The accompanying notes are an
integral part of these financial statements.
Except for our holding of shares of
MVC, substantially all of our portfolio securities are restricted from public sale without prior registration under the Securities
Act or other relevant regulatory authority. 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, we had invested 73.0% of our assets in securities
of portfolio companies that constituted qualifying investments under the 1940 Act. 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 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
DECEMBER 31, 2016, 2015 AND 2014
(1) ORGANIZATION AND BUSINESS PURPOSE
Equus Total Return, Inc. (“we,”
“us,” “our,” “Equus” the “Company” and the “Fund”), a Delaware corporation,
was formed by Equus Investments II, L.P. (the “Partnership”) on August 16, 1991. On July 1, 1992, the Partnership was
reorganized and all of the assets and liabilities of the Partnership were transferred to the Fund in exchange for shares of common
stock of the Fund. Our shares trade on the NYSE 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 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 subordinated debt, debt convertible into common
or preferred stock, or debt combined with warrants and common and preferred stock. Debt and preferred equity financing may also
be used to create long-term capital appreciation through the exercise and sale of warrants received in connection with the financing.
We seek to achieve capital appreciation by making investments in equity and equity-oriented securities issued by privately-owned
companies in transactions negotiated directly with such companies. Given market conditions over the past several years and the
performance of our portfolio, our Management and Board of Directors believe it prudent to continue to review alternatives to refine
and further clarify the current strategies.
We elected to be treated as a BDC under
the 1940 Act, although our shareholders have recently authorized us to withdraw this election (see Note 10 “
Subsequent
Events”
). We currently qualify as a regulated investment company RIC for federal income tax purposes and, therefore,
are not required to pay corporate income taxes on any income or gains that we distribute to our stockholders. We have certain wholly
owned taxable subsidiaries (“Taxable Subsidiaries”) each of which holds one or more portfolio investments listed on
our Schedules of Investments. The purpose of these Taxable Subsidiaries is to permit us to hold certain income-producing investments
or portfolio companies organized as limited liability companies, or LLCs, (or other forms of pass-through entities) and still satisfy
the RIC tax requirement that at least 90% of our gross revenue for income tax purposes must consist of investment income. Absent
the Taxable Subsidiaries, a portion of the gross income of these income-producing investments or of any LLC (or other pass-through
entity) portfolio investment, as the case may be, would flow through directly to us for the 90% test. To the extent that such income
did not consist of investment income, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant
federal income taxes. The income of the LLCs (or other pass-through entities) owned by Taxable Subsidiaries is taxed to the Taxable
Subsidiaries and does not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages. We do not
consolidate the Taxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries’
ownership of the portfolio companies. We reflect any such income tax expense on our Statements of Operations.
(2) LIQUIDITY AND FINANCING ARRANGEMENTS
As of December 31, 2016, we had cash
and cash equivalents of $12.0 million. We had $30.0 million of our net assets of $42.7 million invested in portfolio securities.
We also had $30.3 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, $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 January 3, 2017 and we subsequently repaid this margin loan. The margin interest was paid on February 3, 2017.
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.
During 2016 and 2015, we borrowed sufficient
funds to maintain the Fund’s RIC status by utilizing a margin account with a securities brokerage firm. There is no assurance
that such arrangement will be available in the future. If we are unable to borrow funds to make qualifying investments, we may
no longer qualify as a RIC. We would then be subject to corporate income tax on the Fund’s net investment income and realized
capital gains, and distributions to stockholders would be subject to income tax as ordinary dividends. If we continue to be a BDC,
failure to continue to qualify as a RIC could be material to us and our stockholders.
(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—
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;
|
|
2.
|
With respect to investments with a fair value exceeding $2.5 million that have been held for
more than one year, we engage independent valuation firms to assist our investment professionals. These independent valuation firms
conduct independent valuations and make their own independent assessments;
|
|
3.
|
Our Management produces a report that summarized each of our portfolio investments and recommends
a fair value of each such investment as of the date of the report;
|
|
4.
|
The Audit Committee of our Board reviews and discusses the preliminary valuation of our portfolio
investments as recommended by Management in their report and any reports or recommendations of the independent valuation firms, and
then approves and recommends the fair values of our investments so determined to our Board for final approval; and
|
|
5.
|
The Board discusses valuations and determines the fair value of each portfolio investment in
good faith based on the input of our Management, the respective independent valuation firm, as applicable, and the Audit Committee.
|
During the first twelve months after
an investment is made, we rely on the original investment amount to determine the fair value unless significant developments have
occurred during this twelve month period which would indicate a material effect on the portfolio company (such as results of operations
or changes in general market conditions).
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. Also, any failure by a portfolio company to achieve
its business plan or obtain and maintain its financing arrangements could result in increased volatility and result in a significant
and rapid change in its value.
Our general intent is to hold our loans
to maturity when appraising our privately held debt investments. As such, we believe that the fair value will not exceed the cost
of the investment. However, in addition to the previously described analysis involving allocation of value to the debt instrument,
we perform a yield analysis assuming a hypothetical current sale of the security to determine if a debt security has been impaired. 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 if less than the cost of the investment.
We 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.
Fair Value Measurement—
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 as assumptions market participants would use in pricing an asset or liability. The three levels
of the fair value hierarchy 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.
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.
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, our valuation process as described above.
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 years ended December 31, 2016, 2015 and 2014.
As of December 31, 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 December 31, 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
|
|
$
|
6,462
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6,462
|
|
Affiliate investments
|
|
|
16,200
|
|
|
|
—
|
|
|
|
—
|
|
|
|
16,2
00
|
|
Non-affiliate investments - related party
|
|
|
4,021
|
|
|
|
4,021
|
|
|
|
—
|
|
|
|
—
|
|
Non-affiliate investments
|
|
|
2,978
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,978
|
|
Total investments
|
|
|
29,661
|
|
|
|
4,021
|
|
|
|
—
|
|
|
|
25,640
|
|
Temporary cash investments
|
|
|
29,994
|
|
|
|
29,994
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
|
$
|
59,655
|
|
|
$
|
34,015
|
|
|
$
|
—
|
|
|
$
|
25,640
|
|
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 2016 for all investments for which we determine fair value using significant unobservable (Level 3)
inputs:
|
|
Fair value measurements using significant unobservable inputs (Level 3)
|
(in thousands)
|
|
Control Investments
|
|
Affiliate Investments
|
|
Non-affiliate Investments
|
|
Total
|
Fair value as of December 31, 2015
|
|
$
|
5,715
|
|
|
$
|
9,600
|
|
|
$
|
915
|
|
|
$16,230
|
Change in unrealized appreciation (depreciation)
|
|
|
747
|
|
|
|
6,600
|
|
|
|
—
|
|
|
7,347
|
Purchases of portfolio securities
|
|
|
—
|
|
|
|
—
|
|
|
|
2,063
|
|
|
2,063
|
Fair value as of December 31, 2016
|
|
$
|
6,462
|
|
|
$
|
16,200
|
|
|
$
|
2,978
|
|
|
$25,640
|
The following table provides a reconciliation
of fair value changes during 2015 for all investments for which we determine fair value using significant unobservable (Level 3)
inputs:
|
|
Fair value measurements using significant unobservable inputs (Level 3)
|
(in thousands)
|
|
Control Investments
|
|
Affiliate Investments
|
|
Non-affiliate Investments
|
|
Total
|
Fair value as of December 31, 2014
|
|
$
|
13,173
|
|
|
$
|
960
|
|
|
$
|
1,532
|
|
|
$
|
15,665
|
|
Realized losses
|
|
|
(2,850
|
)
|
|
|
—
|
|
|
|
372
|
|
|
|
(2,478
|
)
|
Change in unrealized appreciation (depreciation)
|
|
|
(1,450
|
)
|
|
|
8,640
|
|
|
|
(435
|
)
|
|
|
6,755
|
|
Purchases of portfolio securities
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Proceeds from sales/dispositions
|
|
|
(3,158
|
)
|
|
|
—
|
|
|
|
(554
|
)
|
|
|
(3,712
|
)
|
Fair value as of December 31, 2015
|
|
$
|
5,715
|
|
|
$
|
9,600
|
|
|
$
|
915
|
|
|
$
|
16,230
|
|
Our investment portfolio is not composed
of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment
portfolio is composed of complex debt and equity securities with distinct contract terms and conditions. As such, our valuation
of each investment in our portfolio is unique and complex, often factoring in numerous different inputs, including historical and
forecasted financial and operational performance of the portfolio company, project cash flows, market multiples comparable market
transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations
and reviews and other inputs.
The following table summarizes the significant
non-observable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique
as of December 31, 2016:
|
|
|
|
|
|
|
|
Range
|
(in thousands)
|
|
Fair Value
|
|
Valuation Techniques
|
|
Unobservable Inputs
|
|
Minimum
|
|
Maximum
|
Secured and subordinated debt
|
|
$
|
2,978
|
|
|
Yield analysis
|
|
Discount for lack of marketability
|
|
|
0
|
%
|
|
|
0
|
%
|
Common stock
|
|
|
16,200
|
|
|
Income/Market approach
|
|
EBITDA Multiple/Discount for lack of marketability/Control premium
|
|
|
10
|
%
|
|
|
32.5
|
%
|
Limited liability company investments
|
|
|
6,462
|
|
|
Asset Approach
Discounted cash
flow; Guideline
transaction method
|
|
Recovery rate
Reserve adjustment
factors
|
|
|
75
|
%
|
|
|
100
|
%
|
|
|
$
|
25,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Because of the inherent uncertainty
of the valuation of portfolio securities which do not have readily ascertainable market values, amounting to $25.6 million and
$16.2 million as of December 31, 2016 and 2015, respectively, our fair value determinations may materially differ from the values
that would have been used had a ready market existed for the securities.
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
.
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.
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 1940 Act.
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 Code necessary to qualify as a RIC 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 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 incorporated in the
State of Delaware are required to file an Annual Report and to pay a franchise tax. As a result, we paid Delaware Franchise tax
in the amount of $0.02 million, for each of the years ended December 31, 2016, 2015 and 2014.
Texas margin tax applies to legal entities
conducting business in Texas. The margin tax is based on our Texas sourced taxable margin. The tax is calculated by applying a
tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result,
we did not owe state income tax for each of the years ended December 31, 2016, 2015 and 2014.
(4) RELATED PARTY TRANSACTIONS AND AGREEMENTS
MVC Capital, Inc. –
Share Exchange.
On May 14, 2014, we announced that the Fund intended to effect a reorganization pursuant to Section
2(a)(33) of the 1940 Act (“Plan of Reorganization”). As a first step to consummating the Plan or Reorganization,
we sold to 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
BDC 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.
During 2016, we received 22,863 additional shares in the form of dividend payments. As of December 31, 2016, we valued our
468,608 MVC shares at $4.0 million, an increase from $3.2 million at December 31, 2015. The value of our MVC shares was based
on MVC’s closing trading price on the NYSE as of such dates. Due to the ownership relationship between the Company
and MVC, the investment and amounts due to and from MVC have been identified and disclosed as “related
party(ies)” in our Consolidated Financial Statements.
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 November 2011, Equus Energy, LLC
(“Equus Energy”), 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 of
the Fund, is a managing partner and co-founder of Global Energy. For each of the years ended December 31, 2016, 2015 and 2014,
payments to Global Energy totaled $75,000.
In
respect of services provided to the Fund by members of the Board not in connection with their roles and duties as directors, the
Fund pays a rate of $250 per hour for services rendered.
During 2016, 2015 and 2014, we paid Kenneth I. Denos, P.C.,
a professional corporation owned by Kenneth I. Denos, a director of the Fund, $0.4 million, $0.3 million and $0.3 million, respectively,
for services provided to the Fund during these years, respectively.
(5) FEDERAL INCOME
TAX MATTERS
As a RIC, our tax liability is dependent
upon whether an election is made to distribute taxable investment income and capital gains above any statutory requirement. As
we have incurred net investment losses and have had no realized gains after taking into account our capital loss carryforwards
in 2016, 2015 and 2014, no distributions were required or made.
Our year-end for determining capital
gains for purposes of Section 4982 of the Code is October 31.
There are no material book to tax differences
for net investment income/losses, realized gains or unrealized appreciation/depreciation. As of December 31, 2016, we had approximately
$31.3 million in capital losses of which $15.6 million will begin expiring after 2017 and the remaining $15.7 million can be carried
forward indefinitely.
Reclassification of returns of capital
had no material book to tax differences for the three years ended December 31, 2016 and therefore has no material book to tax differences
impacting accumulated earnings.
We believe that any aggregate exposure
for uncertain tax positions should not have a material impact on our financial statements as of December 31, 2016 or December 31,
2015. An uncertain tax position is measured as the largest amount of tax return benefits that does not have a greater than 50%
likelihood of being realized upon ultimate settlement. We have not recorded an adjustment to our financial statements related to
any uncertain tax positions. We will continue to evaluate our tax positions and recognize any future impact of uncertain tax positions
as a charge to income in the applicable period in accordance with promulgated standards.
The Fund’s accounting policy related
to income tax penalties and interest assessments is to accrue for these costs and record a charge to expenses during the period
that the Fund takes an uncertain tax position through resolution with the taxing authorities or expiration of the applicable statute
of limitations.
All of the Fund’s federal and
state tax returns for 2012 through 2016 remain open to examination. We believe that there are no tax positions taken or expected
to be taken that would significantly increase or decrease unrecognized tax benefits within 12 months of the reporting date.
(6) COMMITMENTS AND CONTINGENCIES
Lease Commitments
. We had an
operating lease for office space that expired in September 2014. Our current office space lease as of December 31, 2016 is month-to-month.
Rent expense under the operating lease agreement, inclusive of common area maintenance costs, was $89,000, $91,000 and $91,000
for the years ended December 31, 2016, December 31, 2015 and December 31, 2014, respectively.
Portfolio Companies.
As of December
31, 2016 and 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 the portfolio company to ensure that operations are completed, thereby allowing the portfolio company to generate
cash flows to service the debt.
Legal Proceedings–Shareholder Complaint.
On November 16, 2016, Samuel Zalmanoff filed a lawsuit against the Fund and members of the Board of Directors in the Court
of Chancery in the State of Delaware. The lawsuit was filed in connection with the Fund’s 2016 Equity Incentive Plan (“Incentive
Plan”) which was adopted by the Board of Directors on April 15, 2016, approved by the Equus shareholders on June 13, 2016,
and approved, with certain standard exceptions, by the Securities and Exchange Commission on January 10, 2017. Mr. Zalmanoff’s
complaint, which purports to be on behalf of all non-affiliate Equus shareholders entitled to vote for the Incentive Plan, alleges
a breach by the Board of Directors of its fiduciary duties of disclosure in connection with the Incentive Plan, and seeks an order
from the court: (i) enjoining implementation of the Incentive Plan, (ii) requiring the Fund to revise its disclosures relating
to the Incentive Plan, and (iii) for an award of costs, attorneys’ fees, and expenses. We believe this lawsuit is without
merit and intend to vigorously dispute the claims made therein. Accordingly, on January 9, 2017, we filed a Motion to Dismiss the
complaint, which was followed on January 27, 2017 with a supporting brief and other corroborative items. Mr. Zalmanoff is required
to file a response to this motion no later than March 13, 2017.
Legal Proceedings–Champion
Window Arbitration Settlement
. In January 2006, we sold our 31.5% ownership interest in Champion Window,
Inc. (“Champion”), a portfolio company of the Fund, to Atrium Companies Inc. (“Atrium”) pursuant to
a Stock Purchase Agreement (“SPA”) dated December 22, 2005. The SPA contained certain limited rights
of indemnification for Atrium in connection with its purchase of such ownership interest.
More than five years after the closing
of the sale of our Champion interest, Atrium filed suit in Texas state court, which was subsequently consolidated into an Arbitration
Action, against two former officers of Champion, Equus, and another former Champion shareholder. The suit alleged breaches of fiduciary
duty against Champion’s former officers for hiring undocumented workers that were discovered as a result of an investigation
by the U.S. Immigration and Customs Enforcement agency (“ICE”) into Atrium’s hiring practices. The suit also
sought indemnification under the SPA from these officers, Equus, and another former Champion shareholder, for a payment of $2.0
million made to ICE in settlement of the investigation and associated legal costs, as well as for claimed lost profits as a result
of the investigation.
On February 4, 2015, without admitting
to any liability on the part of Equus, we entered into a settlement agreement with Atrium and its associated companies. Pursuant
to the settlement agreement and in view of the estimated costs of protracted litigation and the associated disruption to the operations
of the Fund, we agreed to pay $500,000, in complete settlement of the lawsuit, as being in the best interests of the Fund and its
shareholders. This amount was accrued as of December 31, 2014. The settlement payment was made on February 6, 2015. Atrium filed
a motion to dismiss the lawsuit with prejudice on February 4, 2015.
From time to time, the Fund is also
a party to certain proceedings incidental to the normal course of our business including the enforcement of our rights under contracts
with our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we
do not expect that these proceedings will have a material effect upon the Fund’s financial condition or results of operations.
(7) PORTFOLIO SECURITIES
2016 Portfolio Activity
During the year ended December 31, 2016,
we had investment activity of $2.4 million in three portfolio companies. We invested $2.0 million in Biogenic Reagents, LLC (“Biogenic”)
in the form of a senior secured promissory note, bearing cash and PIK interest at the combined rate of 16% per annum. During 2016,
we received $0.04 million in semi-annual interest and $13 thousand in PIK’d interest in respect of our note with 5
TH
Element Tracking, LLC (“5
TH
Element”). During 2016, we also received 22,863 shares of MVC in the form
of dividend payments.
The following table includes significant
investment activity during the year ended December 31, 2016 (in thousands):
|
|
Investment Activity
|
|
|
|
|
New Investments
|
|
Existing Investments
|
|
|
Portfolio Company
|
|
|
Cash
|
|
|
|
Non-Cash
|
|
|
|
Follow-On
|
|
|
|
PIK
|
|
|
|
Total
|
|
Biogenic Reagents, LLC
|
|
$
|
2,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
13
|
|
|
$
|
2,013
|
|
MVC Capital, Inc.
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
313
|
|
|
|
313
|
|
5
TH
Element Tracking, LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
50
|
|
|
|
50
|
|
|
|
$
|
2,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
376
|
|
|
$
|
2,376
|
|
During 2016, we realized net capital
losses of $13 thousand due to the disposition of temporary cash investments.
During 2016, we recorded an increase
of $7.9 million in net unrealized appreciation, from $2.4 million at December 31, 2015 to $10.3 million at December 31, 2016, in
our portfolio securities. Such increase resulted primarily from the following changes:
(i)
|
|
Increase in the fair value of our shareholding in MVC of $0.5 million due to an increase in the MVC share price during 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. (“PalletOne”) of $6.6 million due to continued strong revenue and earnings growth, and an overall improvement in comparable industry sectors;
|
(iii)
|
|
Increase in the fair value of our holdings in Equus Energy of $0.8 million, principally due to a combination of an increase in comparable transactions for mineral leases, increased production, and a continued increase short- and long-term prices for crude oil and natural gas.
|
2015 Portfolio Activity
During the year ended December 31, 2015,
we received a one-year subordinated note from 5
th
Element in the original principal amount of $0.9 million, bearing
interest at the rate of 14% per annum in connection with the sale of our interest in Spectrum. We also received 23,694 shares of
MVC in the form of dividend payments.
The following table includes significant
investment activity during the year ended December 31, 2015 (in thousands):
|
|
Investment Activity
|
|
|
|
|
New Investments
|
|
Existing Investments
|
|
|
Portfolio Company
|
|
Cash
|
|
Non-Cash
|
|
Follow-On
|
|
PIK
|
|
Total
|
MVC Capital, Inc.
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
222
|
|
|
$
|
222
|
|
5
TH
Element Tracking, LLC
|
|
|
—
|
|
|
|
915
|
|
|
|
—
|
|
|
|
—
|
|
|
|
915
|
|
|
|
$
|
—
|
|
|
$
|
915
|
|
|
$
|
—
|
|
|
$
|
222
|
|
|
$
|
1,137
|
|
During 2015,we realized capital losses
of $2.5 million, including the following significant transactions:
Portfolio Company
|
|
Industry
|
|
Type
|
|
Transaction Type
|
|
Realized Gain (Loss)
|
Spectrum Management, LLC
|
|
Business products and services
|
|
|
Control
|
|
|
Disposition
|
|
$
|
(2,850
|
)
|
Orco Property Group S. A.
|
|
Real estate
|
|
|
Non-affiliate
|
|
|
Disposition
|
|
|
372
|
|
Various others
|
|
|
|
|
|
|
|
Disposition
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
(2,483
|
)
|
During 2015, we recorded a net decrease
in unrealized depreciation of $5.9 million, to arrive at a net unrealized appreciation of our portfolio securities of $2.4 million,
resulting principally from the following:
(i)
|
|
Decrease in the fair value of our holdings in Equus Energy of $4.3 million, principally due to a combination of production without a corresponding increases 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 $0.8 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 and $0.2 million in purchase price adjustment;
|
(iii)
|
|
Increase in fair value of our shareholding in PalletOne, Inc. of $8.6 million due to an overall improvement in the industry sector for packaging companies, as well as continued revenue and earnings growth for the company;
|
(iv)
|
|
|
Transfer of unrealized depreciation to realized gain on our holding of Orco Property Group, S. A. (“OPG”) notes of $0.4 million in connection with the sale of our interest in the OPG Notes; and
|
(iv)
|
|
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.
|
2014 Portfolio Activity
During the year ended December 31,
2014, we made a capital infusion of $0.3 million relating to Spectrum. We also received a semi-annual interest payment of $0.04
million in cash and $0.2 million in the form of PIK’d interest in respect of our €1.2 million [$1.5 million] in OPG
notes. On May 14, 2014, we sold to MVC 2,112,000 newly-issued shares of our common stock in exchange for 395,839 shares of MVC
(see Note 10 -“
Subsequent Events”
). During the year ended December 31, 2014, we also received 9,129 shares
of MVC in the form of dividend payments.
The following table includes significant
investment activity during the year ended December 31, 2014 (in thousands):
|
|
Investment Activity
|
|
|
|
|
New Investments
|
|
Existing Investments
|
|
|
Portfolio Company
|
|
Cash
|
|
Non-Cash
|
|
Follow-On
|
|
PIK
|
|
Total
|
MVC Capital, Inc.
|
|
$
|
524
|
|
|
$
|
5,075
|
|
|
$
|
—
|
|
|
$
|
107
|
|
|
$
|
5,706
|
|
Orco Property Group, S. A.
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
171
|
|
|
|
171
|
|
Spectrum Management, LLC
|
|
|
—
|
|
|
|
—
|
|
|
|
269
|
|
|
|
—
|
|
|
|
269
|
|
|
|
$
|
524
|
|
|
$
|
5,075
|
|
|
$
|
269
|
|
|
$
|
278
|
|
|
$
|
6,146
|
|
During 2014, we realized capital gains
of $0.7 million, including the following significant transactions:
Portfolio Company
|
|
Industry
|
|
Type
|
|
Transaction Type
|
|
Realized Gain (Loss)
|
Orco Property Group, S. A.
|
|
Real estate
|
|
|
Non-affiliate
|
|
|
Disposition
|
|
$
|
(63
|
)
|
MVC Capital, Inc.
|
|
Financial services
|
|
|
Non-affiliate
|
|
|
Share exchange
|
|
|
724
|
|
Various others
|
|
|
|
|
|
|
|
Disposition
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
$
|
660
|
|
During 2014, we recorded a net change
in unrealized depreciation of $0.4 million, to arrive at net unrealized depreciation of $3.6 million as of December 31, 2014.
Such change in depreciation resulted primarily from the following changes:
(i)
|
|
Increase in fair value of our holding in Equus Energy of
$1.8 million due to an increase in comparable transactions for mineral leases, increased oil and gas production, as well as additional
proved developed producing and proved developed producing behind-pipe reserves from new drilling and recompletion activities;
|
(ii)
|
|
Decrease in fair value of Equus Media Development Company,
LLC of $0.1 million due to a net operating loss for the period equal to the amount of the decrease;
|
(iii)
|
|
Decrease in fair value of MVC of $1.7 million due to the
decline in the stock price of MVC, which was partially offset by $0.1 million in dividends received in the form of additional MVC
shares;
|
(iv)
|
|
Decrease in fair value of our holding of OPG Notes of $0.1
million due to adverse changes in the USD-EUR exchange rate; and
|
(v)
|
|
Increase in fair value of our shareholding in PalletOne of $0.7 million due to an improvement in the industry sector for packaging companies and continued revenue and earnings growth.
|
(8) EQUUS ENERGY, LLC
Equus Energy, LLC (“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 presently consisting of 111 producing and non-producing
oil and gas wells. The working interests include associated development rights of approximately 20,900 acres situated on 12 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
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, is working with Chevron in 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 (appx. 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
year ended December 31, 2016, Equus Energy’s revenue, operating revenue less direct operating expenses, and net loss were
$0.7 million, $0.05 million, and ($1.0) million, respectively, as compared to revenue, operating revenue less direct operating
expenses, and net loss of $1.1 million, ($0.01) million, and ($5.1) million, respectively, for the year ended December 31, 2015
and $2.5 million, $1.3 million, and $0.2 million, respectively for the year ended December 31, 2014.
Capital Expenditures
. During
the fourth quarter of 2016, Equus Energy received $0.3 million as a result of the sale of a small working interest it held in the
Permian Basin for approximately $12,500 per acre.
During 2015, Equus Energy invested
$.08 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.
During 2014, Equus Energy invested
$0.5 million in several 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 unaudited consolidated
financial information for Equus Energy as of December 31, 2016 and for the year ended December 31, 2016 and selected financial
information derived from the audited financial statements for Equus Energy as of December 31, 2015 and 2014 and for each of the
years ended December 31, 2015, and 2014 (in thousands):
EQUUS ENERGY, LLC and SUBSIDIARY
Unaudited
Condensed Consolidated
Balance Sheets
|
|
December 31,
|
|
December 31,
|
|
|
2016
|
|
2015
|
|
|
|
|
|
Assets
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
291
|
|
|
$
|
517
|
|
Accounts receivable
|
|
|
91
|
|
|
|
122
|
|
Other current assets
|
|
|
32
|
|
|
|
32
|
|
Total current assets
|
|
|
414
|
|
|
|
671
|
|
Oil and gas properties
|
|
|
8,055
|
|
|
|
8,269
|
|
Less: accumulated depletion, depreciation and amortization
|
|
|
(7,145
|
)
|
|
|
(6,516
|
)
|
Net oil and gas properties
|
|
|
910
|
|
|
|
1,753
|
|
Total assets
|
|
$
|
1,324
|
|
|
$
|
2,424
|
|
Liabilities and member's equity
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and other
|
|
$
|
75
|
|
|
$
|
206
|
|
Due to affiliate
|
|
|
611
|
|
|
|
611
|
|
Total current liabilities
|
|
|
686
|
|
|
|
817
|
|
Asset retirement obligations
|
|
|
184
|
|
|
|
178
|
|
Total liabilities
|
|
|
870
|
|
|
|
995
|
|
Total member's equity
|
|
|
454
|
|
|
|
1,429
|
|
Total liabilities and member's equity
|
|
$
|
1,324
|
|
|
$
|
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 and SUBSIDIARY
Unaudited Condensed Consolidated
Statements of Operations
|
|
Year Ended December 31,
|
|
|
2016
|
|
2015
|
|
2014
|
|
|
|
|
|
|
|
Operating revenue
|
|
$
|
683
|
|
|
$
|
1,091
|
|
|
$
|
2,469
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct operating expenses
|
|
|
632
|
|
|
|
1,103
|
|
|
|
1,148
|
|
General and administrative
|
|
|
392
|
|
|
|
356
|
|
|
|
632
|
|
Depletion, depreciation, amortization and accretion
|
|
|
369
|
|
|
|
771
|
|
|
|
790
|
|
Impairment
|
|
|
265
|
|
|
|
3,978
|
|
|
|
—
|
|
Total operating expenses
|
|
|
1,658
|
|
|
|
6,208
|
|
|
|
2,569
|
|
Operating loss before income tax expense
|
|
|
(975
|
)
|
|
|
(5,117
|
)
|
|
|
(100
|
)
|
Income tax benefit (expense)
|
|
|
—
|
|
|
|
61
|
|
|
|
(63
|
)
|
Net loss
|
|
$
|
(975
|
)
|
|
$
|
(5,056
|
)
|
|
$
|
(163
|
)
|
EQUUS ENERGY, LLC and SUBSIDIARY
Unaudited Condensed Consolidated
Statements of Cash Flows
|
|
Year ended December 31,
|
|
|
2016
|
|
2015
|
|
2014
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(975
|
)
|
|
$
|
(5,056
|
)
|
|
$
|
(163
|
)
|
Adjustments to reconcile net loss to
|
|
|
|
|
|
|
|
|
|
|
|
|
net cash (used in) provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Impairment
|
|
|
265
|
|
|
|
3,978
|
|
|
|
—
|
|
Depletion, depreciation and amortization
|
|
|
369
|
|
|
|
766
|
|
|
|
784
|
|
Accretion expense
|
|
|
—
|
|
|
|
5
|
|
|
|
6
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
31
|
|
|
|
188
|
|
|
|
(22
|
)
|
Prepaid expenses and other current assets
|
|
|
—
|
|
|
|
4
|
|
|
|
(35
|
)
|
Affiliate payable/receivable
|
|
|
—
|
|
|
|
—
|
|
|
|
247
|
|
Accounts payable and other
|
|
|
(131
|
)
|
|
|
95
|
|
|
|
(190
|
)
|
Net cash (used in) provided by operating activities
|
|
|
(441
|
)
|
|
|
(20
|
)
|
|
|
627
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in oil & gas properties
|
|
|
(35
|
)
|
|
|
(76
|
)
|
|
|
(500
|
)
|
Sale of oil & gas properties
|
|
|
250
|
|
|
|
—
|
|
|
|
—
|
|
Net cash provided by (used in) investing activities
|
|
|
215
|
|
|
|
(76
|
)
|
|
|
(500
|
)
|
Net (decrease) increase in cash
|
|
|
(226
|
)
|
|
|
(96
|
)
|
|
|
127
|
|
Cash and cash equivalents at beginning of period
|
|
|
517
|
|
|
|
613
|
|
|
|
486
|
|
Cash and cash equivalents at end of period
|
|
$
|
291
|
|
|
$
|
517
|
|
|
$
|
613
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Revision of net asset retirement obligation
|
|
$
|
—
|
|
|
$
|
(11
|
)
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes refunded (paid)
|
|
$
|
—
|
|
|
$
|
21
|
|
|
$
|
—
|
|
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 for insignificant sales.
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 $0.4 million, $0.8 million and $0.8 million for the years
ended December 31, 2016, December 31 2015, and December 31, 2014, respectively.
Capitalized oil and gas property costs
are limited to an amount (the ceiling limitation) equal to the sum of the following:
(a)
|
|
As of December 31, 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. Based on calculated reserves at December 31, 2016, the unamortized costs of the Equus Energy’s
oil and natural gas properties exceeded the ceiling test limit by $0.3 million, which was recorded as an impairment of oil and
gas properties. During 2015, the Company recognized an impairment loss of $4.0 million. No such impairment was necessary in 2014.
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 December 31, 2016, December 31, 2015 and December
31, 2014, 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 May 2014, the FASB issued
ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 supersedes the revenue
recognition requirements under ASC 605, Revenue Recognition, and most industry-specific guidance throughout the Industry
Topics of the ASC. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of
promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be
entitled in exchange for those goods or services. Under the new guidance, an entity is required to perform the following five
steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the
contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in
the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance
will significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions and
capital markets. Additionally, the guidance requires improved disclosures as to the nature, amount, timing and uncertainty of
revenue that is recognized. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606):
Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarified the implementation guidance on
principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with
Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarified the implementation guidance
regarding performance obligations and licensing arrangements. In May 2016, the FASB issued ASU No. 2016-12, Revenue from
Contracts with Customers (Topic 606) — Narrow-Scope Improvements and Practical Expedients, which clarified
guidance on assessing collectability, presenting sales tax, measuring noncash consideration, and certain transition matters.
The new guidance will be effective for the annual reporting period beginning after December 15, 2017, including interim
periods within that reporting period. Early adoption would be permitted for annual reporting periods beginning
after December 15, 2016. The Company expects to complete its assessment of the impact of adoption of ASU 2014-09
during the first half of 2017.
In August 2014, the FASB issued ASU
2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about
an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”), which requires management to assess
an entity’s ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances.
The amendments in this Update are effective for the annual period ending after December 15, 2016, and for annual periods and interim
periods thereafter. Early application is permitted. The Fund adopted ASU 2014-15 as of and for the annual period ended December
31, 2016, which did not have any impact on its financial statements.
In May 2015, the FASB issued ASU 2015-07,
Fair Value Measurements— Disclosures for Certain Entities that Calculate Net Asset Value per Share. This amendment
updates guidance intended to eliminate the diversity in practice surrounding how investments measured at net asset value under
the practical expedient with future redemption dates have been categorized in the fair value hierarchy. Under the updated guidance,
investments for which fair value is measured at net asset value per share using the practical expedient should no longer be categorized
in the fair value hierarchy, while investments for which fair value is measured at net asset value per share but the practical
expedient is not applied should continue to be categorized in the fair value hierarchy. The updated guidance requires retrospective
adoption for all periods presented and is effective for interim and annual reporting periods beginning after December 15,
2015, with early adoption permitted. The Company adopted this standard during the three months ended March 31, 2016. There
was no impact of the adoption of this new accounting standard on the Company’s financial statements as none
of its investments are measured through the use of the practical expedient.
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 pubic 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.
In February 2016, the FASB issued ASU 2016 02, Leases, which requires lessees to recognize on the balance
sheet a right of use asset, representing its right to use the underlying asset for the lease term, and a lease liability for all
leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to
assess the amount, timing, and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective
transition approach, which includes a number of optional practical expedients that entities may elect to apply. The new guidance
is effective for annual periods beginning after December 15, 2018, and interim periods therein. Early application is permitted.
The adoption of ASU 2016-02 will not have an impact on our financial statements as we currently have no operating
leases and our principal offices are under a month-to-month lease arrangement.
In March 2016, the FASB issued ASU
No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU
2016-09”), which is intended to improve the accounting for share-based payments and affects all organizations that issue
share-based payment awards to their employees. ASU 2016-09 primarily simplifies the accounting for and classification of, income
taxes related to share-based payment awards, including the impact of income taxes withheld on the classification of awards as
equity or liabilities and the classification of income taxes on the statement of cash flows. ASU 2016-09 also permits an
entity to elect a forfeiture rate assumption based on the estimated number of awards expected to vest or to account for forfeitures
when they occur. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those
fiscal years. Early adoption is permitted, including adoption in an interim period. We elected to early adopt ASU 2016-09 effective
January 1, 2016. The provisions of ASU 2019-06 should be adopted on a modified retrospective, retrospective or prospective basis,
depending on the provision. We recently adopted an incentive plan for management; however, no issuances or awards have occurred
to date. We are currently evaluating the impact ASU 2016-13 will have on future issuances and awards.
In June 2016, the FASB issued ASU No.
2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”),
which amends the financial instruments impairment guidance so that an entity is required to measure expected credit losses for
financial assets based on historical experience, current conditions and reasonable and supportable forecasts. As such, an entity
will use forward-looking information to estimate credit losses. ASU 2016-13 also amends the guidance in FASB ASC Subtopic No. 325-40,
Investments-Other, Beneficial Interests in Securitized Financial Assets, related to the subsequent measurement of accretable yield
recognized as interest income over the life of a beneficial interest in securitized financial assets under the effective yield
method. ASU 2016-13 is effective for public business entities that meet the U.S. GAAP definition of an SEC filer, for fiscal years
beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal
years beginning after December 15, 2018, including interim periods within those fiscal years. We are
currently evaluating the impact of ASU 2016-13 on our financial statements.
In August 2016, the FASB issued ASU
No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the
Emerging Issues Task Force) (“ASU 2016-15”), which addresses the diversity in practice in how certain cash receipts
and cash payments are presented and classified in the statement of cash flows under ASC 230, Statement of Cash Flows, and other
topics. ASU 2016-15 provides guidance on eight specific cash flow issues including the statement of cash flows treatment of beneficial
interests in securitized financial transactions as well as the treatment of debt prepayment and extinguishment costs. ASU 2016-15
also provides guidance on the predominance principle to clarify when cash receipts and cash payments should be separated into more
than one class of cash flows. ASU 2016-15 is effective for public business entities for fiscal years beginning after December 15,
2017, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period.
We are currently evaluating the impact of ASU 2016-15 on our consolidated statements of cash flows.
From time to time, new accounting pronouncements
are issued by the FASB or other standards setting bodies that are adopted by the Company as of the specified effective date. Management
believes that the impact of recently issued standards and any that are not yet effective will not have a material impact on its
consolidated financial statements upon adoption.
(10) SUBSEQUENT EVENTS
Our Management performed an evaluation
of the Fund’s activity through the date the financial statements were issued, noting the following subsequent events:
On January 3, 2017, we sold U. S. Treasury
Bills for $30.0 million and repaid our year-end margin loan.
On January 6, 2017, holders of a majority
of the outstanding common stock of the Fund approved our cessation as a BDC under the 1940 Act and authorized our Board of Directors to cause the Fund’s withdrawal of its election to be classified
as a BDC, each effective as of a date designated by the Board and our Chief Executive Officer, but in no event later than July
31, 2017. The authorization given to our Board is a consequence of the Plan of Reorganization described above. Notwithstanding
this authorization to withdraw our BDC election, we will not submit any such withdrawal unless and until Equus has entered into
a definitive agreement to effect a Consolidation. Further, although our shareholders have authorized us to withdraw our election
as a BDC, we will require a subsequent affirmative vote from holders of a majority of our outstanding voting shares to enter into
any such definitive agreement or change the nature of our business. See Note 4 “
Related Party Transactions and Agreements.
”
(11) SELECTED QUARTERLY DATA
(in thousands, except per share amounts)
|
|
Year Ended December 31, 2016
|
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
Total
|
Total investment income
|
|
$
|
138
|
|
|
$
|
227
|
|
|
$
|
191
|
|
|
$
|
192
|
|
|
$
|
748
|
|
Net investment loss
|
|
|
(733
|
)
|
|
|
(452
|
)
|
|
|
(570
|
)
|
|
|
(696
|
)
|
|
|
(2,451
|
)
|
Increase in net assets resulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from operations
|
|
|
242
|
|
|
|
2,067
|
|
|
|
1,889
|
|
|
|
1,234
|
|
|
|
5,432
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings per share
(1)
|
|
|
0.02
|
|
|
|
0.17
|
|
|
|
0.16
|
|
|
|
0.08
|
|
|
|
0.43
|
|
(in thousands, except per share amounts)
|
|
Year Ended December 31, 2015
|
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
Total
|
Total investment income
|
|
$
|
44
|
|
|
$
|
89
|
|
|
$
|
91
|
|
|
$
|
222
|
|
|
$
|
446
|
|
Net investment loss
|
|
|
(1,074
|
)
|
|
|
(594
|
)
|
|
|
(370
|
)
|
|
|
(313
|
)
|
|
|
(2,351
|
)
|
Increase (decrease) in net assets resulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from operations
|
|
|
(839
|
)
|
|
|
2,623
|
|
|
|
(333
|
)
|
|
|
(344
|
)
|
|
|
1,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings (loss) per share
(1)
|
|
|
(0.07
|
)
|
|
|
0.21
|
|
|
|
(0.03
|
)
|
|
|
(0.03
|
)
|
|
|
0.08
|
|
(
1)
The sum of quarterly per
share amount may not equal per share amounts reported for year-to-date periods due to changes in the number of weighted average
shares outstanding and the effects of rounding.