Equus Total Return(EQS) - 2019 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION Item 1. Unaudited Condensed Financial Statements Unaudited financial statements and notes detail business, policies, and investment valuations, highlighting net asset growth from portfolio appreciation Condensed Balance Sheets | Metric (in thousands) | Sep 30, 2019 | Dec 31, 2018 | Change | | :-------------------- | :----------- | :----------- | :----- | | Total Assets | $76,200 | $70,941 | +$5,259 | | Total Liabilities | $27,176 | $27,446 | -$270 | | Total Net Assets | $49,024 | $43,495 | +$5,529 | | Investments in portfolio securities at fair value | $42,904 | $35,015 | +$7,889 | | Cash and cash equivalents | $4,783 | $7,425 | -$2,642 | Condensed Statements of Operations | Metric (in thousands) | Three Months Ended Sep 30, 2019 | Three Months Ended Sep 30, 2018 | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :-------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Total Investment Income | $90 | $85 | $196 | $315 | | Total Expenses | $916 | $807 | $2,809 | $2,964 | | Net Investment Loss | $(826) | $(722) | $(2,613) | $(2,649) | | Net Realized (Loss) Gain | $10 | $3 | $(2,747) | $4 | | Net Change in Unrealized Appreciation of Portfolio Securities | $2,000 | $2,999 | $10,290 | $6,313 | | Net Change in Unrealized Depreciation of Portfolio Securities - Related Party | $(173) | $78 | $359 | $(461) | | Net Increase in Net Assets from Operations | $1,011 | $2,358 | $5,289 | $3,207 | | Basic and Diluted EPS | $0.07 | $0.17 | $0.39 | $0.24 | Condensed Statements of Changes in Net Assets | Metric (in thousands) | Jan 1, 2019 | Sep 30, 2019 | Change | | :-------------------- | :---------- | :----------- | :----- | | Total Net Assets | $43,495 | $49,024 | +$5,529 | | Undistributed Net Investment Losses | $(29,327) | $(31,940) | -$2,613 | | Unrealized Appreciation of Portfolio Securities, net | $19,310 | $29,600 | +$10,290 | | Share-based incentive compensation (9 months) | N/A | $240 | N/A | | Net increase in net assets resulting from operations (9 months) | N/A | $5,289 | N/A | Condensed Statements of Cash Flows | Metric (in thousands) | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :-------------------- | :----------------------------- | :----------------------------- | | Net Cash Used in Operating Activities | $(2,652) | $(1,596) | | Net Cash Provided by (Used in) Financing Activities | $10 | $(1,003) | | Net Decrease in Cash and Cash Equivalents | $(2,642) | $(2,599) | | Cash and Cash Equivalents and Restricted Cash at End of Period | $5,053 | $8,376 | Supplemental Information—Selected Per Share Data and Ratios Schedules of Investments Selected Per Share Data and Ratios | Metric | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :------------------------------------ | :----------------------------- | :----------------------------- | | Net Investment Loss per share | $(0.20) | $(0.20) | | Net Realized Loss per share | $(0.20) | — | | Net Change in Unrealized Appreciation per share | $0.76 | $0.47 | | Net Increase in Net Assets per share | $0.39 | $0.24 | | Net Assets at End of Period per share | $3.63 | $3.45 | | Ratio of Expenses to Average Net Assets | 6.07% | 6.62% | | Ratio of Net Investment Loss to Average Net Assets | (5.65%) | (5.92%) | - Market price per share decreased from $1.96 at the beginning of the period to $1.61 at the end of September 30, 2019, while net assets per share increased, leading to a wider discount[16] Schedule of Investments | Investment Type | Sep 30, 2019 | Dec 31, 2018 | | :-------------- | :----------- | :----------- | | Control Investments | $10,500 | $9,210 | | Affiliate Investments | $26,500 | $20,500 | | Non-affiliate Investments - Related Party | $4,927 | $4,328 | | Non-affiliate Investments | $977 | $977 | | Total Investments in Portfolio Securities | $42,904 | $35,015 | | Temporary Cash Investments | $26,991 | $26,981 | | Total Investments | $69,895 | $61,996 | | Type of Securities | Cost | Fair Value | Fair Value as Percentage of Net Assets | | :----------------- | :--- | :--------- | :------------------------------------- | | Common stock | $7,169 | $31,427 | 64.1% | | Limited liability company investments | $7,050 | $10,500 | 21.4% | | Secured and subordinated debt | $977 | $977 | 2.0% | | Total | $15,196 | $42,904 | 87.5% | | Industry | Fair Value | Fair Value as Percentage of Net Assets | | :--------------------------- | :--------- | :------------------------------------- | | Shipping products and services | $26,500 | 54.1% | | Energy | $10,500 | 21.4% | | Financial services | $4,927 | 10.0% | | Business products and services | $977 | 2.0% | | Total | $42,904 | 87.5% | - The company is a "non-diversified" investment company, with 54.1% of net asset value in "Shipping products and services" and 21.4% in "Energy" as of September 30, 2019, making it highly susceptible to changes in these sectors[23][28] - As of September 30, 2019, 88.5% of assets at fair value were in qualifying investments under the 1940 Act, and the company provides significant managerial assistance to portfolio companies comprising 86.2% of total investment value[23] Notes to Condensed Financial Statements Note 1. Description of Business and Basis of Presentation - Equus Total Return, Inc. is a BDC and RIC, trading on the NYSE under 'EQS', with an investment strategy focused on total return in companies with enterprise values between $5.0 million and $75.0 million[31] - The company uses wholly-owned taxable subsidiaries to hold certain income-producing investments and LLCs, helping satisfy the RIC tax requirement that at least 90% of gross revenue must consist of investment income, preserving RIC status and tax advantages[31] Note 2. Liquidity and Financing Arrangements - As of September 30, 2019, cash and cash equivalents were $4.8 million, and restricted cash and temporary cash investments totaled $27.3 million, primarily from a quarter-end margin loan to maintain RIC diversification requirements[33] - The company borrowed $27.0 million via a margin account as of September 30, 2019, collateralized by $27.3 million in restricted cash and U.S. Treasury bills, to maintain its RIC status[35] - The company believes its operating cash flow and cash on hand are sufficient to meet operating requirements and finance routine follow-on investments for the next twelve months[33] Note 3. Significant Accounting Policies Valuation of Investments - Investments without readily available market quotations are valued quarterly through a multi-step process involving internal professionals, independent valuation firms (for investments over $2.5M held >1 year), management, and approval by the Audit Committee and Board[38] - Valuation methodologies include yield analysis, enterprise value (EV) analysis, net asset value analysis, liquidation analysis, and discounted cash flow analysis, considering factors like security covenants, collateral, portfolio company performance, and market ratios[38][40] Fair Value Measurement - Fair value measurements are categorized into Level 1 (quoted prices in active markets), Level 2 (observable inputs other than Level 1), and Level 3 (unobservable inputs)[40] | Investment Type | Total | Level 1 | Level 2 | Level 3 | | :-------------- | :---- | :------ | :------ | :------ | | Control investments | $10,500 | $— | $— | $10,500 | | Affiliate investments | $26,500 | $— | $— | $26,500 | | Non-affiliate investments - related party | $4,927 | $4,927 | $— | $— | | Non-affiliate investments | $977 | $— | $— | $977 | | Total investments | $42,904 | $4,927 | $— | $37,977 | | Temporary cash investments | $26,991 | $26,991 | $— | $— | | Total investments and temporary cash investments | $69,895 | $31,918 | $— | $37,977 | - As of September 30, 2019, $37.977 million of total investments were classified as Level 3, indicating reliance on significant unobservable inputs and management judgment for valuation[42] | Metric | Control Investments | Affiliate Investments | Non-affiliate Investments | Total | | :-------------------------- | :------------------ | :-------------------- | :------------------------ | :------ | | Fair value as of Jan 1, 2019 | $9,210 | $20,500 | $977 | $30,687 | | Realized losses | — | $(2,789) | — | $(2,789) | | Change in unrealized appreciation | $4,290 | $6,000 | — | $10,290 | | Proceeds from sales/dispositions | $(211) | — | — | $(211) | | Fair value as of Sep 30, 2019 | $10,500 | $26,500 | $977 | $37,977 | Other Significant Accounting Policies - Investment transactions are recorded on an accrual basis, with realized gains/losses computed using specific identification; investments are classified as Control (>25% voting, or >50% board), Affiliate (5-25% voting), or Non-affiliate (<5% voting) per the 1940 Act[46] - Interest income is recognized on an accrual basis, and Payment in Kind (PIK) interest is added to the principal balance of loans and recorded as interest income, requiring distribution to stockholders to maintain RIC status[46][48] - Share-based compensation is accounted for using the fair value method, with grant date fair value amortized as expense over the vesting period[48] - The company intends to qualify as a Regulated Investment Company (RIC) for federal income tax purposes, avoiding corporate income taxes on distributed income or gains[48] Accounting Standards Recently Adopted and Not Yet Adopted - Adoption of ASU 2016-02 (Leases) on January 1, 2019, had no material impact due to the absence of operating leases[48] - The company adopted new SEC rules for disclosing changes in net assets in Form 10-Q, effective January 1, 2019, without material impact[50] - ASU 2016-13 (Credit Losses) and ASU 2018-13 (Fair Value Measurement) are not expected to materially impact financial statements upon future adoption[50] Note 4. Related Party Transactions and Agreements - Independent Directors receive annual fees ($40,000), meeting fees ($2,000 in-person, $1,000 telephonic), and expense reimbursements; Committee chairs receive an additional $50,000 annual fee[51] - The Fund paid Kenneth I. Denos, P.C., a director's professional corporation, $0.07 million for services during each of the three months ended September 30, 2019 and 2018, and $0.3 million for each of the nine months ended September 30, 2019 and 2018[51] Note 5. Portfolio Securities - Net change in unrealized appreciation was $10.7 million for the nine months ended September 30, 2019, increasing total net unrealized appreciation to $27.7 million[54] - Key drivers of unrealized appreciation for the nine months ended September 30, 2019, included: PalletOne, Inc.: +$6.0 million due to improved operating performance; Equus Energy, LLC: +$1.5 million due to increased mineral acreage prices and crude oil prices; MVC Capital, Inc.: +$0.4 million due to share price increase and dividend payments[54] - The dissolution of Equus Media Development Company, LLC resulted in a $2.8 million transfer of unrealized depreciation to realized loss during the nine months ended September 30, 2019[54] Note 6. Plan of Reorganization - The company plans a reorganization to merge with MVC Capital or an operating company, or to terminate its BDC election and restructure as a publicly-traded operating company in energy, natural resources, technology, and/or financial services[56] - Shareholder authorization to withdraw the BDC election expired on July 31, 2019, but is expected to be renewed, with actual withdrawal contingent on a definitive "Consolidation" agreement and a subsequent affirmative shareholder vote[56] Note 7. 2016 Equity Incentive Plan - The 2016 Equity Incentive Plan allows for awards of restricted stock and common stock purchase options, with a maximum of 2,434,728 shares, to align interests and retain key personnel[57] - As of September 30, 2019, 280,000 shares of restricted stock remained unvested[57] | Period | 2019 (in thousands) | 2018 (in thousands) | | :----- | :--- | :--- | | Three Months Ended Sep 30 | $0.08 | $0.08 | | Nine Months Ended Sep 30 | $0.2 | $0.4 | Note 8. Equus Energy, LLC - Equus Energy, LLC, a wholly-owned subsidiary, invests in oil & gas properties, holding working interests in 141 wells across Texas and Oklahoma, including a 50% interest in Conger Field wells and interests in the Eagle Ford Shale play[59] | Metric | Three Months Ended Sep 30, 2019 | Three Months Ended Sep 30, 2018 | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :------------------------------------ | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Operating Revenue | $120 | $278 | $481 | $855 | | Total Operating Expenses | $322 | $364 | $956 | $1,097 | | Operating Loss before Income Tax Expense | $(202) | $(86) | $(475) | $(242) | | Net Loss | $(202) | $(86) | $(475) | $(242) | - Equus Energy's operators intend to delay new drilling and recompletion projects until 2020, anticipating a gradual rise in crude oil prices[59] - Equus Energy follows the Full Cost Method of Accounting for oil and gas properties, capitalizing all acquisition, exploration, and development costs, and amortizing them over the estimated productive life of proved reserves using the unit-of-production method[67] Note 9. Subsequent Events - On October 5, 2019, the company sold $27.0 million in U.S. Treasury Bills and repaid the associated margin loan[68] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Discusses Equus Total Return, Inc.'s BDC and RIC business, investment strategy, reorganization plan, market conditions, liquidity, and operations, highlighting net asset value increase Business Overview and Strategy - Equus is a BDC and RIC, listed on the NYSE (EQS), focused on maximizing total return through capital appreciation and current income from debt and equity investments in companies with enterprise values between $5.0 million and $75.0 million[69][71] - The company utilizes wholly-owned taxable subsidiaries to hold certain income-producing investments, ensuring compliance with the 90% investment income requirement for RIC tax status[71] Plan of Reorganization - The Plan of Reorganization involves a potential merger with MVC Capital, Inc. or an operating company, or restructuring Equus as a publicly-traded operating company focused on energy, natural resources, technology, and/or financial services[72] - Shareholder authorization to withdraw the BDC election expired on July 31, 2019, and a subsequent affirmative vote will be required to enter into any definitive agreement for "Consolidation" or change the business nature[74] 2016 Equity Incentive Plan - The 2016 Equity Incentive Plan aims to promote equity ownership and retention among key personnel, with 844,500 restricted shares granted on March 17, 2017, subject to a 3-year vesting period[75] | Period | 2019 (in thousands) | 2018 (in thousands) | | :----- | :--- | :--- | | Three Months Ended Sep 30 | $0.08 | $0.08 | | Nine Months Ended Sep 30 | $0.2 | $0.4 | Current Market Conditions - U.S. GDP growth was 1.9% in Q3 2019, following 2.0% and 3.1% in Q1 and Q2, respectively, with a tight labor market but signs of weakening business investment[76] - Global M&A activity slowed in Q1 2019 but accelerated in Q2, with approximately $2 trillion in global transactions and $2.4 trillion in undeployed capital, leading to higher median valuation multiples (11x EBITDA) and constrained investment yields[76] - The company's net asset value increased by 12.7% from $3.22 to $3.63 per share during the nine months ended September 30, 2019, but its common stock traded at a 55.6% discount to NAV, up from 39.1% at December 31, 2018[78] Liquidity and Capital Resources - Cash is generated from maturities, security sales, and borrowings, and used for additional investments and stockholder dividends[79] - The company periodically borrows funds, often through margin accounts, to make qualifying investments and maintain its RIC tax status, noting that failure to qualify would result in corporate income tax[79] - Management believes current operating cash flow and cash on hand are sufficient to meet operating requirements and finance routine capital expenditures for the next twelve months[79] Results of Operations Investment Income and Expense | Metric (in millions) | Three Months Ended Sep 30, 2019 | Three Months Ended Sep 30, 2018 | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :-------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Net Investment Loss | $(0.8) | $(0.7) | $(2.6) | $(2.6) | | Investment Income | $0.1 | $0.1 | $0.2 | $0.3 | | Total Expense | $0.9 | $0.8 | $2.8 | $3.0 | - The decrease in total expenses for the nine months ended September 30, 2019, was mainly due to a decline in professional fees[80] Realized Gains and Losses on Sales of Portfolio Securities - A realized loss of $2.8 million was incurred from the dissolution and liquidation of Equus Media Development Company LLC (EMDC) during the nine months ended September 30, 2019[81] Changes in Unrealized Appreciation/Depreciation of Portfolio Securities - Net change in unrealized appreciation was $10.7 million for the nine months ended September 30, 2019, increasing total net unrealized appreciation to $27.7 million[83] - Key contributors to unrealized appreciation included PalletOne, Inc. (+$6.0 million), Equus Energy, LLC (+$1.5 million), and MVC Capital, Inc. (+$0.4 million)[83] - The dissolution of EMDC resulted in a $2.8 million transfer of unrealized depreciation to realized loss[83] Dividends - As a BDC, the company is required to distribute net investment income and/or realized capital gains annually under the 1940 Act[83] Portfolio Securities - Received $0.2 million in dividends as additional MVC shares during the nine months ended September 30, 2019[83] - Dissolved Equus Media Development Company, LLC (EMDC) and transferred its assets, including $211,000 in cash, to the Fund[83] Subsequent Events - On October 5, 2019, the company sold $27.0 million in U.S. Treasury Bills and repaid the associated margin loan[85] Item 3. Quantitative and Qualitative Disclosure about Market Risk Details exposure to financial market risks from interest rate changes and equity prices, noting no derivative use and the impact of significant market shifts on private company valuations - The company is exposed to market risks from changes in interest rates (debt securities, outstanding debt) and marketable equity security prices[86] - It does not use derivative financial instruments to mitigate market risks[86] - While modest public market equity price changes do not significantly impact private company valuations, significant shifts can affect carrying values and realized gains/losses[86] Item 4. Controls and Procedures Management, including CEO and CFO, evaluated disclosure controls and procedures as effective, with no material changes to internal control over financial reporting during the quarter - Disclosure controls and procedures were evaluated by management, CEO, and CFO, and deemed effective at a reasonable assurance level as of September 30, 2019[87] - No material changes to internal control over financial reporting occurred during the quarter ended September 30, 2019[87] PART II. OTHER INFORMATION Item 1. Legal Proceedings A shareholder lawsuit regarding the 2016 Equity Incentive Plan was dismissed, and other incidental legal proceedings are not expected to materially affect financial condition or operations - A shareholder lawsuit challenging the 2016 Equity Incentive Plan was dismissed by the Chancery Court and affirmed by the Delaware Supreme Court on May 16, 2019[89] - The company does not expect other legal proceedings incidental to its normal business to materially affect its financial condition or results of operations[89] Item 1A. Risk Factors Refers to the Annual Report on Form 10-K for risk factors; new risks from planned operating company conversion and related transactions will be disclosed in future filings - Readers should refer to the Annual Report on Form 10-K for a comprehensive discussion of risk factors[90] - New risks may arise from the planned conversion to an operating company and related transactions, which will be identified and disclosed in subsequent filings[90] Item 6. Exhibits Lists various exhibits filed by the company, including corporate governance documents, material contracts, and certifications - The exhibits include corporate governance documents (Restated Certificate of Incorporation, Bylaws), material contracts (Safekeeping Agreement, Share Exchange Agreement with MVC Capital, Inc.), and the 2016 Equity Incentive Plan[92] SIGNATURE The report is signed by John A. Hardy, CEO, on November 13, 2019, certifying compliance with Section 13 or 15(d) of the Securities Exchange Act of 1934 - The report was signed by John A. Hardy, Chief Executive Officer, on November 13, 2019[96]