Quarterly Report (10-q)

Date : 08/14/2019 @ 4:39PM
Source : Edgar (US Regulatory)
Stock : Equus Total Return Inc (EQS)
Quote : 1.61  0.0422 (2.69%) @ 4:33PM

Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2019

 

or

 

  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period to

Commission File Number 814-00098

EQUUS TOTAL RETURN, INC.

(Exact name of registrant as specified in its charter)

 

Delaware 76-0345915

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

   

700 Louisiana St., 48 th Floor

Houston, Texas

 

77002

(Address of principal executive offices) (Zip Code)

 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Registrant’s telephone number, including area code: (713) 529-0900

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Name of each exchange

on which registered

Common Stock New York Stock Exchange

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer Accelerated filer Non-accelerated filer Smaller Reporting Company Emerging Growth Company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   

 

Indicate by check mark whether the registrant is a shell company. Yes No

 

There were 13,518,146 shares of the registrant’s common stock, $.001 par value, outstanding, as of August 14, 2019

 

 

     

EQUUS TOTAL RETURN, INC.

(A Delaware Corporation)

 

INDEX

 

 

  PAGE
PART I. FINANCIAL INFORMATION  
Item 1. Unaudited Condensed Financial Statements 3
Condensed Balance Sheets 3
Condensed Statements of Operations 4
Condensed Statements of Changes in Net Assets 5
Condensed Statements of Cash Flows 6
Supplemental Information—Selected Per Share Data and Ratios 7
Schedules of Investments 8
Notes to Condensed Financial Statements 12
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 27
Item 3. Quantitative and Qualitative Disclosure about Market Risk 32
Item 4. Controls and Procedures 32
PART II. OTHER INFORMATION  
Item 1 . Legal Proceedings 33
Item 1A. Risk Factors 33
Item 6. Exhibits 34
SIGNATURE 35
   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  2  

 

EQUUS TOTAL RETURN, INC.

CONDENSED BALANCE SHEETS

(Unaudited)

 

Part I. Financial Information

Item 1. Unaudited Condensed Financial Statements

   

June 30,

2019

 

December 31,

2018

(in thousands, except per share amounts)                
Assets                
Investments in portfolio securities at fair value:                
     Control investments (cost at $7,050 and $10,050, respectively)   $ 10,500     $ 9,210  
     Affiliate investments (cost at $350)     24,500       20,500  
     Non-affiliate investments - related party (cost at $6,737 and $6,579, respectively)     5,018       4,328  
     Non-affiliate investments (cost at $977)     977       977  
        Total investments in portfolio securities at fair value     40,995       35,015  
Temporary cash investments     26,990       26,981  
Cash and cash equivalents     5,407       7,425  
Restricted cash     270       270  
Accounts receivable from affiliates     561       561  
Accrued interest and dividend receivable     489       568  
Other assets     258       121  
          Total assets     74,970       70,941  
Liabilities and net assets                
     Accounts payable     24       196  
     Accounts payable to related parties     23       269  
     Borrowing under margin account     26,990       26,981  
          Total liabilities     27,037       27,446  
                 
Commitments and contingencies (see Note 2)                
                 
Net assets   $ 47,933     $ 43,495  
                 
Net assets consist of:                
     Common stock, par value   $ 13     $ 13  
     Capital in excess of par value     55,901       55,741  
     Undistributed net investment losses     (31,114 )     (29,327 )
     Undistributed net capital (losses) gains     (2,748 )     9  
     Unrealized appreciation of portfolio securities, net     27,600       19,310  
     Unrealized depreciation of portfolio securities, net - related party     (1,719 )     (2,251 )
          Total net assets   $ 47,933     $ 43,495  
Shares of common stock issued and outstanding, $.001 par value, 50,000 shares authorized     13,518       13,518  
Shares of preferred stock issued and outstanding, $.001 par value, 5,000 shares authorized     —         —    
Net asset value per share   $ 3.55     $ 3.22  

 

The accompanying notes are an integral part of these financial statements.

 

  3  

 

EQUUS TOTAL RETURN, INC.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited) 

 

    Three Months Ended June 30,   Six Months Ended June 30,
(in thousands, except per share amounts)   2019   2018   2019   2018
Investment income:                                
     Interest and dividend income:                                
        Non-affiliate investments - related party   $ 80     $ 75     $ 80     $ 149  
        Non-affiliate investments     —         35       —         69  
           Total interest and dividend income     80       110       80       218  
     Interest from temporary cash investments     11       7       26       12  
         Total investment income     91       117       106       230  
                                 
Expenses:                                
     Compensation expense     380       387       779       898  
     Professional fees     214       406       571       805  
     Director fees and expenses     117       118       202       196  
     General and administrative expenses     108       84       219       174  
     Mailing, printing and other expenses     55       46       95       67  
     Taxes     11       11       21       13  
     Interest expense     2       1       6       4  
          Total expenses     887       1,053       1,893       2,157  
                                 
                                 
Net investment loss     (797 )     (936 )     (1,787 )     (1,927 )
                                 
Net realized (loss) gain:                                
     Affiliate investments     (2,790 )     —         (2,790 )     —    
     Temporary cash investments     23       (1 )     33       1  
        Net realized (loss) gain     (2,767 )     (1 )     (2,757 )     1  
                                 
Net unrealized appreciation of portfolio securities:                                
     End of period     27,600       17,812       27,600       17,812  
     Beginning of period     22,811       15,862       19,310       14,498  
Net change in net unrealized appreciation of portfolio securities     4,789       1,950       8,290       3,314  
                                 
Net unrealized depreciation of portfolio securities - related party:                                
     End of period     (1,719 )     (1,575 )     (1,719 )     (1,575 )
     Beginning of period     (1,795 )     (1,355 )     (2,251 )     (1,036 )
Net change in net unrealized depreciation of portfolio securities - related party     76       (220 )     532       (539 )
                                 
Net increase in net assets resulting from operations   $ 1,301     $ 793     $ 4,278     $ 849  
                                 
Net increase in net assets resulting from operations per share:                                
      Basic and diluted   $ 0.10     $ 0.06     $ 0.32     $ 0.06  
Weighted average shares outstanding:                                
      Basic and diluted     13,518       13,518       13,518       13,518  

 

The accompanying notes are an integral part of these financial statements.

 

  4  

 

EQUUS TOTAL RETURN, INC.

CONDENSED STATEMENTS OF CHANGES IN NET ASSETS

(Unaudited)

    Common Stock                        
(in thousands)   Number of Shares   Par Value   Capital in Excess of Par Value   Undistributed Net Investment Losses   Undistributed Net Capital (Losses) Gains   Unrealized Appreciation of Portfolio Securities, net   Unrealized Depreciation of Portfolio Securities - Related Party   Total Net Assets
 Balances at January 1, 2018     13,518       13       55,304       (25,772 )     —         14,498       (1,036 )     43,007  
                                                                 
 Share-based incentive compensation     —         —         197       —         —         —         —         197  
                                                                 
 Net (decrease) increase in net assets resulting from operations     —         —         —         (991 )     2       1,364       (319 )     56  
                                                                 
 Balances at March 31, 2018     13,518     $ 13     $ 55,501     $ (26,763 )   $ 2     $ 15,862     $ (1,355 )   $ 43,260  
                                                                 
 Share-based incentive compensation     —         —         —         —         —         —         —         —    
                                                                 
 Net increase (decrease) in net assets resulting from operations     —         —         79       (936 )     (1 )     1,950       (220 )     872  
 `                                                                
 Balances at June 30, 2018     13,518     $ 13     $ 55,580     $ (27,699 )   $ 1     $ 17,812     $ (1,575 )   $ 44,132  
                                                                 
                                                                 
 Balances at January 1, 2019     13,518     $ 13     $ 55,741     $ (29,327 )   $ 9     $ 19,310     $ (2,251 )   $ 43,495  
                                                                 
 Share-based incentive compensation     —         —         80       —         —         —         —         80  
                                                                 
 Net decrease (increase) in net assets resulting from operations     —         —         —         (990 )     10       3,501       456       2,977  
 `                                                                
 Balances at March 31, 2019     13,518     $ 13     $ 55,821     $ (30,317 )   $ 19     $ 22,811     $ (1,795 )   $ 46,552  
                                                                 
 Share-based incentive compensation     —         —         80       —         —         —         —         80  
                                                                 
 Net decrease (increase) in net assets resulting from operations     —         —         —         (797 )     (2,767 )     4,789       76       1,301  
 `                                                                
 Balances at June 30, 2019     13,518     $ 13     $ 55,901     $ (31,114 )   $ (2,748 )   $ 27,600     $ (1,719 )   $ 47,933  

 

The accompanying notes are an integral part of these financial statements

 

  5  

 

EQUUS TOTAL RETURN, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

     
    Six Months Ended June 30,
(in thousands)   2019   2018
Reconciliation of increase in net assets resulting from operations to net cash        
      (used in) provided by operating activities:                
Net increase in net assets resulting from operations   $ 4,278     $ 849  
Adjustments to reconcile net increase in net assets resulting from operations to net cash (used in) provided by operating activities:                
     Net realized loss (gain)     2,757       (1 )
     Net change in unrealized appreciation of portfolio securities     (8,290 )     (3,314 )
     Net change in unrealized depreciation of portfolio securities - related party     (532 )     539  
     Share-based incentive compensation     160       276  
     Dissolution of portfolio securities     211          
Changes in operating assets and liabilities:                
     Purchases of temporary cash investments, net     24       6,002  
     Accounts receivable from affiliates     —         25  
     Accrued interest and dividend receivable     (80 )     (218 )
     Other assets     (137 )     85  
     Accounts payable and accrued liabilities     (172 )     217  
     Accounts payable to related parties     (246 )     35  
Net cash (used in) provided by operating activities     (2,027 )     4,495  
Cash flows from financing activities:                
     Borrowings under margin account     53,967       30,990  
     Repayments under margin account     (53,958 )     (36,991 )
Net cash provided by (used in) financing activities     9       (6,001 )
Net decrease in cash and cash equivalents     (2,019 )     (1,506 )
Cash and cash equivalents and restricted cash at beginning of period     7,695       10,975  
                 
Cash and cash equivalents and restricted cash at end of period   $ 5,677     $ 9,469  
Non-cash operating and financing activities:                
     Accrued interest or dividends exchanged for portfolio securities - related party   $ 159     $ 149  
                 
Supplemental disclosure of cash flow information:                
     Interest paid   $ —       $ 4  
     Income taxes paid   $ 10     $ 13  

 

The accompanying notes are an integral part of these financial statements.

 

 

  6  

 

EQUUS TOTAL RETURN, INC.

SUPPLEMENTAL INFORMATION—SELECTED PER SHARE DATA AND RATIOS

(Unaudited)

 

    Six Months Ended June 30,
    2019   2018
         
Investment income   $ 0.01     $ 0.02  
Expenses     0.14       0.16  
                 
Net investment loss     (0.13 )     (0.14 )
                 
Net realized loss     (0.20 )     —    
Net change in unrealized appreciation     0.61       0.24  
Net change in unrealized depreciation - related party     0.04       (0.04 )
Net increase in net assets     0.32       0.06  
Capital transactions:                
  Share-based incentive compensation     0.01       0.02  
  Dilutive effect of shares issued     —         —    
Increase in net assets resulting from capital transactions     0.01       0.02  
Net increase in net assets     0.33       0.08  
Net assets at beginning of period     3.22       3.18  
Net assets at end of period, basic and diluted   $ 3.55     $ 3.26  
Weighted average number of shares outstanding during period,                
     in thousands     13,518       13,518  
Market price per share:                
      Beginning of period   $ 1.96     $ 2.40  
      End of period   $ 1.64     $ 2.36  
Selected information and ratios:                
      Ratio of expenses to average net assets     4.14 %     4.95 %
      Ratio of net investment loss to average net assets     (3.91 %)     (4.42 %)
Ratio of net increase in net assets resulting from operations to average net assets     9.36 %     1.95 %
      Total return on market price (1)     (16.33 %)     (1.67 %)

(1) Total return = [(ending market price per share - beginning price per share) / beginning market price per share ].

 

The accompanying notes are an integral part of these financial statements.

 

 

 

  7  

 

EQUUS TOTAL RETURN, INC.

SCHEDULE OF INVESTMENTS

JUNE 30, 2019

(Unaudited)

(in thousands, except share data)

    Date of Initial          Cost of     Fair 
Portfolio Company Industry Investment Investment   Principal   Investment   Value (1)
Control Investments:  Majority-owned (3) :                  

Equus Energy, LLC

Houston, TX

 Energy   December 2011   Member interest (100%)      $  7,050   $ 10,500
Total Control Investments: Majority-owned (represents 15.4% of total investments at fair value)     $ 7,050   $ 10,500
Affiliate Investments (4) :                  

PalletOne, Inc.

Bartow, FL

 Shipping products and services   October 2001   350,000 shares of common stock (18.7%)      $ 350   $ 24,500
Total Affiliate Investments (represents 34.1% of total investments at fair value)     $ 350   $ 24,500
Non-Affiliate Investments - Related Party (less than 5% owned):            

MVC Capital, Inc.

Purchase, NY

Financial services May 2014 544,813 shares of common stock (1.7%)     $ 6,737   $ 5,018
Total Non-Affiliate Investments - Related Party (represents 7.4% of total investments at fair value)     $ 6,737     5,018
Non-Affiliate Investments (less than 5% owned):            

5 TH Element Tracking, LLC

Boston, MA

Business products and services January 2015 14% promissory note due 5/18 (2) $  977   $  977   $ 977
Total Non-Affiliate Investments (represents 1.4% of total investments at fair value)     $ 977   $ 977
Total Investment in Portfolio Securities           $ 15,114   $ 40,995
Temporary Cash Investments                  
U.S. Treasury Bill Government June 2019 UST 0% 7/19 $ 26,990   $ 26,990   $ 26,990
Total Temporary Cash Investments (represents 40.9% of total investments at fair value)     $ 26,990   $ 26,990
Total Investments           $ 42,104   $ 67,985

 

(1) See Note 3 to the financial statements, Valuation of Investments.
(2) Non-income-producing.  See notes 5 and 9 to the financial statements.
(3) Majority owned investments are generally defined under the 1940 Act as companies in which we own more than 50% of the voting securities of the company.
(4) Affiliate investments are generally defined under the 1940 Act as companies in which we own at least 5% but not more than 25% voting securities of the company.

 

The accompanying notes are an integral part of these financial statements.

 

  8  

EQUUS TOTAL RETURN, INC.

SCHEDULE OF INVESTMENTS – (Continued)

JUNE 30, 2019

(Unaudited)

 

Except for our holding of shares of MVC Capital, Inc. (“MVC”), all of our portfolio securities are restricted from public sale without prior registration under the Securities Act of 1933 (hereafter, the “Securities Act”) 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 business development company (“BDC”) regulated pursuant to the Investment Company Act of 1940 (“1940 Act”), 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 June 30, 2019, we held 87.8% of our assets at fair value in securities of portfolio companies that constituted qualifying investments under the 1940 Act. As of June 30, 2019, 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 85.4% of the total value of the investments in portfolio securities as of June 30, 2019.

 

We are classified as a “non-diversified” investment company under the 1940 Act, which means we are not limited in the proportion of our assets that may be invested in the securities of a single issuer. The value of one segment called “Shipping products and services” includes one portfolio company and was 51.1% of our net asset value, 32.7% of our total assets and 59.8% of our investments in portfolio company securities (at fair value) as of June 30, 2019. The value of one segment called “Energy” includes one portfolio company and was 21.9% of our net asset value, 14.0% of our total assets and 25.6% of our investments in portfolio company securities (at fair value) as of June 30, 2019. Changes in business or industry trends or in the financial condition, results of operations, or the market’s assessment of any single portfolio company will affect the net asset value and the market price of our common stock to a greater extent than would be the case if we were a “diversified” company holding numerous investments.

 

Our investments in portfolio securities consist of the following types of securities as of June 30, 2019 (in thousands):

Type of Securities   Cost   Fair Value  

Fair Value as Percentage of

Net Assets

             
Common stock   $ 7,087     $ 29,518       61.6 %
Limited liability company investments     7,050       10,500       21.9 %
Secured and subordinated debt     977       977       2.0 %
Total   $ 15,114     $ 40,995       85.5 %

 

The following is a summary by industry of the Fund’s investments in portfolio securities as of June 30, 2019 (in thousands):

 

Industry   Fair Value  

Fair Value as Percentage of

Net Assets

Shipping products and services     24,500       51.1 %
Energy     10,500       21.9 %
Financial services     5,018       10.5 %
Business products and services     977       2.0 %
Total   $ 40,995       85.5 %

 

The accompanying notes are an integral part of these financial statements.

  9  

 

EQUUS TOTAL RETURN, INC.

SCHEDULE OF INVESTMENTS

DECEMBER 31, 2018

(Unaudited)

(in thousands, except share data)

 

Name and location of   Date of Initial         Cost of   Fair
Portfolio Company Industry Investment Investment   Principal   Investment   Value (1)
Control Investments:  Majority-owned (3) :                  

Equus Energy, LLC

Houston, TX

 Energy   December 2011   Member interest (100%)      $    7,050   $    9,000

Equus Media Development Company, LLC

Houston, TX

 Media   January 2007   Member interest (100%)             3,000          210
Total Control Investments: Majority-owned (represents 14.9% of total investments at fair value)     $    10,050   $      9,210
Affiliate Investments (4) :                  

PalletOne, Inc.

Bartow, FL

 Shipping products and services   October 2001   350,000 shares of common stock (18.7%)      $      350   $     20,500
Total Affiliate Investments (represents 33.1% of total investments at fair value)     $    350   $    20,500
Non-Affiliate Investments - Related Party (less than 5% owned):            

MVC Capital, Inc.

Purchase, NY

Financial services May 2014 527,138 shares of common stock (1.7%)     $   6,579   $    4,328
Total Non-Affiliate Investments - Related Party (represents 7.0% of total investments at fair value)     $    6,579   $    4,328
Non-Affiliate Investments (less than 5% owned):            

5 TH Element Tracking, LLC

Boston, MA

Business products and services January 2015 14% promissory note due 5/18 (2) $       977   $      977   $      977
Total Non-Affiliate Investments (represents 1.5% of total investments at fair value)     $        977   $         977
Total Investment in Portfolio Securities           $    17,956   $      35,015
Temporary Cash Investments                  
U.S. Treasury Bill Government December 2018 UST 0% 1/19 $       26,981   $     26,981   $       26,981
Total Temporary Cash Investments (represents 43.5% of total investments at fair value)     $     26,981   $       26,981
Total Investments           $     44,937   $       61,996

 

(1) See Note 3 to the financial statements, Valuation of Investments.
(2) Non-income producing.
(3) Majority owned investments are generally defined under the 1940 Act as companies in which we own more than 50% of the voting securities of the company.
(4) Affiliate investments are generally defined under the 1940 Act as companies in which we own at least 5% but not more than 25% voting securities of the company.

 

The accompanying notes are an integral part of these financial statements.

 

  10  

 

EQUUS TOTAL RETURN, INC.

SCHEDULE OF INVESTMENTS – (Continued)

DECEMBER 31, 2018

(in thousands, except share data)

 

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.

 

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, 2018, we had invested 87.5% of our assets in securities of portfolio companies that constituted qualifying investments under the 1940 Act. As of December 31, 2018, 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 84.6% of the total value of the investments in portfolio securities as of December 31, 2018.

 

We are classified as a “non-diversified” investment company under the 1940 Act, which means we are not limited in the proportion of our assets that may be invested in the securities of a single issuer. The value of one segment called “Shipping products and services” includes one portfolio company and was 47.1% of our net asset value, 28.9% of our total assets and 58.5% of our investments in portfolio company securities (at fair value) as of December 31, 2018. The value of one segment called “Energy” includes one portfolio company and was 20.7% of our net asset value, 12.7% of our total assets and 25.7% of our investments in portfolio company securities (at fair value) as of December 31, 2018. Changes in business or industry trends or in the financial condition, results of operations, or the market’s assessment of any single portfolio company will affect the net asset value and the market price of our common stock to a greater extent than would be the case if we were a “diversified” company holding numerous investments.

 

Our investments in portfolio securities consist of the following types of securities as of December 31, 2018 (in thousands):  

 

Type of Securities   Cost   Fair Value  

Fair Value as Percentage of

Net Assets

Common stock   $ 6,929     $ 24,828       57.1 %
Limited liability company investments     10,050       9,210       21.2 %
Secured and subordinated debt     977       977       2.2 %
Total   $ 17,956     $ 35,015       80.5 %

 

The following is a summary by industry of the Fund’s investments in portfolio securities as of December 31, 2018 (in thousands):

 

Industry   Fair Value  

Fair Value as Percentage of

Net Assets

Shipping products and services     20,500       47.1 %
Energy     9,000       20.7 %
Financial services     4,328       9.9 %
Business products and services     977       2.2 %
Media     210       0.6 %
Total   $ 35,015       80.5 %

 

The accompanying notes are an integral part of these financial statements. 

  11  

EQUUS TOTAL RETURN, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

JUNE 30, 2019

(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 our 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 may include 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 three months ended June 30, 2019 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, 2018, as filed with the Securities and Exchange Commission (“SEC”).

  12  

 

  (2) Liquidity and Financing Arrangements

 

Liquidity —There are several factors that may materially affect our liquidity during the reasonably foreseeable future. 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, 2019, we had cash and cash equivalents of $5.4 million. We had $41.0 million of our net assets of $47.9 million invested in portfolio securities.

 

As of December 31, 2018, we had cash and cash equivalents of $7.4 million. We had $35.0 million of our net assets of $43.5 million invested in portfolio securities

 

We exclude “Restricted Cash and Temporary Cash Investments” used for purposes of complying with RIC requirements from cash equivalents.

 

Restricted Cash and Temporary Cash Investments — As of June 30, 2019, we had $27.2 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, $27.3 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 matured on July 5, 2019 and we subsequently repaid this margin loan, plus interest.

 

As of December 31, 2018, we had $27.3 million of restricted cash and of 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. Of this amount, $27.0 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 2, 2019 and we subsequently repaid this margin loan, plus interest.

 

Dividends —So long as we remain a BDC, we will pay out net investment income and/or realized net 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, 2019, 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 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, 2019, we borrowed $27.0 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 $27.3 million.

 

As of December 31, 2018, we borrowed $27.0 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 $27.3 million.

  13  

Certain Risks and Uncertainties —Market and economic volatility which has become endemic in the past few years has constrained the availability of 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 2019, 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 change to our business and become an operating company as described in Note 6 – Plan of Reorganization below. We believe we have sufficient liquidity to meet our operating requirements for the remainder of 2019 and the first six months of 2020.

 

  (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

  14  

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. A 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. In the case of our investment in Equus Energy, we also examine acreage values in comparable transactions and assess the impact upon the working interests held by Equus Energy. 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

  15  

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, 2019 and the year ended December 31, 2018.

 

As of June 30, 2019, 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, 2019
(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   $ 10,500     $ —       $ —       $ 10,500  
Affiliate investments     24,500       —         —         24,500  
Non-affiliate investments - related party     5,018       5,018       —         —    
Non-affiliate investments     977       —         —         977  
Total investments     40,995       5,018       —         35,977  
        Temporary cash investments     26,990       26,990       —         —    
Total investments and temporary cash investments   $ 67,985     $ 32,008     $ —       $ 35,977  

  

  16  

 

As of December 31, 2018, 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, 2018
(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   $ 9,210     $ —       $ —       $ 9,210    
Affiliate investments     20,500       —         —         20,500    
Non-affiliate investments - related party     4,328       4,328       —         —      
Non-affiliate investments     977       —         —         977    
Total investments     35,015       4,328       —         30,687    
        Temporary cash investments     26,981       26,981       —         —      
Total investments and temporary cash investments   $ 61,996     $ 31,309     $ —       $ 30,687    

 

 

The following table provides a reconciliation of fair value changes during the six months ended June 30, 2019 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, 2018           $ 9,210     $ 20,500     $ 977     $30,687
Realized losses             (2,790 )     —         —       (2,790)
Change in unrealized appreciation             4,291       4,000       —       8,291
Proceeds from sales/dispositions             (211 )     —         —       (211)
Transfers in (out) of Level 3             —         —         —       -
Fair value as of June 30, 2019           $ 10,500     $ 24,500     $ 977     $35,977

 

The following table provides a reconciliation of fair value changes during the three months ended June 30, 2018 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, 2017           $ 8,212     $ 16,686     $ 977     $25,875
Change in unrealized appreciation             1,000       2,314       —       3,314
Fair value as of June 30, 2018           $ 9,212     $ 19,000     $ 977     $29,189

 

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.

  

  17  

 

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, 2019:

 

                Range
(in thousands)   Fair Value   Valuation Techniques   Unobservable Inputs   Minimum   Maximum
Secured and subordinated debt   $ 977     Yield analysis   Discount for lack of marketability     0 %     0 %
Common stock     24,500    

Income/

Market approach

  EBITDA Multiple/Discount for lack of marketability/Control premium     10 %     32.5 %
Limited liability company investments     10,500    

Asset approach

Discounted cash flow; Guideline transaction method

 

Recovery rate

Reserve adjustment factors Market approach

    75 %     100 %
    $ 35,977                          

 

Because of the inherent uncertainty of the valuation of portfolio securities which do not have readily ascertainable market values, amounting to $36.0 million and $30.7 million as of June 30, 2019 and December 31, 2018, 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, 2019 and December 31, 2018, one of our portfolio investments, consisting of 544,813 and 527,138 common shares of MVC, respectively, 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 .

 

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. See also Note 4 for discussion of related party investment transactions.

 

As of June 30, 2019, 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

  18  

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 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 and account for forfeitures as they occur.

 

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.

 

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, 2018.

 

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 six months ended June 30, 2019, respectively, and we paid $3 thousand in state income tax for the year ended December 31, 2018.

 

Accounting Standards Recently Adopted — 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 and the use of practical expedient for leases less 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 was permitted. The adoption of ASU 2016-02 did not have an impact on our financial statements as we currently have no operating leases as our principal offices are under a month-to-month lease arrangement for annual periods beginning after December 15, 2018, and interim periods therein. Early application is permitted. There was no impact on the financial position or financial statement disclosures.

 

Accounting Standards Not Yet Adopted —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

  19  

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. There was no impact on the financial position or financial statement disclosures.

 

On August 28, 2018, the FASB issued ASU 2018-13, which changes the fair value measurement disclosure requirements of ASC 820. The amendments remove certain disclosure requirements and modify certain others. The amendments remove the requirement to disclose (1) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, (2) the policy for timing of transfers between levels, (3) the valuation processes for Level 3 fair value measurements and (4) the changes in unrealized gains and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of the reporting period. Also, (1) in lieu of a roll-forward for Level 3 fair value measurements, an entity is required to disclose transfers into and out of Level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities, (2) for investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly, and (3) the amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. Early adoption is permitted. We are currently evaluating the impact of ASU 2018-13 on our financial statements and will make any disclosure adjustments in year-end financial statements.

 

  (4) Related Party Transactions and Agreements

 

Except as noted below, as compensation for services to the Fund, each Independent Director receives an annual fee of $40,000 paid quarterly in arrears, a fee of $2,000 for each meeting of the Board of Directors or committee thereof attended in person, a fee of $1,000 for participation in each telephonic meeting of the Board or committee thereof, and reimbursement of all out-of-pocket expenses relating to attendance at such meetings. The chair of each of our standing committees (audit, compensation, and nominating and governance) also receives an annual fee of $50,000, payable quarterly in arrears. 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. None of our interested directors receive annual fees for their service on the Board of Directors.

 

We may also pay other one-time or recurring fees to members of our Board of Directors in special circumstances. 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 $300 per hour for services.  During each of the six months ended June 30, 2019 and June 30, 2018, we paid Kenneth I. Denos, P.C., a professional corporation owned by Kenneth I. Denos, a director of the Fund, $0.2 million for services provided to the Fund.

  20  

   

  (5) Portfolio Securities

 

During the six months ended June 30, 2019, we received dividends in the form of additional shares of $0.2 million relating to our shareholding in MVC.

 

Also during the six months ended June 30, 2019, we dissolved Equus Media Development Company, LLC (“EMDC”), a wholly-owned subsidiary of the Fund and transferred EMDC’s assets, consisting of approximately $210,000 in cash and various creative entertainment properties, to the Fund. 

 

During the six months ended June 30, 2019, we recorded a net change in unrealized appreciation of $8.8 million, to a net unrealized appreciation of $25.9 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 an increase in the share price of MVC and the receipt of dividend payments in the form of additional shares of MVC during the period;
     
  (ii) Increase in fair value of our shareholding in PalletOne, Inc. of $4.0 million due to improved operating performance and overall improvement in comparable industry sectors;
     
  (iii) Transfer of unrealized depreciation to realized loss of our holdings in EMDC of $2.8 million in connection with the dissolution of EMDC and the transfer of its assets to the Fund; and
     
  (iv) Increase in the fair value of our holdings in Equus Energy, LLC of $1.5 million, principally due to increases in mineral acreage prices proximate to the company’s leasehold interests and an increase in the short- and long-term prices for crude oil during the first half of 2019.

  

During the six months ended June 30, 2018, 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, 2018, we recorded a net change in unrealized appreciation of $2.9 million, to a net unrealized appreciation of $16.2 million. Such change in unrealized appreciation resulted primarily from the following changes:

  

  (i)

Decrease in the fair value of our shareholding in MVC of $0.4 million due to a decrease in the share price of MVC, offset by the receipt of dividend payments in the form of additional shares of MVC during the period;

 

  (ii)

Increase in fair value of our shareholding in PalletOne, Inc. of $2.3 million due to increases in revenue and EBITDA, as well as promising acquisition and growth prospects; and

 

  (iii)

Increase in the fair value of our holdings in Equus Energy, LLC of $1.0 million, principally due to increases in mineral acreage prices proximate to the company’s leasehold interests and a moderate increase in the short- and long-term prices for crude oil and natural gas.

 

 

  21  

 

  (6) Plan of Reorganization

 

Plan of Reorganization and Share Exchange with MVC Capital —On May 14, 2014, we announced that the Fund intended to effect a reorganization pursuant to Section 2(a)(33) of the 1940 Act (hereinafter, the “Plan of Reorganization”). As a first step to consummating the Plan of Reorganization, we sold to MVC Capital, Inc. (“MVC”) 2,112,000 newly-issued shares of the Fund’s common stock in exchange for 395,839 shares of MVC (such transaction is hereinafter referred to as the “Share Exchange”). MVC is a business development company traded on the 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.

 

Pursuant to the terms of a Share Exchange Agreement, dated May 12, 2014, entered into by Equus and MVC which memorialized the Share Exchange, we intend to finalize the Plan of Reorganization by pursuing a merger or consolidation with MVC or an operating company, which operating company may be a subsidiary or portfolio company of MVC (such transaction is hereinafter referred to as a “Consolidation”). Absent Equus merging or consolidating with/into MVC or a subsidiary thereof, our current intention is for Equus to (i) terminate its election to be classified as a BDC under the 1940 Act, and (ii) be restructured as a publicly-traded operating company focused on the energy, natural resources, technology, and/or financial services sector. 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.

 

Authorization to Withdraw BDC Election —On January 21, 2019, 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 to cause the Fund’s withdrawal of its election to be classified as a BDC, effective as of a date designated by the Board and our Chief Executive Officer. Although this authorization, which was given as a consequence of our Plan of Reorganization, expired on July 31, 2019, we expect to receive an additional authorization from our stockholders in the future. Notwithstanding any such 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, even if we are again authorized 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.

 

  (7) 2016 Equity Incentive Plan

 

Share-Based Incentive Compensation —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 Incentive 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. As of March 31, 2019, 280,000 shares of restricted stock which were granted pursuant to the Incentive Plan, remained unvested. We account for share-based compensation using the fair value method, as prescribed by ASC 718. 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, 2019 and 2018, we recorded compensation expense of $0.2 million and $0.3 million, respectively, in connection with these awards. 

  22  

 

  (8) 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, which presently comprise 141 producing and non-producing oil and gas wells. The working interests include associated development rights of approximately 21,520 acres situated on 11 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 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, 2019, Equus Energy’s revenue, operating revenue less direct operating expenses, and net loss were $0.2 million, $0.02 million, and ($0.08) million, respectively, as compared to revenue, operating revenue less direct operating expenses, and net loss which $0.3 million, $0.05 million, and ($0.1) million, respectively, for the three months ended June 30, 2018.

 

Capital Expenditures —During the three months ended June 30, 2019 and June 30, 2018, Equus Energy’s investment, respectively, in capital expenditures for small repairs and improvements was not significant. The operators of the various working interest communicated their intent to wait until 2019, 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 ) .

 

  23  

 

Below is summarized consolidated financial information for Equus Energy as of June 30, 2019 and December 31, 2018 and for the six months June 30, 2019 and 2018, respectively, (in thousands):

 

EQUUS ENERGY, LLC

Unaudited Condensed Consolidated Balance Sheets

 

    June 30,   December 31,
    2019   2018
         
         
Assets        
Current assets:                
Cash and cash equivalents   $ 832     $ 966  
Accounts receivable     112       127  
Other current assets     34       34  
Total current assets     978       1,127  
Oil and gas properties     8,008       8,008  
Less: accumulated depletion, depreciation and amortization     (7,854 )     (7,772 )
Net oil and gas properties     154       236  
Total assets   $1,132     $1,363  
                 
Liabilities and member's equity                
Current liabilities:                
Accounts payable and other   $ 170     $ 131  
Due to affiliate     561       561  
Total current liabilities     731       692  
Asset retirement obligations     198       195  
Total liabilities   929     887  
                 
Total member's equity     203       476  
                 
Total liabilities and member's equity   $1,131     $1,363 1  

 

Revenue and direct operating expenses for the various oil and gas assets included in the unaudited condensed consolidated statements of operations below 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.

 

  24  

 

EQUUS ENERGY, LLC

Unaudited Condensed Consolidated Statements of Operations

 

                 
    Three Months Ended June 30,  

Six Months Ended June 30,

    2019   2018   2019   2018
                 
                 
Operating revenue   $ 217     $ 282     $ 361     $ 577  
Operating expenses                                
Direct operating expenses     198       231       393       394  
General and administrative     73       59       156       153  
Depletion, depreciation, amortization and accretion     31       104       85       186  
Total operating expenses     302       394       634       733  
Operating loss before income tax expense     (85 )     (112 )     (273 )     (156 )
Income tax benefit (expense)     —         —         —         —    
Net loss   $ (85 )   $ (112 )   $ (273 )   $ (156 )

 

EQUUS ENERGY, LLC

Unaudited Condensed Consolidated Statements of Cash Flows

 

    Six Months Ended June 30,
    2019   2018
         
Cash flows from operating activities:                
Net loss     (273 )   $ (156 )
Adjustments to reconcile net loss to                
net cash used in operating activities:                
Depletion, depreciation, amortization and accretion     85       186  
Changes in operating assets and liabilites:                
Accounts receivable     15       (32 )
Prepaid expenses and other current assets     —         —    
Accounts payable and other     39       8  
Due to affiliate     —         (25 )
Net cash used in operating activities     (134 )     (19 )
                 
Cash flows from investing activities:                
Investment in oil & gas properties     —         (63 )
Net cash used in investing activities     —         (63 )
Net decrease in cash     (134 )     (82 )
Cash and cash equivalents at beginning of period     966       307  
Cash and cash equivalents at end of period   $ 832     $ 225  

 

  25  

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 $0.03 million and $0.1 million for the three months ended June 30, 2019 and 2018, respectively and $0.1 million and $0.2 million for the six months ended June 30, 2019 and June 30, 2018, 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, 2019, 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 three months ended June 30, 2019 and 2018, 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.

 

Depreciation, Depletion and Amortization —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, 2019 and 2018, 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.

 

  (9) Subsequent Events

 

Management performed an evaluation of the Fund’s activity through the date the financial statements were issued, noting the following subsequent events:

  

On July 5, 2019, we sold $27.0 million of U.S. Treasury Bills we acquired on margin in June 2019 and used the proceeds to repay the margin loan.

  26  

   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Equus Total Return, Inc. (“we,” “us,” “our,” “Equus,” and the “Fund”), a Delaware corporation, was formed on August 16, 1991. Our shares trade on the New York Stock Exchange under the symbol ‘EQS’. Our investment strategy seeks to provide the highest total return, consisting of capital appreciation and current income.

 

The information contained in this section should be read in conjunction with our financial statements and notes thereto appearing elsewhere in this Quarterly Report and in conjunction with the financial statements and notes thereto in the Fund’s Form 10-K for the year ended December 31, 2018, as filed with the SEC. In addition, some of the statements in this report constitute forward-looking statements. The matters discussed in this Quarterly Report, as well as in future oral and written statements by management of Equus, that are forward-looking statements are based on current management expectations that involve substantial risks and uncertainties which could cause actual results to differ materially from the results expressed in, or implied by, these forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. Important assumptions include our ability to originate new investments, achieve certain margins and levels of profitability, and the availability of additional capital. In light of these and other uncertainties, the inclusion of a forward-looking statement in this Quarterly Report should not be regarded as a representation by us that our plans or objectives will be achieved. The forward-looking statements contained in this Quarterly Report include statements as to:

 

  our future operating results;
  our business prospects and the prospects of our existing and prospective portfolio companies;
  the return or impact of current and future investments;
  our contractual arrangements and other relationships with third parties;
  the dependence of our future success on the general economy and its impact on the industries in which we invest;
  the financial condition and ability of our existing and prospective portfolio companies to achieve their objectives;
  our expected financings and investments;
  our regulatory structure and tax treatment;
  our ability to qualify and operate as a BDC and a RIC, including the impact of changes in laws or regulations governing our operations, or the operations of our portfolio companies;
  the adequacy of our cash resources and working capital;
  the timing of cash flows, if any, from the operations of our portfolio companies;
  the impact of fluctuations in interest rates on our business;
  the valuation of our investments in portfolio companies, particularly those having no liquid trading market;
  our ability to recover unrealized losses; and
  market conditions and our ability to access additional capital, if deemed necessary.

 

There are a number of important risks and uncertainties that could cause our actual results to differ materially from those indicated by such forward-looking statements. For a discussion of factors that could cause our actual results to differ from forward-looking statements contained in this Quarterly Report, please see the discussion in Part II, “Item 1A. Risk Factors”, and in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018. You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this Quarterly Report relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date this Quarterly Report is filed with the SEC.

 

  27  

We attempt to maximize the return to stockholders in the form of current investment income and long-term capital gains by investing in the debt and equity securities of companies with a total enterprise value of between $5.0 million and $75.0 million, although we may engage in transactions with smaller or larger investee companies from time to time. We seek to invest primarily in companies pursuing growth either through acquisition or organically, leveraged buyouts, management buyouts and recapitalizations of existing businesses or special situations. Our income-producing investments consist principally of debt securities including subordinate debt, debt convertible into common or preferred stock, or debt combined with warrants and common and preferred stock. Debt and preferred equity financing may also be used to create long-term capital appreciation through the exercise and sale of warrants received in connection with the financing. We seek to achieve capital appreciation by making investments in equity and equity-oriented securities issued by privately-owned companies (and 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 is 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 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 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 investments. We reflect any such income tax expense on our Statements of Operations.

 

Plan of Reorganization

 

Plan of Reorganization and Share Exchange with MVC Capital —On May 14, 2014, we announced that the Fund intended to effect a reorganization pursuant to Section 2(a)(33) of the 1940 Act (hereinafter, the “Plan of Reorganization”). As a first step to consummating the Plan of Reorganization, we sold to MVC Capital, Inc. (“MVC”) 2,112,000 newly-issued shares of the Fund’s common stock in exchange for 395,839 shares of MVC (such transaction is hereinafter referred to as the “Share Exchange”). MVC is a business development company traded on the 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.

 

Pursuant to the terms of a Share Exchange Agreement, dated May 12, 2014, entered into by Equus and MVC which memorialized the Share Exchange, we intend to finalize the Plan of Reorganization by pursuing a merger or consolidation with MVC or an operating company, which operating company may be a subsidiary or portfolio company of MVC (such transaction is hereinafter referred to as a “Consolidation”). Absent Equus merging or consolidating with/into MVC or a subsidiary thereof, our current intention is for Equus to (i) terminate its election to be classified as a BDC under the 1940 Act, and (ii) be restructured as a publicly-traded operating company focused on the energy, natural resources, technology, and/or financial services sector. 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.

 

  28  

Authorization to Withdraw BDC Election — On January 21, 2019, 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 to cause the Fund’s withdrawal of its election to be classified as a BDC, effective as of a date designated by the Board and our Chief Executive Officer. Although this authorization, which was given as a consequence of our Plan of Reorganization, expired on July 31, 2019, we expect to receive an additional authorization from our stockholders in the future. Notwithstanding any such 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, even if we are again authorized 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.

 

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. For the three months ended March 31, 2019 and 2018, we recorded compensation expense of $0.08 million and $0.2 million, respectively, in connection with these awards.

 

Critical Accounting Policies

 

See the Fund’s Critical Accounting Policies from the disclosure set forth in the Fund’s Annual Report on Form 10-K for the year ended December 31, 2018.  

 

Current Market Conditions

 

The U.S. economy expanded at an annualized rate of 2.1% during the second quarter of 2019, following growth of 3.1% during the first quarter of 2019 and an increase of 2.9% for all of 2018. The decrease in GDP during the second quarter of 2019 was principally due to decreased exports, higher inventories, lower fixed residential and nonresidential investment, and increased imports. Despite rising trade tensions, the Conference Board Economic Forecast projects overall GDP growth in 2019 to be 2.5%, decreasing to 2.0% for 2020. The U.S. unemployment rate is near a 50-year low, continuing to present a tight labor market for employers. Meanwhile, housing starts and building permits slowed during 2018 and have continued to trend downward during the first six months of 2019, which has contrasted with strong growth in existing home sales during the same period. Business investment has continued to be a strong contributor to GDP growth and is expected to remain largely stable during the remainder of 2019. (Sources: U.S. Dept. of Commerce Bureau of Economic Analysis, Bureau of Labor Statistics, Conference Board Leading Economic Index ).

 

Merger and acquisition activity was strong in 2018, with $3.5 trillion in worldwide transactions consummated during the year. Although such activity slowed during the first quarter of 2019, it accelerated during the second quarter of 2019, resulting in approximately $2 trillion in global transactions announced during the six month period. In the United States, merger and acquisition activity was up 19% in the first six months of 2019 as compared to the six months ended June 30, 2018. Market conditions for business transactions during the first six months of 2019 have continued to steadily improve, continuing a multi-year trend, as larger corporations have had increased access to credit markets and are still holding significant amounts of cash and have focused on acquisitions as part of future growth plans. Private equity funds raised almost $46 billion during the first three months of 2019, but did so in an increasingly smaller number of vehicles, resulting in larger fund sizes overall. Total investments during the quarter were approximately $202 billion, an increase of 3.6% from the first quarter of 2018. Data for the second quarter of 2019 have not yet been released but larger amounts of capital have pushed median valuation multiples above 12x during the first six months of 2019, constraining investment yields (Sources: The New York Times, The Wall Street Journal, PitchBook ).

 

  29  

During the six months ended June 30, 2019, our net asset value increased from $3.22 per share to $3.55 per share, an increase of 10.2%. As of June 30, 2019, our common stock is trading at a 53.8% discount to our net asset value as compared to 39.1% as of December 31, 2018.

 

Over the past several years, we have executed certain initiatives to enhance liquidity, achieve a lower operational cost structure, provide more assistance to portfolio companies and realize certain of our portfolio investments. Specifically, we changed the composition of our Board of Directors and Management, terminated certain of our follow-on investments, internalized the management of the Fund, suspended our managed distribution policy, modified our investment strategy to pursue shorter term liquidation opportunities, pursued non-cash investment opportunities, and sold certain of our legacy and underperforming investment holdings. We believe these actions continue to be necessary to protect capital and liquidity in order to preserve and enhance shareholder value. Because our Management is internalized, certain of our expenses should not increase commensurate with an increase in the size of the Fund and, therefore, to the extent we remain a BDC, we expect to achieve efficiencies in our cost structure if we are able to grow the Fund.

 

Liquidity and Capital Resources

 

We generate cash primarily from maturities, sales of securities and borrowings, as well as capital gains realized upon the sale of portfolio investments. We use cash primarily to make additional investments, either in new companies or as follow-on investments in the existing portfolio companies and to pay the dividends to our stockholders.

 

Because of the nature and size of the portfolio investments, we may periodically borrow funds to make qualifying investments to maintain our tax status as a RIC. We often borrow such funds by utilizing a margin account with a securities brokerage firm. There is no assurance that such arrangement will be available in the future. If the Fund is unable to borrow funds to make qualifying investments, it may no longer qualify as a RIC. The Fund would then be subject to corporate income tax on its net investment income and realized capital gains, and distributions to stockholders would be subject to income tax as ordinary dividends.

 

The Fund has the ability to borrow funds and issue forms of senior securities representing indebtedness or stock, such as preferred stock, subject to certain restrictions. Net taxable investment income and net taxable realized gains from the sales of portfolio investments are intended to be distributed at least annually, to the extent such amounts are not reserved for payment of expenses and contingencies or to make follow-on or new investments.

 

The Fund reserves the right to retain net long-term capital gains in excess of net short-term capital losses for reinvestment or to pay contingencies and expenses. Such retained amounts, if any, will be taxable to the Fund as long-term capital gains and stockholders will be able to claim their proportionate share of the federal income taxes paid on such gains as a credit against their own federal income tax liabilities. Stockholders will also be entitled to increase the adjusted tax basis of their Fund shares by the difference between their undistributed capital gains and their tax credit.

 

We are evaluating the impact of current market conditions on our portfolio company valuations and their ability to provide current income. We believe we have followed valuation techniques in a reasonably consistent manner; however, we are cognizant of current market conditions that might affect future valuations of portfolio securities. In view of our present status as a BDC and our anticipated transformation into an operating company, we believe that our operating cash flow and cash on hand will be sufficient to meet operating requirements and to finance routine capital expenditures through the next twelve months.

 

Results of Operations  

 

Investment Income and Expense

 

Net investment loss was $0.8 million and $0.9 million for the three months ended June 30, 2019 and 2018, respectively, and $1.8 million and $1.9 million for the six months ended June 30, 2019 and June 30, 2018, respectively, due to a decline in professional fees for the periods. 

 

Investment income was $0.1 million for the three months ended June 30, 2019 and 2018, respectively and $0.1 million and $0.2 million for the six months ended June 30, 2019 and 2018. The decrease is due to the decline of interest-bearing investments. Total expense was $0.9 million and $1.1 million for the three months ended June 30, 2019 and 201, respectively and $1.9 million and $2.2 million for the six months ended June 30, 2019. This decrease was mainly due to the decline in compensation expense and professional fees.

  30  

 

Realized Gains and Losses on Sales of Portfolio Securities  

 

During the six months ended June 30, 2019, we realized a loss of $2.8 million from the dissolution and liquidation of Equus Media Development Company LLC (“EMDC”).

 

During the six months ended June 30, 2018, we realized a gain of $1.0 thousand from the sale of temporary cash investments. 

 

Changes in Unrealized Appreciation/Depreciation of Portfolio Securities

 

During the six months ended June 30, 2019, we recorded a net change in unrealized appreciation of $8.8 million, to a net unrealized appreciation of $25.9 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 an increase in the share price of MVC and the receipt of dividend payments in the form of additional shares of MVC during the period;
     
  (ii) Increase in fair value of our shareholding in PalletOne, Inc. of $4.0 million due to improved operating performance and overall improvement in comparable industry sectors;
     
  (iii) Transfer of unrealized depreciation to realized loss of our holdings in EMDC of $2.8 million in connection with the liquidation and dissolution of EMDC; and
     
  (iv) Increase in the fair value of our holdings in Equus Energy, LLC of $1.5 million, principally due to increases in mineral acreage prices proximate to the company’s leasehold interests and an increase in the short- and long-term prices for crude oil during the first half of 2019.

 

During the six months ended June 30, 2018, we recorded a net change in unrealized appreciation of $2.9 million, to a net unrealized appreciation of $16.2 million. Such change in unrealized appreciation resulted primarily from the following changes:

 

(i)

Decrease in the fair value of our shareholding in MVC of $0.4 million due to a decrease in the share price of MVC, offset by the receipt of dividend payments in the form of additional shares of MVC during the period;

 

(ii)

Increase in fair value of our shareholding in PalletOne, Inc. of $2.3 million due to increases in revenue and EBITDA, as well as promising acquisition and growth prospects; and

 

(iii)

Increase in the fair value of our holdings in Equus Energy, LLC of $1.0 million, principally due to increases in mineral acreage prices proximate to the company’s leasehold interests and a moderate increase in the short- and long-term prices for crude oil and natural gas.

 

 

  Dividends

 

We will pay out net investment income and/or realized capital gains, if any, on an annual basis as required under the Investment Company Act of 1940.

 

Portfolio Securities  

   

During the six months ended June 30, 2019, 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, 2018, we received dividends in the form of additional shares of $0.1 million relating to our shareholding in MVC.

 

Also during the six months ended June 30, 2019, we dissolved EMDC, a wholly-owned subsidiary of the Fund and transferred EMDC’s assets, consisting of approximately $211,000 in cash and various creative entertainment properties, to the Fund. 

 

  31  

Subsequent Events

  

We performed an evaluation of the Fund’s activity through the date the financial statements were issued, noting the following subsequent events:

  

On July 5, 2019, we sold $27.0 million of U.S. Treasury Bills we acquired on margin in June 2019 and used the proceeds to repay the margin loan.

   

Item 3. Quantitative and Qualitative Disclosure about Market Risk

 

We are subject to financial market risks, including changes in interest rates with respect to investments in debt securities and outstanding debt payable, as well as changes in marketable equity security prices. In the future, we may invest in companies outside the United States, including in Europe and Asia, which would give rise to exposure to foreign currency value fluctuations. We do not use derivative financial instruments to mitigate any of these risks. The return on investments is generally not affected by foreign currency fluctuations.

 

Our investments in portfolio securities consist of some fixed-rate debt securities. Since the debt securities are generally priced at a fixed rate, changes in interest rates do not directly affect interest income. In addition, changes in market interest rates are not typically a significant factor in the determination of fair value of these debt securities, since the securities are generally held to maturity. We determine their fair values based on the terms of the relevant debt security and the financial condition of the issuer.

 

A major portion of our investment portfolio consists of debt and equity investments in private companies. Modest changes in public market equity prices generally do not significantly impact the estimated fair value of these investments. However, significant changes in market equity prices can have a longer-term effect on valuations of private companies, which could affect the carrying value and the amount and timing of gains or losses realized on these investments. A small portion of the investment portfolio could also consist of common stock in publicly traded companies. These investments are directly exposed to equity price risk, in that a hypothetical ten percent change in these equity prices would result in a similar percentage change in the fair value of these securities.

 

Item 4. Controls and Procedures

 

We maintain disclosure controls and other procedures that are designed to ensure that information required to be disclosed by the Fund in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Our management, with the participation of our Fund’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the design and operations of the Fund’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of June 30, 2019. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Fund’s disclosure controls and procedures were effective at a reasonable assurance level. There has been no change in our internal control over financial reporting during the quarter ended June 30, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 

  32  

 

Part II. Other Information

 

Item 1. 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, purports to allege 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 that this lawsuit, and the allegations included therein, are without merit. On September 22, 2017, we filed a motion for summary judgment regarding this action, which was granted by the Chancery Court on November 13, 2018. Mr. Zalmanoff appealed the Chancery Court ruling to the Delaware Supreme Court. On May 16, 2019, the Delaware Supreme Court affirmed the Chancery Court decision and terminated the proceedings.

 

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.

 

Item 1A. Risk Factors

 

In connection with our efforts to convert Equus into an operating company in furtherance of our Plan of Reorganization, we may be subject to a number of risks associated with this process, the transactions that would embody a Consolidation of Equus with another company, as well as specific risks associated with the commercial enterprise with which Equus would seek to combine itself. We intend to identify, as will be reasonably possible, such risks and include the same in our subsequent filings and reports with the Commission.

 

Readers should carefully consider these risks and all other information contained in our annual report on Form 10-K for the year ended December 31, 2018, including the Fund’s financial statements and the related notes thereto. Although there have been no changes to the risk factors facing the Fund since the filing of our Form 10-K, the risks and uncertainties described therein are not the only ones facing the Fund.

 

Additional risks and uncertainties not presently known to us, or not presently deemed material by us, may also impair our operations and performance.  

 

  33  

 

Item 6. Exhibits

 

  3. Articles of Incorporation and by-laws
  (a) Restated Certificate of Incorporation of the Fund, as amended. [Incorporated by reference to Exhibit 3(a) to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007]
  (b) Certificate of Merger dated June 30, 1993, between the Fund and Equus Investments Incorporated [Incorporated by reference to Exhibit 3(b) to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007]
  (c) Amended and Restated Bylaws of the Fund. [Incorporated by reference to Exhibit 3(c) to Registrant’s Current Report on Form 8-K filed on June 30, 2014.]

 

  10. Material Contracts.
  (a) Safekeeping Agreement between the Fund and Amegy Bank dated August 16, 2008. [Incorporated by reference to Exhibit 10(c) to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2008.]
  (b) Form of Indemnification Agreement between the Fund and its directors and certain officers. [Incorporated by reference to Exhibit 10(d) to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011.]
  (c) Form of Release Agreement between the Fund and certain of its officers and former officers. [Incorporated by reference to Exhibit 10(h) to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2004.]
  (d) Code of Ethics of the Fund (Rule 17j-1) [Incorporated by reference to Exhibit 10(f) to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2009.]
  (e) Share Exchange Agreement between the Fund and MVC Capital, Inc., dated May 14, 2014. [Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K, filed on May 15, 2014.]
  (f) 2016 Equity Incentive Plan, adopted June 13, 2016 [Incorporated by reference to Exhibit 1 to Registrant’s Definitive Proxy Statement filed on May 5, 2016.]
     
  31. Rule 13a-14(a)/15d-14(a) Certifications
  1. Certification by Chief Executive Officer
  2. Certification by Chief Financial Officer
     
  32. Section 1350 Certifications
  1. Certification by Chief Executive Officer
  2. Certification by Chief Financial Officer
         

 

  34  

 

SIGNATURE

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed by the undersigned, thereunto duly authorized.

 

   
Dated: August 14, 2019   /s/ John A. Hardy
   

John A. Hardy

Chief Executive Officer



 

 

 

 

 

  35  

 

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