Equus Total Return(EQS) - 2019 Q2 - Quarterly Report

PART I. FINANCIAL INFORMATION Item 1. Unaudited Condensed Financial Statements This section presents the company's unaudited condensed financial statements, investment schedules, and related notes for the reporting period Condensed Balance Sheets | Metric (in thousands) | June 30, 2019 | December 31, 2018 | | :-------------------- | :------------ | :---------------- | | Total Assets | $74,970 | $70,941 | | Total Liabilities | $27,037 | $27,446 | | Total Net Assets | $47,933 | $43,495 | | Net Asset Value per Share | $3.55 | $3.22 | - Total investments in portfolio securities at fair value increased from $35,015 thousand at December 31, 2018, to $40,995 thousand at June 30, 2019[10] Condensed Statements of Operations | Metric (in thousands) | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Total Investment Income | $91 | $117 | $106 | $230 | | Total Expenses | $887 | $1,053 | $1,893 | $2,157 | | Net Investment Loss | $(797) | $(936) | $(1,787) | $(1,927) | | Net Realized (Loss) Gain | $(2,767) | $(1) | $(2,757) | $1 | | Net Change in Unrealized Appreciation of Portfolio Securities | $4,789 | $1,950 | $8,290 | $3,314 | | Net Increase in Net Assets from Operations | $1,301 | $793 | $4,278 | $849 | | Basic and Diluted EPS | $0.10 | $0.06 | $0.32 | $0.06 | - Net increase in net assets resulting from operations significantly increased to $4,278 thousand for the six months ended June 30, 2019, compared to $849 thousand for the same period in 2018, primarily driven by a substantial increase in net unrealized appreciation of portfolio securities[15] Condensed Statements of Changes in Net Assets | Metric (in thousands) | Balances at January 1, 2019 | Balances at June 30, 2019 | | :-------------------- | :-------------------------- | :------------------------ | | Total Net Assets | $43,495 | $47,933 | | Capital in Excess of Par Value | $55,741 | $55,901 | | Undistributed Net Investment Losses | $(29,327) | $(31,114) | | Unrealized Appreciation of Portfolio Securities, net | $19,310 | $27,600 | - Net assets increased by $4,438 thousand from January 1, 2019, to June 30, 2019, primarily due to net increase in net assets resulting from operations and share-based incentive compensation[19] Condensed Statements of Cash Flows | Metric (in thousands) | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :----------------------------- | :----------------------------- | | Net Cash (Used in) Provided by Operating Activities | $(2,027) | $4,495 | | 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 End of Period | $5,677 | $9,469 | - The company experienced a net cash outflow from operating activities of $2,027 thousand for the six months ended June 30, 2019, a significant change from the $4,495 thousand inflow in the prior year period[24] Supplemental Information—Selected Per Share Data and Ratios | Metric | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :---------------------------------------------------------- | :----------------------------- | :----------------------------- | | Net Asset Value at End of Period, Basic and Diluted | $3.55 | $3.26 | | Market Price per Share: End of Period | $1.64 | $2.36 | | 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% | - The net asset value per share increased from $3.22 at the beginning of the period to $3.55 at the end of the period for the six months ended June 30, 2019[25] - However, the market price per share decreased from $1.96 to $1.64 during the same period, resulting in a 53.8% discount to NAV as of June 30, 2019[25][161] Schedules of Investments Investment Type | Investment Type (in thousands) | June 30, 2019 Fair Value | December 31, 2018 Fair Value | | :----------------------------- | :----------------------- | :--------------------------- | | Control Investments | $10,500 | $9,210 | | Affiliate Investments | $24,500 | $20,500 | | Non-Affiliate Investments - Related Party | $5,018 | $4,328 | | Non-Affiliate Investments | $977 | $977 | | Temporary Cash Investments | $26,990 | $26,981 | | Total Investments | $67,985 | $61,996 | Industry Concentration | Industry (in thousands) | June 30, 2019 Fair Value | % of Net Assets (June 30, 2019) | | :--------------------------- | :----------------------- | :------------------------------ | | 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% | - As of June 30, 2019, 87.8% of assets at fair value were in qualifying investments under the 1940 Act, and the company provides significant managerial assistance to portfolio companies comprising 85.4% of total investment value[32] - The company is classified as a 'non-diversified' investment company, with 'Shipping products and services' representing 51.1% of net asset value and 'Energy' representing 21.9% of net asset value as of June 30, 2019, indicating high concentration risk[33][34] Notes to Condensed Financial Statements (1) Description of Business and Basis of Presentation The company operates as a BDC and RIC, investing in companies with enterprise values of $5.0 to $75.0 million for total return - Equus Total Return, Inc. is a Delaware corporation, trading on the NYSE under 'EQS', with an investment strategy focused on total return (capital appreciation and current income)[47] - The Fund invests in debt and equity securities of companies with a total enterprise value of $5.0 million to $75.0 million, primarily targeting growth through acquisition or organically, leveraged buyouts, management buyouts, and recapitalizations[48] - The company qualifies as a Regulated Investment Company (RIC) for federal income tax purposes and uses wholly-owned Taxable Subsidiaries to hold certain income-producing investments, ensuring compliance with the 90% investment income test for RIC status[49] (2) Liquidity and Financing Arrangements The company manages liquidity through cash flow and periodic borrowings via a collateralized margin account to maintain its RIC status | Metric (in thousands) | June 30, 2019 | December 31, 2018 | | :-------------------- | :------------ | :---------------- | | Cash and Cash Equivalents | $5,407 | $7,425 | | Restricted Cash and Temporary Cash Investments | $27,200 | $27,300 | | Borrowing under Margin Account | $27,000 | $27,000 | - The company periodically borrows funds via a margin account, collateralized by U.S. Treasury bills, to maintain its RIC status and avoid corporate income taxes[60][61] - Market and economic volatility have constrained debt financing for small and medium-sized companies, leading Equus to shift strategies from originating new investments to preserving liquidity through monetizations, dividend suspension, and management internalization[64] (3) Significant Accounting Policies This section details key accounting policies, including the Board-approved process for valuing investments using a fair value hierarchy - Investments without readily available market quotations are valued quarterly through a multi-step process involving investment professionals, independent valuation firms (for investments over $2.5 million held for more than one year), Management, the Audit Committee, and final Board approval[66] Fair Value Measurement | Fair Value Measurement (in thousands) | Total | Level 1 (Quoted Prices) | Level 2 (Observable Inputs) | Level 3 (Unobservable Inputs) | | :------------------------------------ | :---- | :---------------------- | :-------------------------- | :---------------------------- | | As of June 30, 2019: | | | | | | 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 | $— | $— | | As of December 31, 2018: | | | | | | 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 | $— | $— | Level 3 Fair Value Changes | Level 3 Fair Value Changes (in thousands) | Control Investments | Affiliate Investments | Non-affiliate Investments | Total | | :---------------------------------------- | :------------------ | :-------------------- | :------------------------ | :---- | | Six Months Ended June 30, 2019: | | | | | | 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) | | Fair value as of June 30, 2019 | $10,500 | $24,500 | $977 | $35,977 | | Three Months Ended June 30, 2018: | | | | | | 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 | - The company records Payment in Kind (PIK) interest as interest income and adds it to the principal balance of the loan, which must be distributed to stockholders as dividends to maintain RIC status, even if cash has not yet been collected[99] (4) Related Party Transactions and Agreements This section discloses compensation for Independent Directors and payments to a director-owned professional corporation for services - Independent Directors receive an annual fee of $40,000, plus $2,000 for in-person meetings and $1,000 for telephonic meetings[110] - Committee chairs receive an additional $50,000 annual fee[110] - Kenneth I. Denos, P.C., a professional corporation owned by a director, received $0.2 million for services provided to the Fund during each of the six months ended June 30, 2019 and 2018[111] (5) Portfolio Securities This note details significant portfolio activities, including dividends, a subsidiary dissolution, and drivers of unrealized appreciation - During the six months ended June 30, 2019, the company received $0.2 million in dividends (additional shares) from MVC Capital and dissolved Equus Media Development Company, LLC (EMDC), transferring its assets to the Fund[113][176][177] Drivers of Unrealized Appreciation Change | Driver of Unrealized Appreciation Change | Six Months Ended June 30, 2019 (in millions) | Six Months Ended June 30, 2018 (in millions) | | :--------------------------------------- | :------------------------------------------- | :------------------------------------------- | | MVC Capital, Inc. | +$0.7 | -$0.4 | | PalletOne, Inc. | +$4.0 | +$2.3 | | Equus Energy, LLC | +$1.5 | +$1.0 | | EMDC (transfer to realized loss) | -$2.8 | N/A | | Total Net Change in Unrealized Appreciation | +$8.8 | +$2.9 | (6) Plan of Reorganization The company is pursuing a Plan of Reorganization aiming for a merger, consolidation, or restructuring into an operating company - In May 2014, Equus entered a Share Exchange with MVC Capital, Inc., selling 2,112,000 shares of its common stock for 395,839 shares of MVC, as a first step in a Plan of Reorganization[117][152] - The company intends to finalize the Plan of Reorganization through a merger or consolidation with MVC or an operating company, or by restructuring as a publicly-traded operating company focused on specific sectors (energy, natural resources, technology, financial services)[118][153] - Shareholders approved the cessation as a BDC in January 2019, authorizing the Board to withdraw its BDC election, but this withdrawal is contingent on entering a definitive 'Consolidation' agreement[119][155] (7) 2016 Equity Incentive Plan The 2016 Equity Incentive Plan aligns stakeholder interests through restricted stock and option grants - The 2016 Equity Incentive Plan, approved by shareholders and the SEC, allows for awards of restricted stock and common stock purchase options, with a maximum of 2,434,728 shares[120][156] - On March 17, 2017, 844,500 shares of restricted stock were granted to directors and executive officers, subject to a 3-year vesting period[120][156] Compensation Expense | Metric (in millions) | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :------------------- | :----------------------------- | :----------------------------- | | Compensation Expense | $0.2 | $0.3 | (8) Equus Energy, LLC This note details the operations, financials, and accounting policies of Equus Energy, LLC, a wholly-owned oil and gas subsidiary - Equus Energy, LLC, a wholly-owned subsidiary, holds working interests in 141 producing and non-producing oil and gas wells across approximately 21,520 acres in Texas and Oklahoma[122] Financial Summary | Metric (in thousands) | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :-------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Operating Revenue | $217 | $282 | $361 | $577 | | Total Operating Expenses | $302 | $394 | $634 | $733 | | Net Loss | $(85) | $(112) | $(273) | $(156) | - Equus Energy follows the Full Cost Method of Accounting for oil and gas properties, capitalizing all acquisition, exploration, and development costs, and amortizing them using the unit-of-production method over proved reserves[136][137] - Capitalized oil and gas property costs are subject to a ceiling limitation based on the present value of estimated future net revenue from proved reserves, with an impairment charge recorded if costs exceed this limit[138][139] (9) Subsequent Events This section notes the post-period sale of U.S. Treasury Bills and repayment of a margin loan - On July 5, 2019, the company sold $27.0 million of U.S. Treasury Bills and used the proceeds to repay the associated margin loan[179] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the company's financial condition, operational results, investment strategy, and Plan of Reorganization - The Fund's investment strategy aims for total return by investing in debt and equity securities of companies with enterprise values between $5.0 million and $75.0 million, while maintaining BDC and RIC status[150][151] - The company's net asset value (NAV) increased by 10.2% from $3.22 per share to $3.55 per share during the six months ended June 30, 2019, though its common stock traded at a 53.8% discount to NAV[161] - Key liquidity initiatives include changes in Board/Management, termination of certain follow-on investments, internalization of management, suspension of managed distribution policy, and modification of investment strategy to pursue shorter-term liquidation opportunities[162] Financial Performance Summary | Metric (in millions) | Three Months Ended June 30, 2019 | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2019 | Six Months Ended June 30, 2018 | | :------------------- | :------------------------------- | :------------------------------- | :----------------------------- | :----------------------------- | | Net Investment Loss | $(0.8) | $(0.9) | $(1.8) | $(1.9) | | Investment Income | $0.1 | $0.1 | $0.1 | $0.2 | | Total Expense | $0.9 | $1.1 | $1.9 | $2.2 | - The company 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, 2019[171] - Net change in unrealized appreciation of portfolio securities was $8.8 million for the six months ended June 30, 2019, primarily driven by increases in the fair value of PalletOne, Inc. (+$4.0 million) and Equus Energy, LLC (+$1.5 million)[173] Item 3. Quantitative and Qualitative Disclosure about Market Risk The company is exposed to interest rate and equity price risks but does not use derivative financial instruments for hedging - The company is subject to financial market risks from changes in interest rates (for debt securities and outstanding debt) and changes in marketable equity security prices[180] - A major portion of the investment portfolio consists of debt and equity investments in private companies, whose fair values are not significantly impacted by modest changes in public market equity prices, but can be affected by significant changes[182] - The company does not use derivative financial instruments to mitigate market risks[180] Item 4. Controls and Procedures Management concluded that the Fund's disclosure controls and procedures were effective as of the reporting date - The Fund's disclosure controls and procedures were evaluated as effective at a reasonable assurance level as of June 30, 2019[184] - There were no material changes in internal control over financial reporting during the quarter ended June 30, 2019[184] PART II. OTHER INFORMATION Item 1. Legal Proceedings This section details the favorable resolution of a shareholder lawsuit regarding the 2016 Equity Incentive Plan - A shareholder lawsuit concerning the 2016 Equity Incentive Plan, alleging breach of fiduciary duties, was filed against the Fund and its Board[186] - The Chancery Court granted summary judgment in favor of the Fund on November 13, 2018, which was affirmed by the Delaware Supreme Court on May 16, 2019, terminating the proceedings[186] Item 1A. Risk Factors This section highlights new risks related to the company's planned conversion into an operating company - Readers should refer to the Annual Report on Form 10-K for the year ended December 31, 2018, for a comprehensive discussion of risk factors[189] - New risks may arise in connection with the company's efforts to convert into an operating company and potential consolidation transactions[188] Item 6. Exhibits This section lists all exhibits filed with the Form 10-Q, including corporate governance documents and material contracts - Key exhibits include the Restated Certificate of Incorporation, Amended and Restated Bylaws, Share Exchange Agreement with MVC Capital, Inc., and the 2016 Equity Incentive Plan[192][193] - The report includes certifications by the Chief Executive Officer and Chief Financial Officer as required by Rule 13a-14(a)/15d-14(a) and Section 1350[193] SIGNATURE This section contains the formal signature block confirming the report's filing