The accompanying notes are an integral
part of these financial statements.
Except for our holding of shares of
MVC Capital, Inc. (“MVC”), all of our portfolio securities are restricted from public sale without prior registration
under the Securities Act of 1933 (hereafter, the “Securities Act”). 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.
We may invest up to 30% of our assets
in non-qualifying portfolio investments, as permitted by the Investment Company Act of 1940 (hereafter, the “1940 Act”).
Specifically, we may invest up to 30% of our assets in entities that are not considered “eligible portfolio companies”
(as defined in the 1940 Act), including companies located outside of the United States, entities that are operating pursuant to
certain exceptions under the 1940 Act, and publicly-traded entities with a market capitalization exceeding $250 million. As of
September 30, 2016, except for our holding of shares of MVC, all of our investments are in enterprises that are considered eligible
portfolio companies under the 1940 Act. We provide significant managerial assistance to portfolio companies that comprise 27.0%
of the total value of the investments in our portfolio securities as of September 30, 2016.
Our investments in portfolio securities
consist of the following types of securities as of September 30, 2016 (in thousands):
The following is a summary by industry
of the Fund’s investments in portfolio securities as of September 30, 2016 (in thousands):
The accompanying notes are an integral
part of these financial statements.
The accompanying notes are an integral
part of these financial statements.
Except for our holding of shares of
MVC, all of our portfolio securities are restricted from public sale without prior registration under the Securities Act. 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.
We may invest up to 30% of our assets
in non-qualifying portfolio investments, as permitted by the 1940 Act. Specifically, we may invest up to 30% of our assets in entities
that are not considered “eligible portfolio companies” (as defined in the 1940 Act), including companies located outside
of the United States, entities that are operating pursuant to certain exceptions under the 1940 Act, and publicly-traded entities
with a market capitalization exceeding $250 million. As of December 31, 2015, except for our shares of MVC, all of our investments
are in enterprises that are considered eligible portfolio companies under the 1940 Act. We provide significant managerial assistance
to portfolio companies that comprise 29.5% of the total value of the investments in our portfolio securities as of December 31,
2015.
Our investments in portfolio securities
consist of the following types of securities as of December 31, 2015 (in thousands):
The following is a summary by industry
of the Fund’s investments in portfolio securities as of December 31, 2015 (in thousands):
The accompanying notes are an integral
part of these financial statements.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 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 team (hereinafter, “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 nine
months ended September 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”).
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
|
(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 September 30, 2017. 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 September 30, 2016, we had cash and cash equivalents of $12.6 million. We had $27.7 million of our net assets of $41.5 million
invested in portfolio securities. We also had $30.3 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, $30.0 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 October 3, 2016 and we subsequently repaid
this margin loan, plus interest.
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, plus interest.
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
September 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 September 30, 2016, we borrowed
$30.0 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 $30.3 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.
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 nine 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
nine 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.
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 our 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.
|
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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.
|
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 $23.8 million and
$16.2 million as of September 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 September 30, 2016, one of our
portfolio investments, 461,292 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 September 30, 2016 and the year ended December 31, 2015.
As of September 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:
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
|
|
Fair Value Measurements as of September 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
|
|
$
|
5,463
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,463
|
|
Affiliate investments
|
|
|
15,400
|
|
|
|
—
|
|
|
|
—
|
|
|
|
15,400
|
|
Non-affiliate investments - related party
|
|
|
3,824
|
|
|
|
3,824
|
|
|
|
—
|
|
|
|
—
|
|
Non-affiliate investments
|
|
|
2,978
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,978
|
|
Total investments
|
|
|
27,665
|
|
|
|
3,824
|
|
|
|
—
|
|
|
|
23,841
|
|
Temporary cash investments
|
|
|
29,998
|
|
|
|
29,998
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
|
$
|
57,663
|
|
|
$
|
33,822
|
|
|
$
|
—
|
|
|
$
|
23,841
|
|
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 nine months ended September 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)
|
|
|
(252
|
)
|
|
|
5,800
|
|
|
|
—
|
|
|
|
5,548
|
|
Purchases of portfolio securities
|
|
|
—
|
|
|
|
—
|
|
|
|
2,063
|
|
|
|
2,063
|
|
Fair value as of September 30, 2016
|
|
$
|
5,463
|
|
|
$
|
15,400
|
|
|
$
|
2,978
|
|
|
$
|
23,841
|
|
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
The following table provides a reconciliation
of fair value changes during the nine months ended September 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)
|
|
|
550
|
|
|
|
6,540
|
|
|
|
(435
|
)
|
|
|
6,655
|
|
Proceeds from sales/dispositions
|
|
|
(3,158
|
)
|
|
|
—
|
|
|
|
(554
|
)
|
|
|
(3,712
|
)
|
Fair value as of September 30, 2015
|
|
$
|
7,715
|
|
|
$
|
7,500
|
|
|
$
|
915
|
|
|
$
|
16,130
|
|
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 September 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.
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 $0.01 million and $0.01 million for the three and nine months ended September 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 nine months ended September 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 September 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
|
|
|
15,400
|
|
|
Income/Market approach
|
|
EBITDA
Multiple/Discount for
lack of
marketability/Control
premium
|
|
|
10
|
%
|
|
|
32.5
|
%
|
Limited liability company investments
|
|
|
5,463
|
|
|
Asset Approach Discounted cash
flow; Guideline
transaction method
|
|
Recovery rate
Reserve adjustment
factors
|
|
|
75
|
%
|
|
|
100
|
%
|
|
|
$
|
23,841
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 $56,250 for each of the nine month periods ended September 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 nine months ended September 30, 2016 and 2015, we paid Kenneth I. Denos, P.C.,
a professional corporation owned by Kenneth I. Denos, a director of the Fund, $289,313 and $215,438, 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. Effective October 31, 2016,
in an effort to facilitate refinancing efforts of 5
TH
Element with its senior lender, we further extended the maturity
of the note to March 31, 2017.
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 nine months ended September
30, 2016, we received dividends in the form of additional shares of $0.2 million relating to our shareholding in MVC.
During the nine months ended September
30, 2016, we recorded an increase of $5.9 million in net unrealized appreciation, from $2.4 million to $8.3 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 $0.4 million due to an increase in the MVC share price during the nine months ended September 30, 2016 and the receipt of dividend payments in the form of additional shares of MVC;
|
(ii)
|
|
Increase in the fair value of our shareholding in PalletOne, Inc. of $5.8 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 $0.3 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 nine months ended September
30, 2015, we received dividends in the form of additional shares of $0.2 million relating to our shareholding in MVC.
During the nine months ended September
30, 2015, we recorded a net change in unrealized appreciation of $6.0 million, to a net unrealized appreciation of $2.4 million.
Such change in unrealized appreciation resulted primarily from the following changes:
(i)
|
|
Decrease in the fair value of our holdings in Equus Energy, LLC of $2.3 million, principally due to a combination of production without a corresponding increase in proved reserves and declining short- and long-term prices for crude oil and natural gas;
|
(ii)
|
|
Decrease in the fair value of our shareholding in MVC of $0.7 million due to a decrease in the MVC share price during the period, which was partially offset by $0.2 million in dividends received in the form of additional MVC shares;
|
(iii)
|
|
Increase in fair value of our shareholding in PalletOne, Inc. of $6.5 million due to an overall improvement in comparable industry sectors, as well as continued revenue and earnings growth;
|
(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
|
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
(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 111 producing and non-producing oil and gas wells. The
working interests include associated development rights of approximately 21,200 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. On October 21, 2016, in exchange for a non-refundable fee of $62,500, Equus Energy granted a 120-day
option to a third-party to acquire all of its mineral interests in approximately 20 acres located in Glasscock County, Texas
for an exercise purchase price $250,000. If exercised, the option fee will be credited toward the purchase price.
Revenue and Income
. During the
three months ended September 30, 2016, Equus Energy’s revenue, operating revenue less direct operating expenses, and net
loss were $0.2 million, $0.1 million, and ($0.07) million, respectively, as compared to revenue, operating revenue less direct
operating expenses, and net income of $0.2 million, ($0.05) million, and ($0.2) million, respectively, for the three months ended
September 30, 2015. During the nine months ended September 30, 2016, Equus Energy’s revenue, operating revenue less direct
operating expenses, and net loss were $0.4 million, ($0.07) million, and ($0.6) million, respectively, as compared to revenue,
operating revenue less direct operating expenses, and net loss of $0.8 million, $0.02 million, and ($0.7), respectively, for the
nine months ended September 30, 2015.
Capital Expenditures
. During
the nine months ended September 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 2017, commensurate with an anticipated
gradual rise in the price of crude oil, to commence new drilling and recompletion projects.
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 September 30, 2016 and December 31, 2015 and for the three and nine months ended September 30,
2016 and 2015, respectively, (in thousands):
EQUUS ENERGY, LLC
Condensed Consolidated Balance Sheets
|
|
September 30,
|
|
December 31,
|
|
|
2016
|
|
2015
|
Assets
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
98
|
|
|
$
|
517
|
|
Accounts receivable
|
|
|
49
|
|
|
|
122
|
|
Other current assets
|
|
|
32
|
|
|
|
32
|
|
Total current assets
|
|
|
179
|
|
|
|
671
|
|
Oil and gas properties
|
|
|
8,275
|
|
|
|
8,269
|
|
Less: accumulated depletion, depreciation and amortization
|
|
|
(6,758
|
)
|
|
|
(6,516
|
)
|
Net oil and gas properties
|
|
|
1,517
|
|
|
|
1,753
|
|
Total assets
|
|
$
|
1,696
|
|
|
$
|
2,424
|
|
Liabilities and member's equity
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and other
|
|
$
|
110
|
|
|
$
|
206
|
|
Due to affiliate
|
|
|
611
|
|
|
|
611
|
|
Total current liabilities
|
|
|
721
|
|
|
|
817
|
|
Asset retirement obligations
|
|
|
183
|
|
|
|
178
|
|
Total liabilities
|
|
|
904
|
|
|
|
995
|
|
Total member's equity
|
|
|
792
|
|
|
|
1,429
|
|
Total liabilities and member's equity
|
|
$
|
1,696
|
|
|
$
|
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 TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
EQUUS ENERGY, LLC
Condensed Consolidated Statements
of Operations
|
|
Three Months ended
September 30,
|
|
Nine Months ended
September 30,
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Operating revenue
|
|
$
|
248
|
|
|
$
|
196
|
|
|
$
|
411
|
|
|
$
|
788
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct operating expenses
|
|
|
127
|
|
|
|
242
|
|
|
|
483
|
|
|
|
764
|
|
Depletion, depreciation, amortization and accretion
|
|
|
110
|
|
|
|
114
|
|
|
|
246
|
|
|
|
462
|
|
General and administrative
|
|
|
77
|
|
|
|
78
|
|
|
|
319
|
|
|
|
282
|
|
Total operating expenses
|
|
|
314
|
|
|
|
434
|
|
|
|
1,048
|
|
|
|
1,508
|
|
Operating loss before income tax expense
|
|
|
(66
|
)
|
|
|
(238
|
)
|
|
|
(637
|
)
|
|
|
(720
|
)
|
Net loss
|
|
$
|
(66
|
)
|
|
$
|
(238
|
)
|
|
$
|
(637
|
)
|
|
$
|
(720
|
)
|
EQUUS ENERGY, LLC
Condensed Consolidated Statements
of Cash Flows
|
|
Nine Months ended September 30,
|
|
|
2016
|
|
2015
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(637
|
)
|
|
$
|
(720
|
)
|
Adjustments to reconcile net loss to
|
|
|
|
|
|
|
|
|
net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depletion, depreciation, amortization and accretion
|
|
|
246
|
|
|
|
462
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Prepaids and deposits
|
|
|
—
|
|
|
|
22
|
|
Accounts receivable and other current assets
|
|
|
73
|
|
|
|
187
|
|
Accounts payable and other
|
|
|
(96
|
)
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
Net cash used in provided by operating activities
|
|
|
(414
|
)
|
|
|
(48
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Investment in oil & gas properties
|
|
|
(5
|
)
|
|
|
(45
|
)
|
Net cash used in investing activities
|
|
|
(5
|
)
|
|
|
(45
|
)
|
Net decrease in cash
|
|
|
(419
|
)
|
|
|
(93
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
517
|
|
|
|
613
|
|
Cash and cash equivalents at end of period
|
|
$
|
98
|
|
|
$
|
520
|
|
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 $0.1 million for the three months ended September 30,
2016 and September 30, 2015, respectively, and $0.2 million for the nine months ended September 30, 2016 compared to $0.5 million
for the nine months ended September 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 September 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 nine months ended September 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 September 30, 2016 and September 30, 2015, the
Company recorded $0 in federal income taxes.
EQUUS TOTAL RETURN, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 2016
(Unaudited)
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 event:
On October 3, 2016, we sold U.S. Treasury
Bills for $30.0 million and repaid our margin loan.