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 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.
As a BDC, 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, 2016, we had invested 86.4% of our assets in securities
of portfolio companies that constituted qualifying investments under the 1940 Act. As of December 31, 2016, 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 31.8% of the total value of the investments in portfolio
securities as of December 31, 2016.
Our investments in portfolio securities
consist of the following types of securities as of December 31, 2016 (in thousands):
The following is a summary by industry
of the Fund’s investments in portfolio securities as of December 31, 2016 (in thousands):
The accompanying notes are an integral
part of these financial statements.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2017
(Unaudited)
|
(1)
|
Description of Business and Basis of Presentation
|
Description of Business
—Equus
Total Return, Inc. (
“we,” “us,” “our,” “Equus” 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.
So long as we remain an investment company
and not an operating company as contemplated in our
Plan of Reorganization
described in Note 6 below, we will attempt to
maximize the return to stockholders in the form of current investment income and long-term capital gains by investing in the debt
and equity securities of companies with a total enterprise value of between $5.0 million and $75.0 million, although we may engage
in transactions with smaller or larger investee companies from time to time. We seek to invest primarily in companies pursuing
growth either through acquisition or organically, leveraged buyouts, management buyouts and recapitalizations of existing businesses
or special situations. Our income-producing investments consist principally of debt securities including subordinate debt, debt
convertible into common or preferred stock, or debt combined with warrants and common and preferred stock. Debt and preferred equity
financing may also be used to create long-term capital appreciation through the exercise and sale of warrants received in connection
with the financing. We seek to achieve capital appreciation by making investments in equity and equity-oriented securities issued
by privately-owned companies (or smaller public companies) in transactions negotiated directly with such companies. Given market
conditions over the past several years and the performance of our portfolio, our Management and Board of Directors believe it prudent
to continue to review alternatives to refine and further clarify the current strategies.
We elected to be treated as a 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 and the Securities Exchange Act of 1934, as amended (“Exchange
Act”), 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 (“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 Exchange Act. Accordingly, they are unaudited and exclude some disclosures
required for annual financial statements. We believe that we have made all adjustments, consisting solely of normal recurring accruals,
necessary for the fair presentation of these interim financial statements.
The results of operations for the six
months ended June 30, 2017 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, 2016, as filed with the
Securities and Exchange Commission (“SEC”).
|
(2)
|
Liquidity and Financing Arrangements
|
Liquidity
—There are several
factors that may materially affect our liquidity during the reasonably foreseeable future. We view this period as the twelve-month
period from the date of the financial statements in this Form 10-Q,
i.e
., the period through June 30, 2018. We are evaluating
the impact of current market conditions on our portfolio company valuations and their ability to provide current income. We have
followed valuation techniques in a consistent manner; however, we are cognizant of current market conditions that might affect
future valuations of portfolio securities. We believe that our operating cash flow and cash on hand will be sufficient to meet
operating requirements and, to the extent we remain a BDC, to finance routine follow-on investments, if any, through the next twelve
months.
Cash and Cash Equivalents
—As
of June 30, 2017, we had cash and cash equivalents of $13.1 million. We had $28.9 million of our net assets of $42.1 million invested
in portfolio securities. We also had $35.3 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, $35.0 million was invested in U.S. Treasury bills and $0.3 million represented a required
1% brokerage margin deposit. These securities were held by a securities brokerage firm and pledged along with other assets to secure
repayment of the margin loan. The U.S. Treasury bills were sold on July 3, 2017 and we subsequently repaid this margin loan, plus
interest, on July 7, 2017.
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.
Dividends
—So long as we
remain a BDC, 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
—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.
As of June 30, 2017, we had no outstanding
commitments to our portfolio company investments.
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 any 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 remain a BDC and do not consummate our Consolidation and therefore do not
become an operating company as described in Note 6 –
Plan of Reorganization
below, our failure to continue to qualify
as a RIC could be materially adverse to us and our stockholders.
As of June 30, 2017, we borrowed $35.0
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 $35.3 million.
As of December 31, 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.
Certain Risks and Uncertainties
—Market
and economic volatility which has become endemic in the past few years has resulted in a relatively limited amount of available
debt financing for small and medium-sized companies such as Equus and its portfolio companies. Such debt financing generally has
shorter maturities, higher interest rates and fees, and more restrictive terms than debt facilities available in the past. In addition,
during these years and continuing into the first six months of 2017, 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. We are also evaluating potential opportunities that could enable us to effect
a Consolidation and become an operating company as described in Note 6 –
Plan of Reorganization
below. 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 2017 and the first six months of 2018.
|
(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 six months ended June 30, 2017 and the year ended December 31, 2016.
As of June 30, 2017, investments measured
at fair value on a recurring basis are categorized in the tables below based on the lowest level of significant input to the valuations:
|
|
|
|
Fair Value Measurements as of June 30, 2017
|
(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
|
|
$
|
6,463
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6,463
|
|
Affiliate investments
|
|
|
16,686
|
|
|
|
—
|
|
|
|
—
|
|
|
|
16,686
|
|
Non-affiliate investments - related party
|
|
|
4,763
|
|
|
|
4,763
|
|
|
|
—
|
|
|
|
—
|
|
Non-affiliate investments
|
|
|
965
|
|
|
|
—
|
|
|
|
—
|
|
|
|
965
|
|
Total investments
|
|
|
28,877
|
|
|
|
4,763
|
|
|
|
—
|
|
|
|
24,114
|
|
Temporary cash investments
|
|
|
34,953
|
|
|
|
34,953
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
|
$
|
63,830
|
|
|
$
|
39,716
|
|
|
$
|
—
|
|
|
$
|
24,114
|
|
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
|
|
|
—
|
|
|
—
|
|
|
16,200
|
|
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
|
|
The following table provides a reconciliation
of fair value changes during the six months ended June 30, 2017 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, 2016
|
|
$
|
6,462
|
|
|
$
|
16,200
|
|
|
$
|
2,978
|
|
|
$25,640
|
Change in unrealized appreciation (depreciation)
|
|
|
1
|
|
|
|
486
|
|
|
|
—
|
|
|
487
|
Proceeds from sales/dispositions
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,013
|
)
|
|
(2,013)
|
Transfers in (out) of Level 3
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
-
|
Fair value as of June 30, 2017
|
|
$
|
6,463
|
|
|
$
|
16,686
|
|
|
$
|
965
|
|
|
$24,114
|
The following table provides a reconciliation
of fair value changes during the six months ended June, 2016 for all investments for which we determine fair value using unobservable
(Level 3) factors:
|
|
Fair value measurements using significant unobservable inputs (Level 3)
|
(in thousands)
|
|
Control Investments
|
|
Affiliate Investments
|
|
Non-affiliate Investments
|
|
Total
|
Fair value as of December 31, 2015
|
|
$
|
5,715
|
|
|
$
|
9,600
|
|
|
$
|
915
|
|
|
$16,230
|
Change in unrealized appreciation (depreciation)
|
|
|
(1,502
|
)
|
|
|
4,700
|
|
|
|
—
|
|
|
3,198
|
Purchases of portfolio securities
|
|
|
—
|
|
|
|
—
|
|
|
|
2,063
|
|
|
2,063
|
Fair value as of June 30, 2016
|
|
$
|
4,213
|
|
|
$
|
14,300
|
|
|
$
|
2,978
|
|
|
$21,491
|
Our investment portfolio is not composed
of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment
portfolio is composed of complex debt and equity securities with distinct contract terms and conditions. As such, our valuation
of each investment in our portfolio is unique and complex, often factoring in numerous different inputs, including historical and
forecasted financial and operational performance of the portfolio company, project cash flows, market multiples comparable market
transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations
and reviews and other inputs.
The following table summarizes the significant
non-observable inputs in the fair value measurements of our Level 3 investments by category of investment and valuation technique
as of June 30, 2017:
|
|
|
|
|
|
|
|
Range
|
(in thousands)
|
|
Fair Value
|
|
Valuation Techniques
|
|
Unobservable Inputs
|
|
Minimum
|
|
Maximum
|
Secured and subordinated debt
|
|
$
|
965
|
|
|
Yield analysis
|
|
Discount for lack of marketability
|
|
|
0
|
%
|
|
|
0
|
%
|
Common stock
|
|
|
16,686
|
|
|
Income/Market approach
|
|
EBITDA Multiple/Discount for lack of marketability/Control premium
|
|
|
10
|
%
|
|
|
32.5
|
%
|
Limited liability company investments
|
|
|
6,463
|
|
|
Asset Approach
Discounted cash flow; Guideline transaction method
|
|
Recovery rate
Reserve adjustment factors
|
|
|
75
|
%
|
|
|
100
|
%
|
|
|
$
|
24,113
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Because of the inherent uncertainty
of the valuation of portfolio securities which do not have readily ascertainable market values, amounting to $24.1 million and
$25.6 million as of June 30, 2017 and December 31, 2016, respectively, our fair value determinations may materially differ from
the values that would have been used had a ready market existed for these securities. As of June 30, 2017, one of our portfolio
investments, 483,090 common shares of MVC, was publicly listed on the New York Stock Exchange (“NYSE”). As of December
31, 2016, one of our portfolio investments, 468,608 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
.
Foreign Exchange—
We record
temporary changes in foreign exchange rates of portfolio securities denominated in foreign currencies as changes in fair value.
These changes are therefore reflected as unrealized gains or losses until realized.
Investment Transactions
—Investment
transactions are recorded on the accrual method. Realized gains and losses on investments sold are computed on a specific identification
basis.
We classify our investments in accordance
with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies
in which the Fund owns more than 25% of the voting securities or maintains greater than 50% of the board representation. Under
the 1940 Act, “Affiliate Investments” are defined as those non-control investments in companies in which we own between
5% and 25% of the voting securities. Under the 1940 Act, “Non-affiliate Investments” are defined as investments that
are neither Control Investments nor Affiliate Investments.
As of June 30, 2017, 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 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.
Net Realized Gains or Losses and
Net Change in Unrealized Appreciation or Depreciation
—Realized gains or losses are measured by the difference between
the net proceeds from the sale or redemption of an investment or a financial instrument and the cost basis of the investment or
financial instrument, without regard to unrealized appreciation or depreciation previously recognized, and includes investments
written-off during the period net of recoveries and realized gains or losses from in-kind redemptions. Net change in unrealized
appreciation or depreciation reflects the net change in the fair value of the portfolio company investments and financial instruments
and the reclassification of any prior period unrealized appreciation or depreciation on exited investments and financial instruments
to realized gains or losses.
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. To the extent we remain BDC and a RIC, 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.
Share-Based Compensation
—We
account for our share-based compensation using the fair value method, as prescribed by ASC718, Compensation—Stock Compensation.
Accordingly, for restricted stock awards, we measure the grant date fair value based upon the market price of its common stock
on the date of the grant and amortizes the fair value of the awards as share-based compensation expense over the requisite service
period, which is generally the vesting term. Effective January 1, 2016, we elected the early adoption of Accounting Standards Update
(“ASU”) 2016-09, Compensation—Stock Compensation. Improvements to Employee Share-Based Payment Accounting (“ASU
2016-09),” and accordingly we have elected to account for forfeitures as they occur and this change had no impact on its
consolidated financial statements. The additional amendments (cash flows classification, minimum statutory tax withholding requirements
and classification of awards as either a liability or equity) did not have an effect on our consolidated financial statements.
Earnings Per Share
—Basic
and diluted per share calculations are computed utilizing the weighted-average number of shares of common stock outstanding for
the period. In accordance with ASC 260, Earnings Per Share, the unvested shares of restricted stock awarded pursuant to our equity
compensation plans are participating securities and, therefore, are included in the basic earnings per share calculation. As a
result, for all periods presented, there is no difference between diluted earnings per share and basic earnings per share amounts.
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
—So long as we remain
a BDC, 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 $0.02 million for the year ended December 31, 2016.
Texas margin tax applies to legal entities
conducting business in Texas. The margin tax is based on our Texas sourced taxable margin. The tax is calculated by applying a
tax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result,
we have no provision for margin tax expense for the three and six months ended June 30, 2017, respectively, and we did not owe
state income tax for the year ended December 31, 2016.
Accounting Standards Recently Adopted
—
In November 2016, the FASB issued ASU No. 2016-18 Statement of Cash Flows (Topic 230), Restricted Cash. This standard provides
guidance on the presentation of restricted cash and restricted cash equivalents in the statement of cash flows. Restricted cash
and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and
end-of-period amounts shown on the statements of cash flows. The amendments of this ASU should be applied using a retrospective
transition method and are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. Other
than the revised statement of cash flows presentation of restricted cash, the adoption of ASU 2016-18 did not have an impact on
our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09,
Compensation-Stock Compensation (Topic 718)
—
Improvements to Employee Share-Based Payment Accounting
, 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 have adopted ASU 2016-09 as of January 1, 2017. The provisions of ASU 2016-09 should
be adopted on a modified retrospective, retrospective or prospective basis, depending on the provision. We recently adopted and
incentive plan for management and issued awards during the quarter ended March 31, 2017. Our adoption of ASU 2016-09 did not have
a material effect on our financial statements.
Accounting Standards Not Yet Adopted
—In
January 2016, the FASB issued ASU 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 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 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 of our
financial statements as we currently have no operating leases and our principal offices are under a month-to-month lease arrangement.
In June 2016, the FASB issued ASU 2016-13,
Financial Instruments-Credit Losses (Topic 326)
—
Measurement of Credit Losses on Financial Instruments
, 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 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 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
2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the
Emerging Issues Task Force),
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 statements of cash flows.
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. In December 2016, the FASB issued ASU No. 2016-20,
Revenue from Contracts with Customers
(Topic 606)—Technical Corrections and Improvements
, which provided disclosure relief, and clarified the scope and application
of the new revenue standard and related cost guidance. 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. We expect to identify similar performance obligations under ASC
606 as compared with deliverables and separate units of account previously identified. As a result, we expect timing of its revenue
recognition to remain the same.
|
(4)
|
Related Party Transactions and Agreements
|
Share Exchange with MVC
—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 NYSE 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. As of June 30, 2017, we valued our 483,090
MVC shares at $4.8 million. As of December 31, 2016, we valued our 468,608 MVC shares at $4.0 million. 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 Financial Statements.
Agreement to Acquire Portfolio Company
of MVC
—On April 24, 2017, we entered into a Stock Purchase Agreement and Plan of Merger (“Merger Agreement”)
with ETR Merger Sub, Inc., a newly-formed wholly-owned subsidiary of Equus, certain shareholders of USG&E, and MVC as a selling
shareholder of U.S. Gas & Electric, Inc. (“USG&E”) and as representative of the selling USG&E shareholders.
On May 30, 2017, USG&E and MVC notified us that they had accepted a proposal from Crius Energy Trust, that was considered
by the respective boards of directors of USG&E and MVC to constitute a “Superior Proposal” (as such term is defined
in the Merger Agreement) to the terms and conditions of the Merger Agreement, and, accordingly, provided us with a notice of termination
pursuant to the Merger Agreement. Further, pursuant to the Merger Agreement, USG&E paid us a termination fee of $2.5 million
(see Note 6 –
Plan of Reorganization
below).
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. Payments to Global Energy totaled $37,500 for each of the six
months ended June, 2017 and 2016.
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 currently pays a fixed amount
at a rate of $300 per hour for services rendered. During the six months ended June 30, 2017 and 2016, we paid Kenneth I. Denos,
P.C., a professional corporation owned by Kenneth I. Denos, a director of the Fund, $0.3 million and $0.2 million respectively,
for services provided to the Fund.
During the six months ended June 30, 2017,
we received full payment of our senior secured promissory note (“Note”) issued by Biogenic Reagents, LLC (“Biogenic”),
in the amount of $2.4 million in cash, consisting of the original principal amount of the Note, together with approximately $0.4
million in interest as accrued thereon.
During the six months ended June 30,
2017, we received dividends in the form of additional shares of $0.1 million relating to our shareholding in MVC.
During the six months ended June 30,
2017, we recorded a net change in unrealized appreciation of $1.1 million, to a net unrealized appreciation of $11.4 million. Such
change in unrealized appreciation resulted primarily from the following changes:
|
(i)
|
Increase in the fair value of our shareholding in MVC of
$0.7 million due to the receipt of a dividend payment in the form of additional shares of MVC along with an increase in the share
price of MVC during the first half of 2017;
|
|
(ii)
|
Increase in fair value of our shareholding in PalletOne, Inc. of $0.5 million due to an overall improvement in comparable industry sectors, as well as continued revenue increases and promising growth prospects;
|
On January 29, 2016, we invested $2.0
million in Biogenic in the form of a senior secured promissory note originally maturing
April 28, 2016 and subsequently extended to June 30, 2016, and bearing cash and PIK interest at the combined rate of 16% per annum.
Biogenic is a developer and producer of high value carbon products from renewable biomass, headquartered in Minneapolis. The company
has developed and commercialized a low-cost platform technology to make carbon products such as activated carbon for use in purification
of air, water, food and pharmaceuticals and agricultural carbon to improve crop production.
On March 2, 2016, we extended the maturity
of the 5
TH
Element Tracking, LLC (“5
TH
Element”) promissory note to July 1, 2016 and received
fees in the form of a PIK and cash totaling $0.05 million. Effective June 30, 2016, we agreed to further extend the maturity of
the note to October 31, 2016 in exchange for fees in the form of a PIK and cash totaling $0.05 million. On August 8, 2017, we agreed
to further extend the maturity date of the note to May 14, 2018 in exchange for $32,500 consisting of $12,500 in PIK interest and
two payments of $10,000 (see Note 9 –
Subsequent Events
below).
On April 1, 2016, we received $40,000
in cash representing payment of accrued cash interest on our $2.0 million loan to Biogenic, made on January 29, 2016.
During the six months ended June 30,
2016, we received dividends in the form of additional shares of $0.2 million relating to our shareholding in MVC.
During the six months ended June 30,
2016, we recorded an increase of $3.5 million in net unrealized appreciation, from $2.4 million to $5.9 million, in our portfolio
securities. Such increase resulted primarily from the following changes:
|
(i)
|
Increase in the fair value of our shareholding in MVC of $0.3 million due to an increase in the MVC share price during the first half of 2016 and the receipt of dividend payments in the form of additional shares of MVC;
|
|
(ii)
|
Increase in fair value of our shareholding in PalletOne, Inc. of $4.7 million due to continued strong revenue and earnings growth, and an overall improvement in comparable industry sectors;
|
|
(iii)
|
Decrease in the fair value of our holdings in Equus Energy, LLC of $1.5 million, principally due to a combination of lower production without a corresponding increase in proved reserves and continued lower short- and long-term prices for crude oil and natural gas.
|
|
(6)
|
Plan of Reorganization
|
Share Exchange with MVC
—On
May 14, 2014, we announced that the Fund intended to effect a Plan of Reorganization. As a first step to consummating the Plan
of Reorganization, we executed a Share Exchange with MVC, wherein we sold to MVC 2,112,000 newly-issued shares of our common stock
in exchange for 395,839 newly-issued shares of MVC. We also announced that, pursuant to the Plan of Reorganization, our intention
was for Equus to pursue a Consolidation with MVC or one of its portfolio companies.
Authorization to Withdraw BDC Election
—As
a consequence of our Plan of Reorganization, 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. On July 31, 2017, this
authorization given by our shareholders to withdraw our BDC election expired (see Note 9
- Subsequent Events
below
).
Notwithstanding this authorization to withdraw our BDC election, we will not submit any such withdrawal unless and until we are
reasonably confident that such Consolidation will be completed.
Agreement to Acquire U.S. Gas &
Electric, Inc.
—On April 24, 2017, we entered into the Merger Agreement with ETR Merger Sub, Inc., a newly-formed wholly-owned
subsidiary of Equus, certain shareholders of USG&E, and MVC as a selling shareholder of USG&E and as representative of
the selling USG&E shareholders. On May 30, 2017, USG&E and MVC notified us that they had accepted a proposal from Crius
Energy Trust, that was considered by the respective boards of directors of USG&E and MVC to constitute a “Superior Proposal”
(as such term is defined in the Merger Agreement) to the terms and conditions of the Merger Agreement, and, accordingly, provided
us with a notice of termination pursuant to the Merger Agreement. Further, pursuant to the Merger Agreement, USG&E paid us
a termination fee of $2.5 million.
Intention to Continue to Pursue Consolidation
—Notwithstanding
the termination of the Merger Agreement with USG&E described above, we intend to pursue a Consolidation and the completion
of our Plan of Reorganization with another operating company. While we are presently evaluating various opportunities that could
enable us to accomplish a Consolidation, we cannot assure you that we will be able to do so within any particular time period or
at all. Moreover, we cannot assure you that the terms of any such transaction that would embody a Consolidation would be acceptable
to us.
|
(7)
|
2016 Equity Incentive Plan
|
On June 13, 2016, our shareholders approved
the adoption of our 2016 Equity Incentive Plan (“Incentive Plan”). On January 10, 2017, the SEC issued an order approving
the Incentive Plan and certain awards intended to be made thereunder. The Incentive Plan is intended to promote the interests of
the Fund by encouraging officers, employees, and directors of the Fund and its affiliates to acquire or increase their equity interest
in the Fund and to provide a means whereby they may develop a proprietary interest in the development and financial success of
the Fund, to encourage them to remain with and devote their best efforts to the business of the Fund, thereby advancing the interests
of the Fund and its stockholders. The Incentive Plan is also intended to enhance the ability of the Fund and its affiliates to
attract and retain the services of individuals who are essential for the growth and profitability of the Fund. The Incentive Plan
permits the award of restricted stock as well as common stock purchase options. The maximum number of shares of common stock that
are subject to awards granted under the Incentive Plan is 2,434,728 shares. The term of the Incentive Plan will expire on June
13, 2026. On March 17, 2017, we granted awards of restricted stock under the Plan to certain of our directors and executive officers
in the aggregate amount of 844,500 shares. The awards are each subject to a vesting requirement over a 3-year period unless the
recipient thereof is terminated or removed from their position as a director or executive officer without “cause”,
or as a result of constructive termination, as such terms are defined in the respective award agreements entered into by each of
the recipients and the Fund. We account for share-based compensation using the fair value method, as prescribed by ASC 718, Compensation—Stock
Compensation. Accordingly, for restricted stock awards, we measure the grant date fair value based upon the market price of our
common stock on the date of the grant and amortize the fair value of the awards as share-based compensation expense over the requisite
service period, which is generally the vesting term. For the six months ended June 30, 2017, we recorded compensation expense of
$1.0 million in connection with these awards.
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 144 producing and non-producing oil and gas wells. The
working interests include associated development rights of approximately 22,360 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
experienced operators, including Chevron USA, Inc., which has operating responsibility for all of Equus Energy’s 40 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 (approximately 8,500 feet) on 2,400 acres in
the Conger Field. Also included in the interests acquired by Equus Energy are working interests of 7.5% and 2.5% in the Burnell
and North Pettus Units, respectively, which collectively comprise approximately 13,000 acres located in the area known as the “Eagle
Ford Shale” play.
Revenue and Income
. During the
three months ended June 30, 2017, Equus Energy’s revenue, operating revenue less direct operating expenses, and net loss
were $0.1 million, $0.08 million, and ($0.1) million, respectively, as compared to revenue, operating revenue less direct operating
expenses, and net loss were $0.1 million, $0.01 million, and ($0.1) million, respectively, for the three months ended June 30,
2016. During the six months ended June 30, 2017, Equus Energy’s revenue, operating revenue less direct operating expenses,
and net loss were $0.5 million, $0.2 million, and ($0.2) million, respectively, as compared to revenue, operating revenue less
direct operating expenses, and net loss were $0.2 million, ($0.2) million, and ($0.6) million, respectively, for the six months
ended June 30, 2016.
Capital Expenditures
. During
the six months ended June 30, 2017 and June 30, 2016, Equus Energy invested $0.01 million and $0.005 million, respectively, in
capital expenditures for small repairs and improvements. The operators of the various working interest communicated their intent
to wait until 2018, commensurate with an anticipated gradual rise in the price of crude oil, to commence new drilling and recompletion
projects.
We do not consolidate Equus Energy or
its wholly-owned subsidiaries and accordingly only the value of our investment in Equus Energy is included on our balance sheets.
Our investment in Equus Energy is valued in accordance with our normal valuation procedures and is based in part on using a discounted
cash flow analysis based on a reserve report prepared for Equus Energy by Lee Keeling & Associates, Inc., an independent petroleum
engineering firm, the transactions and values of comparable companies in this sector, and the estimated value of leasehold mineral
interests associated with the acreage held by Equus Energy. A valuation of Equus Energy was performed by a third-party valuation
firm, who recommended a value range of Equus Energy consistent with the fair value determined by our Management (See
Schedule
of Investments
)
.
Below is summarized consolidated financial information
for Equus Energy as of June 30, 2017 and December 31, 2016 and for the three months and six months ended June 30, 2017 and 2016,
respectively, (in thousands):
EQUUS ENERGY, LLC
Unaudited Condensed Consolidated Balance
Sheets
|
|
June 30,
|
|
December 31,
|
|
|
2017
|
|
2016
|
Assets
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
301
|
|
|
$
|
291
|
|
Accounts receivable
|
|
|
93
|
|
|
|
91
|
|
Other current assets
|
|
|
33
|
|
|
|
32
|
|
Total current assets
|
|
|
427
|
|
|
|
414
|
|
Oil and gas properties
|
|
|
8,064
|
|
|
|
8,055
|
|
Less: accumulated depletion, depreciation and amortization
|
|
|
(7,342
|
)
|
|
|
(7,145
|
)
|
Net oil and gas properties
|
|
|
722
|
|
|
|
910
|
|
Total assets
|
|
$
|
1,149
|
|
|
$
|
1,324
|
|
|
|
|
|
|
|
|
|
|
Liabilities and member's equity
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and other
|
|
$
|
113
|
|
|
$
|
75
|
|
Due to affiliate
|
|
|
586
|
|
|
|
611
|
|
Total current liabilities
|
|
|
699
|
|
|
|
686
|
|
Asset retirement obligations
|
|
|
187
|
|
|
|
184
|
|
Total liabilities
|
|
|
886
|
|
|
|
870
|
|
|
|
|
|
|
|
|
|
|
Total member's equity
|
|
|
263
|
|
|
|
454
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and member's equity
|
|
$
|
1,149
|
|
|
$
|
1,324
|
|
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 operations 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 operations 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
Unaudited Condensed Consolidated Statements
of Operations
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Operating revenue
|
|
$
|
229
|
|
|
$
|
105
|
|
|
$
|
476
|
|
|
$
|
163
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct operating expenses
|
|
|
152
|
|
|
|
94
|
|
|
|
299
|
|
|
|
356
|
|
Depletion, depreciation, amortization and accretion
|
|
|
103
|
|
|
|
73
|
|
|
|
200
|
|
|
|
136
|
|
General and administrative
|
|
|
75
|
|
|
|
73
|
|
|
|
168
|
|
|
|
242
|
|
Total operating expenses
|
|
|
330
|
|
|
|
240
|
|
|
|
667
|
|
|
|
734
|
|
Operating loss before income tax expense
|
|
|
(101
|
)
|
|
|
(135
|
)
|
|
|
(191
|
)
|
|
|
(571
|
)
|
Net loss
|
|
$
|
(101
|
)
|
|
$
|
(135
|
)
|
|
$
|
(191
|
)
|
|
$
|
(571
|
)
|
EQUUS ENERGY, LLC
Unaudited Condensed Consolidated Statements
of Cash Flows
|
|
Six Months Ended June 30,
|
|
|
2017
|
|
2016
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(191
|
)
|
|
$
|
(571
|
)
|
Adjustments to reconcile net loss to
|
|
|
|
|
|
|
|
|
net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depletion, depreciation, amortization and accretion
|
|
|
200
|
|
|
|
136
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(2
|
)
|
|
|
89
|
|
Prepaid expenses and other current assets
|
|
|
(1
|
)
|
|
|
—
|
|
Affiliate payable/receivable
|
|
|
(25
|
)
|
|
|
—
|
|
Accounts payable and other
|
|
|
38
|
|
|
|
(83
|
)
|
Net cash used in operating activities
|
|
|
19
|
|
|
|
(429
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Investment in oil & gas properties
|
|
|
(9
|
)
|
|
|
(5
|
)
|
Net cash used in investing activities
|
|
|
(9
|
)
|
|
|
(5
|
)
|
Net decrease in cash
|
|
|
10
|
|
|
|
(434
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
291
|
|
|
|
517
|
|
Cash and cash equivalents at end of period
|
|
$
|
301
|
|
|
$
|
83
|
|
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 and $0.07 million for the three months ended
June 30, 2017 and June 30, 2016, respectively and $0.2 million and $0.1 million for the six months ended June 30, 2017 and June
30, 2016, 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 June 30, 2017, the present value of estimated future net revenue from the projected production of proved oil and gas reserves, calculated at the simple arithmetic average, first-day-of-the-month prices during the twelve-month period before the balance sheet date (with consideration of price changes only to the extent provided by contractual arrangements) and a discount factor of 10%;
|
|
(b)
|
The cost of investments in unproved and unevaluated properties excluded from the costs being amortized; and
|
|
(c)
|
The lower of cost or estimated fair value of unproved properties included in the costs being amortized.
|
When it is determined that oil and gas
property costs exceed the ceiling limitation, an impairment charge is recorded to reduce its carrying value to the ceiling limitation.
The Company did not recognize an impairment loss on its oil and gas properties during the six months ended June 30, 2017 and June
30, 2016, respectively.
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 is 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 components of its income and expenses flow through directly
to the members. However, the Company is subject to certain state income taxes. 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. Taxable Subsidiaries 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. As of June 30, 2017 and June 30, 2016, the Company had no federal income
tax expense.
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.
Management performed an evaluation of
the Fund’s activity through the date the financial statements were issued, noting the following subsequent events:
On July 3, 2017, we sold U.S. Treasury
Bills for $35.0 million and repaid our margin loan.
On July 31, 2017, this authorization
given by our shareholders to withdraw our BDC election expired (see Note 6 –
Plan of Reorganization
).
On August 8, 2017, we agreed to extend
the maturity date of the $1.0 million promissory note issued to Equus by 5
th
Element Tracking, LLC to May 14, 2018 in exchange for $32,500, consisting of $12,500 in PIK interest and two cash
payments of $10,000.