NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Financial Statements
The consolidated balance sheet of Ameritrans Capital Corporation ("Ameritrans", the "Company", "our", "us", or "we") as of September 30, 2007, and the related consolidated statements of operations and cash flows for the three months ended September 30, 2007 and 2006 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the "Commission"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of management and the board of directors of the Company ("Management" and "Board of Directors"), the accompanying consolidated financial statements include all adjustments (consisting of normal, recurring adjustments) necessary to summarize fairly the Company’s financial position and results of operations. The results of operations for the three months ended September 30, 2007 are not necessarily indicative of the results of operations for the full year or any other interim period. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2007, as filed with the Commission.
Organization and Principal Business Activity
Ameritrans Capital Corporation (the "Company", "Ameritrans", "our", "us", or "we"), is a Delaware closed-end investment company formed in 1998, which, among other activities, makes loans and investments with the goal of generating both current income and capital appreciation, and through its subsidiary, Elk Associates Funding Corporation ("Elk"), makes loans to taxi owners to finance the acquisition and operation of taxi medallions and related assets, and to other diversified small businesses as permitted by the U.S. Small Business Administration (the "SBA"). Ameritrans also makes loans to and invests in opportunities that Elk has historically been unable to make due to SBA restrictions. Ameritrans makes loans which have primarily been secured by real estate mortgages, and equity investments which have primarily been in income producing real estate properties, or in real estate construction projects.
Elk was organized primarily to provide long-term loans to businesses eligible for investments by small business investment companies (each an "SBIC") under the Small Business Investment Act of 1958, as amended (the "1958 Act"). Elk makes loans for financing the purchase or continued ownership of taxi medallions, taxis and related assets, and for other diversified businesses that qualify for funding as small concerns under the SBA Regulations.
The Company's internet site is
www.ameritranscapital.com
. Ameritrans makes available, free of charge through its internet site its annual report on form 10-K, quarterly reports on form 10-Q, current reports on form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Both Ameritrans and Elk are registered as business development companies, or "BDCs," under the Investment Company Act of 1940, as amended (the "1940 Act"). Accordingly, Ameritrans and Elk are subject to the provisions of the 1940 Act governing the operation of BDCs. Both companies are managed by their executive officers under the supervision of their Boards of Directors. Ameritrans and Elk have also elected to be treated as regulated investment companies, or "RICs," for tax purposes. Under the Internal Revenue Code, as a RIC, we will generally not be subject to U.S. federal corporate income tax on our investment income if we make qualifying distributions of our income to stockholders. We qualify for this treatment as long as we distribute at least 90% of our investment company taxable income to our stockholders as dividends. Elk paid qualifying dividends from July 1983 through June 1992 and continuously since June 1996. Since December 16, 1999, when we acquired Elk, these dividends have been payable to Ameritrans as Elk's sole stockholder. On November 8, 2007 The Board of Ameritrans declared a dividend of $0.01 per share on its Common Stock for the period July 1, 2007 through September 30, 2007. The dividend is payable on or about December 12, 2007 to stockholders of record as of November 19, 2007. The dividend was declared from estimated earnings for the period ending September 30, 2007. Prior to this dividend, Ameritrans had not paid common dividends to its stockholders since the three month period ended December 31, 2002. All Preferred Stock dividends have been duly paid each quarter which enables the Company to fulfill its 90% distribution of earnings requirement.
Because it is a small business investment company ("SBIC"), Elk's operations are subject to other restrictions, and all loans and investments must comply with applicable SBA Regulations. For example, the interest rate that Elk can charge, the percentage of any other company it can own, the size of the businesses to which it can make loans, and the length of time to the maturity date are limited by SBA rules. Elk's business is funded by loans from banks and, to a lesser extent, by the proceeds of subordinated debentures issued to the SBA. Ameritrans is not an SBIC and is not subject to SBA regulation.
5
Basis of Consolidation
The consolidated financial statements include the accounts of Ameritrans, Elk and Elk's wholly owned subsidiaries, EAF Holding Corporation ("EAF"), EAF Leasing LLC, EAF Leasing II LLC and EAF Leasing III LLC. All significant inter-company transactions have been eliminated in consolidation.
EAF began operations in December 1993 and owns and operates certain real estate assets acquired in satisfaction of defaulted loans by Elk debtors. At September 30, 2007 EAF was not operating any assets acquired in satisfaction of defaulted loans by Elk.
EAF Leasing LLC owned, leased, and resold medallions acquired in satisfaction of foreclosures by Elk. EAF Leasing LLC was voluntarily liquidated and dissolved on July 17, 2007.
EAF Leasing II LLC owned, leased, and resold medallions acquired in satisfaction of foreclosures by Elk. EAF Leasing II LLC was voluntarily liquidated and dissolved on July 17, 2007.
EAF Leasing III LLC owned, leased, and resold medallions acquired in satisfaction of foreclosures by Elk. EAF Leasing III LLC was voluntarily liquidated and dissolved on April 10, 2007.
6
Ameritrans organized another subsidiary on June 8, 1998, Elk Capital Corporation ("Elk Capital"), which may engage in lending and investment activities similar to its parent. Since its inception, Elk Capital has had no operations.
Income Taxes
The Company has elected to be taxed as a Regulated Investment Company ("RIC") under the Internal Revenue Code (the "Code"). A RIC generally is not taxed at the corporate level to the extent its income is distributed to its stockholders. In order to qualify as an RIC, a company must payout at least ninety percent (90%) of its net taxable investment income to its stockholders as well as meet other requirements under the Code. In order to preserve this election for fiscal 2008, the Company intends to make the required distributions to its stockholders.
The Company is subject to certain state and local franchise taxes, as well as related minimum filing fees assessed by state taxing authorities. Such taxes and fees are reported as "provisions for income taxes" and reflected in each of the periods presented.
7
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing income (loss) available to common stockholders by the weighted average number of common shares outstanding for the applicable period. Diluted earnings per share reflect, in periods in which they have a dilutive effect, the effect of common shares issuable upon the exercise of stock options and warrants. The difference between reported basic and diluted weighted average common shares results from the assumption that all dilutive stock options outstanding were exercised. For the period ended September 30, 2006, the effect of stock options and warrants has been excluded from the diluted calculation since their inclusion would be antidilutive.
Loan Valuations
The Company’s loan portfolio is carried at fair value. Where no ready market exists for these loans, the fair value is determined in good faith by the Board of Directors with Management's participation. In determining the fair value, the Board of Directors considers factors such as the financial condition of the borrower, the adequacy of the collateral to support the loans, individual credit risks, historical loss experience and the relationships between current and projected market rates and portfolio rates of interest and maturities. The fair value of the loans approximates cost less unrealized depreciation.
Unrealized depreciation in loan values has generally been caused by specific events related to credit risk. Loans are considered "non-performing" once they become 90 days past due as to principal or interest. These past due loans are periodically evaluated by management and if, in the judgment of management, the amount is not collectible and the fair value of the collateral is less than the amount due, a reserve is established. If the fair value of the collateral exceeds the loan balance at the date of valuation, the Company makes no write-down of the loan amount.
Stock Options
The Company began applying Statement of Financial Accounting Standards No. 123R ("SFAS No. 123R"),
"Accounting for Stock-Based Compensation",
and related interpretations in accounting for its stock option plans effective January 1, 2006, and accordingly, the Company will expense these grants as required. Stock-based employee compensation costs pertaining to stock options will be reflected in net income (loss), for grants made including and subsequent to January 1, 2006, only, since there were no unvested options outstanding at December 31, 2005, using the fair values established by usage of the Black-Scholes option pricing model, expensed over the vesting period of the underlying option. Previously, the Company applied APB Opinion No. 25 and related Interpretations in accounting for all the plans. Accordingly, no compensation cost was recognized under these plans, and the Company followed the disclosure-only provisions of SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure.
The Company elected the modified prospective transition method for adopting SFAS No. 123R. Under this method, the provisions of SFAS 123R apply to all awards granted or modified after the date of adoption. The compensation cost is then recognized over the vesting period of the options (see Note 7).
Equity Investments
Equity investments are comprised principally of common stock investments, as well as member and limited partnership interests in various companies. The Company classifies its investments under the equity and cost basis methods of accounting, and certain investments are classified as available-for-sale.
Investments that meet certain ownership criteria, or when the Company has the ability to exercise significant influence regarding operating and financial policies, are accounted for under the equity basis method. Under the equity method, the carrying value of the investment is adjusted by the Company’s proportionate share of net income (loss) of the investee and is decreased by any dividends received from the investee.
Investments that do not qualify to be treated as equity basis investments, and have no readily determinable fair value, are accounted for under the cost method. Under the
cost method, a long-term investment is recorded at cost and carried at that amount until it is sold or otherwise disposed of or until it is written down due to either an impairment of value, as determined in good faith by the Board of Directors, or a dividend representing a return of capital is received. Any dividends received from investee earnings are recorded as investment income when received.
Investments classified as available-for-sale are required to be reported at fair value with unrealized gains and losses, net of taxes, excluded from earnings and recorded in the statement of comprehensive income (loss), and separately as a component of accumulated other comprehensive income (loss) within stockholders’ equity unless an unrealized loss is deemed to be other than temporary, in which case, the cost basis of the individual security is written down to fair value as a new cost basis and such loss is charged to earnings. Realized gains and losses on the sale of securities available-for-sale are determined using the specific-identification method and are reported in earnings. In addition, any unrealized gains and losses deferred in accumulated other comprehensive income (loss) is recognized in determining net gain or loss on disposition.
Investment in Life Settlement Contracts
The Company uses the investment method to value contracts, which capitalizes contract costs plus premiums paid to keep the policies in force. The difference between the carrying value of the contract and proceeds received, either upon death of the insured or sale of the policy, are recorded in earnings. Contracts are also tested for impairment based on changes in the insured’s life expectancy or creditworthiness of the issuer of the policy. If an impairment loss is recognized, the carrying amount of the investment is written down to its estimated fair value.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires Management to make extensive use of estimates and assumptions that affect the reported amounts of 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. Estimates that are particularly susceptible to change are these estimates that relate to the determination of the fair value of loans receivable and other financial instruments.
2.
Equity Investments
Equity investments consist of the following:
|
|
|
|
|
|
September 30, 2007 (unaudited)
|
June 30, 2007
|
|
|
|
|
|
Investments, equity basis
|
$
545,256
|
$
629,693
|
|
Investments, other
|
2,069,110
|
2,208,026
|
|
|
|
|
|
|
$
2,614,366
|
$
2,837,719
|
Investments, Equity Basis
The Company invested $750,000 and $25,000 to obtain membership interests in two (2) separate limited liability companies in June 2006 and June 2007, respectively. Since the Company has membership interests in excess of 20% and has significant influence, these investments are accounted for using the equity basis of accounting. For the three months ended September 30, 2007 and 2006, equity in (loss) income of these investments was ($84,437) and $28,139, respectively.
Investments, Other
As of September 30, 2007 and June 30, 2007, the Company held investments classified as available-for-sale of $186,334 and $325,250, respectively. The unrealized gain (loss) included in comprehensive income (loss) for the three months ended September 30, 2007 and 2006 was $6,276 and ($19,526), respectively (see Note 8). As of September 30, 2007 and June 30, 2007, the Company also held investments in non-publicly traded companies carried under the cost-method of $1,882,776.
Elk obtained a 48% stock ownership interest in a company during December 2003 in exchange for providing 100% financing for this company to acquire and gain title to certain Chicago medallions from Elk arising from defaulted and foreclosed loans, to purchase vehicles, and for related start up costs. The profit or loss of this company is to be retained by the majority stockholder of this company. Commencing on or after July 1, 2007, and for a two and one-half year period thereafter, the majority stockholder has the right to purchase Elk's interest in this company at a price stipulated in the stockholders' agreement, by giving notice and exercising its right to repurchase Elk's shares. Elk has the right (put option) under the agreement to require the company to repurchase Elk's 48% interest in this company. Under both arrangements, the price is determined by the difference between the market value of the medallions and the outstanding balance on the loan on the date the right is exercised.
During the three months ended September 30, 2007, the Company received $145,191 as proceeds from the partial sale of the above investment, which is included in gain on sale of equity investments in the accompanying consolidated statements of operations.
3. Investment in Life Settlement Contracts
On September 20, 2006, the Company entered into an agreement (the "Agreement") with an unaffiliated company to purchase previously issued life insurance policies owned by unrelated individuals. Under terms of the Agreement, the Company was designated as nominee to maintain possession of the policies and process transactions related to such policies until the policies are subsequently sold or paid off. The Company is entitled to receive from the unaffiliated company a twelve percent (12%) annual return on the amount of funds paid by the Company and outstanding on a monthly, prorated basis. Proceeds from the sale of the policies are to be distributed, net of direct expenses, as defined in the Agreement.
As of September 30, 2007, the carrying value of amounts invested was $2,130,116, which represents the amounts paid to cover first year premiums for eight (8) life insurance policies with an aggregate face value of $40,750,000, and to obtain ownership and beneficiary rights on those policies. Premiums on the policies will continue to be paid by the Company, until the policies are sold. If an insured dies before the policy is resold, 50% of the death benefit proceeds of the policy will be paid to the insured party's family, and the other 50% of the death benefit proceeds will be paid to the Company, to be distributed in accordance with the terms of the Agreement. The Company may sell the policies at any time, at its sole discretion. However, if the Company were to continue to make payments on each of the policies for the life expectancy of the insured, the approximate future minimum premiums due for each of the next five (5) years and in the aggregate thereafter are as follows:
|
|
|
|
Year Ending
June 30
|
Policy Premiums
|
|
|
|
|
2008
|
$
1,800,000
|
|
2009
|
1,800,000
|
|
2010
|
1,800,000
|
|
2011
|
1,800,000
|
|
2012
|
1,800,000
|
|
Thereafter
|
11,600,000
|
|
|
|
|
|
$
20,600,000
|
8
4. Debentures Payable to SBA
At September 30, 2007 and June 30, 2007, debentures payable to the SBA consisted of subordinated debentures with interest payable semiannually, as follows:
|
|
|
|
|
|
Issue Date
|
Due Date
|
Effective
Interest Rate
|
9/30/07 and 6/30/07
Principal Amount
|
|
July 2002
|
September 2012
|
4.67%
(1)
|
$ 2,050,000
|
|
December 2002
|
March 2013
|
4.63%
(1)
|
3,000,000
|
|
September 2003
|
March 2014
|
4.12%
(1)
|
5,000,000
|
|
February 2004
|
March 2014
|
4.12%
(1)
|
1,950,000
|
|
|
|
|
$ 12,000,000
|
(1)
Elk is required to pay an additional annual user fee of 0.866% on these debentures.
Under the terms of the subordinated debentures, the Company may not repurchase or retire any of its capital stock or make any distributions to its stockholders other than dividends out of retained earnings (as computed in accordance with SBA regulations) without the prior written approval of the SBA.
5. Notes Payable
Banks:
At September 30, 2007 and June 30, 2007, Elk had loan agreements with three (3) banks for lines of credit aggregating $36,000,000. At September 30, 2007 and June 30, 2007, $27,925,697 and $29,332,500 respectively, were outstanding under these lines. The loans, which mature at various dates through January 3, 2008, and bear interest at the lower of either the reserve adjusted LIBOR rate plus 1.5% or the banks’ prime rate minus 0.50%. At September 30, 2007, the weighted average interest rate on outstanding bank debt was approximately 6.84%.
Upon maturity, the Company anticipates that the banks will extend these lines of credit for another year, as has been the practice in previous years. Pursuant to the terms of the agreements, the Company is required to comply with certain covenants and conditions, as defined in the agreements. The Company has pledged its loans receivable and all other assets as collateral for the above lines of credit. Pursuant to the SBA agreement and an "intercreditor agreement" among the lending banks, the SBA agreed to subordination in favor of the banks, provided that the Company maintains certain debt levels based on performance of its portfolio.
Other:
On July 12 and July 13, 2007, the Company received three loans totaling $500,000 from three related parties to facilitate the funding of a new loan receivable. The loan principal is due and payable within 30 days of demand and bears interest at a rate of 10% per annum. Payments of interest only are due and payable on the first of each month.
9
6. Commitments and Contingencies
Interest Rate Swaps
On October 14, 2005, Elk entered into two (2) interest rate swap transactions for notional amounts of $5,000,000 each, one of which expired October 15, 2007 and one will expire on October 14, 2008. As a portion of the Company’s loan portfolio is at “fixed” rates, Elk entered into these swap transactions to hedge against an upward movement in interest rates on outstanding bank debt. The swap transaction that expired October 15, 2007 provided for a fixed rate of 6.20%, and the swap transaction expiring October 14, 2008, provides for a fixed rate of 6.23%. If the Company's floating borrowing rate (the one-month LIBOR rate plus 1.5%) falls below the fixed rate, Elk is obligated to pay the bank the difference in rates. If the Company’s floating borrowing rate rises above the fixed rate, the bank is obligated to pay Elk the difference in rates. As of September 30, 2007, the LIBOR plus 1.5% was above the fixed rates of 6.20% and 6.23%. The Company regularly monitors the cost and efficiency of swaps.
7
.
Stock Option Plan
s
Employee Incentive Stock Option Plan
An employee stock option plan (the "1999 Employee Plan") was adopted by the Ameritrans Board, including a majority of the non-interested directors, and approved by a vote of the stockholders, in order to link the personal interests of key employees to the Company's long-term financial success and the growth of stockholder value. Subsequent amendments to the 1999 Employee Plan were approved by the stockholders in January 2002 and June 2007. The amendments increased the number of shares reserved under the plan from 125,000 to 200,000 shares and from 200,000 to 300,000 shares, respectively.
The 1999 Employee Plan authorizes the grant of incentive stock options within the meaning of Section 422 of the Internal Revenue Code for the purchase of an aggregate of 300,000 shares (subject to adjustment for stock splits and similar capital changes) of common stock to the Company's employees. By adopting the 1999 Employee Plan, the Board believes that the Company will be better able to attract, motivate, and retain as employees people upon whose judgment and special skills the Company's success in large measure depends. As of September 30, 2007, options to purchase an aggregate of 138,850 shares of Common Stock were issued and outstanding under the 1999 Employee Plan.
The 1999 Employee Plan is administered by the 1999 Employee Plan Committee of the Board, which is comprised solely of non-employee directors (who are "outside directors" within the meaning of Section 152(m) of the Internal Revenue Code and "disinterested persons" within the meaning of Rule 16b-3 under the Securities Exchange Act of 1934 (the "Exchange Act")). The committee can make such rules and regulations and establish such procedures for the administration of the 1999 Employee Plan as it deems appropriate.
Non-Employee Directors Stock Option Plan
A stock option plan for non-employee directors (the "Director Plan") was adopted by the Ameritrans Board and approved by a vote of the stockholders, in order to link the personal interests of non-employee directors to the Company's long-term financial success and the growth of stockholder value. The Director Plan is substantially identical to, and the successor to, a non-employee director stock option plan adopted by the Board of Elk and approved by its stockholders in September 1998 (the "Elk Director Plan"). Ameritrans and Elk submitted an application for, and received on August 31, 1999, an exemptive order relating to these plans from the SEC. The Director Plan was amended by the Board on November 14, 2001, and approved by the stockholders at the Annual Meeting on January 18, 2002. The amendment is still subject to the approval of the Securities and Exchange Commission. The amendment (i) increases the number of shares reserved under the plan from 75,000 to 125,000 and (ii) authorizes the automatic grant of an option to purchase up to 1,000 shares at the market value at the date of grant to each eligible director who is re-elected to the Board.
The total number of shares for which options may be granted from time to time under the Director Plan is 75,000 shares, which will be increased to 125,000 shares upon SEC approval of the Amended Director Plan. As of September 30, 2007, options to purchase an aggregate of 46,491 shares were issued and outstanding under the Director Plan. The Director Plan is administered by a committee of directors who are not eligible to participate in the Director Plan.
Options Granted, Exercised, and Canceled
During the three months ended September 30, 2007 and 2006, the Company did not grant any options under either plan.
An officer of the Company was terminated on May 18, 2007. Pursuant to the terms of the 1999 Employee Plan, the officer had ninety (90) days from the date of termination of employment with the Company to exercise 8,750 Shares issuable upon the exercise of five-year options granted under the 1999 Employee Plan. On August 16, 2007, the officer exercised 4,375 options at a purchase price of $4.50 per share. The remaining 4,375 options terminated, unexercised.
After adoption of SFAS 123(R) (See Note 1), the fair value of the options granted to date amounted to $118,475 at September 30, 2007, which is reflected as stock options outstanding in the accompanying consolidated balance sheets. As of September 30, 2007, total deferred compensation related to unvested options was $94,475, which is expected to be recognized over a period of approximately three years.
The following tables summarize information about the transactions of both stock option plans:
|
|
|
|
|
|
Stock Options
|
|
|
Number of Options
|
Weighted Average Exercise Price Per Share
|
|
|
|
|
|
Options outstanding at June 30, 2007
|
194,091
|
$5.29
|
|
Granted
|
-
|
-
|
|
Canceled
|
-
|
-
|
|
Expired
|
(4,375)
|
$5.56
|
|
Exercised
|
(4,375)
|
$4.50
|
|
|
|
|
|
Options outstanding at September 30, 2007
|
185,341
|
$5.30
|
10
|
|
|
|
|
|
|
|
|
Options Outstanding
|
Options Exercisable
|
|
Range of Exercise Prices
|
Number Outstanding at September 30, 2007
|
Weighted Average Remaining Contractual Life
|
Weighted Average Exercise Price
|
Number Exercisable at September 30, 2007
|
Weighted Average Exercise Price
|
|
|
|
|
|
|
|
|
$ 4.50-$ 4.95
|
29,425
|
2.08 years
|
$ 4.70
|
29,425
|
$ 4.70
|
|
$ 5.56-$ 6.12
|
29,425
|
3.25 years
|
$ 5.81
|
29,425
|
$ 5.81
|
|
$ 4.58
|
10,917
|
.99 years
|
$ 4.58
|
10,917
|
$ 4.58
|
|
$ 6.25
|
16,000
|
2.29 years
|
$ 6.25
|
16,000
|
$ 6.25
|
|
$ 5.28
|
80,000
|
5.66 years
|
$ 5.28
|
20,000
|
$ 5.28
|
|
$ 5.30
|
9,433
|
4.23 years
|
$ 5.30
|
-
|
$ 5.30
|
|
$ 4.93
|
10,141
|
4.61 years
|
$ 4.93
|
-
|
$ 4.93
|
|
|
|
|
|
|
|
|
$ 4.50-$ 6.25
|
185,341
|
4.02 years
|
$ 5.30
|
105,767
|
$5.34
|
8.
Comprehensive Income
The components of comprehensive income are as follows:
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
2007
|
2006
|
|
|
|
|
|
Net income
|
$142,832
|
$33,027
|
|
Other comprehensive income:
|
|
|
|
Reclassification adjustment for gain included in net income
|
(145,191)
|
-
|
|
Unrealized gain (loss) on equity investments
|
6,276
|
(19,526)
|
|
Total comprehensive income
|
$3,917
|
$13,501
|
9. Other Matters
Quarterly
Dividend
The Company has declared and paid the quarterly dividend on its 9 3/8% Cumulative Participating Preferred Stock (the "Participating Preferred Stock") since the Participating Preferred Stock was issued. Most recently, on September 19, 2007 the Company's Board of Directors declared a dividend of $0.28125 per share on the Participating Preferred Stock for the period July 1, 2007 through September 30, 2007, which was paid on or about October 15, 2007 to all holders of record as of September 28, 2007.
SBA Matter
In August, 2007, the Company received a letter from the US Small Business Administration ("SBA") together with a copy of the Examination Report dated March 9, 2007, for the 18 month period ended September 30, 2006 (the "Report"). The letter and Examination Report contained findings that Elk had potentially violated certain provisions of the SBA regulations, relating to (1) reduction in capital without obtaining the SBA's prior written approval, (2) payment of dividends without sufficient net income from operations without obtaining the SBA's prior written consent, and (3) the occurrence of a conflict of interest on one loan transaction and the need for Elk to improve its internal controls to prevent a reoccurrence of a similar conflict transaction in the future. The Report also contained certain other comments with respect to SBA's review and approval of management expenses. Each of the findings of the SBA are internal in nature and have since been rectified to SBA's satisfaction, except for the review of management expenses which is still under review by SBA, as additional information was provided to SBA for review by a letter from the Company dated October 26, 2007. Management believes these findings will not have any adverse financial consequence to the Company.