NOTES
TO FINANCIAL STATEMENTS
JUNE
30, 2016
(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 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 (or smaller public 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 (“BDC”) under the 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.
Basis
of Presentation -
In accordance with Article 6 of Regulation S-X under the Securities Act of 1933 and the 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 six months ended June 30, 2016 are not necessarily indicative of results that ultimately may be
achieved for the remainder of 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 Annual Report on Form 10-K for the fiscal year ended
December 31, 2015, as filed with the Securities and Exchange Commission (“SEC”).
|
(2)
|
Liquidity
and Financing Arrangements
|
Liquidity
-
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-Q,
i.e
., the period through
June 30, 2016. We are evaluating the impact of current market conditions on our portfolio company valuations and the ability of
these companies 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 follow-on investments, if any, through
the next twelve months.
Cash
and Cash Equivalents -
As of June 30, 2016, we had cash and cash equivalents of $13.3 million. We had $25.1
million of our net assets of $39.6 million invested in portfolio securities. We also had $28.3 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, $28.0 million was
invested in U.S. Treasury bills and $0.3 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 July 1, 2016 and we subsequently repaid this margin loan, plus interest, on July 5, 2016.
As
of December 31, 2015, we had cash and cash equivalents of $17.0 million. We had $19.4 million of our net assets of $37.3 million
invested in portfolio securities. We also had $15.1 million of temporary cash investments and restricted cash, including primarily
the proceeds of a quarter-end margin loan that we incurred to maintain the diversification requirements applicable to a RIC. Of
this amount, $15.0 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 4, 2016 and we subsequently repaid this margin loan. The margin interest was
paid on February 3, 2016.
Dividends
-
We will pay out net investment income and/or realized capital gains, if any, on an annual basis as required under the 1940
Act.
Investment
Commitments -
As of June 30, 2016, 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. We cannot assure you 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.
As
of June 30, 2016, we borrowed $28.0 million 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 $28.3 million.
As
of December 31, 2015, we borrowed $15.0 million 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 $15.1 million.
Certain
Risks and Uncertainties -
Market and economic volatility which has become endemic in the past few years has resulted in a
relatively limited amount of available debt financing for small and medium-sized companies such as Equus and its portfolio companies.
Such debt financing generally 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 into the first six months of 2016, the price of our common
stock remained well below our net asset value, thereby making it undesirable to issue additional shares of our common stock below
net asset value. 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 operating requirements for the
remainder of 2016 and the first six months of 2017.
|
(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 -
We follow ASC Topic 820 for measuring fair value. Prior to our election to become a BDC, we also followed
the guidance in ASC Topic 820 in disclosing the fair value reported for all financial instruments that were either impaired or
available for sale securities, using the definitions provided in Accounting Standards Codification Topic 320, “Investments
– Debt and Equity Securities” (“ASC Topic 320”). Fair value is 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 and sets
out a fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical
assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Inputs are broadly defined under ASC
Topic 820 as assumptions market participants would use in pricing an asset or liability. The three levels of the fair value hierarchy
under ASC Topic 820 are described below:
Level
1 - Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to
access at the measurement date.
Level
2 Inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly;
and fair value is determined through the use of models or other valuation methodologies.
Level
3 - Inputs are unobservable for the asset or liability and include situations where there is little, if any, market activity for
the asset or liability. The inputs into the determination of fair value are based upon the best information under the circumstances
and may require significant management judgment or estimation.
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 portfolio 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.
In
certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases,
an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair
value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires
judgment, and considers factors specific to the investment.
Investments
for which prices are not observable are generally private investments in the debt and equity securities of operating companies.
The primary valuation method used to estimate the fair value of these Level 3 investments is the discounted cash flow method (although
a liquidation analysis, option theoretical, or other methodology may be used when more appropriate). The discounted cash flow
approach to determine fair value (or a range of fair values) involves applying an appropriate discount rate(s) to the estimated
future cash flows using various relevant factors depending on investment type, including comparing the latest arm’s length
or market transactions involving the subject security to the selected benchmark credit spread, assumed growth rate (in cash flows),
and capitalization rates/multiples (for determining terminal values of underlying portfolio companies). The valuation based on
the inputs determined to be the most reasonable and probable is used as the fair value of the investment. The determination of
fair value using these methodologies may take into consideration a range of factors including, but not limited to, the price at
which the investment was acquired, the nature of the investment, local market conditions, trading values on public exchanges for
comparable securities, current and projected operating performance, financing transactions subsequent to the acquisition of the
investment and anticipated financing transactions after the valuation date. Application of these valuation methodologies involves
a significant degree of judgment by management. Fair values of new investments are generally assumed to be equal to their cost
to the Fund for up to twelve months after their initial purchase.
To
assess the reasonableness of the discounted cash flow approach, the fair value of equity securities, including warrants, in portfolio
companies may also consider the market approach—that is, through analyzing and applying to the underlying portfolio companies,
market valuation multiples of publicly-traded firms engaged in businesses similar to those of the portfolio companies. The market
approach to determining the fair value of a portfolio company’s equity security (or securities) will typically involve:
(1) applying, to the portfolio company’s trailing twelve months (or current year projected) EBITDA, a low to high range
of enterprise value to EBITDA multiples that are derived from an analysis of publicly-traded comparable companies, in order to
arrive at a range of enterprise values for the portfolio company; (2) subtracting from the range of calculated enterprise values
the outstanding balances of any debt or equity securities that would be senior in right of payment to the equity securities we
hold; and (3) multiplying the range of equity values derived therefrom by our ownership share of such equity tranche in order
to arrive at a range of fair values for our equity security (or securities). Application of these valuation methodologies involves
a significant degree of judgment by Management.
Due
to the inherent uncertainty of determining the fair value of Level 3 investments that do not have a readily available market value,
the fair value of the investments may differ significantly from the values that would have been used had a ready market existed
for such investments and may differ materially from the values that may ultimately be received or settled. Further, such investments
are generally subject to legal and other restrictions or otherwise are less liquid than publicly traded instruments. If we were
required to liquidate a portfolio investment in a forced or liquidation sale, we might realize significantly less than the value
at which such investment had previously been recorded. With respect to Level 3 investments, where sufficient market quotations
are not readily available or for which no or an insufficient number of indicative prices from pricing services or brokers or dealers
have been received, we undertake, on a quarterly basis, a valuation process as described below:
•
|
|
For
each debt investment, a basic credit review process is completed. The risk profile on every credit facility is reviewed and
either reaffirmed or revised by our Investment Committee.
|
•
|
|
Each
portfolio company or investment is valued by an investment professional
|
•
|
|
Third
party valuation firm(s) are engaged to provide valuation services as requested, by reviewing Management’s preliminary
valuations and/or analysis of the portfolio investment in question. For investments with a fair value exceeding $2.5 million
held for more than 1 year, our Management’s preliminary fair value conclusions on each of the Fund’s assets for
which sufficient market quotations are not readily available is reviewed and assessed by a third-party valuation firm at least
once in every 12-month period, and more often as determined by the Audit Committee or required by our valuation policy. Such
valuation assessment may be in the form of positive assurance, range of values or another valuation method based on the discretion
of our Board.
|
•
|
|
The
Audit Committee reviews the preliminary valuations of our Management and independent valuation firms and, if appropriate,
recommends the approval of the valuations by the Board.
|
•
|
|
Our
Board discusses valuations and determines the fair value of each investment in the portfolio in good faith based on the input
of Management, the Audit Committee and, where appropriate, the respective independent valuation firms.
|
The
following sections describe the valuation techniques we use to measure different financial instruments at fair value and include
the levels within the fair value hierarchy in which the financial instruments are categorized.
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 will often 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.
For
most of our investments, market quotations are not available. With respect to investments for which market quotations are not
readily available or when such market quotations are deemed not to represent fair value, our Board has approved a multi-step valuation
process each quarter, as described below:
1.
|
|
Each
portfolio company or investment is reviewed by our investment professionals and, where necessary, with independent valuation
firms engaged by the Fund;
|
2.
|
|
The
independent valuation firms conduct independent valuations and make their own independent assessments;
|
3.
|
|
The
Audit Committee of our Board reviews and discusses the preliminary valuation of the Fund and that of the independent valuation
firms; and
|
4.
|
|
The
Board discusses valuations and determines the fair value of each investment in our portfolio in good faith based on the input
of our Management, the respective independent valuation firm and the Audit Committee.
|
Investments
are valued utilizing a yield analysis, enterprise value (“EV”) analysis, net asset value analysis, liquidation analysis,
discounted cash flow analysis, or a combination of methods, as appropriate. The yield analysis uses loan spreads and other relevant
information implied by market data involving identical or comparable assets or liabilities. Under the EV analysis, the EV of a
portfolio company is first determined and allocated over the portfolio company’s securities in order of their preference
relative to one another (i.e., “waterfall” allocation). To determine the EV, we typically use a market multiples approach
that considers relevant and applicable market trading data of guideline public companies, transaction metrics from precedent M&A
transactions and/or a discounted cash flow analysis. The net asset value analysis is used to derive a value of an underlying investment
(such as real estate property) by dividing a relevant earnings stream by an appropriate capitalization rate. For this purpose,
we consider capitalization rates for similar properties as may be obtained from guideline public companies and/or relevant transactions.
The liquidation analysis is intended to approximate the net recovery value of an investment based on, among other things, assumptions
regarding liquidation proceeds based on a hypothetical liquidation of a portfolio company’s assets. The discounted cash
flow analysis uses valuation techniques to convert future cash flows or earnings to a range of fair values from which a single
estimate may be derived utilizing an appropriate discount rate. The measurement is based on the net present value indicated by
current market expectations about those future amounts.
In
applying these methodologies, additional factors that we consider in fair value pricing our investments may include, as we deem
relevant: security covenants, call protection provisions, and information rights; the nature and realizable value of any collateral;
the portfolio company’s ability to make payments; the principal markets in which the portfolio company does business; publicly
available financial ratios of peer companies; the principal market; and enterprise values, among other factors.
Because
of the inherent uncertainty of the valuation of portfolio securities which do not have readily ascertainable market values, amounting
to $21.5 million and $16.2 million as of June 30, 2016 and December 31, 2015, respectively, our fair value determinations may
materially differ from the values that would have been used had a ready market existed for these securities. As of June 30, 2016,
one of our portfolio investments, 453,718 common shares of MVC, was publicly listed on the NYSE. As of December 31, 2015, one
of our portfolio investments, 428,662 common shares of MVC, was publicly listed on the NYSE.
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 report those
amounts to Lipper Analytical Services, Inc. Our net asset value appears in various publications, including
Barron’s
and
The Wall Street Journal
.
For
loan and debt securities held for longer than one year, the Fund will often perform a yield analysis assuming a hypothetical current
sale of the security. The yield analysis considers changes in interest rates and changes in leverage levels of the portfolio company
as compared to the market interest rates and leverage levels. Assuming the credit quality of the portfolio company remains stable,
the Fund will use the value determined by the yield analysis as the fair value for that security.
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.
We
assess the levels of the investments at each measurement date, and transfers between levels are recognized on the subsequent measurement
date closest in time to the actual date of the event or change in circumstances that caused the transfer. There were no transfers
among Level 1, 2 and 3 for the quarter ended June 30, 2016 and the year ended December 31, 2015.
As
of June 30, 2016, 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 June 30, 2016
|
(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
|
|
$
|
4,213
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,213
|
|
Affiliate investments
|
|
|
14,300
|
|
|
|
—
|
|
|
|
—
|
|
|
|
14,300
|
|
Non-affiliate investments - related party
|
|
|
3,648
|
|
|
|
3,648
|
|
|
|
—
|
|
|
|
—
|
|
Non-affiliate investments
|
|
|
2,978
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,978
|
|
Total investments
|
|
|
25,139
|
|
|
|
3,648
|
|
|
|
—
|
|
|
|
21,491
|
|
Temporary
cash investments
|
|
|
27,986
|
|
|
|
27,986
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
|
$
|
53,125
|
|
|
$
|
31,634
|
|
|
$
|
—
|
|
|
$
|
21,491
|
|
As
of December 31, 2015, 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, 2015
|
(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
|
|
$
|
5,715
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,715
|
|
Affiliate investments
|
|
|
9,600
|
|
|
|
—
|
|
|
|
—
|
|
|
|
9,600
|
|
Non-affiliate investments - related party
|
|
|
3,159
|
|
|
|
3,159
|
|
|
|
—
|
|
|
|
—
|
|
Non-affiliate investments
|
|
|
915
|
|
|
|
—
|
|
|
|
—
|
|
|
|
915
|
|
Total investments
|
|
|
19,389
|
|
|
|
3,159
|
|
|
|
—
|
|
|
|
16,230
|
|
Temporary cash investments
|
|
|
15,000
|
|
|
|
15,000
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
|
$
|
34,389
|
|
|
$
|
18,159
|
|
|
$
|
—
|
|
|
$
|
16,230
|
|
The
following table provides a reconciliation of fair value changes during the six months ended June 30, 2016 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, 2015
|
|
$
|
5,715
|
|
|
$
|
9,600
|
|
|
$
|
915
|
|
|
$
|
16,230
|
|
Change in unrealized appreciation (depreciation)
|
|
|
(1,502
|
)
|
|
|
4,700
|
|
|
|
—
|
|
|
|
3,198
|
|
Purchases of portfolio securities
|
|
|
—
|
|
|
|
—
|
|
|
|
2,063
|
|
|
|
2,063
|
|
Fair value as of June 30, 2016
|
|
$
|
4,213
|
|
|
$
|
14,300
|
|
|
$
|
2,978
|
|
|
$
|
21,491
|
|
The
following table provides a reconciliation of fair value changes during the six months ended June 30, 2015 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, 2014
|
|
$
|
13,173
|
|
|
$
|
960
|
|
|
$
|
1,532
|
|
|
$
|
15,665
|
|
Realized gains (losses)
|
|
|
(2,850
|
)
|
|
|
—
|
|
|
|
372
|
|
|
|
(2,478
|
)
|
Change in unrealized appreciation (depreciation)
|
|
|
1,550
|
|
|
|
4,667
|
|
|
|
(580
|
)
|
|
|
5,637
|
|
Purchases of portfolio securities
|
|
|
—
|
|
|
|
—
|
|
|
|
54
|
|
|
|
54
|
|
Proceeds from sales/dispositions
|
|
|
(3,158
|
)
|
|
|
—
|
|
|
|
(463
|
)
|
|
|
(3,621
|
)
|
Fair value as of June 30, 2015
|
|
$
|
8,715
|
|
|
$
|
5,627
|
|
|
$
|
915
|
|
|
$
|
15,257
|
|
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 the Fund 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.
As
of June 30, 2016 and December 31, 2015, we had no outstanding commitments to our portfolio company investments; however, 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. Follow-on investments may include capital infusions
which are expenditures made directly to, or on behalf of, the portfolio company to ensure that operations are completed, thereby
allowing the portfolio company to generate cash flows to service their debt.
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 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. 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 will write off uncollectible interest upon the occurrence of a definitive event such as a sale,
bankruptcy, or reorganization of the relevant portfolio interest.
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. 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.
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 and Temporary Cash Investments” used for purposes of complying with RIC requirements
from cash equivalents.
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 1 for discussion of Taxable
Subsidiaries and see Note 2 for further discussion of the Fund’s RIC borrowings.
All
corporations organized 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 $.007 million for the three and six months ended June 30, 2016, respectively,
and $0.02 million for the year ended December 31, 2015.
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 have no provision for margin tax expense for the three and six months ended June 30, 2016, respectively,
and we did not owe state income tax for the year ended December 31, 2015.
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 June 30, 2016:
|
|
|
|
|
|
|
|
Range
|
(in thousands)
|
|
Fair Value
|
|
Valuation Techniques
|
|
Unobservable Inputs
|
|
Minimum
|
|
Maximum
|
Secured and subordinated debt
|
|
$
|
2,978
|
|
|
Yield-to-maturity
|
|
Discount for lack of marketability
|
|
|
0
|
%
|
|
|
0
|
%
|
Common stock
|
|
|
14,300
|
|
|
Income/Market approach
|
|
EBITDA Multiple/Discount for lack of marketability/Control premium
|
|
|
10
|
%
|
|
|
32.5
|
%
|
Limited liability company investments
|
|
|
4,213
|
|
|
Asset approach
Discounted cash flow; Guideline transaction method
|
|
Recovery rate
Reserve adjustment factors
|
|
|
75
|
%
|
|
|
100
|
%
|
|
|
$
|
21,491
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, 2015:
|
|
|
|
|
|
|
|
Range
|
(in
thousands)
|
|
Fair
Value
|
|
Valuation
Techniques
|
|
Unobservable
Inputs
|
|
Minimum
|
|
Maximum
|
Secured
and subordinated debt
|
|
$
|
915
|
|
|
Yield-to-maturity
|
|
Discount
for lack of marketability
|
|
|
0
|
%
|
|
|
0
|
%
|
Common stock
|
|
|
9,600
|
|
|
Income/Market
approach
|
|
EBITDA
Multiple/Discount for lack of marketability/Control premium
|
|
|
10
|
%
|
|
|
32.5
|
%
|
Limited liability
company investments
|
|
|
5,715
|
|
|
Asset
approach
Discounted cash flow; Guideline transaction method
|
|
Recovery
rate
Reserve adjustment factors
|
|
|
75
|
%
|
|
|
100
|
%
|
|
|
$
|
16,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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
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 $37,500 for each of the six month periods
ended June 30, 2016 and 2015.
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 fixed amount at a rate of $250 per hour for services rendered. During the six months ended June 2016 and 2015, we
paid Kenneth I. Denos, P.C., a professional corporation owned by Kenneth I. Denos, a director of the Fund, $197,063 and $163,813,
respectively, for services provided to the Fund.
We
will pay out net investment income and/or realized capital gains, if any, on an annual basis as required under the 1940 Act.
On
January 29, 2016, we invested $2.0 million in Biogenic Reagents, LLC (“Biogenic”) in the form of a senior secured
promissory note originally maturing April 28, 2016 and subsequently extended to June 30, 2016, and bearing cash and PIK interest
at the combined rate of 16% per annum. Biogenic is a developer and producer of high value carbon products from renewable biomass,
headquartered in Minneapolis. The company has developed and commercialized a low-cost platform technology to make carbon products
such as activated carbon for use in purification of air, water, food and pharmaceuticals and agricultural carbon to improve crop
production.
On
March 2, 2016, we extended the maturity of the 5
TH
Element Tracking, LLC (“5
TH
Element”) promissory
note to July 1, 2016 and received fees in the form of a PIK and cash totaling $0.05 million. Effective June 30, 2016, we agreed
to further extend the maturity of the note to October 31, 2016 in exchange for fees in the form of a PIK and cash totaling $0.05
million.
On
April 1, 2016, we received $40,000 in cash representing payment of accrued cash interest on our $2.0 million loan to Biogenic,
made on January 29, 2016.
During
the six months ended June 30, 2016, we received dividends in the form of additional shares of $0.2 million relating to our shareholding
in MVC.
During
the six months ended June 30, 2016, we recorded an increase of $3.5 million in net unrealized appreciation, from $2.4 million
to $5.9 million, in our portfolio securities. Such increase resulted primarily from the following changes:
(i)
|
|
Increase
in the fair value of our shareholding in MVC of $0.3 million due to an increase in the MVC share price during the first half of
2016 and the receipt of dividend payments in the form of additional shares of MVC;
|
(ii)
|
|
Increase
in fair value of our shareholding in PalletOne, Inc. of $4.7 million due to continued strong revenue and earnings growth, and
an overall improvement in comparable industry sectors;
|
(iii)
|
|
Decrease
in the fair value of our holdings in Equus Energy, LLC of $1.5 million, principally due to a combination of lower production without
a corresponding increase in proved reserves and continued lower short- and long-term prices for crude oil and natural gas.
|
On
January 6, 2015, we sold our interests in Spectrum Management, LLC (“Spectrum”) to 5
th
Element. The purchase price of $3.9 million paid by 5
th
Element consisted of $3.0 million in cash and a 1-year subordinated note in the original principal amount of $0.9 million, bearing
interest at the rate of 14% per annum. We realized a net capital loss of $2.8 million in connection with the sale of our interest
in Spectrum.
Also
on January 6, 2015, in connection with the sale of our interest in Spectrum, our $0.5 million loan to Security Monitor Holdings,
LLC, together with all accrued interest amounting to approximately $0.1 million, was repaid.
On
January 30, 2015, we received a partial redemption payment in respect of our holding of Notes of Orco Property Group S.A. (“OPG
Notes”) in the amount of €36,587 [$41,478].
On
February 20, 2015, we sold our OPG Notes at a discount of 23% to their par value, receiving $1.0 million in cash and a realized
gain of $0.4 million.
During
the six months ended June 30, 2015, we received dividends in the form of additional shares of $0.1 million relating to our shareholding
in MVC.
During
the six months ended June 30, 2015, we recorded an increase of $5.9 million in net unrealized appreciation, from net unrealized
depreciation of $3.6 million to net unrealized appreciation of $2.4 million, in our portfolio securities. Such increase resulted
primarily from the following changes:
(i)
|
|
Decrease
in the fair value of our holdings in Equus Energy, LLC of $1.3 million, principally due to a combination of decreased production
and declining oil and prices;
|
(ii)
|
|
Increase
in the fair value of our shareholding in MVC of $0.2 million due to an increase in the MVC share price during the period, along
with dividends received in the form of additional MVC shares;
|
(iii)
|
|
Increase
in fair value of our shareholding in PalletOne, Inc. of $4.6 million due to strong revenue and earnings group, as well as an overall
improvement in the industry sector for packaging companies;
|
(iv)
|
|
Transfer
of unrealized depreciation to realized gain on our holding of OPG Notes of $0.4 million in connection with the sale of our interest
in the OPG Notes; and
|
(v)
|
|
Transfer
of unrealized depreciation to realized loss on our holdings in Spectrum of $2.9 million in connection with the sale of our interest
in Spectrum.
|
|
(7)
|
Plan
of Reorganization - Share Exchange with MVC Capital
|
On
May 14, 2014, we announced that the Fund intended to effect a reorganization pursuant to Section 2(a)(33) of the 1940 Act. As
a first step to consummating the reorganization, we sold to MVC Capital, Inc. (“MVC”) 2,112,000 newly-issued shares
of the Fund’s common stock in exchange for 395,839 shares of MVC (such transaction is hereinafter referred to as the “Share
Exchange”). MVC is a business development company traded on the New York Stock Exchange that provides long-term debt and
equity investment capital to fund growth, acquisitions and recapitalizations of companies in a variety of industries. The Share
Exchange was calculated based on the Fund’s and MVC’s respective net asset value per share. At the time of the Share
Exchange, the number of MVC shares received by Equus represented approximately 1.73% of MVC’s total outstanding shares of
common stock.
Pursuant
to the terms of a Share Exchange Agreement, dated May 12, 2014, entered into by Equus and MVC which memorialized the Share Exchange,
we intend to finalize the reorganization by pursuing a merger or consolidation with MVC, a subsidiary of MVC, or one or more of
MVC’s portfolio companies (the “Consolidation”). Absent Equus merging or consolidating with/into MVC or a subsidiary
thereof, our current intention is for Equus to (i) consummate the Consolidation with a portfolio company of MVC, (ii) terminate
its election to be classified as a BDC under the 1940 Act, and (iii) be restructured as a publicly-traded operating company focused
on the energy and/or financial services sector. Our management is currently evaluating these alternatives.
Equus
Energy was formed in November 2011 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. On December 27, 2012, we invested an additional $6.8 million in Equus Energy for the purpose of additional working
capital and to fund the purchase of $6.6 million in working interests, which presently comprise 112 producing and non-producing
oil and gas wells. The working interests include associated development rights of approximately 21,220 acres situated on 13 separate
properties in Texas and Oklahoma. The working interests range from a
de minimus
amount to 50% of the leasehold that includes
these wells.
The
wells are operated by a number of experienced operators, including Chevron USA, Inc., which has operating responsibility for all
of Equus Energy’s 22 producing well interests located in the Conger Field, a productive oil and gas field on the edge of
the Permian Basin that has experienced successful gas and hydrocarbon extraction in multiple formations. Equus Energy, which holds
a 50% working interest in each of these Conger Field wells, has worked previously with Chevron on a recompletion program of existing
Conger Field wells to the Wolfcamp formation, a zone containing oil as well as gas and natural gas liquids. Part of Equus Energy’s
acreage rights described above also includes a 50% working interest in possible new drilling to the base of the Canyon formation
(approximately 8,500 feet) on 2,400 acres in the Conger Field. Also included in the interests acquired by Equus Energy are working
interests of 7.5% and 2.5% in the Burnell and North Pettus Units, respectively, which collectively comprise approximately 13,000
acres located in the area known as the “Eagle Ford Shale” play.
Revenue
and Income
. During the three months ended June 30, 2016, Equus Energy’s revenue, operating revenue less direct operating
expenses, and net loss were $0.1 million, $0.01 million, and ($0.1) million, respectively, as compared to revenue, operating revenue
less direct operating expenses, and net income of $0.3 million, $0.05 million, and ($0.2) million, respectively, for the three
months ended June 30, 2015. During the six months ended June 30, 2016, Equus Energy’s revenue, operating revenue less direct
operating expenses, and net loss were $0.2 million, ($0.2) million, and ($0.6) million, respectively, as compared to revenue,
operating revenue less direct operating expenses, and net loss of $0.6 million, $0.07 million, and ($0.5), respectively, for the
six months ended June 30, 2015.
Capital
Expenditures
. During the six months ended June 30, 2016, Equus Energy invested $0.005 million in capital expenditures for
small repairs and improvements. The operators of the various working interest have communicated their intent to wait until later
in 2016 or 2017, commensurate with an anticipated gradual rise in the price of crude oil, to commence new drilling and recompletion
projects.
We
do not consolidate Equus Energy or its wholly-owned subsidiaries and accordingly only the value of our investment in Equus Energy
is included on our statement of assets and liabilities. Our investment in Equus Energy is valued in accordance with our normal
valuation procedures and is based in part on using a discounted cash flow analysis based on a reserve report prepared for Equus
Energy by Lee Keeling & Associates, Inc., an independent petroleum engineering firm, the transactions and values of comparable
companies in this sector, and the estimated value of leasehold mineral interests associated with the acreage held by Equus Energy.
A valuation of Equus Energy was performed by a third-party valuation firm, who recommended a value range of Equus Energy consistent
with the fair value determined by our Management (See
Schedule of Investments
)
.
Below
is summarized consolidated financial information for Equus Energy as of June 30, 2016 and December 31, 2015 and for the three
and six months ended June 30, 2016 and 2015, respectively, (in thousands):
EQUUS
ENERGY, LLC
Condensed
Consolidated Balance Sheets
|
|
June 30,
|
|
December 31,
|
|
|
2016
|
|
2015
|
Assets
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
83
|
|
|
$
|
517
|
|
Accounts receivable
|
|
|
33
|
|
|
|
122
|
|
Other current assets
|
|
|
32
|
|
|
|
32
|
|
Total current assets
|
|
|
148
|
|
|
|
671
|
|
Oil and gas properties
|
|
|
8,275
|
|
|
|
8,269
|
|
Less: accumulated depletion, depreciation and amortization
|
|
|
(6,650
|
)
|
|
|
(6,516
|
)
|
Net oil and gas properties
|
|
|
1,625
|
|
|
|
1,753
|
|
Total assets
|
|
$
|
1,773
|
|
|
$
|
2,424
|
|
Liabilities and member's capital
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and other
|
|
$
|
123
|
|
|
$
|
206
|
|
Due to affiliate
|
|
|
611
|
|
|
|
611
|
|
Total current liabilities
|
|
|
734
|
|
|
|
817
|
|
Asset retirement obligations
|
|
|
181
|
|
|
|
178
|
|
Total liabilities
|
|
|
915
|
|
|
|
995
|
|
Total member's equity
|
|
|
858
|
|
|
|
1,429
|
|
Total liabilities and member's equity
|
|
$
|
1,773
|
|
|
$
|
2,424
|
|
Revenue
and direct operating expenses for the various oil and gas assets included in the accompanying statements represent the net collective
working and revenue interests acquired by Equus Energy. The revenue and direct operating expenses presented herein relate only
to the interests in the producing oil and natural gas properties and do not represent all of the oil and natural gas operations
of all of these properties. Direct operating expenses include lease operating expenses and production and other related taxes.
General and administrative expenses, depletion, depreciation and amortization (“DD&A”) of oil and gas properties
and federal and state taxes have been excluded from direct operating expenses in the accompanying statements of revenues and direct
operating expenses because the allocation of certain expenses would be arbitrary and would not be indicative of what such costs
would have been had Equus Energy been operated as a stand-alone entity.
The statements of revenue and direct operating
expenses presented are not indicative of the financial condition or results of operations of Equus Energy on a go forward basis
due to changes in the business and the omission of various operating expenses.
EQUUS
ENERGY, LLC
Condensed
Consolidated Statements of Operations
|
|
Three Months ended June
30,
|
|
Six Months ended June 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Operating revenue
|
|
$
|
105
|
|
|
$
|
309
|
|
|
$
|
163
|
|
|
$
|
592
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct operating expenses
|
|
|
94
|
|
|
|
263
|
|
|
|
356
|
|
|
|
522
|
|
Depletion, depreciation, amortization and accretion
|
|
|
73
|
|
|
|
162
|
|
|
|
136
|
|
|
|
348
|
|
General and administrative
|
|
|
73
|
|
|
|
75
|
|
|
|
242
|
|
|
|
204
|
|
Total operating expenses
|
|
|
240
|
|
|
|
500
|
|
|
|
734
|
|
|
|
1,074
|
|
Operating income (loss) before income tax expense
|
|
|
(135
|
)
|
|
|
(191
|
)
|
|
|
(571
|
)
|
|
|
(482
|
)
|
Net loss (income)
|
|
$
|
(135
|
)
|
|
$
|
(191
|
)
|
|
$
|
(571
|
)
|
|
$
|
(482
|
)
|
EQUUS
ENERGY, LLC
Condensed
Consolidated Statements of Cash Flows
|
|
Six Months ended June 30,
|
|
|
2016
|
|
2015
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(571
|
)
|
|
$
|
(482
|
)
|
Adjustments to reconcile net loss to
|
|
|
|
|
|
|
|
|
net cash (used in) provided by operating activities:
|
|
|
|
|
|
|
|
|
Depletion, depreciation, amortization and accretion
|
|
|
136
|
|
|
|
348
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaids and deposits
|
|
|
—
|
|
|
|
22
|
|
Accounts receivable and other current assets
|
|
|
89
|
|
|
|
154
|
|
Accounts payable and other
|
|
|
(83
|
)
|
|
|
5
|
|
Net cash (used in) provided by operating activities
|
|
|
(429
|
)
|
|
|
47
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Investment in oil & gas properties
|
|
|
(5
|
)
|
|
|
(46
|
)
|
Net cash used in investing activities
|
|
|
(5
|
)
|
|
|
(46
|
)
|
Net (decrease) increase in cash
|
|
|
(434
|
)
|
|
|
1
|
|
Cash and cash equivalents at beginning of period
|
|
|
517
|
|
|
|
613
|
|
Cash and cash equivalents at end of period
|
|
$
|
83
|
|
|
$
|
614
|
|
Critical
Accounting Policies for Equus Energy
– Equus Energy and its wholly-owned subsidiary EQS Energy Holdings, Inc. (collectively,
“the Company”) follow the
Full Cost Method of Accounting
for oil and gas properties. Under the full cost method,
all costs associated with property acquisition, exploration, and development activities are capitalized. Capitalized costs include
lease acquisitions, geological and geophysical work, delay rentals, costs of drilling, completing and equipping successful and
unsuccessful oil and gas wells and related costs. Gains or losses are normally not recognized on the sale or other disposition
of oil and gas properties. Gains or losses are normally reflected as an adjustment to the full cost pool.
The
capitalized costs of oil and gas properties, plus estimated future development costs relating to proved reserves and estimated
cost of dismantlement and abandonment, net of salvage value, are amortized on a unit-of-production method over the estimated productive
life of the proved oil and gas reserves. Unevaluated oil and gas properties are excluded from this calculation. Depletion,
depreciation, amortization and accretion expense for the Company’s oil and gas properties totaled $0.07 million and $0.2
million for the three months ended June 30, 2016 and June 30, 2015, respectively, and $0.1 million for the six months ended June
30, 2016 compared to $0.4 million for the six months ended June 30, 2015.
Capitalized
oil and gas property costs are limited to an amount (the ceiling limitation) equal to the sum of the following:
(a)
|
|
As of June
30, 2016, the present value of estimated future net revenue from the projected production of proved oil and gas reserves, calculated
at the simple arithmetic average, first-day-of-the-month prices during the twelve-month period before the balance sheet date (with
consideration of price changes only to the extent provided by contractual arrangements) and a discount factor of 10%;
|
(b)
|
|
The cost
of investments in unproved and unevaluated properties excluded from the costs being amortized; and
|
(c)
|
|
The lower
of cost or estimated fair value of unproved properties included in the costs being amortized.
|
When
it is determined that oil and gas property costs exceed the ceiling limitation, an impairment charge is recorded to reduce its
carrying value to the ceiling limitation. The Company did not recognize an impairment loss on its oil and gas properties
during the six months ended June 30, 2016. However, during 2015, the Company recognized an impairment loss of $4.0 million.
The
costs of certain unevaluated leasehold acreage and certain wells being drilled are not amortized. The Company excludes all costs
until proved reserves are found or until it is determined that the costs are impaired. Costs not amortized are periodically assessed
for possible impairment or reduction in value. If a reduction in value has occurred, costs being amortized are increased accordingly.
Revenue
Recognition
-
Revenue recognized for oil and natural gas sales under the sales method of accounting. Under this method,
revenue recognized on production as it is taken and delivered to its purchasers. The volumes sold may be more or less than the
volumes entitled to, based on the owner’s net leasehold interest. These differences result from production imbalances, which
are not significant, and are reflected as adjustments to proven reserves and future cash flows in the unaudited consolidated financial
information included herein.
Accounting
Policy on DD&A
- The Company employs the “Units of Production” method in calculating depletion of its
proved oil and gas properties, wherein capitalized costs, as adjusted for future development costs and asset retirement obligations,
are amortized over the total estimated proved reserves.
Income
Taxes
- A limited liability company is not subject to the payment of federal income taxes as items of income and expenses
flow through directly to its members. However, the Company may be liable for certain state income taxes. Texas margin tax applies
to legal entities conducting business in Texas, and is assessed on the company’s Texas sourced taxable margin. The tax is
calculated by applying the appropriate tax rate to a base that considers both revenue and expenses and therefore has the characteristics
of an income tax. Taxable Subsidiaries may also generate income tax expense because of the Taxable Subsidiaries’ ownership
of the portfolio companies; as such we reflect any such income tax expense on our Statements of Operations. As of June 30,
2016 and June 30, 2015, the Company recorded $0 in federal income taxes.
Asset
Retirement Obligations
- The fair value of asset retirement obligations are recorded in the period in which they are incurred
if a reasonable estimate of fair value can be made, and the corresponding cost is capitalized as part of the carrying amount of
the related long-lived asset. The fair value of the asset retirement obligation is measured using expected future cash outflows
discounted at the Company’s credit-adjusted risk-free interest rate. Fair value, to the extent possible, should include
a market risk premium for unforeseeable circumstances. No market risk premium was included in the Company’s asset
retirement obligation fair value estimate since a reasonable estimate could not be made. The liability is accreted to its
then present value each period, and the capitalized cost is depleted or amortized over the estimated recoverable reserves using
the units-of-production method.
|
(9)
|
Recent
Accounting Pronouncements
|
In
January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities.
Among other things, this ASU requires that public business entities use the exit price notion when measuring the fair value of
financial instruments for disclosure purposes. ASU No. 2016-01 is effective for public entities for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2017. Our adoption of ASU No. 2016-01 is not anticipated
to have a material effect on our financial statements.
Management
performed an evaluation of the Fund’s activity through the date the financial statements were issued, noting the following
subsequent events:
On
July 1, 2016, we sold U.S. Treasury Bills for $27.9 million and repaid our margin loan.