NOTES TO CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 2021
(Unaudited)
(1) Description
of Business and Basis of Presentation
Description of Business—Equus
Total Return, Inc. (“we,” “us,” “our,” “Equus” the “Company” and the
“Fund”), a Delaware corporation, was formed by Equus Investments II, L.P. (the “Partnership”) on August
16, 1991. On July 1, 1992, the Partnership was reorganized and all of the assets and liabilities of the Partnership were transferred
to the Fund in exchange for shares of common stock of the Fund. Our shares trade on the NYSE under the symbol ‘EQS’.
On August 11, 2006, our shareholders approved the change of the Fund’s investment strategy to a total return investment objective.
This strategy seeks to provide the highest total return, consisting of capital appreciation and current income. In connection with
this strategic investment change, the shareholders also approved the change of name from Equus II Incorporated to Equus Total Return,
Inc.
We attempt
to maximize the return to stockholders in the form of current investment income and long-term capital gains by investing in the
debt and equity securities of companies with a total enterprise value between $5.0 million and $75.0 million, although we may engage
in transactions with smaller or larger investee companies from time to time. We seek to invest primarily in companies pursuing
growth either through acquisition or organically, leveraged buyouts, management buyouts and recapitalizations of existing businesses
or special situations. Our income-producing investments consist principally of debt securities including subordinated debt, debt
convertible into common or preferred stock, or debt combined with warrants and common and preferred stock. Debt and preferred equity
financing may also be used to create long-term capital appreciation through the exercise and sale of warrants received in connection
with the financing. If we remain a BDC, we will seek to achieve capital appreciation by making investments in equity and equity-oriented
securities issued by privately-owned companies in transactions negotiated directly with such companies. Given market conditions
over the past several years and the performance of our portfolio, our Management and Board of Directors believe it prudent to continue
to review alternatives to refine and further clarify the current strategies.
We elected
to be treated as a BDC under the 1940 Act, although our shareholders have authorized us to withdraw this election on or before
January 31, 2022 (see Note 6 “Conversion to an Operating Company – Authorization to Withdraw BDC Election”
below). 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.
Impact of
COVID-19—In 2019, SARS-CoV-2, a highly contagious pathogen which causes COVID-19, coronavirus disease, or simply, the
‘coronavirus’, arose in Wuhan Province, China. By the second quarter of 2020, all U.S. States had imposed various restrictions
on travel, movement, and public assembly, and substantial portions of the U.S. economy, including the energy industry, were materially
and negatively affected as a result.
The highly
contagious nature of the coronavirus and its various strains has caused numerous private and public organizations to substantially
alter the way in which they operate. In some cases, these workplace and operational alterations have become permanent. Many such
organizations have, to the extent possible, required employees to work remotely to reduce opportunities for contagion. We have
also taken steps to minimize the exposure of our employees and service providers by allowing all such persons to work from a remote
location. We utilize a cloud-based storage and retrieval system for our records and can communicate electronically or by telephone
with third parties such as our financial institutions, legal and accounting advisors, and our portfolio companies. Our day-to-day
operations and management have not, therefore, been materially affected by the coronavirus pandemic. However, the rise of the Delta
variant, as well as other coronavirus strains, and continued government directives on social distancing and other conditions and
restrictions have impaired our ability to travel to attend board meetings, negotiations, and other functions which are endemic
to the interpersonal nature of private equity investing. As a consequence, our ability to source new investment prospects, facilitate
dispositions of existing portfolio holdings, or consummate a substantial transaction has been constrained by these limitations.
Should these disruptions and restrictions continue as a result of the coronavirus, we cannot, therefore, assure you that our operations
as a BDC or our efforts to effect a transformative transaction involving Equus will not be materially adversely affected thereby.
Although our
Company and our portfolio investments are generally affected by macroeconomic factors such as changes in the U.S. economy and fluctuations
in energy prices, we are presently unable to predict either the potential near-term or longer-term impact that the coronavirus
may have on our financial and operating results due to numerous uncertainties regarding the duration and severity of the crisis.
Moreover, we are unable to predict the effect that the economic dislocation caused by the coronavirus will have on our efforts
to complete a transformative transaction as described below. The ultimate impact of the coronavirus pandemic is highly uncertain
and subject to change, and our business, results of operations, and financial condition have been and will likely continue to be
impacted by future developments concerning the pandemic and the resulting economic disruption.
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 nine months ended September 30, 2021 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, 2020, as filed with the SEC.
(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. In view of the foregoing, we believe that our operating cash flow and cash on hand will be sufficient
to meet operating requirements from the date of this filing through the next twelve months.
Cash and
Cash Equivalents—As of September 30, 2021, we had cash and cash equivalents of $22.9 million. We had $12.0 million of
our net assets of $36.2 million invested in portfolio securities.
As of December 31, 2020, we had cash
and cash equivalents of $23.6 million. We had $7.0 million of our net assets of $33.8 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 September 30, 2021, we did not
secure a quarter-end margin loan as we have historically done, and thus had no restricted cash and temporary cash investments as
of that date.
As of December
31, 2020, we had $24.2 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, $24.0 million was
invested in U.S. Treasury bills and $0.2 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 January 5, 2021 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 September 30, 2021, we had a follow-on
commitment of $150,000 to invest in additional equity of Equus Energy, LLC.
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 – Conversion to an Operating Company below, our failure to continue to qualify as a RIC could
be materially adverse to us and our stockholders.
As of December
31, 2020, we borrowed $24.0 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 $24.2 million.
Asset Coverage
Ratio—Under the 1940 Act, BDCs are required to have an asset coverage ratio of 200%, meaning that the maximum debt that
may be incurred by a BDC is the BDC’s net asset value. Pursuant to amendments made to the 1940 Act in March 2018, BDCs may
now, with stockholder or board of directors approval, reduce this ratio to 150%, meaning that the maximum debt that may be incurred
by a BDC is two times the BDC’s net asset value. In November 2019, we obtained approval of our shareholders to reduce our
asset coverage ratio to 150%. This authorization permits Equus to borrow up to twice the value of the Fund’s net assets.
Other than the margin loan obtained by the Fund from time to time to acquire U.S. Treasury bills to maintain our RIC status as
described above, we have not yet undertaken any other additional borrowings.
Certain
Risks and Uncertainties—Market and economic volatility which has become endemic in the past few years, together with
the economic dislocation caused by the onset of the coronavirus, 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 third quarter of 2021, 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 – Conversion to an Operating
Company. We believe we have sufficient liquidity to meet our operating requirements for 12 months from the date of this filing.
|
(3)
|
Significant Accounting Policies
|
The following
is a summary of significant accounting policies followed by the Fund in the preparation of our 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 various methodologies and approaches, including a yield analysis, enterprise value (“EV”) analysis,
net asset value analysis, liquidation analysis, discounted cash flow analysis, or a combination of methods, as appropriate. The
yield analysis uses loan spreads and other relevant information implied by market data involving identical or comparable assets
or liabilities. Under the EV analysis, the EV of a portfolio company is first determined and allocated over the portfolio company’s
securities in order of their preference relative to one another (i.e., “waterfall” allocation). To determine the EV,
we typically use a market multiples approach that considers relevant and applicable market trading data of guideline public companies,
transaction metrics from precedent M&A transactions and/or a discounted cash flow analysis. The net asset value analysis is
used to derive a value of an underlying investment (such as real estate property) by dividing a relevant earnings stream by an
appropriate capitalization rate. For this purpose, we consider capitalization rates for similar properties as may be obtained from
guideline public companies and/or relevant transactions. The liquidation analysis is intended to approximate the net recovery value
of an investment based on, among other things, assumptions regarding liquidation proceeds based on a hypothetical liquidation of
a portfolio company’s assets. The discounted cash flow analysis uses valuation techniques to convert future cash flows or
earnings to a range of fair values from which a single estimate may be derived utilizing an appropriate discount rate. The measurement
is based on the net present value indicated by current market expectations about those future amounts.
In estimating
the fair value of our interest in Equus Energy, we have given more emphasis to a market approach that examines developed and undeveloped
reserves and mineral acreage values, as well as a market approach that examines comparable industry transactions involving oil
and gas assets in proximity to the leasehold interests held by Equus Energy. Our management received advice and assistance from
a third-party valuation firm to support our determination of the fair value of this investment.
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
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 nine months ended September 30, 2021 and the year ended December 31, 2020.
As of September
30, 2021, 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 September 30, 2021
|
(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
|
|
$
|
12,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
12,000
|
|
Total investments and temporary cash investments
|
|
$
|
12,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
12,000
|
|
As of December
31, 2020, 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, 2020
|
(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
|
|
$
|
7,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
7,000
|
|
Total investments
|
|
|
7,000
|
|
|
|
—
|
|
|
|
—
|
|
|
|
7,000
|
|
Temporary cash investments
|
|
|
24,000
|
|
|
|
24,000
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
|
$
|
31,000
|
|
|
$
|
24,000
|
|
|
$
|
—
|
|
|
$
|
7,000
|
|
The
following table provides a reconciliation of fair value changes during the three months ended September 30, 2021 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 June 30, 2021
|
|
|
|
|
|
$
|
10,250
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$10,250
|
Change in unrealized appreciation
|
|
|
|
|
|
|
1,750
|
|
|
|
—
|
|
|
|
—
|
|
|
1,750
|
Fair value as of September 30, 2021
|
|
|
|
|
|
$
|
12,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$12,000
|
The following table provides a reconciliation
of fair value changes during the nine months ended September 30, 2021 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 January 1, 2021
|
|
|
|
|
|
$
|
7,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$7,000
|
Change in unrealized appreciation
|
|
|
|
|
|
|
4,650
|
|
|
|
—
|
|
|
|
—
|
|
|
4,650
|
Purchases of portfolio securities
|
|
|
|
|
|
|
350
|
|
|
|
—
|
|
|
|
—
|
|
|
350
|
Fair value as of September 30, 2021
|
|
|
|
|
|
$
|
12,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$12,000
|
The following table provides a reconciliation of fair
value changes during the three months ended September 30, 2020 for all investments for which we determine fair value using
observable (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 June 30, 2020
|
|
|
|
|
|
$
|
5,500
|
|
|
$
|
27,500
|
|
|
$
|
977
|
|
|
$33,977
|
Change in unrealized appreciation
|
|
|
|
|
|
|
(561
|
)
|
|
|
(3,500
|
)
|
|
|
—
|
|
|
(4,061)
|
Purchase of portfolio securites
|
|
|
|
|
|
|
561
|
|
|
|
—
|
|
|
|
—
|
|
|
561
|
Fair value as of September 30, 2020
|
|
|
|
|
|
$
|
5,500
|
|
|
$
|
24,000
|
|
|
$
|
977
|
|
|
$30,477
|
The following table provides a reconciliation
of fair value changes during the nine months ended September 30, 2020 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 January 1, 2020
|
|
|
|
|
|
$
|
8,000
|
|
|
$
|
26,500
|
|
|
$
|
977
|
|
|
$35,477
|
Change in unrealized appreciation
|
|
|
|
|
|
|
(3,061
|
)
|
|
|
(2,500
|
)
|
|
|
—
|
|
|
(5,561)
|
Purchases of portfolio securities
|
|
|
|
|
|
|
561
|
|
|
|
—
|
|
|
|
—
|
|
|
561
|
Fair value as of September 30, 2020
|
|
|
|
|
|
$
|
5,500
|
|
|
$
|
24,000
|
|
|
$
|
977
|
|
|
$30,477
|
Our investment portfolio is not composed
of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment
portfolio is composed of complex debt and equity securities with distinct contract terms and conditions. As such, our valuation
of each investment in our portfolio is unique and complex, often factoring in numerous different inputs, including historical and
forecasted financial and operational performance of the portfolio company, project cash flows, market multiples comparable market
transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations
and reviews and other inputs.
The following table summarizes the
significant non-observable inputs in the fair value measurements of our Level 3 investments by category of investment and valuation
technique as of September 30, 2021: (fair value expressed in thousands; acreage range expressed in dollars and not rounded):
|
|
|
|
|
|
|
|
Range
|
(in thousands)
|
|
Fair Value
|
|
Valuation Techniques
|
|
Unobservable Inputs
|
|
Minimum
|
|
Maximum
|
|
Weighted Average
|
Limited liability company investments
|
|
|
|
Asset approach
Guideline transaction method
Market approach
|
|
Acreage value (per acre)
|
|
$ 5,000
|
|
$ 9,000
|
|
$ 7,000
|
|
$ 12,000
|
|
|
Recovery Rate
Reserve Adjustment Factors
|
|
75%
|
|
100%
|
|
100%
|
Because of the inherent uncertainty
of the valuation of portfolio securities which do not have readily ascertainable market values, amounting to $12.0 million and
$7.0 million as of September 30, 2021 and December 31, 2020, respectively, our fair value determinations may materially differ
from the values that would have been used had a ready market existed for these securities.
We adjust our net asset value for the
changes in the value of our publicly held securities, if applicable, and material changes in the value of private securities, generally
determined on a quarterly basis or as announced in a press release, and report those amounts to Lipper Analytical Services, Inc.
Our net asset value appears in various publications, including Barron’s and The Wall Street Journal.
Escrowed
Receivables, at Estimated Fair Value—In December 2020, we sold our interest in PalletOne, Inc (“PalletOne”).
A portion of the proceeds from the sale was placed in a cash escrow account to secure the representations and warranties made to
the purchaser. On March 31, 2021, we received $2.5 million in cash from PalletOne. We recognized a capital gain of $0.5 million
due to the change in our estimated fair value of this receivable, which was $1.2 million as of September 30, 2021. See Subsequent
Events.
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.
Interest
and Dividend 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. Dividend
income is recorded as dividends are declared by the portfolio company or at the point
an obligation exists for the portfolio company to make a distribution.
Net Realized
Gains or Losses and Net Change in Unrealized Appreciation or Depreciation—Realized gains or losses are measured by the
difference between the net proceeds from the sale or redemption of an investment or a financial instrument and the cost basis of
the investment or financial instrument, without regard to unrealized appreciation or depreciation previously recognized, and includes
investments written-off during the period net of recoveries and realized gains or losses from in-kind redemptions. Net change in
unrealized appreciation or depreciation reflects the net change in the fair value of the portfolio company investments and financial
instruments and the reclassification of any prior period unrealized appreciation or depreciation on exited investments and financial
instruments to realized gains or losses.
Payment in
Kind Interest (PIK)—From time to time, 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.
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.
Distributable Earnings—The
components that make up distributable earnings (accumulated undistributed deficit) on the Condensed Balance Sheet as of September
30, 2021 and December 31, 2020 are as follows:
​
|
|
As of
September 30, 2021
|
|
As of
December 31, 2020
|
Accumulated undistributed net investment losses
|
|
$
|
(42,843
|
)
|
|
$
|
(40,310
|
)
|
Unrealized appreciation of portfolio securities, net
|
|
|
4,039
|
|
|
|
(611
|
)
|
Accumulated undistributed net capital gains
|
|
|
349
|
|
|
|
18,543
|
|
Accumulated earnings deficit
|
|
$
|
(38,455
|
)
|
|
$
|
(22,378
|
)
|
In
general, we may take certain adjustments to the classification of net assets as a result of permanent book-to-tax
differences, which may include differences in the book and tax basis of certain assets and liabilities, and undistributed net
capital gains for which we have loss carryforwards, among other items. During the nine months ended September 30, 2021, we
recharacterized $18.5 million in accumulated undistributed net capital gains for which we had loss carryforwards, among other
items. Accordingly, this recharacterization has increased capital in excess of par and decreased accumulated deficit.
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 RIC and,
as such, will not be subject to federal income taxes on otherwise taxable income (including net realized capital gains) which is
distributed to stockholders. Therefore, no provision for federal income taxes is recorded in the financial statements. We borrow
money from time to time to maintain our tax status under the 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 $0.03 million for the year ended December 31, 2020.
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 nine months ended September 30, 2021, and we expect
no state income tax for the year ended December 31, 2021.
Although on
March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”),
which contains provisions intended to mitigate the adverse economic effects of the COVID-19 pandemic. Our portfolio companies did
not benefit from the CARES Act or any other subsequent legislation intended to provide financial relief or assistance.
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.
Recent Accounting
Standards—We consider the applicability and impact of all accounting standard updates (“ASU”) issued by the
Financial Accounting Standards Board (“FASB”). ASUs not listed below were assessed and either determined to be not
applicable or expected to have minimal impact on our financial statements.
Accounting Standards
Recently Adopted— In May 2020, the SEC adopted rule amendments that will impact the requirement of investment companies,
including BDCs, to disclose the financial statements of certain of their portfolio companies or acquired funds (the “Final
Rules”). The Final Rules adopted a new definition of “significant subsidiary” set forth in Rule 1-02(w)(2) of
Regulation S-X under the Securities Act. Rules 3-09 and 4-08(g) of Regulation S-X require investment companies to include separate
financial statements or summary financial information, respectively, in such investment company’s periodic reports for any
portfolio company that meets the definition of “significant subsidiary.” The Final Rules amend the definition of “significant
subsidiary” in a manner that is intended to more accurately capture those portfolio companies that are more likely to materially
impact the financial condition of an investment company. The Final Rules became effective on January 1, 2021, but voluntary compliance
was permitted in advance of the effective date. The Company elected to comply with the Final Rules effective June 30, 2020 which
reduced the requirement for the Company to provide separate audited financial statements and summarized financial information for
its controlled portfolio companies going forward.
|
(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.
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. We paid Kenneth I. Denos, P.C., a professional
corporation owned by Kenneth I. Denos, a director of the Fund, $249,675 during the
nine months ended September 30, 2020. Effective November 1, 2020, we entered into a
written agreement with Mr. Denos to receive, in lieu of an hourly rate, a fixed monthly fee of $30,000.
(5) Portfolio
Securities
During the
nine months ended September 30, 2021, we made a follow-on investment of $0.35 million in Equus Energy, LLC.
During the nine
months ended September 30, 2021, we recognized a capital gain of $0.5 million due to the change in the estimated fair value of
our escrow receivable related to the sale of PalletOne.
During
the nine months ended September 30, 2021, with respect to our holding in Equus Energy, LLC, we recorded an increase in the fair
value of $5.0 million and an increase in our cost basis of $0.35 million, resulting in a net change in unrealized appreciation
of $4.65 million. Such change in fair value was principally due to increases in mineral acreage prices and a substantial
increase in short-and long-term prices for crude oil and natural gas.
During the nine months ended September
30, 2020, in connection with our shareholding in MVC, we received dividends in the form of additional MVC shares valued at $0.2
million, together with $134,585 in cash.
During the nine months ended September
30, 2020, we converted into equity $0.6 million in advances we made to Equus Energy, LLC, our wholly-owned subsidiary.
During the
nine months ended September 30, 2020, we recorded a net change in unrealized appreciation of $6.3 million, to a net unrealized
appreciation of $19.0 million. Such change in unrealized appreciation resulted primarily from the following changes:
|
(i)
|
Decrease in the fair value of our shareholding in MVC Capital, Inc. (“MVC”) of $0.8 million due to a decrease in the share price of MVC which was partially offset by the receipt of dividend payments in the form of additional shares of MVC during the period;
|
|
(ii)
|
Decrease in the fair value of our holdings in Equus Energy, LLC of $3.0 million, principally due to decreases in mineral acreage prices and a substantial decrease in the short- and long-term prices for crude oil, which fell from $61.06 per barrel at December 31, 2019 to $20.48 at March 31, 2020, before recovering moderately to $40.22 at September 30, 2020; and
|
|
(iii)
|
Decrease in the fair value of our shareholding in PalletOne, Inc. of $2.5 million due to a less favorable outlook for the Company in 2021 and the remainder of 2020.
|
(6) Conversion
to an Operating Company
Authorization
to Withdraw BDC Election— On August 17, 2021, 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, but no later than January 31, 2022. This
authorization and others which preceded it are a consequence of our expressed intent to transform Equus into an operating company
or a permanent capital vehicle. 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 transformative transaction. 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. While we are
presently evaluating various opportunities that could enable us to accomplish this transformation, we cannot assure you that we
will be able to do so within any particular time period or at all, and, although we expect that our shareholders will extend our
current authorization we do not expect to cause the Fund to withdraw its election to be classified as BDC by January 31, 2022.
Moreover, we cannot assure you that the terms of any such transformative transaction would be acceptable to us.
Increase
in Authorized Shares—On January 20, 2021, holders of a majority of the outstanding common stock of the Fund approved
the restatement of our Certificate of Incorporation to increase the number of our authorized shares of common stock from 50,000,000
to 100,000,000, and the number of our authorized shares of preferred stock from 5,000,000 to 10,000,000. The increase is intended
to help facilitate the transformation of Equus into an operating company and provide sufficient authorized shares to evaluate larger
business concerns as possible acquisition or merger candidates.
|
(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,
2020, all awards granted under the Incentive Plan were fully vested. 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. We recorded compensation expense of $0.08 million
for the three months ended March 31, 2020, in connection with these awards.
Equus
Energy was formed in November 2011 as a wholly-owned subsidiary of the Fund to make investments in companies in the energy
sector, with particular emphasis on income-producing oil & gas properties. In December 2011, we contributed $250,000 to
the capital of Equus Energy. On December 27, 2012, we invested an additional $6.8 million in Equus Energy for the purpose of
additional working capital and to fund the purchase of $6.6 million in working interests, which presently comprise 141
producing and non-producing oil and gas wells. On September 30, 2020, the Fund provided an additional $0.6 million in capital
to Equus Energy for the purpose of additional working capital. On June 30, 2021, the Fund provided an additional $0.3 million
in capital to Equus Energy for the purpose of additional working capital. The working interests include associated
development rights of approximately 21,520 acres situated on 10 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 the operator of Equus Energy’s 40 well interests located in the
Conger Field, an oil and gas field on the edge of the Permian Basin that has experienced gas and hydrocarbon extraction in multiple
formations. Equus Energy, which holds a 50% working interest in each of these Conger Field wells, was working with the operator
in a recompletion program, now presently on hold, 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.
The Impact
of COVID-19 and Other Events—2020 witnessed unprecedented systemic events that had a material effect on oil prices globally
and continued through the first three quarters of the year. Commencing in the fourth quarter of 2020, crude and natural gas prices
began to rise and, as of the date of this filing on Form 10-Q, have recovered to, or have exceeded, pre-pandemic levels.
Notwithstanding
present pricing conditions and forecasts for the remainder of 2021, operators of the leasehold interests held by Equus Energy have
not yet undertaken significant capital expenditures, which could have a material adverse effect upon the operations and long-term
financial condition of Equus Energy. To conserve existing cash resources or create additional cash resources during the next year,
Equus Energy intends to either: (i) attempt to secure equity or debt financing from one or more institutional sources, which sources
may include the Fund, a commercial lender, or other investors, (ii) request that its operators shut-in additional wells, (iii)
sell certain of its oil and gas holdings, or (iv) undertake a combination of the foregoing. However, we cannot assure you that
Equus Energy will be able to implement these plans successfully, or that such plans will generate sufficient liquidity to continue
as a going concern. The factors discussed above, therefore, raise substantial doubt about Equus Energy’s ability to continue
as a going concern.
Going-Concern—The
accompanying unaudited condensed consolidated financial statements of Equus Energy have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities and other commitments in the normal course of
business. As such, the unaudited condensed consolidated financial statements do not include adjustments relating to the recoverability
and classification of assets and their carrying amount, or the amount and classification of liabilities that may result should
the Equus Energy be unable to continue as a going concern.
Revenue and
Income—During the three months ended September 30, 2021, Equus Energy’s revenue, operating revenue less direct
operating expenses, and net loss were $0.2 million, $0.08 million, and ($0.03) million, respectively, as compared to revenue, operating
revenue less direct operating expenses, and net loss which were $0.1 million, ($0.08) million, and ($0.2) million, respectively,
for the three months ended September 30, 2020.
During the nine
months ended September 30, 2021, Equus Energy’s revenue, operating revenue less direct operating expenses, and net loss were
$0.6 million, $0.1 million, and ($0.07) million, respectively, as compared to revenue, operating revenue less direct operating
expenses, and net loss which were $0.3 million, ($0.15) million, and ($0.36) million, respectively, for the three months ended
September 30, 2020.
Capital Expenditures—During
the three and nine months ended September 30, 2021 and September 30, 2020, Equus Energy’s
investment, respectively, in capital expenditures for small repairs and improvements was not significant.
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 a reserve report prepared for Equus Energy by Lee Keeling & Associates, Inc., an independent petroleum engineering firm,
the transactions and values of comparable companies in this sector, and the estimated value of leasehold mineral interests associated
with the acreage held by Equus Energy. A valuation of Equus Energy was performed by a third-party valuation firm, who recommended
a value range of Equus Energy consistent with the fair value determined by our Management (See Schedule of Investments).
Below is summarized
consolidated financial information for Equus Energy as of September 30, 2021 and December 31, 2020 and for the three months and
nine months ended September 30, 2021 and 2020, respectively (in thousands):
EQUUS ENERGY, LLC
Unaudited Condensed Consolidated Balance
Sheets
|
|
September 30,
|
|
December 31,
|
|
|
2021
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
694
|
|
|
$
|
621
|
|
Accounts receivable
|
|
|
156
|
|
|
|
77
|
|
Total current assets
|
|
|
850
|
|
|
|
698
|
|
Oil and gas properties
|
|
|
8,093
|
|
|
|
8,061
|
|
Less: accumulated depletion, depreciation and amortization
|
|
|
(8,093
|
)
|
|
|
(8,061
|
)
|
Net oil and gas properties
|
|
|
—
|
|
|
|
—
|
|
Total assets
|
$
|
850
|
|
|
$
|
698
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and member's deficit
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and other
|
|
$
|
100
|
|
|
$
|
229
|
|
Due to affiliate
|
|
|
350
|
|
|
|
350
|
|
Total current liabilities
|
|
|
450
|
|
|
|
579
|
|
Asset retirement obligations
|
|
|
213
|
|
|
|
208
|
|
Total liabilities
|
|
663
|
|
|
|
787
|
|
|
|
|
|
|
|
|
|
|
|
Total member's equity (deficit)
|
|
|
187
|
|
|
|
(89
|
)
|
|
|
|
|
|
|
|
|
|
Total liabilities and member'sequity (deficit)
|
$
|
850
|
|
|
$
|
698
|
|
|
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.
EQUUS ENERGY, LLC
Unaudited Condensed Consolidated Statements
of Operations
EQUUS ENERGY, LLC
|
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating revenue
|
|
$
|
237
|
|
|
$
|
120
|
|
|
$
|
623
|
|
|
$
|
337
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct operating expenses
|
|
|
155
|
|
|
|
200
|
|
|
|
482
|
|
|
|
492
|
|
General and administrative
|
|
|
53
|
|
|
|
38
|
|
|
|
178
|
|
|
|
187
|
|
Depletion, depreciation, amortization and accretion
|
|
|
2
|
|
|
|
84
|
|
|
|
5
|
|
|
|
21
|
|
Impairment of oil and gas properties
|
|
|
—
|
|
|
|
—
|
|
|
|
32
|
|
|
|
—
|
|
Total operating expenses
|
|
|
210
|
|
|
|
322
|
|
|
|
697
|
|
|
|
700
|
|
Net loss
|
|
|
27
|
|
|
|
(202
|
)
|
|
|
(74
|
)
|
|
|
(363
|
)
|
EQUUS ENERGY, LLC
Unaudited Condensed Consolidated Statements
of Cash Flows
|
|
Nine months ended September 30,
|
|
|
2021
|
|
2020
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(74
|
)
|
|
$
|
(320
|
)
|
Adjustments to reconcile net loss to
|
|
|
|
|
|
|
|
|
net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depletion, depreciation and amortization
|
|
|
5
|
|
|
|
15
|
|
Impairment
|
|
|
32
|
|
|
|
—
|
|
Changes in operating assets and liabilites:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(79
|
)
|
|
|
22
|
|
Prepaid expenses and other current assets
|
|
|
—
|
|
|
|
34
|
|
Accounts payable and other
|
|
|
(129
|
)
|
|
|
(15
|
)
|
Due to Parent
|
|
|
—
|
|
|
|
—
|
|
Net cash used in operating activities
|
|
|
(245
|
)
|
|
|
(264
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Investment in oil & gas properties
|
|
|
(32
|
)
|
|
|
(30
|
)
|
Net cash (used in) provided by investing activities
|
|
|
(32
|
)
|
|
|
(30
|
)
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Member contributions
|
|
|
350
|
|
|
|
—
|
|
Net cash provided by investing activities
|
|
|
350
|
|
|
|
—
|
|
Net increase (decrease) in cash
|
|
|
73
|
|
|
|
(294
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
621
|
|
|
|
553
|
|
Cash and cash equivalents at end of period
|
|
$
|
694
|
|
|
$
|
259
|
|
Critical Accounting Policies for Equus Energy
Oil &
Gas Properties—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. Any excess of the net book value of proved oil and gas
properties over the ceiling is charged to expense and reflected as additional impairment in the accompanying statements of operations.
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 $5 thousand and $21 thousand for the nine months ended
September 30, 2021 and 2020, 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 September 30, 2021, 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 recognized an impairment loss on its oil and gas properties during the nine months ended September
30, 2021 and 2020 of $32 thousand and $0, 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—The Company recognizes revenue in accordance with Accounting Standards Codification ("ASC") 606,
Revenue from Contracts with Customers.
The Company’s
revenue is generated primarily from the sale of oil, gas and natural gas liquids (“NGL”) produced from working interests
and to a lesser extent from royalty interests in oil and gas properties owned by the Company. As a working interest owner, the
Company is responsible for the incurred production expenses proportionate to the interest stipulated in the operating agreement.
As a non-operator, the Company does not manage the daily well operations, which are borne by the well operator. Sales of oil, gas
and NGLs are recognized at the time control of the product is transferred to the customer.
Various
arrangements amongst the eleven different oil and gas properties all differ in some respects, although they do share the commonality
that, as a non-operating working interest holder, the Company does not engage in the selling process, but instead relies on the
operator, as their selling agent, for negotiating and determining pricing, volume, and delivery terms. Such pricing terms are often
a function of a specified discount from the daily/monthly NYMEX or Henry Hub average. The discount is usually based on differentials
such as distance of the field/wells from the distribution node or the buyer’s storage facility, as well as the quality of
the product itself (i.e., in the case of oil, its gravity).
Revenue
is measured based on consideration specified in the contract with the customer, and excludes any amounts collected on behalf of
third parties. The Company recognizes revenue in the amount that reflects the consideration it expects to be entitled to in exchange
for transferring control of those goods to the customer. The contract consideration is typically allocated to specific performance
obligations in the contract according to the terms of the contract. Each unit of oil or gas is considered a separate performance
obligation under the contract. Wells are spot measured once a month to determine production and the composition of each of the
products (i.e. oil, gas, NGLs) from the well. Each month the consideration obtained by the operator is allocated to the related
performance obligations.
Performance
Obligations
A performance
obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC
606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when,
or as, the performance obligation is satisfied. Revenue is recognized when performance obligations are satisfied in accordance
with contractual terms, in an amount that reflects the consideration the Company expects to be entitled to in exchange for services
rendered.
Depending
on the contract and commodity, there are various means by which upstream entities can transfer control (i.e., at the wellhead,
inlet, tailgate of the processing plant, or a location where the product is delivered to a third party). The Company has control
of the commodity before it is extracted, therefore consideration must be given to whether the transfer of control of the commodity
is to the operator or to the end customer at the point of sale.
Unless
special arrangements are entered into, the Company’s performance obligations are generally considered performed when control
of the extracted commodity transfers when it is delivered to the end customer at the agreed-upon market or index price. At the
end of each month, when the performance obligation is satisfied, the variable consideration can be reasonably estimated. Variances
between the Company’s estimated revenue and actual payments are recorded in the month the payment is received.
Principal
vs. Agent
While
the guidance on principal versus agent considerations is similar to legacy GAAP, the key difference is that ASC 606 focuses on
control of the specified goods and services as the overarching principle for entities to consider when determining whether they
are acting as a principal or an agent. This could result in entities reaching different conclusions than they did under legacy
GAAP.
An entity
acting as a principal records revenue on a gross basis if it controls a promised good or service before transferring that good
or service to the customer. An entity is an agent if it does not control the promised good or service before transfer to the customer.
If the entity is an agent, it records as revenue the net amount it retains for its agency services. However, due to the uncertainty
of the variable pricing component and the separation of expenses billed to the Company from the consideration processed and paid
by the operator, the revenue is recorded at net.
Under
the Company’s normal operating activity arrangements, the operator is responsible for negotiating, fulfilling and collecting
the agreed-upon amount from the sale with the end customer and is, therefore, determined to be acting as agent on behalf of the
Company. The principal versus agent consideration will continue to be assessed for new contracts, both within and outside the company’s
normal operating activities.
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. The Company had no federal income tax expense
for the nine months ending September 30, 2021 and 2020, respectively.
Asset Retirement Obligations—The
fair value of asset retirement obligations are recorded in the period in which they are incurred if a reasonable estimate of fair
value can be made, and the corresponding cost is capitalized as part of the carrying amount of the related long-lived asset. The
fair value of the asset retirement obligation is measured using expected future cash outflows discounted at the Company’s
credit- adjusted risk-free interest rate. Fair value, to the extent possible, should include a market risk premium for unforeseeable
circumstances. No market risk premium was included in the Company’s asset retirement obligation fair value estimate since
a reasonable estimate could not be made. The liability is accreted to its then present value each period, and the capitalized cost
is depleted or amortized over the estimated recoverable reserves using the units-of-production method.
Management performed
an evaluation of the Fund’s activity through the date the financial statements were issued, noting the following subsequent
event:
In October 2021,
we received $1.2 million for the cash escrow receivable related to the sale of PalletOne.