Management Report of Fund Performance

Transcription

1 Management Report of Fund Performance Covington Venture Fund Inc. Series I Series II Series III For The Period Ended January 31, 2010

2 TABLE OF CONTENTS Table of Contents... 1 Foward Looking Statements... 1 Investment Objective and Strategies... 2 Risk Factors... 2 Results of Operations... 3 Recent Developments Related Party Transactions...5 Financial Highlights Management Fees... 8 Past Performance... 8 Summary of Investment Portfolio Corporate Information... Back Cover This interim management report of fund performance contains financial highlights but does not contain the complete semi-annual financial statements of the Covington Venture Fund Inc., Series I, II, III (the Fund ). You may obtain a copy of the semi-annual financial statements at your request, and at no cost, by calling , by writing to us at Covington Capital Corporation, 200 Front St. West, Suite 3003, Toronto, Ontario M5V 3K2 or by visiting our website at or on SEDAR at Shareholders may also contact us using one of these methods to request a copy of the Fund s proxy voting polices and procedures or proxy voting disclosure record. FORWARD LOOKING STATEMENTS This report may contain forward-looking statements about the Fund, its future performance, strategies or prospects, and possible future Fund actions. The words anticipate, could, should, may, expect, believe, plan, intends, estimate, forecast, objective, would ; and similar expressions are intended to identify forward-looking statements. Forward-looking statements involve inherent risks and uncertainties, both about the Fund and general economic factors. It is not possible to guarantee that future performance, predictions, forecasts, projections or other forward-looking statements will be achieved. Factors such as economic, political and market factors in Canada, the United States and internationally, interest and foreign exchange rates, global equity markets, business competition, technological changes, changes in laws and regulations, judicial or regulatory judgments, legal proceedings or catastrophic events could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement made by the Fund. Please consider these and other pertinent factors before making any investment decisions and do not place undue reliance on forward-looking statements. All opinions contained in forward-looking statements are subject to change without notice. 1

3 INVESTMENT OBJECTIVE AND STRATEGIES The Fund combines the tax benefits of a Labour Sponsored Investment Fund ( LSIF ) while giving investors access to the venture capital market. The investment objective of the Fund is to realize long-term capital appreciation on all or part of its investment portfolio. The Fund has invested primarily in emerging, high-growth potential Canadian companies and helped to develop and grow these investee businesses by creating strategic relationships to provide product and market credibility to prospective customers. Many of these emerging companies are technology based and sell in all segments of the economy and investing in such companies provides the Fund with balanced exposure to a variety of industries including information technology, life sciences, automated manufacturing, communications and retail. RISK FACTORS The Fund is suitable for investors with a longer-term investment focus and higher risk tolerance as discussed in the Fund s prospectus dated January 30, Last year the international credit crisis marred confidence in the markets and plunged the global economy into recession. During the past 6 months, signs of strengthening markets have begun to appear however, the timing and magnitude of a recovery cannot be forecast with certainty. While full economic recovery is not likely imminent, the credit crisis in North America appears to be curbed as the US and Canadian governments work through their respective stimulus plans. There is still uncertainty in both consumers and the equity markets which impacts the overall markets in which the Fund s portfolio companies operate. This affects the Fund s overall risks but particularly liquidity, portfolio and valuation risk. Exit opportunities for private companies within the portfolio continue to be elusive. The exit strategy for these companies is typically through the mergers and acquisitions ( M&A ) channel whereby strategic buyers may seek to augment their portfolios by purchasing smaller, private companies or, the private companies may seek to grow themselves by accessing the public equity markets through an initial public offering ( IPO ). In the current markets, both M&A and IPO activity continue to be sluggish and thereby, may add a liquidity strain on the Fund should the need to generate cash to fund redemptions outweigh the goal of optimizing the returns to the Fund. The process of valuing venture investments for which no published market exists is subject to inherent uncertainties and the resulting values may differ from values which would have been ascribed had a ready market existed for those investments The overall economic downturn has impacted the liquidity of the Fund. The Fund s current investment portfolio consists of 33 companies of which 8 are publicly traded and 25 are privately held. Approximately 91% of the Fund s net asset value is held within these private companies. In order to provide for liquidity within the Fund, the more liquid publicly traded companies may be exited first in order to generate cash. In times of market uncertainty, this may lead to a further tightening of liquidity if some investments are exited earlier than the optimal time to realize stronger gains for the Fund. Investors who purchase LSIFs are required to hold their investment for eight years in order to retain the tax credit offered by the provincial and federal governments. The amalgamated Funds in Series I,II and III (the Series ) were launched in 1996, 1999 and 2001 and therefore, the 8 year hold period for the Series initial investors expired in 2004 and 2007 (for the 1996 and 1999 launches respectively ), and expired in 2009 for the 2001 launches. In any financial year, the Series is not obligated to redeem greater than 20% of the net asset value of the Series. The Fund was closed to new subscriptions on December 1, As such the Fund is dependent upon internally generated cash to fund the operations, investing and redemption activities of the business. This may lead to further liquidity pressures on the Fund. Management is closely monitoring the current liquidity of the fund and continues to manage the portfolio going forward with the goal of negotiating successful exits on the mature portion of the portfolio and is pursuing strategic alternatives for liquidity within the venture portfolio to continue to meet redemption requests. Finding opportunities for liquidity in the current market environment remains challenging. As at January 31, 2010, the Fund maintained a strong cash position of approximately $4,389; however, if all or substantially all shareholders were to redeem their shares at the same time, the Fund may need to liquidate investments at lower values than currently ascribed and shareholders may not receive the posted Net Asset Values ( NAV ). 2

4 [in $000 s except for per share amounts, number of shares and percentages] RESULTS OF OPERATIONS Net assets as of January 31, 2010 totaled $45,984 which have decreased by $8,066 compared to net assets at July 2009 of $54,050. This is due mostly to redemptions of $5,739 which are relatively flat when compared to the same period in The Fund is now in its fourteenth year of operations and nearly all of the Series I shares are now eligible for redemption. The Fund s cash position of $4,389 is higher than yearend due to the release of funds held in escrow on sale of venture investments in prior periods. At this point, the Fund has no surplus cash held in the form of marketable securities. Operationally, revenues for the six months ended January, 2010 have decreased by $1,060 compared to the same period in In fiscal 2009, the Fund recorded approximately $900 interest income from the disposal of its investment in Cyence International Inc. This has not recurred in the current fiscal year. Interest from marketable securities has declined by $250 from the prior year as the marketable securities of the Fund were used to fund redemptions, investments and operations. While overall, expenses appear to have increased by 5% compared to the same period in 2009, the single largest expense increase was contingent incentive participation amounts. This line item has increased by $1,076 compared to the semi-annual period of Contingent IPA is the determination of the bonus that would be payable to the Manager if the Fund were to dispose of its venture investment at its carrying value as at the financial statement date. The Manger is entitled to this bonus only upon realization of certain conditions as outlined in the Fund s prospectus. The Manager was paid $1,390 based on realized gains from its disposition of RuggedCom Inc. during the six months ended January 31, Excluding contingent IPA, expenses have decreased by 39% for the current period ending January 31, 2010 compared to the same period in The Fund had one year returns as at January 31, 2020 of % for Series I, % for Series II and % for Series III which reflects some of the macroeconomic challenges in the broader market. Investment Performance The Fund made investments totaling $2,005 in five companies during in the six month period ended January 31, Four of these were follow-on investments to support existing investee companies: Acorn Energy Inc., Enerworks Inc., PowerBand Canada Inc., and Signal Hill Equity Partners II, LP. A new investment of $1,407 was made in BPS Resolver Inc. ( BPS ). BPS was created on January 1, 2010 by the merger of the Fund s former investee company, Business Propulsion Systems Inc. with Resolver Inc. The company develops and offers governance, risk and compliance ( GRC ) products including large scale customized enterprise licensed solutions, to utilities, financial institutions and healthcare markets worldwide. The Fund realized a net losses of $5,993 as it has now completely exited four investee companies including Greenarm Development Partners Inc., Business Propulsion Systems Inc., Diaphonics Inc. and RuggedCom Inc. RECENT DEVELOPMENTS While it appears that the global financial crisis has been curbed and public equity markets have recovered somewhat, the pace of the overall economic recovery still remains slow. The US economy is in a period of extended government stimulus with the US Federal Reserve holding interest rates at record lows. In early February, the Fed has announced its plans to withdraw stimulus as the economy recovers but has added that steps to do so are still months away. With the US being Canada s largest trading partner, the uncertainty about the strength and speed of economic recovery impacts both the environments in which the Fund s investee companies operate and the exit market for these companies should they be sold to generate cash for the Fund. The ability to exit both public companies and smaller private companies is dependent upon the strength of the equity markets on both sides of the border. In times of greater volatility and downward market pressures, there is less opportunity to exit these investments. Therefore, we would expect to see a stronger economic recovery and more bullish markets before ideal exit opportunities are presented for the Fund s investee companies. 3

5 [in $000 s except for per share amounts, number of shares and percentages] RECENT DEVELOPMENTS Continued Future Accounting Standards - Conversion to International Financial Reporting Standards The Canadian Accounting Standards Board (AcSB) confirmed that effective January 1, 2011, International Financial Reporting Standards ( IFRS ) will replace Canadian GAAP for publicly accountable enterprises, which includes investment funds. IFRS will apply to fiscal years beginning on or after January 1, The Manager has commenced the development of a changeover plan in order to report under IFRS for the Fund s year ended July 31, At January 31, 2010, the Manager is taking the following steps under the changeover plan: Timing the Fund will adopt IFRS beginning August 1, 2011 with the first financial statements under IFRS to be released for the semiannual period ending January 31, Accounting policies- the Manager is currently reviewing differences between the current accounting policies of the Fund and IFRS standards. IFRS allows for accounting policy choices upon first time implementation. The Manager is reviewing these options to determine the appropriate choices, implementation decisions and related impacts, if any to the Fund. Disclosure the Manager is reviewing disclosure requirements under IFRS and expects the implementation of IFRS to result in additional disclosures in the notes to the financial statements and potentially different presentation of certain financial statement items. Operations Management is assessing which operations of the Fund will be affected by the adoption of IFRS including current reporting and back office systems. Impact on net asset value the Manager has determined that there is no expected impact on net asset value for pricing of purchases and redemptions anticipated as a result of transition to IFRS. This determination may change if new standards are issued or if interpretations of existing standards are revised. Progress on the changeover plan will be reported in subsequent interim and annual financial statements until the adoption of IFRS is complete. Future Accounting Standards - Financial Instruments Disclosures The AcSB has amended Section Finanicial Instruments-Disclosures to enhance the disclosure requirements regarding fair value measurements and the liquidity risk of financial instruments. The amendments will be effective for annual financial statements relating to fiscal years ending after September 30, 2009 specifically the July 31, 2010 financial statements of the Fund. These amendments have been made to address the need for increased consistency and comparability of fair value measurements, and to expand disclosure surrounding the fair value measurements and do not have any impact on the net assets of the Fund. Change of Control of the Manager On July 2, 2009, Covington Capital Corporation, the Manager of the Fund, was acquired by RC Capital Management Inc. ( RC Capital ). RC Capital is 50% owned by a trust of which Philip R. Reddon is the sole trustee, and 50% by a trust of which Scott D. Clark is the sole trustee. Philip R. Reddon and Scott D. Clark each has extensive experience providing management and investment management services to the Fund and have been officers and/or directors of the Fund for a number of years. The transaction constituted a change of control of Covington Capital which is the manager and/or investment advisor of Covington Fund II Inc., Covington Strategic Capital Fund Inc., Covington Venture Fund Inc., and New Generation Biotech (Equity) Fund Inc, collectively, the Funds. RC Capital does not anticipate any changes to the day-today operations of the Funds. The investment style, objectives and strategy used by the investment advisor to approve the investments made on behalf of the Funds will remain unaffected, as will the investment professionals responsible for managing the investments held by Funds. Quantum Leap Asset Management Limited Quantum Leap Asset Management Limited ( Quantum Leap ) was retained as an investment specialist pursuant to an agreement effective as of January 6, 2006 with the Fund and Manager to assist with, and provide services to, the Fund with respect to its investments in several eligible businesses. Quantum Leap provided in-house expertise and the expertise of an advisory board of individuals experienced in alternative energy, resource productivity, environmental remediation and related industries to assist, support and advise the Manager on certain investee companies appropriate for its expertise. All of the fees payable to Quantum Leap for the services rendered by it are paid by the Manger. This agreement was concluded effective January 18,

6 [in $000 s except for per share amounts, number of shares and percentages] RECENT DEVELOPMENTS Continued Ontario Sales Tax Harmonization Effective July 1, 2010 the Ontario s 8% Retail Sales Tax (RST) will be replaced by a single value-added sales tax combined with the 5% federal Goods and Services Tax (GST). The tax will be federally administered and would use the same tax base and structure as the GST. This harmonized tax will be applied at the rate of 13% and will impact the management and operating services used by the Fund. RELATED PARTY TRANSACTIONS The Manager and Sponsor are deemed to be related parties. Please refer to the section entitled Management Fees which outlines the fees paid to these related parties. FINANCIAL HIGHLIGHTS The following tables show selected key financial information about the Fund and are intended to help the reader understand the Fund s financial performance. All references to net assets or net assets per share are determined in accordance with Canadian GAAP as presented in the interim financial statements of the Fund. All references to net asset value or net asset value per shares are determined in accordance with the net asset value calculated for pricing purposes. 5

7 [in $000 s except for per share amounts, number of shares and percentages] FINANCIAL HIGHLIGHTS Continued FUND S NET ASSETS PER SHARE Six months ended January 31, 2010 Series I Series II Series III Net assets, beginning of period (1) (2) $ 9.07 $ 8.86 $ 9.07 Increase (decrease) from operations: Total revenue Total expenses (0.48) (0.56) (0.55) Realized and unrealized gain (loss) on investments Total increase (decrease) from operations (2) (0.41) (0.42) (0.43) Net assets, end of period (1) (2) $ 8.66 $ 8.39 $ 8.61 Year ended July 31, 2009 Year ended July 31, 2008 Series I Series II Series III Series I Series II Series III Net assets, beginning of period (1) (2) $ $ $ $ $ $ Increase (decrease) from operations: Total revenue Total expenses (1.00) (1.21) (1.16) (1.33) (1.65) (1.55) Realized and unrealized gain (loss) on investments (1.06) (1.17) (1.27) Total increase (decrease) from operations (2) (1.83) (2.16) (2.21) Net assets, end of period (1) (2) $ 9.07 $ 8.86 $ 9.07 $ $ $ Year ended July 31, 2007 Period ended July 31, 2006 (3) Series I Series II Series III Series I Series II Series III Net assets, beginning of period (1) (2) $ 9.27 $ 9.64 $ 9.69 $ 9.49 $ $ Increase (decrease) from operations: Total revenue Total expenses (0.49) (0.63) (0.60) (0.38) (0.52) (0.48) Realized and unrealized gain (loss) on investments Total increase (decrease) from operations (2) (0.21) (0.35) (0.31) Net assets, end of period (1) (2) $ $ $ $ 9.27 $ 9.64 $ 9.69 (1) With the exception of the six months ended January 31, 2010, this information is derived from the Fund s audited annual financial statements. The net assets per security presented in the financial statements differs from the asset value calculated for fund pricing purposes. On August 1, 2007, the Fund adopted CICA section 3855 on a retrospective basis without restatement of prior periods. As such, the beginning balance of net assets per share for the year ended July 31, 2008 may not equal the closing balance on July 31, (2) Net assets are based on the actual number of shares outstanding as at the stated dates. The increase/(decrease) from operations is based on the weighted average number of shares outstanding over the fiscal period. (3) For the period from January 6 to July 31,

8 [in $000 s except for per share amounts, number of shares and percentages] FINANCIAL HIGHLIGHTS Continued RATIOS AND SUPPLEMENTAL DATA Six months ended January 31, 2010 Series I Series II Series III Net asset value (1) $ 44,220 $ 532 $ 1,397 Number of shares outstanding (1) 5,085,585 63, ,707 Management expense ratio (2)* 10.94% 13.10% 12.54% Portfolio turnover rate (3) 4.00% 4.00% 4.00% Trading expense ratio (4) 0.04% 0.04% 0.04% Closing net asset value per share (1) $ 8.70 $ 8.42 $ 8.64 Year ended July 31, 2009 Period ended July 31, 2008 Series I Series II Series III Series I Series II Series III Net asset value (1) $ 52,360 $ 564 $ 1,493 $ 84,016 $ 664 $ 1,773 Number of shares outstanding (1) 5,735,588 63, ,387 7,690,449 60, ,478 Management expense ratio (2)* 9.94% 12.19% 11.47% 13.16% 16.04% 14.90% Portfolio turnover rate (3) 18.17% 18.17% 18.17% 26.01% 26.01% 26.01% Trading expense ratio (4) 0.04% 0.04% 0.04% Closing net asset value per share (1) $ 9.13 $ 8.92 $ 9.13 $ $ $ Year ended July 31, 2007 Period ended July 31, 2006 (5) Series I Series II Series III Series I Series II Series III Net asset value (1) $ 99,007 $ 602 $ 1,652 $ 96,110 $ 569 $ 1,549 Number of shares outstanding (1) 9,801,107 58, ,091 10,365,400 58, ,847 Management expense ratio (2)* 5.24% 6.70% 6.35% 6.82% 9.39% 8.37% Portfolio turnover rate (3) 35.33% 35.33% 35.33% 4.15% 4.15% 4.15% Trading expense ratio (4) Closing net asset value per share (1) $ $ $ $ 9.64 $ 9.64 $ 9.69 * The management expense ratio before contingent IPA was 5.33%, 7.17% and 6.33% respectively for the period ended January 31, 2010 ( 6%, 8.39% and 8.33% for Series I, II, III respectively for the year ended July 31, 2009 and 5.23%, 7.84% and 7.43% for respectively for the year-ended July 31, 2008) (1) This information is provided as the dates shown. (2) Management expense ratio includes all fees, expenses, capital taxes,goods and Services Tax, and the Manager s contingent Incentive Participation Amount ( IPA ), and is expressed as annualized percentage of the average net assets administered during the year. Contingent IPA is the determination of the bonus that would be payable to the Manager if the Fund were to dispose of its venture investment at its carrying value as at the date shown. The Manger is entitled to this bonus only upon realization of certain conditions as outlined in the Fund s prospectus. (3) The Fund s portfolio turnover rate indicates how actively the Fund s portfolio advisor manages its portfolio investments. A portfolio turnover rate of 100% is equivalent to the Fund buying and selling all of the securities in its portfolio once in the course of the period. The higher a fund s portfolio turnover rate in a period, the greater the trading costs payable by the fund in the period, and the greater the chance of an investors receiving taxable capital gains in the period. There is not necessarily a relationship between a high turnover rate and the performance of a Fund. (4) The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average net assets during the period. (5) For the period from January 6 to July 31,

9 [in $000 s except for per share amounts, number of companies and percentages] MANAGEMENT FEES The Manager is responsible for directing the business, operations and affairs of the Fund and also for implementing the investment strategy, monitoring the Fund s investments and providing management assistance to portfolio companies. Because the portfolio companies of the Fund are generally small in size and in an earlier stage of development relative to conventional mutual funds, the Fund requires a greater level of management involvement in the analysis, monitoring support and development activities. The Manager uses its management fees to finance its operations as follows: 86% for general administration over the affairs of the Fund including implementation of the Fund s investment strategy, portfolio management and monitoring, retaining and supervising service providers and managing the overall business affairs of the Fund and the Manager; and 14% for the implementation of communications, sales, marketing, and distribution strategies of the Fund and the Manager. The Fund pays annual fees of 2.5% of the net asset value of the Fund for these management services. The Fund s management expense ratio ( MER ) consists of all of its operating expenses, including sales commissions, certain ongoing marketing costs of the Fund, audit and legal expenses, fees paid to any independent valuator, IPA (if any), and certain consultancy costs. The largest component of the MER are fees that are calculated as a percentage of the NAV of the Fund and these fees are the Management fees, Investment Advisor fees, the Dealer Service fees, the Sponsor s fees and the Transfer Agent s fees. For a summary of these fees, please see Note 6 to the Fund s interim financial statements. PAST PERFORMANCE The performance information shown does not take into account sales, redemption, distribution or other optional charges that would have reduced returns on performance. The Fund s past performance is no guarantee of how it will perform in the future. Year by Year Non-Cumulative Returns The following charts show how the performance of each series of Class A Shares of the Fund has varied for the six months ended January 31, 2010 and for the stated years ended July 31. It also shows, in percentage terms, how an investment made in the Fund would have increased or decreased over the Fund s reporting period. 8

10 [in $000 s except for per share amounts, number of companies and percentages] SUMMARY OF INVESTMENT PORTFOLIO Below is a summary of the Fund s portfolio as at July 31, This is a summary only and may change due to on-going portfolio activity in the Fund. See the Statement of investment Portfolio in the financial statements for a complete listing. An update is available quarterly on Covington s website at % Total Venture Number of Cost of % Total Venture Fair Value of Investments Companies Investments Investments at Cost Investments at fair value Stage of Development $ % $ % Start-Up / Early 10 12, , Expansion 16 31, , Later 7 13, , , , Industry Class Entertainment/Retail 3 4, , Health Sciences 3 4, , Financial Services 9 5, , Technology 13 28, , Manufacturing 5 14, , , , Fair Value of % of Net Investments Assets Composition of net assets $ % Venture investments 45, Other assets, net of liabilities Net assets 45,

11 [in $000 s] SUMMARY OF INVESTMENT PORTFOLIO Continued TOP HOLDINGS (1) Debt at cost Equity at cost Total at cost $ $ $ Venture investments Agile Systems Inc. - 6,555 6,555 CounterPath Corporation - 5,507 5,507 Mist Mobility Integrated System Technology Inc. 3,100 2,300 5,400 Firan Technology Group Corporation - 4,438 4,438 Bedlam Games Inc. 4,150-4,150 Compower Systems Inc. 3,920-3, Canada Inc. - 3,030 3, Ontario Inc. - 2,467 2,467 Enerworks Inc ,558 2,296 Protus IP Solutions Inc. - 2,129 2,129 YM Biosciences Inc. - 1,802 1,802 BTE Technologies Inc ,431 1,780 BPS Resolver Inc. - 1,407 1,407 Longitude Fund, LP units - 1,350 1,350 Adventus Bioremediation Technologies - 1,292 1,292 Mo Products Inc. 1,125-1,125 Neoedge Networks, Inc PowerBand Canada Inc Iron Bridge Partners I, LP Trilliant Inc Black Bull Resources Inc Ivey Robarts CSBIF I Ivey Robarts CSBIF II Toxin Alert Inc (1) Excluding cash and short-term investments 10

12 Fund Symbols Series I CIG987 closed Series II CIG988 closed Series III CIG989 closed Fund Manager and Advisor Covington Capital Corporation 200 Front Street West, Suite 3003, Toronto, ON M5V 3K2 Sponsor Canadian Federal Pilots Association 350 Sparks Street, Suite 400, Ottawa, ON K1R 7S8 Auditor Ernst & Young LLP Ernst & Young Tower, P.O. Box 251, Toronto-Dominion Centre, Toronto, ON M5K 1J7 Transfer Agent and Registrar CI Investments Inc. 151 Yonge Street, 8th Floor, Toronto, ON M5C 2W7 Customer Service: Legal Counsel Gowling Lafleur Henderson LLP Suite 1600, 1 First Canadian Place, 100 King Street West, Toronto, ON M5X 1G5 200 Front Street West Suite 3003 Toronto, ON M5V 3K2 Telephone: Facsimile: [email protected] Website: SKU CGOF 1060A 02/10