The
accompanying notes are an integral part of these financial statements.
The
accompanying notes are an integral part of these financial statements.
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 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
DECEMBER 31, 2012, 2011 AND 2010
(1) ORGANIZATION AND BUSINESS PURPOSE
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 $5.0 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 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 BDC 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 certain income-producing investments or 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 these
income-producing investments or of any LLC (or other pass-through entity) portfolio investment, as the case may be, 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.
(2) LIQUIDITY AND FINANCING ARRANGEMENTS
Liquidity and Revolving Line of Credit
—There
are several factors that may materially affect our liquidity during the reasonably foreseeable future. We view this period as the
twelve month period from the date of the financial statements in this Form 10-K,
i.e
., the period through December 31, 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 expenditures through the next twelve months.
As of December 31, 2012, we had
cash and cash equivalents of $23.7 million. We had $9.2 million of our net assets of $32.9 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 on January 3, 2012 and we subsequently repaid this margin deposit.
As of December 31, 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 and Temporary Cash
Investments
—During 2012 and 2011, we borrowed 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 material to us and our stockholders.
We had no RIC borrowings or restricted
cash as of December 31, 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 total amount borrowed was repaid at that time.
Economic Conditions
—Economic
conditions since the second quarter of 2008 and market dislocations have resulted 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 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 undertook beginning in 2010 to provide necessary liquidity
included monetizations and the utilization of non-cash resources of the Fund to make portfolio investments. Although there can
be no assurances that such initiatives will be sufficient, we believe we have sufficient liquidity to meet our 2013 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 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.
Thinly Traded and Over-the-Counter
Securities
—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the
average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market
value of restricted or thinly traded public securities to reflect the impact that these restrictions have on the value of these
securities. We review factors, including the trading volume, total securities outstanding and our percentage ownership of securities
to determine whether the trading levels are active (Level 1) or inactive (Level 2) or unobservable (Level 3). As of December 31,
2012, these securities represented 15.4% of our investments in portfolio securities. We utilized independent pricing services with
certain of our fair value estimates. To corroborate “bid/ask” quotes from independent pricing services, we perform
a market-yield approach to validate prices obtained or obtain other evidence.
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, we consider 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, we consider
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. We allocate value to these securities based on their relative priorities. For equity securities
such as warrants, we may also incorporate alternative methodologies including the Black-Scholes Option Pricing
Model.
Market approach
– The
market approach typically employed by 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. We will apply liquidity and other discounts as deemed appropriate to equity valuations where
applicable. We 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 our 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. We will apply liquidity and other
discounts as deemed appropriate to equity valuations where applicable.
Asset approach
– We
consider 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) we believe
the credit quality of a loan has deteriorated due to changes in the business and underlying asset or market conditions 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.
We base 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 or substantially declining operations, we may base a portfolio company’s fair value upon the company’s
estimated liquidation value. Fair valuations are necessarily subjective, and our 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.
Our general intent is to hold
our loans to maturity when appraising our privately held debt investments. As such, we believe 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, we perform 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 $9.0 million and $19.2 million as of December 31, 2012 and 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. As of December 31, 2012, one of
the Fund’s portfolio investments, the 73,666 ordinary shares of OPG were publicly listed on the NYSE Euronext Paris Exchange,
along with €1,200,790 10% OPG notes due 2018
.
As of December
31, 2011, our 8,890 4% bonds of Orco Germany into which the OPG shares and OPG notes were converted, were publicly listed on the
Euro MTF Market of the Luxemburg Stock Exchange. However, there had been no recent trading activity.
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.
Offering costs of $0.4 million were
expensed at September 30, 2011, due to the delay in completing an offering to issue new shares.
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 we own 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 accrete or amortizes 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. 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 it recognizes any additional
interest income.
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 recorded 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.
Income Taxes
—We intend
to comply with the requirements of the Internal Revenue Code necessary to qualify as a regulated investment company and, as such,
will not be subject to federal income taxes on otherwise taxable income (including net realized capital gains) which is distributed
to stockholders. Therefore, no provision for federal income taxes is recorded
in the 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.
All corporations incorporated in
the State of Delaware are required to file an Annual Report and to pay a franchise tax. As a result, we paid
Delaware Franchise tax in the amount of $0.01 million, $0.01 million and $0.04 million for the years ended December 31, 2012,
December 31, 2011 and December 31, 2010, respectively.
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 years ended December 31, 2012, and December 31, 2011, and December 31, 2010 respectively.
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 our 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, we consider
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, we consider 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. We allocate value to these securities based on their relative priorities.
For equity securities such as warrants, we 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 December 31, 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 December 31, 2012
|
(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
|
|
$
|
7,419
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
7,419
|
|
Affiliate investments
|
|
|
150
|
|
|
|
—
|
|
|
|
—
|
|
|
|
150
|
|
Non-affiliate investments
|
|
$
|
1,663
|
|
|
$
|
238
|
|
|
$
|
—
|
|
|
$
|
1,425
|
|
Total investments
|
|
$
|
9,232
|
|
|
$
|
238
|
|
|
$
|
—
|
|
|
$
|
8,994
|
|
The following table provides a
reconciliation of fair value changes during 2012 for all investments for which we determine fair value using significant unobservable
(Level 3) inputs:
|
|
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 losses
|
|
|
(5,187
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(5,187
|
)
|
Change in unrealized appreciation (depreciation)
|
|
|
1,996
|
|
|
|
—
|
|
|
|
(282
|
)
|
|
|
1,714
|
|
Purchases of portfolio securities
|
|
|
6,939
|
|
|
|
—
|
|
|
|
301
|
|
|
|
7,240
|
|
Proceeds from sales/dispositions
|
|
|
(9,627
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
(9,627
|
)
|
Transfers in (out) of Level 3
|
|
|
—
|
|
|
|
—
|
|
|
|
(4,328
|
)
|
|
|
(4,328
|
)
|
Fair value as of December 31, 2012
|
|
$
|
7,419
|
|
|
$
|
150
|
|
|
$
|
1,425
|
|
|
$
|
8,994
|
|
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 2011 for all investments for which we determine fair value using significant unobservable
(Level 3) inputs:
|
|
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
|
|
Realized gains/losses
|
|
|
(10,074
|
)
|
|
|
138
|
|
|
|
(992
|
)
|
|
|
(10,928
|
)
|
Change in unrealized appreciation (depreciation)
|
|
|
6,600
|
|
|
|
(38
|
)
|
|
|
3,338
|
|
|
|
9,900
|
|
Purchases of portfolio securities
|
|
|
575
|
|
|
|
—
|
|
|
|
3,083
|
|
|
|
3,658
|
|
Proceeds from sales/dispositions
|
|
|
(1,379
|
)
|
|
|
(712
|
)
|
|
|
(9,019
|
)
|
|
|
(11,110
|
)
|
Fair value as of December 31, 2011
|
|
$
|
13,298
|
|
|
$
|
150
|
|
|
$
|
150
|
|
|
$
|
19,182
|
|
Significant Unobservable Inputs
— Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number
of 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, project cash
flows, market multiples 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
non-observable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as
of December 31, 2012:
(in thousands)
|
|
Fair Value
|
|
Valuation Techniques
|
|
Unobservable Inputs
|
|
Minimum
|
|
Maximum
|
Secured and subordinated debt
|
|
$
|
1,843
|
|
|
Yield Analysis
|
|
Market interest rate
|
|
|
5.4
|
%
|
|
|
12.4
|
%
|
|
|
|
|
|
|
Pending Transaction
|
|
Discount for lack of
marketability
|
|
|
5
|
%
|
|
|
15
|
%
|
|
|
|
|
|
|
Asset Approach
|
|
Recovery rate
|
|
|
0
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock
|
|
|
150
|
|
|
Pending Transaction
|
|
Discount
|
|
|
0
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Limited liability company investments
|
|
|
7,001
|
|
|
Asset Approach
|
|
Recovery rate
|
|
|
0
|
%
|
|
|
100
|
%
|
|
|
$
|
8,994
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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. None of our interested directors
receive annual fees for their service on the Board of Directors.
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. The Fund incurred $7,000 and $14,000 in services rendered by A+ Filings for the years ended December 31,
2012 and 2011, respectively. Mr. Kenneth I. Denos, Secretary of the Fund, held a majority of the voting shares of A+ Filings;
however, Mr. Denos sold his interest in A+ Filings in March 2013.
In 2010, payments to Versatile Systems
Inc. (“Versatile Systems”) and Versatile Acquisition Corporation amounted to $51,000 for reimbursements for proxy related
expenses incurred for the 2010 Annual Shareholder meeting. John A. Hardy, Chief Executive Officer, Fraser Atkinson,
Director and Chairman of the Audit Committee, Alessandro Benedetti, Executive Chairman, and Bertrand des Pallieres, Director, are
all members of the board of directors of Versatile Systems. Messrs. Hardy and Atkinson are also the Chief Executive Officer and
Chief Financial Officer, respectively, of Versatile Systems.
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. For the years ended December 31, 2012 and 2011, payments to Global Energy totaled $75,000 and $12,500, respectively.
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.
.
(5) FEDERAL INCOME TAX MATTERS
We are required to make distributions of any
net taxable investment income on an annual basis, and may elect to distribute or retain net taxable realized capital gains. The
Internal Revenue Service approved our request, effective October 31, 1998, to change our year-end for determining capital
gains for purposes of Section 4982 of the Internal Revenue Code from December 31 to October 31.
We were not required
to make distributions of ordinary income for 2010, 2011 and 2012 under income tax regulations.
For the year ended December 31, 2012, we have
a net investment loss for book purposes of $2.7 million and $2.7 million for tax purposes. During 2012, we had a net capital loss
for book purposes of $2.8 million and a net capital loss for tax purposes of $2.8 million for tax purposes. The aggregate cost
of investments for federal income tax purposes as of December 31, 2012
was $23.3 million. Such investments had unrealized
appreciation of approximately $0.8 million and unrealized depreciation of $18.0 million for book purposes, or net unrealized
depreciation of approximately $17.2 million. We had unrealized appreciation of approximately $1.0 million and unrealized
depreciation of approximately $15.2 million for tax purposes, or net unrealized depreciation of approximately $14.2 million
as of December 31, 2012. As of December 31, 2012, we had approximately $29.3 million in capital losses, of which $15.6
million will expire after 2017, and remaining $13.7 million can be carried over indefinitely.
In regards to the Return of Capital Statement
of Position, during the three years ended December 31, 2012, we recorded a reclassification for permanent book to tax differences
of less 1,000 thousand in each year. These differences were primarily due to the tax exempt interest income received. These
differences resulted in a net decrease in accumulated earnings. This reclassification had no effect on net assets.
For the year ended December 31, 2011, we
have a net investment loss for book purposes of $3.5 million and a net investment loss of $3.5 million for tax purposes.
During 2011, we had a net capital loss for book purposes of $10.9 million and a net capital loss for tax purposes of $10.9
million. The aggregate cost of investments for federal income tax purposes as of December 31, 2011 was $33.6 million.
Such investments had unrealized appreciation of approximately $ 2.7 million and unrealized depreciation of $20.1 million for
book purposes, or net unrealized depreciation of approximately $17.4 million. We had unrealized appreciation of approximately
$2.8 million and unrealized depreciation of approximately $17.2 million for tax purposes, or net unrealized depreciation of
approximately $14.4 million as of December 31, 2011. As of December 31, 2011, we had approximately $26.5 million of
which $15.6 million will expire after 2017 and the remaining $10.9 million can be carried over indefinitely.
For the year ended December 31, 2010, we had
a net investment loss for book purposes of $0.8 million and a net investment loss for tax purposes of $0.8 million. During 2010,
we had a net capital loss for book purposes of $7,000 and a net capital loss for tax purposes of $7,000. The aggregate
cost of investments for federal income tax purposes as of December 31, 2010 was $51.9 million. Such investments had unrealized
appreciation of approximately $1.3 million and unrealized depreciation of $28.6 million for book purposes, or net unrealized depreciation
of approximately $27.3 million. The Fund had unrealized appreciation of approximately $1.4 million and unrealized depreciation
of approximately $25.7 million for tax purposes, or net unrealized depreciation of approximately $24.3 million as of December 31,
2010. As of December 31, 2010, we had approximately $15.6 million in capital loss carry forwards which will expire after 2017.
We are a flow through, non-tax paying entity;
further, our net operating loss carry forwards have been exhausted. Based upon an examination of our tax position, we determined
that the aggregate exposure for uncertain tax positions did not have a material impact on our financial statements as of December 31,
2012 and December 31, 2011. The uncertain tax position is measured at the largest amount of benefits/expense that is greater
than 50% likely of being realized upon ultimate settlement. We have not recorded an adjustment to our financial statements related
to uncertain tax positions. We will continue to evaluate our tax positions and recognize any future impact of uncertain tax positions
as a charge to income in the applicable period in accordance with the standard.
Our accounting policy related
to income tax penalties and interest assessments is to accrue for these costs and record a charge to expenses during the period
that the Fund takes an uncertain tax position through resolution with the taxing authorities or expiration of the applicable statute
of limitations.
All of the Fund’s federal and state income
tax returns for 2009 through 2012 remain open to examination. We believe that there are no tax positions taken or expected to be
taken that would significantly increase or decrease unrecognized tax benefits within 12 months of the reporting date.
(6) CONTRACTUAL OBLIGATIONS
We have operating leases for office
space and office equipment. The lease for office space expires in 2014 with a one-time option to terminate the lease as of
the last day of the 36
th
month. The lease also contains a provision for certain annual rental escalations. Rent
expense inclusive of common area maintenance costs was $84,000 for the year ended December 31, 2012, $81,000 for the year ended
December 31, 2011 and $70,000 for the years ended December 31, 2010.
Future minimum lease payments under
the operating lease as of December 31, 2012 were as follows (in thousands):
|
2013
|
|
|
$
|
56.0
|
|
|
2014
|
|
|
|
42.0
|
|
|
|
|
|
$
|
98.0
|
|
As of December 31, 2012 we had
no outstanding commitments to our portfolio company investments.
(7) DIVIDENDS
On March 24, 2009, we announced
that we suspended our managed distribution policy and payment of quarterly distributions for an indefinite period. We will continue
to 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.
(8) PORTFOLIO SECURITIES
2012 Portfolio Activity
During the year ended December 31,
2012, we received $6.4 million from the disposal of the Fund’s 55% fully-diluted equity interest in Sovereign Business
Forms, Inc. (“Sovereign”), together with the Fund’s promissory note and all interest as accrued interest.
We also received $5.3 million from the disposal of the Fund’s 34.2% equity interest in ConGlobal Industries Holding,
Inc. (“ConGlobal”), together with the Fund’s promissory note and all interest as accrued interest.
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, OPG. 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. Also in October, the remaining 15.5% of the Orco Germany bonds held by
each bondholder was 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.
On October 15,
2012, we announced the sale of 1,500,000 of our 1,573,666 OPG shares, where we received net cash proceeds of €3.8
million [$4.9 million]. As of December 31, 2012, we held 73,666 OPG shares, and
€
1,200,790 New
OPG Notes.
During the year ended
December 31, 2012, we had investment activity of $7.2 million in two portfolio companies.
We
made a follow-on investment of $6.8 million in Equus Energy, LLC.
The restructuring of the Orco Germany bonds noted
above resulted in the capitalization of $0.3 million accrued interest received in the form of additional portfolio securities
(PIK). We capitalized legal and consulting expenses of $0.1 million relating to Spectrum Management.
The following table includes significant
investment activity during the year ended December 31, 2012 (in thousands):
|
|
Investment Activity
|
|
|
|
|
New Investments
|
|
Existing Investments
|
|
|
Portfolio Company
|
|
Cash
|
|
Non-Cash
|
|
Follow-On
|
|
PIK
|
|
Total
|
Equus Energy, LLC
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6,800
|
|
|
$
|
—
|
|
|
$
|
6,800
|
|
Orco
Property Group S.A.
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
301
|
|
|
|
301
|
|
Spectrum Management, LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
139
|
|
|
|
—
|
|
|
|
139
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6,939
|
|
|
$
|
301
|
|
|
$
|
7,240
|
|
During 2012, we realized net
capital losses of $2.8 million, including the following significant transactions:
Portfolio Company
|
|
Industry
|
|
Type
|
|
Realized Gain (Loss)
|
ConGlobal Industries Holding, Inc.
|
|
Shipping products and services
|
|
|
Control
|
|
|
$
|
(4,114
|
)
|
Sovereign Business Forms, Inc.
|
|
Business products and services
|
|
|
Control
|
|
|
|
(1,073
|
)
|
Orco Property Group S.A.
|
|
Real Estate
|
|
|
Non-affiliate
|
|
|
|
2,318
|
|
Various others
|
|
|
|
|
|
|
|
|
72
|
|
|
|
|
|
|
|
|
|
$
|
(2,797
|
)
|
During 2012, we recorded a net
change in unrealized depreciation of $0.2 million, to a net unrealized depreciation of $17.2 million. Such change in depreciation
resulted primarily from the following changes:
(i)
|
|
Transfer of unrealized depreciation to realized loss of ConGlobal Industries Holding, Inc. of $1.6 million upon the divestiture of the investment.
|
(ii)
|
|
Transfer of unrealized depreciation to
realized loss of Sovereign Business Forms, Inc. of $0.6 million upon the divestiture of the investment.
|
(iii)
|
|
The restructuring of the 8,890 Orco
Germany bonds resulted in the Fund holding 1,573,666 ordinary shares of OPG and €1,200,790 newly-issued 6-year OPG
notes. The capitalization of $0.3 million accrued interest and the subsequent sale of 1.5 million shares of OPG shares in
October 2012 resulted in a decrease in fair value of OPG of $1.8 million.
|
(iv)
|
|
Decrease
in the fair value of Equus Energy, LLC of $0.2 million due to working capital expenditures.
|
2011 Portfolio Activity
During the year ended December 31, 2011,
we received $0.4 million from Sovereign Business Forms, Inc. in the form of principal payments and a
distribution from Equus Media Development Company, LLC in the amount of $1.0 million. We sold our promissory
notes in 1848 Capital Partners, LLC , Big Apple Entertainment Partners, LLC, 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. We 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,
resulting in a value of $0. We also received $0.8 million in connection with the sale and redemption of our membership interest
in RP&C International Investments LLC
.
During the year ended December 31,
2011, we had investment activity of $3.7 million in three portfolio companies.
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 4% bonds due May 2012 (“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. These shares are unregistered
under the Securities Act of 1933. 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 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. On September 30, 2011, we formed Equus Energy
as a wholly-owned subsidiary of the Fund, to make investments in companies in the energy sector, with particular emphasis on income-producing
oil & gas properties. In December 2011, we contributed $250,000 to the capital of Equus Energy.
The following table includes significant
investment activity during the year ended December 31, 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
|
|
Equus Energy, LLC
|
|
|
250
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
250
|
|
|
|
$
|
317
|
|
|
$
|
3,016
|
|
|
$
|
325
|
|
|
$
|
—
|
|
|
$
|
3,658
|
|
During 2011, we realized net
capital losses of $10.9 million, including the following significant transactions (in thousands):
Portfolio Company
|
|
Industry
|
|
Type
|
|
Realized Gain (Loss)
|
Riptide Entertainment, LLC
|
|
Entertainment and leisure
|
|
|
Control
|
|
|
$
|
(10,074
|
)
|
London Bridge Entertainment Partners Ltd
|
|
Entertainment and leisure
|
|
|
Non-affiliate
|
|
|
|
(992
|
)
|
RP&C International Investments LLC
|
|
Healthcare
|
|
|
Affiliate
|
|
|
|
138
|
|
Various others
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
$
|
(10,930
|
)
|
During 2011, we recorded a net change
in unrealized depreciation of $9.9 million, to a net unrealized depreciation of $17.4 million. Such change in unrealized depreciation
resulted primarily from the following changes:
(i)
|
|
Decline in fair market value of ConGlobal Industries Holding, Inc. of $2.6 million due to the decline in operating performance.
|
(ii)
|
|
Transfer of unrealized depreciation to realized depreciation for London Bridge Entertainment Partners, Ltd. of $0.8 million due to the sale of the promissory note.
|
(iii)
|
|
Increase in the fair market value of Orco
Germany S.A. bonds of $2.7 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 the change in Euro-USD exchange rate.
|
(iv)
|
|
Increase in the fair market value of PalletOne, Inc. of $0.1 million due to steady improvement in operating performance and indications of value from independent third parties.
|
(v)
|
|
Transfer of unrealized depreciation to realized depreciation for Riptide Entertainment Partners, LLC of $10.1 million due to the sale of the promissory notes and the winding up of the entity.
|
(vi)
|
|
Transfer of unrealized appreciation to realized appreciation for RP&C International Investments, LLC of $0.1 million due to the maturity of the investment.
|
(vii)
|
|
Increase in fair market value of Sovereign Business Forms, Inc. of $0.6 million as Sovereign has seen an upward trend in operating results and has continued to reduce its debt which has resulted in a corresponding increase its equity value.
|
(viii)
|
|
Decrease in fair market value of Spectrum
Management, Inc. of $1.4 million due to the decline in operating performance and the maturity of its
funded debts which remain in default.
|
(ix)
|
|
Decrease in the fair market value of Trulite, Inc. of $0.1 due to the lack of progress and inability to achieve sufficient funding with regards to its product development program.
|
2010 Portfolio Activity
During the year ended December 31, 2010,
we received payment in full for the Trulite, Inc. promissory note, in the amount of $2.6 million, which included interest income
of $0.3 million, a distribution from Equus Media Development Company, LLC of $1.0 million, and repayment of the Nickent Golf, Inc.
receivership certificate in the amount of $0.1 million.
We also received repayment of the $0.6
million bridge loan from London Bridge Entertainment Partners, Ltd.
During the year ended
December 31, 2010, we had investment activity of $1.8 million in five portfolio companies, including $0.6 million in
the form of accrued interest and dividends received in the form of additional portfolio securities (PIK).
The following table includes significant
investment activity during the year ended December 31, 2010 (in thousands):
|
|
Investment Activity
|
|
|
|
|
New Investments
|
|
Existing Investments
|
|
|
Portfolio Company
|
|
Cash
|
|
PIK
|
|
Follow-On
|
|
PIK
|
|
Total
|
London Bridge Entertainment Partners Ltd
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
575
|
|
|
$
|
148
|
|
|
$
|
723
|
|
Spectrum Management, LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
425
|
|
|
|
—
|
|
|
|
425
|
|
1848 Capital Partners LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
295
|
|
|
|
295
|
|
Trulite, Inc.
|
|
|
—
|
|
|
|
—
|
|
|
|
200
|
|
|
|
—
|
|
|
|
200
|
|
Big Apple Entertainment Partners LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
121
|
|
|
|
121
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,200
|
|
|
$
|
564
|
|
|
$
|
1,764
|
|
During 2010, we realized no material
gains or losses on sales of portfolio securities.
During 2010, we recorded an increase
in net unrealized depreciation of $12.1 million, to a net unrealized depreciation of $27.3 million. Such increase in unrealized
depreciation resulted primarily from the following changes:
(i)
|
|
Increase in fair market value of ConGlobal of $0.2 million. ConGlobal’s value reflects the general stability of business performance over last year.
|
(ii)
|
|
Decline in fair market value of EMDC of $2.8 million. In June 2010, we received a distribution of $1.0 million from EMDC. Currently, EMDC holds $1.5 million in cash and has a remaining funding commitment of $0.3 under our agreement with Kopleson Entertainment. In addition, if Kopleson Entertainment generates $0.2 million of income for EMDC, that event will trigger an additional $1.0 million funding obligation of EMDC. EMDC has written down the fair value of its assets to reflect the holding period of the projects held by EMDC.
|
(iii)
|
|
Decline in fair market value of Infinia of $1.5 million. Infinia has informed us of its significant capital and ongoing liquidity needs. Based on these factors, the negative book value of equity, our nominal equity holdings and the future potential dilution or possible restructuring of the capital structure of the company, we have written down the investment to $0.
|
(iv)
|
|
Increase in fair market value of PalletOne of $0.1 million. PalletOne has continued to generate cash flows which have reduced debt levels. We believe the performance of the company in recent years and its continued debt reduction initiatives has created a nominal increase in the value of our equity holdings.
|
(v)
|
|
Decrease in fair market value of Sovereign of $0.4 million. The value of Sovereign reflects a slight decline in business performance compared with last year.
|
(vi)
|
|
Decline in fair market value of Spectrum Management,
LLC of $3.9 million. In the fourth quarter, we loaned Spectrum $0.4 million to meet its immediate working capital
needs. The valuation reflects Spectrum’s operating results, market conditions of its customer base, working capital
shortfall and near-term maturity of the company’s debt.
|
(vii)
|
|
Increase in fair market value of Trulite of $0.1 million. We hold approximately nine million warrants in Trulite, many with a nominal exercise price. Based on Trulite’s recent equity raise, operating performance and repayment of the Fund’s debt, the Fund determined the warrants have increased in value. We have valued these warrants utilizing the Black-Sholes option pricing model.
|
(viii)
|
|
Subsequent to year-end, we sold our promissory notes in 1848 Capital Partners, LLC, Big Apple Entertainment Partners, LLC, and London Bridge Entertainment Partners, Ltd in a transaction which also combined all of the assets of Riptide Entertainment Partners, LLC (“Riptide”). 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. We allocated the proceeds to the promissory notes resulting in a loss of approximately $0.9 million at London Bridge. In addition, the monies provided to Riptide were sufficient to satisfy its outstanding liabilities, resulting in a value of $0. For the year, the changes in fair value for each investment include an increase of $0.3 million of the 1848 note, and increase of $0.2 million of the Big Apple note, a decline of $0.7 million of the London Bridge note and a decline of $3.2 million in Riptide.
|
(9) RECENT ACCOUNTING PRONOUNCEMENTS
In May 2011, the FASB issued changes
to disclosure requirements for fair value measurements which resulted in a consistent definition of fair value and common requirements
for measurement of and disclosure about fair value between GAAP and International Financial Reporting Standards.
These changes become effective for interim and annual periods beginning after December 15, 2011. We adopted this standard beginning
on January 1, 2012. Our implementation of this standard did not have a material impact on our process for measuring fair
values, our financial position or our results of operations.
(10) SUBSEQUENT EVENTS
Our Management performed an
evaluation of the Fund’s activity through the date the financial statements were issued, noting the following
subsequent event:
On March 1, 2013 we received
a semi-annual interest payment of $0.03 million and a 5.75% partial principal payment of $9,000 in respect of our
€1,200,790 [$1,575,420] notes of OPG that we received in October 2012.
(11) SELECTED QUARTERLY DATA
(in thousands, except per share amounts)
|
|
Year Ended December 31, 2012
|
|
|
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
|
|
|
2012
|
|
2012
|
|
2012
|
|
2012
|
|
TOTAL
|
Total investment income (loss)
|
|
$
|
227
|
|
|
$
|
212
|
|
|
$
|
(100
|
)
|
|
$
|
177
|
|
|
$
|
516
|
|
Net investment loss
|
|
$
|
(498
|
)
|
|
$
|
(777
|
)
|
|
$
|
(685
|
)
|
|
$
|
(694
|
)
|
|
$
|
(2,654
|
)
|
Increase (decrease) in net assets resulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from operations
|
|
$
|
(498
|
)
|
|
$
|
(4,232
|
)
|
|
$
|
(1,754
|
)
|
|
$
|
1,211
|
|
|
|
(5,273
|
)
|
Basic and diluted earnings per share
(1)
|
|
$
|
(0.05
|
)
|
|
$
|
(0.40
|
)
|
|
$
|
(0.17
|
)
|
|
$
|
0.12
|
|
|
$
|
(0.50
|
)
|
(in thousands, except per share amounts)
|
|
Year Ended December 31, 2011
|
|
|
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
|
|
|
2011
|
|
2011
|
|
2011
|
|
2011
|
|
TOTAL
|
Total investment income (loss)
|
|
$
|
439
|
|
|
$
|
392
|
|
|
$
|
(169
|
)
|
|
$
|
(123
|
)
|
|
$
|
539
|
|
Net investment loss
|
|
$
|
(686
|
)
|
|
$
|
(1,203
|
)
|
|
$
|
(891
|
)
|
|
$
|
(720
|
)
|
|
$
|
(3,500
|
)
|
Increase (decrease) in net assets resulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from operations
|
|
$
|
(1,717
|
)
|
|
$
|
474
|
|
|
$
|
(2,463
|
)
|
|
$
|
(823
|
)
|
|
|
(4,529
|
)
|
Basic and diluted earnings per share (1)
|
|
$
|
(0.18
|
)
|
|
$
|
0.05
|
|
|
$
|
(0.28
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.50
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(
1)
The sum of quarterly per
share amount may not equal per share amounts reported for year-to-date periods due to changes in the number of weighted average
shares outstanding and the effects of rounding.
(12) LEGAL PROCEEDINGS
On March 10, 2010, American General
Life Insurance Company (American General”) filed a complaint against the Fund in the District Court of Harris County, Texas,
in connection with an office lease entered into by our former administrator with American General. The complaint by American General
sought to hold the Fund liable for unpaid rent, improvements, and attorneys fees totaling approximately $450,000. We agreed to
a settlement with American General in exchange for a one-time payment of $120,000, which was paid on June 7, 2011.
On April 26, 2010, the Securities
and Exchange Commission (“SEC”) subpoenaed records of the Fund in connection with certain trades in the Fund’s
shares by SPQR Capital LLP, SAE Capital Ltd., Versatile Systems Inc., Mobiquity Investments Limited, and anyone associated with
those entities. We have fully cooperated with the SEC’s request.
On June 9, 2011, RNR Production, Land
and Cattle Company, Inc. (“RNR”) filed a lawsuit against the Fund and each of the members of the Board in the District
Court of Harris County, Texas, seeking various monetary and equitable remedies, including a motion for a temporary restraining
order against the Fund from holding its annual meeting of shareholders which was scheduled for June 10, 2011. The Fund prevailed
against the motion but agreed to a nuisance settlement with RNR in exchange for a one-time payment of $200,000 which was paid on
September 2, 2011.
In January 2006, we sold our 31.5% ownership
interest in Champion Window, Inc. (“Champion”), a portfolio company of the Fund, to Atrium Companies Inc. (“Atrium”)
pursuant to a Stock Purchase Agreement (“SPA”) dated December 22, 2005. The SPA contained certain limited rights of
indemnification for Atrium in connection with its purchase of such ownership interest.
Atrium filed suit in the District Court
of Harris County, Texas against two former officers of Atrium’s subsidiary, Champion, alleging, amongst other matters, that
the former officers breached their fiduciary duties to Champion by hiring undocumented workers. This action was commenced primarily
as a result of an investigation by the U.S. Immigration and Customs Enforcement agency (“ICE”) into Atrium’s
hiring practices. On March 12, 2012, to protect its interests, we filed a Petition in Intervention in the State Court Action seeking
a declaration from the Court that Equus did not owe any obligation to indemnify Atrium or Champion for any penalties, costs or
fees associated with the investigation by ICE.
On March 16, 2012, Atrium and Champion
filed a claim with the American Arbitration Association in Dallas, Texas, against Equus and a number of the other sellers under
the SPA.
In the Arbitration Action, Atrium and
Champion seek damages arising from Equus’ and the other sellers’ indemnity obligations set forth in the SPA. Atrium
claims it is entitled to indemnification under the SPA for costs it has incurred in responding to an ongoing investigation by ICE.
Atrium entered into a Non-Prosecution Agreement with ICE. It appears that one condition of the Non-Prosecution Agreement required
Atrium to pay ICE $2,000,000. Atrium and Champion asserted two counts of breach of contract against Equus, both arising out of
the alleged obligation to indemnify Atrium and Champion pursuant to certain provisions of the SPA. Atrium and Champion also asserted
claims for fraudulent inducement against two former officers and directors of Champion. Through the arbitration, Atrium and Champion
seek to recover an unspecified amount in the form of alleged “losses, damages, assessments, penalties, interest, reasonable
attorneys’ and accountants’ fees, settlement costs, and other costs and expenses arising directly or indirectly out
of or incident to,” the alleged breach of the indemnity provisions in the SPA. As a consequence of their fraudulent inducement
claim against the two former officers and directors, Atrium and Champion alternatively seek equitable rescission of the SPA and
exemplary damages from the two former officers and directors.
Atrium and Champion have yet to specify
the amount of damages they seek from Equus or the other sellers pursuant to the alleged indemnity obligations under the SPA. Atrium
and Champion have disclosed the payment of $2 million to ICE to resolve the investigation and avoid prosecution for their hiring
practices.
We intend to vigorously contest the
claims and deny that we owe any indemnity obligations to Atrium or Champion and further deny that the Fund is in any way liable
to Atrium or Champion. To the extent Atrium and Champion are able to establish a right to an indemnity, we will contest the amount
of the claimed indemnity, inasmuch as we believe (among other defenses) that the indemnity obligation can only exist, if at all,
with respect to damages arising as a direct and proximate result of employees who were hired prior to the closing date of the 2006
sale of Champion and remained in continuous employment after the 2006 sale, and not to any employee who may have been hired in
the six years after the sale.
While we believe the Atrium claim is
without merit and we intend to vigorously dispute the claim, there is a reasonable possibility of an adverse ruling which may require
the Fund to indemnify Atrium. If Equus is required to indemnify Atrium and Champion, we estimate that such indemnity obligation
could vary from $2.0 - $3.0 million. Pursuant to the SPA, the indemnification obligation of Equus and the other sellers is several
and not joint, and any such indemnity, however uncertain, would likely be reduced proportionately to our percentage ownership in
Champion at the time of sale, which was 31.5% of Champion’s shares outstanding.
On August 12, 2012, Paula Douglass filed
a lawsuit against the Fund and members of the Board of Directors in the District Court of Harris County, Texas. Ms. Douglass’
complaint alleges various causes of action, including minority shareholder oppression, dilution, and breach of fiduciary duty,
and seeks unspecified damages and attorney’s fees. We consider the lawsuit as being without merit and intend to defend the
matter vigorously.
From time to time, the Fund is also
a party to certain legal proceedings incidental to the normal course of our business including the enforcement of our rights under
contracts with our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty,
we do not expect that these proceedings will have a material effect upon the Fund’s financial condition or results of operations.