The accompanying
notes are an integral part of these financial statements.
The accompanying
notes are an integral part of these financial statements.
Except for our holding of 8,890 4% bonds issued
by Orco Germany S.A., substantially all of our portfolio securities are restricted from public sale without prior registration
under the Securities Act of 1933. We negotiate certain aspects of the method and timing of the disposition of our investment in
each portfolio company, including registration rights and related costs.
As defined in the Investment Company Act of
1940, all of our investments, except for our holding of 8,890 Orco Germany bonds, are in eligible portfolio companies. We provide
significant managerial assistance to portfolio companies that comprise 70.1% of the total value of the investments in portfolio
securities as of December 31, 2011.
Our investments in portfolio securities consist
of the following types of securities as of December 31, 2011 (in thousands):
Cash payments of interest are currently being
received and/or accrued on notes aggregating $13.8 million in fair value, while accrued interest has been impaired on notes
receivable
included in secured and subordinated debt with a fair value of $0.3 million.
The following is a summary by industry of our
investments in portfolio securities as of December 31, 2011 (in thousands):
The accompanying notes are an integral part
of these financial statements.
NOTES TO FINANCIAL STATEMENTS
September 30, 2012
(Unaudited)
(1)
Description of Business and Basis of Presentation
Description of Business
—Equus
Total Return, Inc. (
“we,” “us,” “our,” “Equus” the
“Company” and the “Fund
”), a Delaware corporation, was formed by Equus Investments II, L.P.
(the “Partnership”) on August 16, 1991. On July 1, 1992, the Partnership was reorganized and all of the assets
and liabilities of the Partnership were transferred to the Fund in exchange for shares of common stock of the Fund. Our shares
trade on the New York Stock Exchange under the symbol EQS. On August 11, 2006, our shareholders approved the change of the Fund’s
investment strategy to a total return investment objective. This new strategy seeks to provide the highest total return, consisting
of capital appreciation and current income. In connection with this strategic investment change, the shareholders also approved
the change of name from Equus II Incorporated to Equus Total Return, Inc.
We attempt to maximize the return to stockholders
in the form of current investment income and long-term capital gains by investing in the debt and equity securities of companies
with a total enterprise value of between $15.0 million and $75.0 million, although we may engage in transactions with smaller or
larger investee companies from time to time. We seek to invest primarily in companies pursuing growth either through acquisition
or organically, leveraged buyouts, management buyouts and recapitalizations of existing businesses or special situations. Our income-producing
investments consist principally of debt securities including bonds, subordinate debt, debt convertible into common or preferred
stock, or debt combined with warrants and common and preferred stock.
Debt and preferred equity financing
may also be used to create long-term capital appreciation through the exercise and sale of warrants received in connection with
the financing.
We seek to achieve capital appreciation by making investments in equity and equity-oriented
securities issued by privately-owned companies in transactions negotiated directly with such companies.
Given market conditions over the past several years and the performance of our portfolio, our management and board of directors
believe it prudent to continue to review alternatives to refine and further clarify the current strategies.
We elected to be treated as a business development
company under the Investment Company Act of 1940 (“1940 Act”). We currently qualify as a regulated investment company
(“RIC”) for federal income tax purposes and, therefore, are not required to pay corporate income taxes on any income
or gains that we distribute to our stockholders. We have certain wholly owned taxable subsidiaries (“Taxable Subsidiaries”)
each of which holds one or more portfolio investments listed on our Schedules of Investments. The purpose of these Taxable Subsidiaries
is to permit us to hold portfolio companies organized as limited liability companies, or LLCs, (or other forms of pass-through
entities) and still satisfy the RIC tax requirement that at least 90% of our gross revenue for income tax purposes must consist
of investment income. Absent the Taxable Subsidiaries, a portion of the gross income of any LLC (or other pass-through entity)
portfolio investment would flow through directly to us for the 90% test. To the extent that such income did not consist of investment
income, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes.
The income of the LLCs (or other pass-through entities) owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries and
does not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages. We do not consolidate the
Taxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries’
ownership of the portfolio companies. We reflect any such income tax expense on our Statements of Operations.
Basis of Presentation
—In accordance
with Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, we do not consolidate portfolio
company investments, including those in which we have a controlling interest. Our interim unaudited financial statements were prepared
in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim financial information
and in accordance with the requirements of reporting on Form 10-Q and Article 10 of Regulation S-X, under the Securities Exchange
Act of 1934, as amended. Accordingly, they are unaudited and exclude some disclosures required for annual financial statements.
Management believes it has made all adjustments, consisting solely of normal recurring accruals, necessary for the fair presentation
of these interim financial statements.
The results of operations for the
three and nine months ended September 30, 2012 are not necessarily indicative of results that ultimately may be achieved for
the year. The interim unaudited financial statements and notes thereto should be read in conjunction with the financial
statements and notes thereto included in the Fund’s Form 10-K for the fiscal year ended December 31, 2011, as
filed with the Securities and Exchange Commission (“SEC”).
(2)
Liquidity and Financing Arrangements
Liquidity
—There are several factors
that may materially affect the Fund’s liquidity during the reasonably foreseeable future. The Fund views this period as the
twelve month period from the date of the financial statements in this Form 10-Q,
i.e
., the period through September 30,
2013.
We are evaluating the impact of current market
conditions on our portfolio company valuations and their ability to provide current income. We have followed valuation techniques
in a consistent manner; however, we are cognizant of current market conditions that might affect future valuations of portfolio
securities. We believe that our operating cash flow and cash on hand will be sufficient to meet operating requirements and to finance
routine capital expenditures through the next twelve months.
Cash and Temporary Cash Investments
—As
of September 30, 2012, we had cash and cash equivalents of $26.2 million. We had $5.3 million of our net assets of $31.7 million
invested in portfolio securities.
As of December 31, 2011, we had cash and
cash equivalents of $16.8 million. We had $19.2 million of our net assets of $38.1 million invested in portfolio securities. We
also had $6.1 million of restricted cash and temporary cash investments, including primarily the proceeds of a quarter-end margin
loan that we incurred to maintain the diversification requirements applicable to a RIC to maintain our pass-through tax treatment.
Of this amount, $6.0 million was invested in U.S. Treasury bills and $0.1 million represented a required 1% brokerage margin deposit.
These securities were held by a securities brokerage firm and pledged along with other assets to secure repayment of the margin
loan. The U.S. Treasury bills were sold and the margin loan was repaid to the brokerage firm on January 3, 2012.
Dividends
— We will pay out net
investment income and/or realized capital gains, if any, on an annual basis as required under the Investment Company Act of 1940.
Investment Commitments
—As of September
30, 2012, we had no outstanding commitments to our portfolio company investments.
Under certain circumstances, we may be called
on to make follow-on investments in certain portfolio companies. If we do not have sufficient funds to make follow-on investments,
the portfolio company in need of the investment may be negatively impacted. Also, our equity interest in the estimated fair value
of the portfolio company could be reduced.
RIC Borrowings, Restricted Cash and Temporary
Cash Investments
—We may periodically borrow sufficient funds to maintain the Fund’s RIC status by utilizing a margin
account with a securities brokerage firm. There is no assurance that such arrangement will be available in the future. If we are
unable to borrow funds to make qualifying investments, we may no longer qualify as a RIC. We would then be subject to corporate
income tax on the Fund’s net investment income and realized capital gains, and distributions to stockholders would be subject
to income tax as ordinary dividends. Failure to continue to qualify as a RIC could be materially adverse to us and our stockholders.
We had no RIC borrowings or restricted cash
as of September 30, 2012.
As of December 31, 2011, we borrowed $6.0
million to make qualifying investments to maintain our RIC status by utilizing a margin account with a securities brokerage firm.
We collateralized such borrowings with restricted cash and temporary cash investments in U.S. Treasury bills of $6.1 million.
The U.S. Treasury bills were sold on January 3, 2012 and the margin loan was repaid at that time.
Certain Risks and
Uncertainties
— Economic conditions during the previous three and a half years and resulting market dislocations
have resulted in a significant decline in the availability of debt and equity capital declining significantly. Generally, the
limited amount of available debt financing has shorter maturities, higher interest rates and fees, and more restrictive terms
than debt facilities available in the past. In addition, during these years and continuing through the nine months ended
September 30, 2012, the price of our common stock continued to fall well below our net asset value, thereby making
it undesirable to issue additional shares of our common stock. Because of these challenges, our near-term strategies
shifted from originating debt and equity investments to preserving liquidity necessary to meet our operational needs. Key
initiatives that we have previously undertaken to provide necessary liquidity include monetizations, the suspension of
dividends and the internalization of management. Although we cannot assure you that such initiatives will be sufficient, we
believe we have sufficient liquidity to meet our 2012 operating requirements.
(3)
Significant Accounting Policies
The following is a summary of significant accounting
policies followed by the Fund in the preparation of its financial statements:
Use of Estimates
—The preparation
of financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”)
requires us to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Although
we believe the estimates and assumptions used in preparing these financial statements and related notes are reasonable in light
of known facts and circumstances, actual results could differ from those estimates.
Valuation of Investments
—Portfolio
investments are carried at fair value with the net change in unrealized appreciation or depreciation included in the determination
of net assets. Valuations of portfolio securities are performed in accordance with accounting principles generally accepted in
the United States of America and the financial reporting policies of the Securities and Exchange Commission (“SEC”).
The applicable methods prescribed by such principles and policies are described below:
Publicly-traded portfolio securities
—Investments
in companies whose securities are publicly traded are generally valued at their quoted market price at the close of business on
the valuation date.
Privately-held portfolio securities
—The
fair value of investments for which no market exists is determined on the basis of procedures established in good faith by our
Board of Directors. As a general principle, the current “fair value” of an investment would be the amount we might
reasonably expect to receive for it upon its current sale, in an orderly manner. Appraisal valuations are necessarily subjective
and the estimated values arrived at by the Fund may differ materially from amounts actually received upon the disposition of portfolio
securities.
During the first twelve months after an investment
is made, the original investment value is utilized to determine the fair value unless significant developments have occurred during
this twelve month period which would indicate a material effect on the portfolio company (such as results of operations or changes
in general market conditions). After the twelve month period, or if material events have occurred within the twelve month period,
Fund management considers a two step process when appraising investments of privately held companies. The first step involves
determining the enterprise value of the portfolio company. During this step, Fund management considers three different valuation
approaches: a market approach, an income approach, and an asset approach. The particular facts and circumstances of each portfolio
company determine which approach, or combination of approaches, will be utilized. The second step when appraising equity investments
of privately held companies involves allocating value to the various debt and equity securities of the company. Fund management
allocates value to these securities based on their relative priorities. For equity securities such as warrants, the Fund may also
incorporate alternative methodologies including the Black-Scholes Option Pricing Model.
Market approach
—The market approach
typically employed by Fund management calculates the enterprise value of a company as a multiple of earnings before interest,
taxes, depreciation and amortization (“EBITDA”) generated by the company for the trailing twelve month period.
Adjustments to the company’s EBITDA, including those for non-recurring items, may be considered. Multiples are estimated
based on current market conditions and past experience in the private company marketplace and are subjective in nature. The Fund
will apply liquidity and other discounts it deems appropriate to equity valuations where applicable. The Fund may also use, when
available, third-party transactions in a portfolio company’s securities as the basis of valuation (the “private market
method”). The private market method will be used only with respect to completed transactions or firm offers made by sophisticated,
independent investors.
Income approach
—The income approach
typically utilized by Fund management calculates the enterprise value of a company utilizing a discounted cash flow model incorporating
projected future cash flows of the company. Projected future cash flows consider the historical performance of the company
as well as current and projected market participant performance. Discount rates are estimated based on current market conditions
and past experience in the private company marketplace and are subjective in nature. The Fund will apply liquidity and other discounts
it deems appropriate to equity valuations where applicable.
Asset approach
—The Fund considers
the asset approach to determine the fair value of significantly deteriorated investments demonstrating circumstances indicative
of a liquidation analysis. This situation may arise when a portfolio company: 1) cannot generate adequate cash flow to meet the
principal and interest payments on its indebtedness; 2) is not successful in refinancing its debt upon maturity; 3) Fund
management believes the credit quality of a loan has deteriorated due to changes in the business and underlying asset or market
conditions which may result in the company’s inability to meet future obligations; or 4) the portfolio company’s reorganization
or bankruptcy. Consideration is also given as to whether a liquidation event would be orderly or forced.
The Fund bases adjustments upon such factors
as the portfolio company’s earnings, cash flow and net worth, the market prices for similar securities of comparable companies,
an assessment of the company’s current and future financial prospects and various other factors and assumptions. In the
case of unsuccessful operations, the Fund may base a portfolio company’s fair value upon the company’s estimated liquidation
value. Fair valuations are necessarily subjective, and management’s estimate of fair value may differ materially from amounts
actually received upon the disposition of its portfolio securities. Also, any failure by a portfolio company to achieve its business
plan or obtain and maintain its financing arrangements could result in increased volatility and result in a significant and rapid
change in its value.
Fund management considers that the Fund’s
general intent is to hold its loans to maturity when appraising its privately held debt investments. As such, Fund management believes
that the fair value will not exceed the cost of the investment. However, in addition to the previously described analysis involving
allocation of value to the debt instrument, the Fund performs a yield analysis to determine if a debt security has been impaired.
Certificates of deposit purchased by the Fund
generally will be valued at their face value, plus interest accrued to the date of valuation.
The Audit Committee of the Board of Directors
may engage independent, third-party valuation firms to conduct independent appraisals and review management’s preliminary
valuations of each privately-held investment in order to make their own independent assessment. Any third-party valuation data
would be considered as one of many factors in a fair value determination. The Audit Committee then would recommend the fair values
for all privately-held securities based on all relevant factors to the Board of Directors for final approval.
Because of the inherent uncertainty of the
valuation of portfolio securities which do not have readily ascertainable market values, amounting to $5.3 million and $19.2 million
as of September 30, 2012 and December 31, 2011, respectively, our fair value determinations may materially differ from the values
that would have been used had a ready market existed for the securities. One of the Fund’s portfolio investments, consisting
of 1,102,455 ordinary shares of Orco Property Group S.A. (“OPG”), is publicly listed on the NYSE Euronext Paris Exchange
as of September 30, 2012.
See Subsequent Events, describing the receipt of the additional OPG shares and the New OPG Notes,
as well as the sale of 1,500,000 of the Fund’s OPG Shares for cash in October 2012.
On a daily basis, we adjust our net asset value
for the changes in the value of our publicly held securities, if applicable, and material changes in the value of private securities,
generally determined on a quarterly basis or as announced in a press release, and reports those amounts to Lipper Analytical Services,
Inc. Weekly and daily net asset values appear in various publications, including
Barron’s
and
The Wall Street Journal
.
Deferred Offering Costs—
Accumulation
of costs related to the offering whereby we will sell additional shares or rights to acquire shares at a market price that may
have been below net asset value. The main components of the costs are legal fees and consultant’s fees specifically related
to the offering.
Foreign Exchange
—We record temporary
changes in foreign exchange rates of portfolio securities denominated in foreign currencies as changes in fair value. These changes
are therefore reflected as unrealized gains or losses until realized.
Investment Transactions
—Investment
transactions are recorded on the accrual method. Realized gains and losses on investments sold are computed on a specific identification
basis.
We classify our investments in accordance with
the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies
in which EQS owns more than 25% of the voting securities or maintains greater than 50% of the board representation. Under the 1940
Act, “Affiliate Investments” are defined as those non-control investments in companies in which EQS owns between 5%
and 25% of the voting securities. Under the 1940 Act, “Non-affiliate Investments” are defined as investments that are
neither Control Investments nor Affiliate Investments.
Interest Income Recognition
—We
record interest income, adjusted for amortization of premium and accretion of discount, on an accrual basis to the extent that
we expect to collect such amounts. We stop accruing interest on investments when we determine that interest is no longer collectible.
We may also impair the accrued interest when we determine that all or a portion of the current accrual is uncollectible. If we
receive any cash after determining that interest is no longer collectible, we treat such cash as payment on the principal balance
until the entire principal balance has been repaid, before we recognize any additional interest income. We accrete or amortize
discounts and premiums on securities purchased over the life of the respective security using the effective yield method. The
amortized cost of investments represents the original cost adjusted for the accretion of discount and/or amortization of premium
on debt securities.
Payment in Kind Interest (PIK)
—We
have loans in our portfolio that may pay PIK interest. We add PIK interest, if any, computed at the contractual rate specified
in each loan agreement, to the principal balance of the loan and record it as interest income. To maintain our status as a RIC,
we must pay out to stockholders this non-cash source of income in the form of dividends even if we have not yet collected any cash
in respect of such investments.
Cash Flows
—For purposes of the
Statements of Cash Flows, we consider all highly liquid temporary cash investments purchased with an original maturity of three
months or less to be cash equivalents. We include our investing activities within cash flows from operations. We exclude “Restricted
Cash & Temporary Cash Investments” used for purposes of complying with RIC requirements from cash equivalents. See
Note 2 for further discussion of the Fund’s RIC borrowings.
Income Taxes
—We intend to comply
with the requirements of the Code necessary for us to qualify as a RIC. So long as we comply with these requirements, we generally
will not be subject to corporate-level federal income taxes on otherwise taxable income (including net realized capital gains)
distributed to stockholders. Therefore, we did not record a provision for federal income taxes in our financial statements. We
borrow money from time to time to maintain our tax status under the Internal Revenue Code as a RIC. See Note 2 for further discussion
of the Fund’s RIC borrowings.
Texas margin tax applies to legal entities
conducting business in Texas. The margin tax is based on our Texas sourced taxable margin. The tax is calculated by applying a
tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result,
we did not owe state income tax for the year ended December 31, 2011.
Fair Value Measurement
—Fair value
is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. We have categorized all investments recorded at fair value based upon the level of
judgment associated with the inputs used to measure their fair value. Hierarchical levels, directly related to the amount of subjectivity
associated with the inputs to fair valuation of these assets and liabilities, are as follows:
Level 1—Inputs are unadjusted, quoted prices in active markets
for identical assets at the measurement date. The types of assets carried at Level 1 fair value generally are equities listed in
active markets.
Level 2—Inputs (other than quoted prices included in Level
1) are either directly or indirectly observable for the asset in connection with market data at the measurement date and for the
extent of the instrument’s anticipated life. Fair valued assets that are generally included in this category are warrants
held in a public company.
Level 3—Inputs reflect management’s best estimate of
what market participants would use in pricing the asset at the measurement date. It includes prices or valuations that require
inputs that are both significant to the fair value measurement and unobservable. Generally, assets carried at fair value and included
in this category are debt, warrants and/or other equity investments held in a private company. As previously described, Fund management
considers a two step process when appraising investments of privately held companies. The first step involves determining the enterprise
value of the portfolio company. During this step, Fund management considers three different valuation approaches: a market approach,
an income approach, and a cost approach. The particular facts and circumstances of each portfolio company determine which approach,
or combination of approaches, will be utilized. The second step when appraising equity investments of privately held companies
involves allocating value to the various debt and equity securities of the company. Fund management allocates value to these securities
based on their relative priorities. For equity securities such as warrants, the Fund may also incorporate alternative methodologies
including the Black-Scholes Option Pricing Model. Yield analysis is also employed to determine if a debt security has been impaired.
We will record unrealized depreciation on investments
when we determine that the fair value of a security is less than its cost basis, and will record unrealized appreciation when we
determine that the fair value is greater than its cost basis.
As of September 30, 2012, investments measured
at fair value on a recurring basis are categorized in the tables below based on the lowest level of significant input to the valuations:
|
|
|
|
Fair
Value Measurements As of September 30, 2012 (unaudited)
|
(in thousands)
|
|
Total
|
|
Quoted
Prices in Active Markets for Identical Assets (Level 1)
|
|
Significant
Other Observable Inputs (Level 2)
|
|
Significant
Unobservable Inputs
(Level 3)
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Control investments
|
|
$
|
375
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
375
|
|
Affiliate investments
|
|
|
150
|
|
|
|
—
|
|
|
|
—
|
|
|
|
150
|
|
Non-affiliate investments
|
|
|
4,808
|
|
|
|
2,395
|
|
|
|
—
|
|
|
|
2,413
|
|
Total investments
|
|
$
|
5,333
|
|
|
$
|
2,395
|
|
|
$
|
—
|
|
|
$
|
2,938
|
|
As of December 31, 2011, investments measured
at fair value on a recurring basis are categorized in the tables below based on the lowest level of significant input to the valuations:
|
|
|
|
Fair
Value Measurements As of December 31, 2011
|
(in thousands)
|
|
Total
|
|
Quoted
Prices in Active Markets for Identical Assets (Level 1)
|
|
Significant
Other Observable Inputs (Level 2)
|
|
Significant
Unobservable Inputs
(Level 3)
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Control investments
|
|
$
|
13,298
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
13,298
|
|
Affiliate investments
|
|
|
150
|
|
|
|
—
|
|
|
|
—
|
|
|
|
150
|
|
Non-affiliate investments
|
|
|
5,734
|
|
|
|
—
|
|
|
|
—
|
|
|
|
5,734
|
|
Total investments
|
|
|
19,182
|
|
|
|
—
|
|
|
|
—
|
|
|
|
19,182
|
|
Temporary cash investments
|
|
|
6,000
|
|
|
|
6,000
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
|
$
|
25,182
|
|
|
$
|
6,000
|
|
|
$
|
—
|
|
|
$
|
19,182
|
|
The following table provides a reconciliation
of fair value changes during the nine months ended September 30, 2012 for all investments for which we determine fair value using
unobservable (Level 3) factors:
|
|
Fair
value measurements using significant unobservable inputs (Level 3)
|
(in thousands)
|
|
Control
Investments
|
|
Affiliate
Investments
|
|
Non-affiliate
Investments
|
|
Total
|
Fair value as of December 31, 2011
|
|
$
|
13,298
|
|
|
$
|
150
|
|
|
$
|
5,734
|
|
|
$
|
19,182
|
|
Realized gains (losses)
|
|
|
(5,187
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(5,187
|
)
|
Change in unrealized appreciation (depreciation)
|
|
|
1,891
|
|
|
|
—
|
|
|
|
(473
|
)
|
|
|
1,418
|
|
Purchases of portfolio securities
|
|
|
|
|
|
|
|
|
|
|
301
|
|
|
|
301
|
|
Proceeds from sales/dispositions
|
|
|
(9,627
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(9,627
|
)
|
Transfers in (out) of Level 3
|
|
|
—
|
|
|
|
—
|
|
|
|
(3,149
|
)
|
|
|
(3,149
|
)
|
Fair value as of September 30, 2012
|
|
$
|
375
|
|
|
$
|
150
|
|
|
$
|
2,413
|
|
|
$
|
2,938
|
|
The following table provides a reconciliation
of fair value changes during the nine months ended September 30, 2011 for all investments for which we determine fair value using
unobservable (Level 3) factors:
|
|
Fair
value measurements using significant unobservable inputs (Level 3)
|
(in
thousands)
|
|
Control
Investments
|
|
Affiliate
Investments
|
|
Non-affiliate
Investments
|
|
Total
|
Fair value as of December 31, 2010
|
|
$
|
17,576
|
|
|
$
|
762
|
|
|
$
|
9,324
|
|
|
$
|
27,662
|
|
Total realized gains (losses)
|
|
|
(10,074
|
)
|
|
|
138
|
|
|
|
(992
|
)
|
|
$
|
(10,928
|
)
|
Change in unrealized appreciation (depreciation)
|
|
|
7,178
|
|
|
|
(138
|
)
|
|
|
2,962
|
|
|
|
10,002
|
|
Purchases, issuances and settlements, net
|
|
|
45
|
|
|
|
(712
|
)
|
|
|
(5,937
|
)
|
|
|
(6,604
|
)
|
Transfers in (out) of Level 3
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Fair value as of September 30, 2011
|
|
$
|
14,725
|
|
|
$
|
50
|
|
|
$
|
5,357
|
|
|
$
|
20,132
|
|
Significant Unobservable
Inputs
—Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a
small number if inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities
with distinct contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and
complex, often factoring in numerous different inputs, including historical and forecasted financial and operational
performance of the portfolio company, projected cash flows, market multiples of comparable market transactions, the priority of
our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews and
other inputs.
The following table summarizes
the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and
valuation technique as of September 30, 2012:
|
|
|
|
|
|
|
|
Range
|
(in
thousands)
|
|
Fair
Value
(in thousands)
|
|
Valuation
Techniques
|
|
Unobservable
Inputs
|
|
Minimum
|
|
Maximum
|
Secured
and subordinated debt
|
|
$
|
1,526
|
|
|
Yield
Analysis;
|
|
Market
interest rate(s);
|
|
|
5.4
|
%
|
|
|
12.4
|
%
|
|
|
|
|
|
|
Pending
Transaction;
|
|
Discount(s)
for lack of marketability;
|
|
|
5
|
%
|
|
|
15
|
%
|
|
|
|
|
|
|
Asset
Approach
|
|
Recovery
rate(s)
|
|
|
0
|
%
|
|
|
100
|
%
|
Common
stock
|
|
|
1,174
|
|
|
Pending
Transaction
|
|
Discount(s)
|
|
|
0
|
%
|
|
|
0
|
%
|
Limited
liability company investments
|
|
|
238
|
|
|
Asset
Approach
|
|
Recovery
rate(s)
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
$
|
2,938
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4)
Related Party Transactions and Agreements
Except as noted below, as compensation
for services to the Fund, each Independent Director receives an annual fee of $20,000 paid quarterly in arrears, a fee of
$2,000 for each meeting of the Board of Directors attended in person, a fee of $1,000 for participation in each telephonic
meeting of the Board and a fee of $1,000 for each committee meeting attended, and reimbursement of all out-of-pocket expenses
relating to attendance at such meetings.
A quarterly fee of $15,000 is paid to the Chairman of the
Audit Committee and a quarterly fee of $3,750 is paid to the Chairman of the Independent Directors. We may also pay other
one-time or recurring fees to members of our Board of Directors in special circumstances.
During the nine months ended
September 30, 2012 and 2011, we paid Fraser Atkinson a fee of $45,000, respectively, in lieu of his standard
compensation as Chairman of the Audit Committee for additional duties undertaken in connection with the Fund’s review
and analysis of its portfolio holdings for the year. Neither Mr. Bertrand des Pallieres, an Independent Director, nor any of
our interested directors, receive annual fees for their service on the Board of Directors. The Fund incurred $323,457 and
$309,670 in fees to our directors for the nine months ended September 30, 2012 and 2011, respectively.
In June 2010, the Fund ratified and approved
the use of A+ Filings, LLC (“A+ Filings”) to file its reports with the Securities and Exchange Commission. Mr. Kenneth
I. Denos, Secretary of the Fund, holds a majority of the voting shares of A+ Filings. The Fund incurred $6,000 and $12,578 in services
rendered by A+ Filings for the nine months ended September 30, 2012 and 2011, respectively.
On December 20, 2010, our board of
directors approved a consulting agreement ("Consulting Agreement") with John A. Hardy, the Fund's Chief Executive
Officer. The Consulting Agreement provides for base compensation to Mr. Hardy of $200,000 per annum and an annual bonus
based upon achievement of certain criteria. The bonus is subject to an annual payout cap of $150,000, and any bonus
earned that exceeds the payout cap will be carried over into subsequent fiscal years. If the Consulting Agreement is
terminated without cause, as defined therein, Mr. Hardy will be entitled to receive one year's base consulting fee, together
with all bonuses earned and unpaid up to the date of termination. Mr. Hardy is not entitled to participate in any
employee-related benefits, including health, life and disability plans, of the Fund. During the nine months ended September
30, 2012, Mr. Hardy was principally responsible for the disposition of two of the Fund’s legacy portfolio investments,
the gross proceeds of which totaled $11,611,143. These dispositions were the principal trigger for an annual bonus payment to
Mr. Hardy for the fiscal year ended December 31, 2012 of $150,000. For the nine months ended September 30, 2012, the Fund
incurred compensation expense of $300,000, relating to Mr. Hardy’s Consulting Agreement, which amount includes the
bonus described above. Mr. Hardy has further waived his right to $672,585 of earned but unpaid bonus in connection with
activities of the Fund during the nine months ended September 30, 2012.
As of September 30, 2011,
the Fund incurred compensation expense of $300,000 relating to Mr. Hardy’s Consulting Agreement which included the
$150,000 cash bonus for fiscal 2011 in connection with the disposal of certain investments in January 2011 where the Fund
received 10,000,000 in cash. Mr. Hardy has further permanently waived his right to $648,137 of earned but unpaid bonus
in connection with activities of the Fund during the nine months ended September 30, 2011.
In November, 2011, Equus Energy, LLC, a wholly-owned
subsidiary of the Fund, entered into a consulting agreement with Global Energy Associates, LLC (“Global Energy”) to
provide consulting services for energy related investments. Henry W. Hankinson, Director, is a managing partner and co-founder
of Global Energy. Payments to Global Energy totaled $56,250 for the nine months ended September 30, 2012.
In respect of services provided to the
Fund by members of the Board not in connection with their roles and duties as directors, the Fund pays a rate of $250 per
hour for services rendered. In connection with services rendered by Kenneth I. Denos, Secretary and Chief Compliance Officer
of the Fund, the Fund incurred $187,563 which is included in compensation expense for the nine months ended September 30,
2012. For the nine months ended September 30, 2011, the Fund incurred $172,625 which is included in compensation expense in
the statement of operations and $117,188 which is included in deferred offering costs on the Statement of Operations as of
September 30, 2011 for services provided by Kenneth I. Denos, Secretary and Chief Compliance Officer of the Fund.
(5)
Dividends
We will pay out net investment income and/or
realized capital gains, if any, on an annual basis as required under the Investment Company Act of 1940.
(6)
Portfolio Securities
During the nine month ended September 30,
2012, we realized net capital losses of $5.2 million,
including the following significant
transactions (in thousands):
Portfolio Company
|
|
Industry
|
|
Type
|
|
Transaction Type
|
|
Realized Loss
|
ConGlobal Industries Holding, Inc.
|
|
Shipping products and services
|
|
Control
|
|
|
Disposition
|
|
$
|
(4,114
|
)
|
Sovereign Business Forms, Inc.
|
|
Business products and services
|
|
Control
|
|
|
Disposition
|
|
|
(1,073
|
)
|
Various others
|
|
|
|
|
|
|
|
Disposition
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
(5,188
|
)
|
Net unrealized depreciation on investments
decreased $0.7 million during the nine months ended September 30, 2012, to a net unrealized depreciation of $16.7 million.
Such decrease in unrealized depreciation is largely due to the following changes:
|
(i)
|
Transfer of unrealized loss to realized loss of ConGlobal Industries Holding, Inc. (“ConGlobal”)
of $1.6 million upon the disposition of the investment.
|
|
(ii)
|
Transfer of unrealized loss to realized loss of Sovereign Business Forms, Inc, (“Sovereign”)
of $0.6 million upon the disposition of the investment.
|
|
(iii)
|
Restructuring of the Orco Germany, S.A. bonds (“Bonds”) with the capitalization
of $0.3 million accrued interest resulting in a corresponding decrease in unrealized gain, along with a $0.9 million decline
in the fair value of the resulting new securities of
Orco Property Group S.A.
|
|
(iv)
|
Decrease in fair market value of Spectrum Management, Inc. (“Spectrum”)
of $0.2 million due to operating performance.
|
On May 7, 2012, holders of 72.5% of
all Orco Germany bondholders approved a joint restructuring of certain bond debt of Orco Germany and its parent company, Orco Property
Group S.A. Pursuant to such restructuring, approximately 84.5% of the Orco Germany bonds held by each bondholder
were converted into
Obligations Convertibles en Actions
(“OCA”) on May 9, 2012.
The OCA were converted into an
aggregate of 26,209,613 OPG shares which were delivered in two tranches. The first tranche, consisting of 18,361,540 OPG
shares, was delivered in May 2012, of which the Fund received 1,102,455 OPG shares. The second tranche, consisting of
7,848,073 OPG shares, was received in October 2012 of which the Fund received 471,211 OPG shares. Also in October 2012, the
remaining 15.5% of the Orco Germany bonds held by each bondholder were converted into newly-issued 6-year OPG
notes (“New OPG Notes”) with a face value of €20.0 million bearing cash and PIK interest each at 5% per
annum, which interest percentages may be reduced over time upon timely repayments of principal tranches during a four-year
period commencing in 2015. Of the total amount of New OPG Notes issued, Equus received New OPG Notes in the face amount
of €1,200,790. As of September 30, 2012, Equus held 1,102,455 OPG shares, OCA that had yet to be converted into
an additional 471,211 OPG shares, and 1,377 Orco Germany bonds, which had yet to be converted into the New OPG Notes.
See
Subsequent Events, describing the receipt of the additional OPG shares and the New OPG Notes, as well as the sale of
1,500,000 of the Fund’s OPG Shares for cash in October 2012.
During the nine months ended September 30,
2012, we made no new or follow-on investments. However, the restructuring of the Orco Germany bonds noted above resulted in the
capitalization of $0.3 million in accrued interest.
During the nine months ended September 30,
2011, we realized net capital losses of $10.9 million, including the following significant transactions (in thousands):
Portfolio Company
|
|
Industry
|
|
Type
|
|
Transaction Type
|
|
|
Realized Loss
|
Riptide Entertainment, LLC
|
|
Entertainment and leisure
|
|
Control
|
|
Disposition
|
|
$
|
(10,074)
|
London Bridge Entertainment Partners Ltd
|
|
Entertainment and leisure
|
|
Non-affiliate
|
|
Disposition
|
|
|
(992)
|
RP&C International Investments LLC
|
|
Healthcare
|
|
Affiliate
|
|
Disposition
|
|
|
138
|
Various others
|
|
|
|
|
|
|
|
|
(2)
|
|
|
|
|
|
|
|
|
$
|
(10,930)
|
During the
nine months ended September 30, 2011, we received $0.3 million from Sovereign Business Forms, Inc. in the form of
principal payments. During the nine months ended September 30, 2011, we sold our promissory notes in 1848 Capital Partners,
LLC (“1848”), Big Apple Entertainment Partners, LLC (“Big Apple”), and London Bridge Entertainment
Partners, Ltd (“London Bridge”) and certain assets of Riptide Entertainment Partners, LLC (“Riptide”)
in which we hold a 64.67% membership interest. All of these assets were sold to Capital Markets Acquisition Partners,
LLC for a combined price of $10 million, with $9.8 million allocated to the promissory notes held by the Fund and $0.2
million to Riptide. The Fund allocated the proceeds to the promissory
notes resulting in a realized loss of
approximately $0.9 million at London Bridge. In addition, the monies provided to Riptide were sufficient to satisfy its
outstanding liabilities. We also received $0.8 million in connection with the sale and redemption of our membership interest
in RP&C International Investments LLC.
Net unrealized depreciation on investments
decreased by $10.0 million, during the nine months ended September 30, 2011, to a net unrealized depreciation of $17.3 million.
Such decrease in depreciation resulted from the following changes:
|
(i)
|
Decline in fair market value of ConGlobal of $2.4 million due to the decline in operating performance
.
|
|
(ii)
|
Transfer of unrealized depreciation to realized depreciation for London Bridge of $0.8 million due to the sale of the promissory note.
|
|
(iii)
|
Transfer of unrealized depreciation to realized depreciation for Riptide of $10.1 million due to the sale of the promissory notes and the winding up of the entity.
|
|
(iv)
|
Transfer of unrealized appreciation to realized appreciation for RP&C International
Investments, LLC (“RP&C”) of $0.1 million due to the maturity of the investment.
|
|
(v)
|
Increase in fair market value of Sovereign of $0.3 million as Sovereign has continued to reduce its debt which has resulted in a corresponding increase its equity value
.
|
|
(vi)
|
Decrease in fair market value of Spectrum Management, Inc. (“Spectrum”)
of $0.8 million due to operating performance.
|
|
(vii)
|
Increase in the fair market value of Orco Germany S.A. bonds of $2.3 million due
to the difference in the market price of Equus shares used as consideration for the bonds on the date of acquisition offset by
changes in exchange rate.
|
During the nine months ended September 30,
2011, we made a follow-on investment of $0.3 million in Spectrum Management, LLC. On April 27, 2011, we announced that we had
entered into two separate
transactions involving the purchase of an aggregate of 11,408 bonds (“Bonds”)
issued by Orco Germany S.A., a commercial and multi-family residential real estate holding company and
developer based
in Berlin. The consideration provided to the selling bondholders consisted of an aggregate of 1,700,000 newly issued shares of
common stock of the Fund. We received 8,890 of the Bonds on April 27, 2011. On May 9, 2011, one of these agreements was amended
and restated to provide for an additional 45 days to deliver the remaining 2,518 of the Bonds in exchange for providing to the
Fund approximately $1.6 million in cash as security for such delivery. As the remaining bonds were not delivered by the specified
date, the cash collateral became free and clear property of the Fund on June 23, 2011.
The following table includes significant investment
activity during the nine months ended September 30, 2011 (in thousands):
|
|
Investment Activity
|
|
|
|
|
New Investments
|
|
Existing Investments
|
|
|
Portfolio Company
|
|
Cash
|
|
Non-Cash
|
|
Follow-On
|
|
PIK
|
|
Total
|
Orco Germany S.A.
|
|
$
|
67
|
|
|
$
|
3,016
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,083
|
|
Spectrum Management, LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
325
|
|
|
|
—
|
|
|
|
325
|
|
|
|
$
|
67
|
|
|
$
|
3,016
|
|
|
$
|
325
|
|
|
$
|
—
|
|
|
$
|
3,408
|
|
(7)
Subsequent Events
Management performed an evaluation of the Fund’s
activity through the date the financial statements were issued, noting the following subsequent events:
On October 8,
2012, pursuant to the terms of the conversion for the original bonds, the Fund received
471,211 OPG shares. The Fund also received 6-Year OPG notes in the principal amount of €1,200,790. The OPG notes, due February 2018, bear interest of 5% cash and 5% PIK per annum, which interest percentages may be reduced
over time upon timely repayments of principal tranches during a four-year period commencing in 2015.
On October 15, 2012, the Fund
announced
that it sold 1,500,000 of its 1,573,666 shares of OPG and received net cash proceeds of
€3.8 million, or $4.9 million, based on the settlement date’s EUR-USD intra-day exchange rate of 1.293.