:
Interest 88,709 48,120
Administration fees and expenses 107,226 700,140 934,086 1,101,149
----------- ----------- ----------- -----------
TOTAL EXPENSES 195,935 700,140 982,206 1,101,149
NET INVESTMENT LOSS (195,935) (700,140) (982,206) (1,101,149)
NET UNREALIZED GAIN ON INVESTMENTS 259,758 -- 259,758 --
INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF ACCOUNTING CHANGES 63,823 (700,140) (722,448) (1,101,149)
INCOME FROM DISCONTINUED OPERATIONS -- 12,822 598,253 16,254
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS $ 63,823 $ (687,318) $ (124,195) $(1,084,895)
Notes to Financial Statements are an integral part of
these Financial Statements
6
FRANCHISE CAPITAL CORPORATION
STATEMENTS OF CHANGES IN NET ASSETS (UNAUDITED)
Nine Months Ended
March 31,
2005 2004
----------- -----------
OPERATIONS:
Net investment loss $ (928,203) $(1,101,149)
Income from discontinued operations 598,253 16,254
Net realized and unrealized gain (loss) on
investment transactions 259,758 --
Net decrease in net assets resulting from operations (124,195) (1,084,895)
SHAREHOLDER ACTIVITY:
Stock sales and conversion 650,791 134,742
NET INCREASE (DECREASE) IN ASSET VALUE 526,596 (950,153)
NET ASSETS:
Beginning of Period (162,201) (25)
End of Period $ 364,395 $ (950,178)
Notes to Financial Statements are an integral part of
these Financial Statements.
7
FRANCHISE CAPITAL CORPORATION
STATEMENTS OF CASH FLOWS (UNAUDITED)
Prior to becoming
a Business
Development
Company
For the For the For the
three months six months nine months
ended Ended ended
March 31, December 31, March 31,
2005 2004 2004
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (loss) $ 63,823 $ (188,018) $(1,084,895)
Adjustments to reconcile net income to net cash
used in operating activities:
Common stock issued as consideration for services -- 296,000 949,742
Depreciation and amortization 777 5,243 3,336
Amortization of deferred compensation 16,000 --
Unrealized appreciation of portfolio investments (259,758) -- --
Amortization of beneficial conversion feature 23,662 30,303 --
Finance costs 54,003 -- --
Impairment of goodwill -- 44,836 --
Changes in assets and liabilities (net of business
acquisition):
Prepaid expenses (85,086) (24,963)
Accounts receivable 106,626 (219,703) 679
Equipment, net of accumulated depreciation
Inventories 13,567
Intangibles (11,870)
Accounts payable and accrued liabilities (129,086) 75,335 64,414
Deferred revenue 325,000
Minority interest (2,510)
Cumulative effect of accounting change (549,727) --
----------- ----------- -----------
Net cash used in operating activities (139,956) (252,327) (89,990)
----------- ----------- -----------
Cash acquired in business combination -- -- 3,619
Cash invested in portfolio companies (29,166)
Purchase of computer equipment -- (3,586) (16,338)
Advances to affiliate/officers -- -- (9,970)
----------- ----------- -----------
-- (32,752) (22,689)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Common stock issued for cash 284,790 -- 90,000
Proceeds from advances from shareholder -- (8,647) 24,409
Repayment of notes payable and convertible debentures (131,211)
Proceeds from notes payable and convertible debentures -- 249,938 --
----------- ----------- -----------
153,581 241,291 114,409
----------- ----------- -----------
INCREASE IN CASH AND EQUIVALENTS 13,625 (43,788) 1,730
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 2,213 46,001 --
----------- ----------- -----------
CASH AND EQUIVALENTS, END OF PERIOD $ 15,836 $ 2,213 $ 1,730
=========== =========== ===========
Supplemental disclosures of non-cash investing
and financing activities:
Debentures converted to common stock $ 70,000
===========
Notes to Financial Statements are an integral part of
these Financial Statements.
8
FRANCHISE CAPITAL CORPORATION
NOTES TO UNAUDITED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED MARCH 31, 2005 AND MARCH 31, 2004
1. ORGANIZATION AND BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States for interim
financial information and the instructions for Form 10-Q/A and Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the United States for complete
financial statements. All adjustments that, in the opinion of management, are
necessary for a fair presentation of the results of operations for the interim
periods have been made and are of a recurring nature unless otherwise disclosed
herein. The results of operations for the three months ended March 31, 2005, are
not necessarily indicative of the results that will be realized for the entire
fiscal year. These financial statements should be read in conjunction with the
Company's Annual Report on Form 10-KSB for the year ended June 30, 2004.
a. General
Franchise Capital Corporation (the "Company") a Nevada corporation, was
incorporated on July 6, 2001 as Cortex Systems, Inc. In December of 2004 the
Company changed its name to Franchise Capital Corporation, to more accurately
reflect its true business nature. The Company invests in developing and
franchising casual dining restaurants. The Company is seeking to acquire
additional investments within this industry and has acquired the rights to at
least one concept. To date, the Company has had no revenues associated with
these activities. Effective December 23, 2004, the Company as an internally
managed, closed end investment company elected to be treated as a business
development company under the Investment Company Act of 1940, as amended.
As a business development company, we provide long-term debt and equity
investment capital to support the expansion of companies in the casual, fast
food restaurant industry. We generally invest in private, small to middle market
companies that lack access to public capital or whose securities may not be
marginable. Today, our investment and lending activity is generally focused in
private finance.
Our investment portfolio consists primarily of equity investments in companies,
which may or may not constitute a controlling equity interest. At March 31, 2005
our investment portfolio totaled $799,244 at fair value. Our investment
objective is to achieve current income.
The Company did not elect to be treated for federal income tax purposes as a
regulated investment company under the Internal Revenue Code.
b. Going Concern
The Company faces many operating and industry challenges. There is no meaningful
operating history to evaluate the Company's prospects for successful operations.
Future losses for the Company are anticipated. The proposed plan of operations
would include seeking an operating entity with which to merge. Even if
successful, a merger may not result in cash flow sufficient to finance the
continued expansion of a business.
9
The accompanying financial statements reflect the accounts of Franchise Capital
Corporation, and the related results of operations. In accordance with Article 6
of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act
of 1934, the Company does not consolidate portfolio company investments in which
the Company has a controlling interest. These financial statements have been
prepared assuming that the Company will continue as a going concern. The Company
has incurred material operating losses, has continued operating cash flow
deficiencies and has working capital deficit at March 31, 2005. These factors
raise substantial doubt about the Company's ability to continue as a going
concern. The Company believes that it will be successful in the management of
its investment portfolio. However, the Company will likely require additional
debt or equity capital in order to implement its business plan. The accompanying
financial statements do not include any adjustments that might result from this
uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Franchise Capital Corporation changed to a Business Development Company,
effective December 23, 2004. Therefore, the prior periods are no longer directly
comparable. The balance sheet as of March 31, 2005, is presented to reflect the
change to a BDC. The statements of operations for the periods ended December 31,
2004, are presented as if the all of the Company's portfolio companies are
consolidated through the last day of the period. The Company determined that the
effect of segregating operations for December 18, through December 31, would not
be material. The Company's Board of Directors determined that absent any other
operating information, all investments are valued at fair market value.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include all short-term
liquid investments that are readily convertible to known amounts of cash and
have original maturities of three months or less.
INCOME TAXES - The Company provides for income taxes based on the provisions of
Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME
TAXES, which among other things, requires that recognition of deferred income
taxes be measured by the provisions of enacted tax laws in effect at the date of
financial statements.
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.
INCOME (LOSS) PER COMMON SHARE - Basic income per share is computed using the
weighted average number of shares of common stock outstanding for the period.
The Company has a complex capital structure and therefore there is a
presentation for diluted loss per share.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS -
In October 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which requires companies to record the fair value of a liability
for asset retirement obligations in the period in which they are incurred. The
statement applies to a company's legal obligations associated with the
retirement of a tangible long-lived asset that results from the acquisition,
construction, and development or through the normal operation of a long-lived
asset. When a liability is initially recorded, the company would capitalize the
cost, thereby increasing the carrying amount of the related asset. The
capitalized asset retirement cost is depreciated over the life of the respective
10
asset while the liability is accreted to its present value. Upon settlement of
the liability, the obligation is settled at its recorded amount or the company
incurs a gain or loss. The statement is effective for fiscal years beginning
after June 30, 2002. The Company does not expect the adoption to have a material
impact to the Company's financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". Statement 144 addresses the accounting and
reporting for the impairment or disposal of long-lived assets. The statement
provides a single accounting model for long-lived assets to be disposed of. New
criteria must be met to classify the asset as an asset held-for-sale. This
statement also focuses on reporting the effects of a disposal of a segment of a
business. This statement is effective for fiscal years beginning after December
15, 2001. The Company does not expect the adoption to have a material impact to
the Company's financial position or results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
With Exit or Disposal Activities". This Standard requires costs associated with
exit or disposal activities to be recognized when they are incurred. The
requirements of SFAS No. 146 apply prospectively after December 31, 2002, and as
such, the Company cannot reasonably estimate the impact of adopting these new
rules.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transaction and Disclosure, which provides alternative methods of
transition for a voluntary change to fair value based method of accounting for
stock-based employee compensation as prescribed in SFAS 123, Accounting for
Stock-Based Compensation. Additionally, SFAS No. 148 requires more prominent and
more frequent disclosures in financial statements about the effects of
stock-based compensation. The provisions of this statement are effective for
fiscal years ending after December 15, 2002, with early application permitted in
certain circumstances.
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"), Guarantor's
Accounting and Disclosure Requirements for Guarantees, including Indirect
Guarantees of Indebtedness of Others. FIN 45 requires a company, at the time it
issues a guarantee, to recognize an initial liability for the fair value of
obligations assumed under the guarantees and elaborates on existing disclosure
requirements related to guarantees and warranties. The initial recognition
requirements are effective for the Company during the third quarter ending March
31, 2003. The adoption of FIN 45 did not have an impact on the Company's
financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be applied for the first interim
or annual period beginning after June 15, 2003. The adoption of FIN 46 did not
have an impact on the Company's financial position or results of operations.
3. ACCOUNTING CHANGE
As a result of the Company converting to a Business Development Company, the
Company changed its accounting principles. The primary difference relates to the
accounting for investments. The investments that were previously consolidated,
are now reflected at the estimated fair value of those investments. The Company
11
estimated that the investments at cost approximate fair value. The effect of
recoding those investments at the original cost and adjusting for the previously
recorded consolidated net losses of those investments was $598,253.
4. CONVERTIBLE DEBENTURE
During the year ended June 30, 2004 the Company issued a 2-year 7.5% convertible
debenture to Golden Gate Investors, Inc. "Golden Gate" amounting to $85,000 with
interest payable monthly and due June 9, 2006. The debenture also included
non-detachable warrants for 2,500,000 shares of common stock. During the three
months ended December 31, 2004, this debenture was increased to $177,438. Upon
approval of the Company's change to a Business Development Company, the warrants
were cancelled. As of March 31, 2005, we currently owe $238,177.
Subsequent to March 31, 2005, the Company contacted Golden Gate regarding what
we believe may be securities law violations in connection with transactions
involving the convertible debenture and its related warrants and agreements.
Among other things, the Company believes Golden Gate violated Section 16 of the
Securities Exchange Act of 1934 when they converted nearly 12% of the Company's
outstanding shares and immediately resold shares in the market. The Company has
terminated all agreements with Golden Gate, and is currently seeking legal
counsel to advise it regarding pursuing Golden Gate for short swing profits
resulting from the purchase and sale of shares.
On October 14, 2004 the Company issued a six month convertible debenture
amounting to $25,000, with interest payable at the end of the term. The
debenture may be converted, at the option of the holder, into common shares of
the Company. The conversion price is 50% of the closing bid on the day the
Company receives notice of conversion. The debenture may be converted, at the
option of the Company, into common shares of the Company. The conversion price
is 50% of the closing bid on the day the Company receives notice of conversion.
On October 4, 2004, the Company issued a six month convertible debenture
amounting to $25,000, with interest payable at the end of the term. The
debenture may be converted, at the option of the holder, into common shares of
the Company. The conversion price is 50% of the closing bid on the day the
Company receives notice of conversion. The debenture may be converted, at the
option of the Company, into common shares of the Company. The conversion price
is 50% of the closing bid on the day the Company receives notice of conversion.
As of March 31, 2005 a total of 900,000 shares of common stock were issued as
partial redemption of this debenture. Total balance at March 31, 2005 is
$20,500.
On December 1, 2004, the Company issued a twelve month convertible debenture
amounting to $50,000, with interest of $1,250 payable quarterly beginning March
1, 2005. The debenture may be converted, at the option of the holder, into
common shares of the Company. The conversion price is 50% of the closing bid on
the day the Company receives notice of conversion. The debenture may be
converted, at the option of the Company, into common shares of the Company. The
conversion price is 50% of the closing bid on the day the Company receives
notice of conversion.
For the debentures issued in the period ended December 31, 2004, the Company
computed the beneficial conversion feature to be equal to the face amount of the
debentures. The $100,000 discount is being amortized over the terms of the debt.
During the three month period ended March 31, 2005, $46,035 of the discount was
amortized leaving a remaining discount of $53,965.
Subsequent to March 31, 2005, the Company was notified by the Securities and
Exchange Commission ("Commission") that the debentures issued by the Company
were considered "senior securities" as defined by the Investment Company Act of
12
1940. Franchise Capital Corporation believed at the time the debentures issued
were not senior securities. As a result, the Company may not be in compliance
with Section 18 of the Investment Company Act of 1940 which required that the
Company maintain net assets to senior security coverage of at least 200%.
Further, the Company was informed that the convertible nature of the debentures
made them subject to Section 61 of the Investment Company Act which requires,
among other things, that rights to acquire common stock:
* Expire within 10 years from date of grant
* Are approved by a vote of shareholders, and
* Are exercisable at a price not less than the fair market value on the
date of grant.
The convertible debentures did not comply with these provisions of Section 61 at
the time they were issued. . The Company is in negotiations with the remaining
debenture holder to restructure the obligation into a format that is compliant
with the Investment Company Act.
5. CAPITAL STOCK
The Company declared a 6 for 1 stock split during the year ended June 30, 2003.
The number of shares presented in these financial statements has been
retroactively restated for all periods to reflect this stock split.
During the three months ended December 31, 2003, the Company sold 125,000 shares
of its common stock for $55,000. In connection with this sale of common stock,
the Company also granted 137,500 warrants to acquire the Company's common stock
at $0.50 per share.
Also during the three months ended December 31, 2003, the Company granted
275,000 shares of its common stock to consultants as consideration for services
rendered. The shares were valued at the trading price of the common shares
aggregating to $99,966.
Additionally, during the three months ended December 31, 2003, the Company
granted 675,000 shares of its common stock to consultants as consideration for
services rendered. The shares were valued at the trading price of the common
shares aggregating to $247,500.
The Company reacquired 15,535,000 shares of its common stock in the three month
period ended December 31, 2003. The Company entered into an agreement to acquire
all of the outstanding shares of "ICEBERG FOOD SYSTEMS,CORP." ("IFSC"). IFSC was
owned by a former officer and director of the Company. The only holdings of IFSC
were 30,000,000 shares of the Company's common stock. As part of the agreement,
IFSC distributed 14,465,000 shares of the Company's common stock to its
shareholder. IFSC then became a wholly owned subsidiary of the Company with its
only holdings being the remaining 15,535,000 shares of the Company's common
stock. Effectively, the transaction was an acquisition of treasury stock by the
Company. In exchange, the Company would assume a commitment to raise capital and
develop the Iceberg Drive-In concept. The rights to develop that concept were
previously held by IFSC. The Company is to assist IFSC in providing up to
$1,130,000. The Company has accounted for this transaction as an acquisition of
treasury stock through the issuance of a note payable of $1,130,000.
During the three months ended September 30, 2004, the Company sold 140,000
shares of its common stock for $35,000.
13
Also during the three months ended September 30, 2004, the Company granted
3,050,000 shares of its common stock to consultants as consideration for
services rendered. The shares were valued at the trading price of the common
shares aggregating to $602,275.
On October 13, 2004, the Company negotiated a consulting agreement with Javelin
Holdings, Inc. The agreement with Javelin provides for $15,000 upon execution of
the agreement, $15,000 cash and a $30,000 60 day Convertible Note upon
successful filing of requisite SEC documents. In addition, Javelin receives 5%
of any Preferred Class of stock created for the benefit of the Company, 10% of
any bridge financing and 5% of any subsequent funding. During October, 2004,
Javelin earned finders fee of $5,000 from the Company for two short-term
convertible debentures in the amount of $25,000 each.
In November 2004, the Company converted its Preferred Series B stock into common
stock. This conversion resulted in the retiring of all Preferred Series B stock,
and issuance of 10,000,000 shares of common stock.
In December, 2004, the Company approved a reverse 1 for 10 common stock split.
In conjunction with the transactions discussed in Note 4, the Company issued an
aggregate of 5,015,000 shares of its common stock.
Effective December 17, 2004, the Company designated 30,000,000 shares of Series
C Preferred Stock. The Series C Preferred Stock is non-interest bearing, does
not have voting rights and is not entitled to receive dividends. Each share of
Series C issued can be converted into Common Stock on a 1:1 basis. In the event
of a liquidation event, the Series C stock automatically converts into common
stock based on the foregoing formula. By designation, the Series C Preferred
Stock is not affected by forward or reverse splits of the Company's common stock
or other adjustments to the Company's capital structure. The Series C is
entitled to name three members of the Company's Board of Directors at all times.
During the quarter ended December 31, 2004, the Company issued a total of
13,500,000 shares of Series C Preferred Stock for services rendered prior to the
Company's election to become a business development company.
Subsequent to March 31, 2005, the Company was notified by the Securities and
Exchange Commission ("Commission") that the terms of the Series C Preferred
Stock issued by the Company may be in violation of Section 23 of the Investment
Company Act of 1940. As a result, the Series C holders agreed to a 1:10 reverse
split of the Series C stock corresponding to the similar 1:10 reverse split of
the Company's common stock on January 14, 2005. Further, the Company has
restructured the terms of the Series C Preferred Stock. Most significantly, the
rights of the Series C Preferred Stock to convert to common stock and provisions
in the Series C Preferred Stock affording protections against capital
reorganization were eliminated.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in this section should be read in conjunction with the
Selected Financial and Other Data, the Selected Operating Data and our Financial
Statements and notes thereto appearing elsewhere in this Quarterly Report. This
Quarterly Report, including the Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements that involve substantial risks and uncertainties. These
forward-looking statements are not historical facts, but rather are based on
current expectations, estimates and projections about our industry, our beliefs,
and our assumptions. Words such as "anticipates", "expects", "intends", "plans",
"believes", "seeks", and "estimates" and variations of these words and similar
expressions are intended to identify forward-looking statements. These
statements are not guarantees of future performance and are subject to risks,
uncertainties, and other factors, some of which are beyond our control and
difficult to predict and could cause actual results to differ materially from
those expressed or forecasted in the forward-looking statements including
without limitation (1) any future economic downturn could impair our customers'
ability to repay our loans and increase our non-performing assets, (2)economic
downturns can disproportionately impact certain sectors in which we concentrate,
and any future economic downturn could disproportionately impact the industries
in which we concentrate causing us to suffer losses in our portfolio and
experience diminished demand for capital in these industry sectors, (3) a
contraction of available credit and/or an inability to access the equity markets
could impair our lending and investment activities, (4) interest rate volatility
could adversely affect our results, (5) the risks associated with the possible
disruption in the Company's operations due to terrorism and (6) the risks,
uncertainties and other factors we identify from time to time in our filings
with the Securities and Exchange Commission, including our Form 10-Ks, Form
10-Qs and Form 8-Ks. Although we believe that the assumptions on which these
forward-looking statements are based are reasonable, any of those assumptions
could prove to be inaccurate, and as a result, the forward-looking statements
based on those assumptions also could be incorrect. In light of these and other
uncertainties, the inclusion of a projection or forward-looking statement in
this Quarterly Report should not be regarded as a representation by us that our
plans and objectives will be achieved. You should not place undue reliance on
these forward-looking statements, which apply only as of the date of this
Quarterly Report.
OVERVIEW
Franchise Capital Corporation. is a solutions-focused financial services company
providing financing and advisory services to small and medium-sized companies
throughout the United States primarily in the restaurant franchising industry.
Effective December 23, 2004, we became an internally managed, non-diversified,
closed-end investment company that elected to be treated as a business
development company under the Investment Company Act of 1940. Franchise Capital
Corporation will not elect to be treated for federal income tax purposes as a
regulated investment company under the Internal Revenue Code with the filing of
its federal corporate income tax return for 2004.
PORTFOLIO COMPOSITION AND ASSET QUALITY
Our primary business is lending to and investing in businesses, primarily in the
restaurant franchising industry, through investments in senior debt,
subordinated debt and equity-based investments, including warrants and equity
appreciation rights. Though we intend to increase our level of subordinated debt
and equity-based investments, we expect a substantial majority of our portfolio
will continue to consist of investments in portfolio companies. The total fair
value of investments in non-publicly traded securities was $799,244 and $315,709
at March 31, 2005 and December 31, 2004, respectively (exclusive of unearned
income).
15
The following table summarizes Franchise Capital Corporation's assets held and
income from Majority Owned Companies, Controlled Companies and Other Affiliates:
March 31, December 31,
2005 2004
---- ----
ASSETS HELD:
Majority Owned Companies (a):
Investments in and advances to 799,244 619,099
Controlled Companies (b):
Other Affiliates (c):
Loans at fair value -- --
Equity Investments at fair value -- --
Nine Months Ended
March 31,
2005 2004
---- ----
INCOME RECOGNIZED:
From Majority Owned Companies (a):
Interest and fee income -- --
From Controlled Companies (b):
From Other Affiliates (c): 1
Interest and fee income -- --
Net change in unrealized appreciation
(depreciation) on investments 286,771 --
Realized losses on investments -- --
----------
(a) Majority owned companies are generally defined under the Investment Company
Act of 1940 as companies in which Franchise Capital Corporation owns more
than 50% of the voting securities of the company.
(b) Controlled companies are generally defined under the Investment Company Act
of 1940 as companies in which Franchise Capital Corporation owns more than
25% but not more than 50% of the voting securities of the company.
(c) Other affiliates are generally defined under the Investment Company Act of
1940 as companies in which Franchise Capital Corporation owns at least 5%
but not more than 25% of the voting securities of the company.
ASSET QUALITY
Asset quality is generally a function of our underwriting and ongoing management
of our investment portfolio. As a business development company, our loans and
equity investments are carried at market value or, in the absence of market
value, at fair value as determined by our board of directors in good faith on a
quarterly basis. As of March 31, 2005 and December 31, 2004, unrealized
appreciation on investments totaled $259,758 and $0, respectively. For
additional information on the change in unrealized depreciation on investments,
16
see the section entitled "Reconciliation of Net Operating Income to Net Increase
(Decrease) in Stockholders' Equity from Earnings".
We monitor loan concentrations in our portfolio, both on an individual loan
basis and on a sector or industry basis, to manage overall portfolio performance
due to specific customer issues or specific industry issues.
We monitor individual customer's financial trends in order to assess the
appropriate course of action with respect to each customer and to evaluate
overall portfolio quality. We closely monitor the status and performance of each
individual investment on a quarterly and, in some cases, a monthly or more
frequent basis. Because we are a provider of long-term privately negotiated
investment capital to growth-oriented companies and we actively manage our
investments through our contract structure, we do not believe that contract
exceptions such as breaches of contractual covenants or late delivery of
financial statements are necessarily an indication of deterioration in the
credit quality or the need to pursue remedies or an active workout of a
portfolio investment.
When a loan becomes 90 days or more past due, or if we otherwise do not expect
the customer to be able to service its debt and other obligations, we will, as a
general matter, place the loan on non-accrual status and cease recognizing
interest income on that loan until all principal has been paid. However, we may
make exceptions to this policy if the investment is well secured and in the
process of collection.
As of March 31, 2005 and December 31, 2004, none of the loans to our other
affiliates were on non-accrual status.
When principal and interest on a loan is not paid within the applicable grace
period, we will contact the customer for collection. At that time, we will make
a determination as to the extent of the problem, if any. We will then pursue a
commitment for immediate payment and will begin to more actively monitor the
investment. We will formulate strategies to optimize the resolution process and
will begin the process of restructuring the investment to better reflect the
current financial performance of the customer. Such a restructuring may involve
deferring payments of principal and interest, adjusting interest rates or
warrant positions, imposing additional fees, amending financial or operating
covenants or converting debt to equity. In general, in order to compensate us
for any enhanced risk, we receive appropriate compensation from the customer in
connection with a restructuring. During the process of monitoring a loan that is
out of compliance, we will in appropriate circumstances send a notice of
non-compliance outlining the specific defaults that have occurred and preserving
our remedies, and initiate a review of the collateral. When a restructuring is
not the most appropriate course of action, we may determine to pursue remedies
available under our loan documents or at law to minimize any potential losses,
including initiating foreclosure and/or liquidation proceedings.
OPERATING INCOME
Operating income includes interest income on commercial loans, advisory fees and
other income. Interest income is comprised of commercial loan interest at
contractual rates and upfront fees that are amortized into income over the life
of the loan. Most of our loans contain lending features that adjust the rate
margin based on the financial and operating performance of the borrower, which
generally occurs quarterly.
The change in operating income from the nine months ended March 31, 2005
compared to the same period in 2004 is attributable to the following items:
17
(Due to the conversion to a Business Development Company, effective December 23,
2005, the periods are not directly comparable.)
NINE MONTHS ENDED
MARCH 31, 2005
CHANGE DUE TO:
Asset growth $259,758
Increase in fee income 0
Interest and other income 8,881
Manufacturing income 0
--------
Total change in operating income $268,639
========
Total operating income for the nine months ended March 31, 2005 increased
$268,639 to $308,284 from $39,645 for the nine months ended March 31, 2005.
Operating income for the three months ended March 31, 2005 increased $841,381,
to $154,063 from $(687,318) for the three months ended March 31, 2005.
OPERATING EXPENSES
Operating expenses include interest expense on borrowings, including
amortization of deferred debt issuance costs, employee compensation, and general
and administrative expenses.
The change in operating expenses from the nine months March 31, 2005 compared to
the same period in 2004 is attributable to the following items:
NINE MONTHS ENDED
MARCH 31, 2005 VS. 2004
CHANGE DUE TO:
Advertising & Selling (0)
Interest Expense 88,709
Depreciation & Amortization (19)
Salaries and benefits 31,305
General and administrative expense (420,952)
---------
Total change in operating expense $(300,957)
=========
Total operating expenses for the nine months ended March 31, 2005 decreased
$300,957 to $800,192 from $1,101,149 for the nine months ended March 31, 2005.
General and administrative expenses decreased $300,957 for the nine months ended
March 31, 2005 as compared to the same period in 2004 primarily due to a
decrease in the Company's reliance on outside consultants. Total operating
expenses decreased $594,445 to $105,695 for the 3 months ended March 31, 2005,
from $700,140 for the three months ended March 31, 2004.
18
NET OPERATING INCOME
Net operating income/loss before investment gains and losses (NOI) for the nine
months ended March 31, 2005 totaled ($377,584) compared with a loss of
$(1,084,895) for the nine months ended March 31, 2004.
NET INVESTMENT GAINS AND LOSSES
There were no realized gains or losses for the three and nine months ended March
31, 2005.
The net change in unrealized appreciation (depreciation) on investments of
$259,758 for the nine months ended March 31, 2005 consisted of $259,758 of net
appreciation less $0 advanced to controlled companies. The appreciation is
related to additional equity interest granted an increase in the valuation of
Kokopelli Franchise Company who commenced operations, and Fathom Business
Systems, Inc., who continues to increase sales.
INCOME TAXES
We are taxed under Subchapter C of the Internal Revenue Code. We did not elect
to be a regulated investment company under Subchapter M of the Internal Revenue
Code with the filing of our federal corporate income tax return for 2004.
NET INCOME
Net income (loss) totaled $63,823 and $(124,195) for the three months and nine
months ended March 31, 2005 compared to $(687,318) and ($1,084,895) for the
three months and nine months ended March 31, 2004.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CASH, CASH EQUIVALENTS AND CASH, SECURITIZATION ACCOUNTS
At March 31, 2005 and December 31, 2004, we had $15,836 and $2,213,
respectively, in cash and cash equivalents. Our objective is to maintain
sufficient cash on hand to cover current funding requirements and operations.
LIQUIDITY AND CAPITAL RESOURCES
We expect our cash on hand, future equity offerings, and cash generated from
operations to be adequate to meet our cash needs at our current level of
operations. We generally fund new originations using cash on hand, borrowings
under our credit facilities and equity financings.
During the third quarter of 2005, the Company raised $165,500 by selling
8,573,231 shares of common stock issued under Regulation E.
BORROWINGS
At March 31, 2005, we had aggregate outstanding borrowings of $446,227.
At December 31, 2004, we had aggregate outstanding borrowings of $507,741.
See the Notes to the Financial Statements for further discussion of our
borrowings.
19
CRITICAL ACCOUNTING POLICIES
The financial statements are based on the selection and application of
significant accounting policies, which require management to make significant
estimates and assumptions. We believe that the following are some of the more
critical judgment areas in the application of our accounting policies that
currently affect our financial condition and results of operations.
INCOME RECOGNITION
Interest on commercial loans is computed by methods that generally result in
level rates of return on principal amounts outstanding. When a loan becomes 90
days or more past due, or if we otherwise do not expect the customer to be able
to service its debt and other obligations, we will, as a general matter, place
the loan on non-accrual status and cease recognizing interest income on that
loan until all principal has been paid. However, we may make exceptions to this
policy if the investment is well secured and in the process of collection.
In accordance with GAAP, we include in income certain amounts that we have not
yet received in cash, such as contractual payment-in-kind (PIK) interest, which
represents contractually deferred interest added to the loan balance that is
generally due at the end of the loan term. We currently do not have any interest
income of this nature, but we may during future periods.
Loan origination fees are deferred and amortized as adjustments to the related
loan's yield over the contractual life of the loan. In certain loan
arrangements, warrants or other equity interests are received from the borrower
as additional origination fees. The borrowers granting these interests are
typically non-publicly traded companies. We record the financial instruments
received at estimated fair value as determined by our board of directors. Fair
values are determined using various valuation models which attempt to estimate
the underlying value of the associated entity. These models are then applied to
our ownership share considering any discounts for transfer restrictions or other
terms which impact the value. Changes in these values are recorded through our
statement of operations. Any resulting discount on the loan from recordation of
warrant and other equity instruments are accreted into income over the term of
the loan.
VALUATION OF INVESTMENTS
At March 31, 2005, approximately 98% of our total assets represented investments
recorded at fair value. Value, as defined in Section 2(a)(41) of 1940 Act, is
(i) the market price for those securities for which a market quotation is
readily available and (ii) for all other securities and assets, fair value is as
determined in good faith by the board of directors. Since there is typically no
readily ascertainable market value for the investments in our portfolio, we
value substantially all of our investments at fair value as determined in good
faith by the board of directors pursuant to a valuation policy and a consistent
valuation process. Because of the inherent uncertainty of determining the fair
value of investments that do not have a readily ascertainable 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.
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. Unlike banks, we are not
permitted to provide a general reserve for anticipated loan losses. Instead, we
20
must determine the fair value of each individual investment on a quarterly
basis. We will record unrealized depreciation on investments when we believe
that an investment has become impaired, including where collection of a loan or
realization of an equity security is doubtful. Conversely, we will record
unrealized appreciation if we believe that the underlying portfolio company has
appreciated in value and, therefore, our investment has also appreciated in
value, where appropriate.
As a business development company, we invest primarily in illiquid securities
including debt and equity securities of private companies. The structure of each
debt and equity security is specifically negotiated to enable us to protect our
investment and maximize our returns. We generally 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 some restrictions on resale and generally have no
established trading market. Because of the type of investments that we make and
the nature of our business, our valuation process requires an analysis of
various factors. Our fair value methodology includes the examination of, among
other things, the underlying investment performance, financial condition and
market changing events that impact valuation.
AT DECEMBER 31, 2004, THE BOARD OF DIRECTORS ELECTED TO EMPLOY A VALUATION
METHOD CONSISTING OF COST BASIS FOR THOSE PORTFOLIO COMPANIES THAT WERE NOT YET
OPERATIONAL, AND A METHOD OF GROSS REVENUE, NET REVENE AND NET ASSETS FOR THOSE
COMPANIES THAT ARE OPERATIONAL. THE COMPANY WILL EMPLOYE INDEPENDENT BUSINESS
VALUATION CONSULTANTS TO PROVIDE A VALUATION OF OUR EXISTING PORTFOLIO COMPANIES
AND CERTAIN OTHER INVESTMENTS FOR THE YEAR ENDED JUNE 30, 2005.
VALUATION OF LOANS AND DEBT SECURITIES
As a general rule, we do not value our loans or debt securities above cost, but
loans and debt securities will be subject to fair value write-downs when the
asset is considered impaired. In many cases, our loan agreements allow for
increases in the spread to the base index rate if the financial or operational
performance of the customer deteriorates or shows negative variances from the
customer's business plan and, in some cases, allow for decreases in the spread
if financial or operational performance improves or exceeds the customer's plan.
VALUATION OF EQUITY SECURITIES
With respect to private equity securities, each investment is valued using
industry valuation benchmarks, and then the value is assigned a discount
reflecting the illiquid nature of the investment, as well as our minority,
non-control position. When an external event such as a purchase transaction,
public offering, or subsequent equity sale occurs, the pricing indicated by the
external event will be used to corroborate our private equity valuation.
Securities that are traded in the over-the-counter market or on a stock exchange
generally will be valued at the prevailing bid price on the valuation date.
However, restricted and unrestricted publicly traded securities may be valued at
discounts from the public market value due to restrictions on sale, the size of
our investment or market liquidity concerns.
RECENT DEVELOPMENT
Kokopelli Franchise Company, LLC, a portfolio company specializing in the
franchising of fast, casual sonoran style food, opened its first franchised
restaurant in April. As a result, our valuation of Kokopelli Franchise Company
21
was based on the projected operations of the franchise. We anticipate receiving
royalty fee income from this and each franchise location as they develop.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate sensitivity refers to the change in earnings that may result from
the changes in the level of interest rates. Our net interest income can be
affected by changes in various interest rates, including LIBOR, prime rates and
commercial paper rates.
As a business development company, we use a greater portion of equity to fund
our business. Accordingly, other things being equal, increases in interest rates
will result in greater increases in our net interest income and reductions in
interest rates will result in greater decreases in our net interest income
compared with the effects of interest rate changes on our results under more
highly leveraged capital structures.
Currently, we do not engage in hedging activities because we have determined
that the cost of hedging the risks associated with interest rate changes
outweighs the risk reduction benefit. We monitor this position on an ongoing
basis.
ITEM 4. CONTROLS AND PROCEDURES
(a) Within the 90 days prior to the date of this report, Franchise Capital
Corporation carried out an evaluation, under the supervision and with the
participation of Franchise Capital Corporation's management, including Franchise
Capital Corporation's Chief Executive Officer and President and Chief Financial
Officer, of the effectiveness of the design and operation of Franchise Capital
Corporation 's disclosure controls and procedures (as defined in Rule 13a-14 of
the Securities Exchange Act of 1934). Based on that evaluation, the Chief
Executive Officer and President and the Chief Financial Officer have concluded
that Franchise Capital Corporation's current disclosure controls and procedures
are effective in timely alerting them of material information relating to
Franchise Capital Corporation that is required to be disclosed in Franchise
Capital Corporation's SEC filings.
(b) There have not been any significant changes in the internal controls of
Franchise Capital Corporation or other factors that could significantly affect
these internal controls subsequent to the date of their evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not presently a party to any legal action.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
There were no material changes in securities for the quarter ended March 31,
2005, other than the debenture conversions previously discussed.
22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(a) The following exhibits are either attached hereto or incorporated herein by
reference as indicated:
Exhibit
Number Description
------ -----------
31.1 CEO Certification pursuant to SEC Release No. 33-8238, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 CFO Certification pursuant to SEC Release No. 33-8238, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 CEO Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 CFO Certification pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated: April 18, 2006 /s/ Edward Heisler
------------------------------------------------
Edward C. Heisler, President and Chief Executive
Officer (Principal Executive Officer)
Dated: April 18, 2006 /s/ Janet Crance
------------------------------------------------
Janet Crance, Chief Financial Officer
(Principal Accounting Officer)
23