-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, T42QYvYlS/j/U85gFiOH7ZOE5lM/Dis2uEcORINhriz0Th2KJUJ6tZwBXJ8z12wI YIYUSCK3lAth0eTeUzzd2g== 0000890566-98-001778.txt : 19981113 0000890566-98-001778.hdr.sgml : 19981113 ACCESSION NUMBER: 0000890566-98-001778 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EQUUS II INC CENTRAL INDEX KEY: 0000878932 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 760345915 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11362 FILM NUMBER: 98743895 BUSINESS ADDRESS: STREET 1: 2929 ALLEN PKWY STE 2500 CITY: HOUSTON STATE: TX ZIP: 77019 BUSINESS PHONE: 7135290900 MAIL ADDRESS: STREET 1: 2929 ALLEN PARKWAY STREET 2: STE 2500 CITY: HOUSTON STATE: TX ZIP: 77019 10-Q 1 FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-19509 EQUUS II INCORPORATED (Exact name of registrant as specified in its charter) DELAWARE 76-0345915 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2929 ALLEN PARKWAY, SUITE 2500 HOUSTON, TEXAS 77019-2120 (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code: (713) 529-0900 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered COMMON STOCK NEW YORK STOCK EXCHANGE Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Approximate aggregate market value of common stock held by non-affiliates of the registrant: $81,632,265 computed on the basis of $19.00 per share, closing price of the common stock on the New York Stock Exchange Inc. on November 9, 1998. For the purpose of calculating this amount only, all directors and executive officers of the registrant have been treated as affiliates. There were 4,828,492 shares of the registrant's common stock, $.001 par value, outstanding, as of November 9, 1998. The net asset value of a share at September 30, 1998 was $24.89. Documents incorporated by reference: None EQUUS II INCORPORATED (A Delaware Corporation) INDEX PART I. FINANCIAL INFORMATION PAGE Item 1. Financial Statements Balance Sheets - September 30, 1998 and December 31, 1997.................. 1 Statements of Operations - For the three months ended September 30, 1998 and 1997.... 2 - For the nine months ended September 30, 1998 and 1997..... 3 Statements of Changes in Net Assets - For the nine months ended September 30, 1998 and 1997..... 4 Statements of Cash Flows - For the nine months ended September 30, 1998 and 1997..... 5 Selected Per Share Data and Ratios - For the nine months ended September 30, 1998 and 1997 .... 7 Schedule of Portfolio Securities - September 30, 1998........................................ 8 Notes to Financial Statements............................... 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......................... 20 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K ........................... 25 SIGNATURE ............................................................... 25 ii PART I. FINANCIAL STATEMENTS ITEM 1. FINANCIAL STATEMENTS EQUUS II INCORPORATED BALANCE SHEETS SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 (Unaudited)
1998 1997 ------------ ------------ ASSETS Investments in portfolio securities at fair value (cost $116,329,572 and $85,556,433, respectively) .. $154,463,392 $151,449,786 Temporary cash investments, at cost which approximates fair value ............................ 80,042,444 75,164,751 Cash .................................................... 16,424 15,991 Accounts receivable ..................................... 6,270 932,038 Accrued interest receivable ............................. 771,545 513,623 Commitment fees ......................................... -- 18,750 ------------ ------------ Total assets .................................. 235,300,075 228,094,939 ------------ ------------ LIABILITIES AND NET ASSETS Liabilities: Accounts payable ................................... 123,336 173,277 Dividend payable ................................... 132,677 828,556 Due to management company .......................... 600,841 722,354 Notes payable to bank .............................. 114,275,000 81,900,000 ------------ ------------ Total liabilities ............................. 115,131,854 83,624,187 ------------ ------------ Commitments and contingencies Net assets: Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued .................... -- -- Common stock, $.001 par value, 10,000,000 shares authorized, 4,828,492 shares outstanding ........ 4,828 4,828 Additional paid-in capital ......................... 77,034,495 78,537,258 Undistributed net investment income ................ -- -- Undistributed net capital gains .................... 4,995,079 35,313 Unrealized appreciation of portfolio securities, net 38,133,819 65,893,353 ------------ ------------ Total net assets .............................. $120,168,221 $144,470,752 ============ ============ Net assets per share .......................... $ 24.89 $ 29.92 ============ ============
The accompanying notes are an integral part of these financial statements 1 EQUUS II INCORPORATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Unaudited) 1998 1997 ------------ ------------ Investment income: Income from portfolio securities ...................... $ 927,246 $ 1,718,123 Interest from temporary cash investments .............. 10,136 24,135 ------------ ------------ Total investment income .......................... 937,382 1,742,258 ------------ ------------ Expenses: Management fee ........................................ 600,841 775,765 Director fees and expenses ............................ 54,514 44,950 Professional fees ..................................... 67,033 29,231 Administrative fees ................................... 12,500 12,500 Mailing, printing and other expenses .................. 104,583 67,544 Interest expense ...................................... 604,528 189,723 Franchise taxes ....................................... 8,200 6,279 ------------ ------------ Total expenses ................................... 1,452,199 1,125,992 ------------ ------------ Net investment income (loss) ............................... (514,817) 616,266 ------------ ------------ Realized gain on sales of portfolio securities, net ........ 500,700 6,288,021 ------------ ------------ Unrealized appreciation of portfolio securities, net: End of period ......................................... 38,133,819 78,194,053 Beginning of period ................................... 70,045,805 84,464,151 ------------ ------------ Decrease in unrealized appreciation, net .............. (31,911,986) (6,270,098) ------------ ------------ Total increase (decrease) in net assets from operations $(31,926,103) $ 634,189 ============ ============
The accompanying notes are an integral part of these financial statements 2 EQUUS II INCORPORATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Unaudited)
1998 1997 ------------ ------------ Investment income: Income from portfolio securities ...................... $ 2,811,865 $ 3,121,712 Interest from temporary cash investments .............. 35,164 76,660 ------------ ------------ Total investment income .......................... 2,847,029 3,198,372 ------------ ------------ Expenses: Management fee ........................................ 2,125,550 2,072,441 Management incentive fee .............................. -- 55,824 Deferred management incentive fee ..................... -- 426,501 Director fees and expenses ............................ 185,904 153,812 Professional fees ..................................... 333,795 356,575 Administrative fees ................................... 37,500 37,500 Mailing, printing and other expenses .................. 202,395 183,836 Interest expense ...................................... 1,269,206 415,495 Franchise taxes ....................................... 98,078 100,643 Amortization .......................................... -- 11,730 ------------ ------------ Total expenses ................................... 4,252,428 3,814,357 ------------ ------------ Net investment loss ........................................ (1,405,399) (615,985) ------------ ------------ Realized gain on sales of portfolio securities, net ........ 4,995,079 4,812,355 ------------ ------------ Unrealized appreciation of portfolio securities, net: End of period ......................................... 38,133,819 78,194,053 Beginning of period ................................... 65,893,353 41,671,464 ------------ ------------ Increase (decrease) in unrealized appreciation, net ... (27,759,534) 36,522,589 ------------ ------------ Total increase (decrease) in net assets from operations $(24,169,854) $ 40,718,959 ============ ============
The accompanying notes are an integral part of these financial statements 3 EQUUS II INCORPORATED STATEMENTS OF CHANGES IN NET ASSETS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Unaudited)
1998 1997 ------------- ------------- Operations: Net investment loss ............................. $ (1,405,399) $ (615,985) Realized gain on sales of portfolio securities, net .............................. 4,995,079 4,812,355 Increase (decrease) in unrealized appreciation of portfolio securities, net .................... (27,759,534) 36,522,589 ------------- ------------- Increase (decrease) in net assets from operations .... (24,169,854) 40,718,959 ------------- ------------- Capital share transactions: Dividends declared ............................... (132,677) -- Stock issued in payment of deferred management incentive fee ..................... -- 11,210,529 ------------- ------------- Increase (decrease) in net assets from capital share transactions ....................... (132,677) 11,210,529 ------------- ------------- Net increase (decrease) in net assets ................ (24,302,531) 51,929,488 Net assets at beginning of period .................... 144,470,752 103,223,308 ------------- ------------- Net assets at end of period .......................... $ 120,168,221 $ 155,152,796 ============= =============
The accompanying notes are an integral part of these financial statements 4 EQUUS II INCORPORATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Unaudited)
1998 1997 ------------- ------------- Cash flows from operating activities: Interest and dividends received ............ $ 1,212,802 $ 2,672,925 Cash paid to management company, directors, bank and suppliers ...................... (4,405,132) (3,053,567) ------------- ------------- Net cash used by operating activities ... (3,192,330) (380,642) ------------- ------------- Cash flows from investing activities: Purchase of portfolio securities ........... (37,375,126) (22,561,092) Proceeds from sales of portfolio securities 12,886,562 15,773,791 Principal payments from portfolio companies 1,012,576 3,206,728 Advance to co-investor ..................... -- (501,547) ------------- ------------- Net cash used by investing activities ... (23,475,988) (4,082,120) ------------- ------------- Cash flows from financing activities: Advances from bank ......................... 271,900,000 269,600,000 Repayments to bank ......................... (239,525,000) (247,600,000) Dividend payments .......................... (828,556) (1,209,850) ------------- ------------- Net cash provided by financing activities 31,546,444 20,790,150 ------------- ------------- Net increase in cash and cash equivalents ....... 4,878,126 16,327,388 Cash and cash equivalents at beginning of period 75,180,742 69,129,290 ------------- ------------- Cash and cash equivalents at end of period ...... $ 80,058,868 $ 85,456,678 ============= =============
The accompanying notes are an integral part of these financial statements 5 EQUUS II INCORPORATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Unaudited) (Continued)
1998 1997 ------------ ------------ Reconciliation of increase (decrease) in net assets from operations to net cash used by operating activities: Increase (decrease) in net assets from operations ............................. $(24,169,854) $ 40,718,959 Adjustments to reconcile increase (decrease) in net assets from operations to net cash used by operating activities: Realized gain on sale of portfolio securities, net ....................... (4,995,079) (4,812,355) (Increase) decrease in unrealized appreciation, net ...................... 27,759,534 (36,522,589) Accrued interest and dividends exchanged for portfolio securities ................................................. (1,376,305) (991,962) (Increase) decrease in accrued interest receivable ....................... (257,922) 466,515 Amortization of commitment fee ........................................... 18,750 55,000 Commitment fee paid ...................................................... -- (75,000) Amortization of reorganization costs ..................................... -- 11,730 Decrease in accounts payable ............................................. (49,941) (42,223) Stock issued to management company in payment of deferred management incentive fee .................................. -- 11,210,529 Decrease in due to management company .................................... (121,513) (10,399,246) ------------ ------------ Net cash used by operating activities ......................................... $ (3,192,330) $ (380,642) ============ ============
The accompanying notes are an integral part of these financial statements 6 EQUUS II INCORPORATED SUPPLEMENTAL INFORMATION - SELECTED PER SHARE DATA AND RATIOS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 (Unaudited)
1998 1997 -------- -------- Investment income ........................................ $ 0.59 $ 0.68 Expenses ................................................. 0.88 0.81 -------- -------- Net investment loss ................................. (0.29) (0.13) Realized gain on sale of portfolio securities, net ....... 1.04 1.02 Increase (decrease) in unrealized appreciation of portfolio securities, net ....................... (5.75) 7.70 -------- -------- Increase (decrease) in net assets from operations ... (5.00) 8.59 Capital share transactions: Dividends declared .................................. (0.03) -- Net assets at beginning of period ........................ 29.92 24.00 -------- -------- Net assets at end of period .............................. $ 24.89 $ 32.59 ======== ======== Ratio of expenses to average net assets .................. 3.21% 2.95% Ratio of net investment loss to average net assets ....... (1.06)% (0.48)% Ratio of increase (decrease) in net assets from operations to average net assets ............................... (18.27)% 31.52%
The accompanying notes are an integral part of these financial statements 7 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES SEPTEMBER 30, 1998 (Unaudited)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ --------- ----------- A. C. Liquidating Corporation February 1985 -10% secured promissory notes $ 188,014 $ -- Allied Waste Industries, Inc. (NASDAQ - AWIN) March 1989 -1,100,000 shares of common stock 4,037,572 24,941,125 -Warrants to buy up to 125,000 shares of common stock at $5.00 per share through August 1999 -- 1,551,797 American Residential Services, Inc. (NYSE - ARS) December 1995 -1,125,000 shares of common stock 3,000,272 4,084,524 -Warrants to buy up to 100,000 shares of common stock at $15 per share through September 2001 -- -- Atlas Acquisition, Inc. May 1997 -32,000 shares of common stock 32,000 -- -19,680 shares of preferred stock 1,968,000 -- -Junior participation agreement 850,000 250,000 Brazos Sportswear, Inc. (NASDAQ - BRZS) February 1989 -2,160,308 shares of common stock 1,331,187 216,031 -4,181,309 shares of 8% Series B1 preferred stock 4,181,309 1,045,328 -1,422,012 shares of 8% Series B2 preferred stock 1,422,012 355,503 -1,164,391 shares of 8% Series B3 preferred stock 1,164,391 291,098 -Warrants to buy up to 30,261 and 140,578 shares of common stock at $4.62 and $6.59 per share through August 2006 and March 2007, respectively -- -- -1,000 shares of common stock of GCS RE, Inc. 132,910 300,000 Carruth-Doggett Industries, Inc. December 1995 -10% senior subordinated promissory note 2,250,000 2,250,000 -Warrant to buy up to 33,333 shares of common stock at $0.01 per share through December 2005 -- 2,250,000 -Warrant to buy up to 249 shares of common stock of CDE Corp. at $0.01 per share through December 2005 -- --
The accompanying notes are an integral part of these financial statements 8 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES SEPTEMBER 30, 1998 (Unaudited) (Continued)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ ----------- ----------- Container Acquisition, Inc. February 1997 -1,370,000 shares of common stock $ 1,370,000 $ 1,370,000 -52,749 shares of preferred stock 5,274,900 5,274,900 -Warrant to buy up to 370,588 shares of common stock at $.01 per share through June 2003 1,000 1,000 CRC Holdings, Corp. June 1997 -59,891 shares of common stock 5,474,037 16,484,000 -12% subordinated promissory note 959,700 959,700 The Drilltec Corporation August 1998 -1,400,000 shares of common stock 1,400,000 1,400,000 -62,450 shares of preferred stock 6,245,000 6,245,000 Drypers Corporation (NASDAQ - DYPR) July 1991 -3,677,906 shares of common stock 9,328,556 7,884,801 Equicom, Inc. (formerly Texrock Radio, Inc.) July 1997 -500,000 shares of common stock 156,250 156,250 -523,230 shares of preferred stock 5,232,300 5,232,300 -10% subordinated note 2,682,000 2,682,000 Garden Ridge Corporation (NASDAQ - GRDG) July 1992 -474,942 shares of common stock 685,030 3,541,813 Hot & Cool Holdings, Inc. March 1996 -9% increasing rate subordinated promissory note 1,300,000 1,300,000 -10% subordinated note 2,200,000 2,200,000 -12% subordinated note 1,000,000 1,000,000 -Warrants to buy up to 14,942 shares of common stock at $.01 per share through March 2006 -- 280,000 -Warrants to buy up to 16,316 shares of common stock at $26 per share through April, 2007 -- --
The accompanying notes are an integral part of these financial statements 9 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES SEPTEMBER 30, 1998 (Unaudited) (Continued)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ ---------- ------------ HTD Corporation (formerly Triad Medical Inc.) April 1997 -1,251,944 shares of common stock $8,165,000 $ 10,015,552 -Non-interest bearing $2,025,000 promissory note 1,319,509 1,319,509 NCI Building Systems, Inc. (NYSE - NCS) April 1989 -200,000 shares of common stock 159,784 3,962,500 OEI International, Inc. October 1997 (formerly One Engineering, Inc.) -1,218,973 shares of common stock 667 667 -Prime + 1/2% promissory note 2,271,731 2,271,731 Paracelsus Healthcare Corporation (NYSE - PLS) December 1990 -1,263,058 shares of common stock 5,278,748 2,492,226 Petrocon Engineering, Inc. September 1998 -15% promissory note 2,500,000 2,500,000 -Warrant to buy 1,000,000 shares of common stock at $4.00 per share through September 2008 - - Raytel Medical Corporation (NASDAQ - RTEL) August 1997 -33,073 shares of common stock 330,730 146,385 Restaurant Development Group, Inc. June 1987 -610,909 shares of Class A common stock 2,891,156 775,000 Sovereign Business Forms, Inc. August 1996 -13,106 shares of preferred stock 1,310,600 1,310,600 -15% promissory notes 800,000 800,000 -Warrant to buy 551,894 shares of common stock at $1 per share through August 2006 - 1,440,818 -Warrant to buy 25,070 shares of common stock at $1.25 per share through October 2007 - 59,182
The accompanying notes are an integral part of these financial statements 10 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES SEPTEMBER 30, 1998 (Unaudited) (Continued)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ ----------- ----------- Stephen L. LaFrance Holdings, Inc. September 1997 -2,498,452 shares of preferred stock $ 2,498,452 $ 2,498,452 -Warrant to buy 269 shares of common stock for $.01 per share through September 2007 -- -- Strategic Holdings, Inc. September 1995 -3,089,751 shares of common stock 3,088,389 -- -3,822,157 shares of Series B preferred stock 3,820,624 3,820,624 -Warrants to buy 225,000 and 100,000 shares of common stock at $0.4643 and $1.50 per share, respectively, through August 2005 -- -- -1,000 shares of SMIP, Inc. common stock 150,000 -- -15% promissory note of SMIP, Inc. 175,000 -- Summit/DPC Partners, L.P. October 1995 -36.11% limited partnership interest 2,600,000 4,600,000 Travis International, Inc. December 1986 -66,784 shares of common stock 534,589 2,537,792 -104,500 shares of Class A common stock 25,701 3,971,000 Tulsa Industries, Inc. December 1997 -27,500 shares of common stock 33,846 33,846 -546,615 shares of Series A preferred stock 5,466,154 5,466,154 -Warrants to buy 31,731 shares of common stock at $.001 per share -- -- United Industrial Services, Inc. July 1998 -35,000 shares of preferred stock 3,500,000 3,500,000 -Warrants to buy 63,637 shares of common stock at $0.01 per share through June 2008 100 100 United Rentals, Inc. (NYSE - URI) October 1997 -54,334 shares of common stock 397 1,300,647
The accompanying notes are an integral part of these financial statements 11 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES SEPTEMBER 30, 1998 (Unaudited) (Continued)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ ------------- ----------- United States Filter Corporation (NYSE - USF) October 1989 -130,300 shares of common stock $ 1,544,606 $ 2,101,088 VRPI Spin Off, Inc. January 1988 -100 shares of common stock 250,000 250,000 -10% secured promissory note 2,672,349 2,672,349 -12% secured promissory note 1,050,000 1,050,000 -10,000 shares of common stock of Equus Video Corporation 25,000 20,000 ------------- ------------- Total $ 116,329,572 $ 154,463,392 ============= =============
The majority of the Fund's portfolio securities are restricted from public sale without prior registration under the Securities Act of 1933. The Fund negotiates certain aspects of the method and timing of the disposition of the Fund's investment in each portfolio company, including registration rights and related costs. In connection with the investments in Allied Waste Industries, Inc., American Residential Services, Inc., Atlas Acquisition, Inc., Brazos Sportswear, Inc., Container Acquisition, Inc., CRC Holdings, Corp., The Drilltec Corporation, Drypers Corporation, Hot & Cool Holdings, Inc., HTD Corporation, Sovereign Business Forms, Inc., Strategic Holdings, Inc. and United Industrial Services, Inc. rights have been obtained to demand the registration of such securities under the Securities Act of 1933, providing certain conditions are met. The Fund does not expect to incur significant costs, including costs of any such registration, in connection with the future disposition of its portfolio securities As defined in the Investment Company Act of 1940, the Fund is considered to have a controlling interest in Atlas Acquisition, Inc., Brazos Sportswear, Inc., Container Acquisition, Inc., CRC Holdings, Corp., The Drilltec Corporation, Drypers Corporation, Equicom, Inc., OEI International, Inc., Restaurant Development Group, Inc., Sovereign Business Forms, Inc., Strategic Holdings, Inc., Tulsa Industries, Inc., United Industrial Services, Inc. and VRPI Spin Off, Inc. In addition, HTD Corporation and Travis International, Inc. are considered to be affiliated entities of the Fund. The fair values of the Fund's investments in publicly traded securities include discounts from the closing market prices to reflect the estimated effects of restrictions on the sale of such securities at September 30, 1998. Such discounts, shown in the following table, total $9,491,271 or $1.97 per share as of September 30, 1998. The accompanying notes are an integral part of these financial statements 12 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES SEPTEMBER 30, 1998 (Unaudited) (Continued) DISCOUNT FROM MARKET VALUE ------------ Allied Waste Industries, Inc. ........... $ 1,516,453 American Residential Services, Inc. ..... 415,476 Brazos Sportswear, Inc. ................. 4,104,585 Drypers Corporation ..................... 3,148,917 Garden Ridge Corporation ................ 109,541 Paracelsus Healthcare Corporation ....... 191,772 Raytel Medical Corporation .............. 4,527 ------------ Total discount .................... $ 9,491,271 ============ Income was earned in the amount of $1,958,751 and $1,570,687 for the nine months ended September 30, 1998 and 1997 respectively, on portfolio securities of companies in which the Fund has a controlling interest. As defined in the Investment Company Act of 1940, all of the Fund's investments are in eligible portfolio companies. The Fund provides significant managerial assistance to all of the portfolio companies in which it has invested, except Garden Ridge Corporation, Raytel Medical Corporation, Summit/DPC Partners, L.P., United Rentals, Inc. and United States Filter Corporation. The Fund provides significant managerial assistance to portfolio companies that comprise 92% of the total value of the investments in portfolio companies at September 30, 1998. The accompanying notes are an integral part of these financial statements 13 EQUUS II INCORPORATED NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 1998 AND 1997 (Unaudited) (1) ORGANIZATION AND BUSINESS PURPOSE Equus II Incorporated (the "Fund"), a Delaware corporation with perpetual existence, 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. The shares of the Fund trade on the New York Stock Exchange under the symbol EQS. The Fund seeks 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. The Fund seeks to invest primarily in companies which intend to acquire other businesses, including leveraged buyouts. The Fund may also invest in recapitalizations of existing businesses or special situations from time to time. The Fund's investments in Portfolio Companies consist principally of equity securities such as common and preferred stock, but also include other equity-oriented securities such as debt convertible into common or preferred stock or debt combined with warrants, options or other rights to acquire common or preferred stock. Current income is not a significant factor in the selection of investments. The Fund has elected to be treated as a business development company under the Investment Company Act of 1940, as amended. (2) MANAGEMENT The Fund has entered into a management agreement with Equus Capital Management Corporation, a Delaware corporation (the "Management Company"). Pursuant to such agreement, the Management Company performs certain services, including certain management and administrative services necessary for the operation of the Fund. The Management Company receives a management fee at an annual rate of 2% of the net assets of the Fund, paid quarterly in arrears. The Management Company also receives $50,000 per year as compensation for providing certain investor communication services, of which $37,500 is included in the accompanying Statements of Operations for each of the nine months ended September 30, 1998 and 1997. Through March 31, 1997, the Management Company also received or reimbursed a management incentive fee equal to 20% of net realized capital gains less unrealized capital depreciation, computed on a cumulative basis over the life of the Fund. The management incentive fee was paid or reimbursed quarterly in arrears. Pursuant to the vote of the stockholders at a special meeting held on April 9, 1997 ("Special Meeting"), the Fund entered into a new management agreement with the Management Company. The only significant change from the previous management agreement was the elimination of incentive fees based on capital gains effective as of April 1, 1997. Pursuant to the vote of the stockholders at the Special Meeting, the deferred incentive fee, which was calculated to be $11,210,529 based on the net unrealized appreciation of investments in portfolio securities at March 31, 1997, was paid by the issuance to the Management Company of 459,973 unregistered shares of common stock of the Fund on May 15, 1997. The number of shares issued was determined by dividing the deferred incentive fee by $24.37 per share, the net asset value per share at March 31, 1997. Deferred management incentive fee expense of $426,501 resulting from increases in 14 net unrealized appreciation on portfolio securities has been included in the accompanying Statement of Operations for the nine months ended September 30, 1997. Current management incentive fees of $55,824 were included in the accompanying Statement of Operations for the nine months ended September 30, 1997. The Management Company is controlled by a privately-owned corporation. As compensation for services rendered to the Fund, each director who is not an officer of the Fund receives an annual fee of $25,000 paid quarterly in arrears, a fee of $3,000 for each meeting of the Board of Directors attended in person, a fee of $1,500 for participation in each telephonic meeting of the Board of Directors and for each committee meeting attended ($500 for each committee meeting if attended on the same day as a Board Meeting), and reimbursement of all out-of-pocket expenses relating to attendance at such meetings. In addition, each director who is not an officer of the Fund is automatically granted incentive stock options to purchase shares of the Fund's stock at the time of their initial election and annually thereafter. (See Note 10). Certain officers and directors of the Fund serve as directors of Portfolio Companies, and may receive and retain fees, including non-employee director stock options, from such Portfolio Companies in consideration for such service. (3) SIGNIFICANT ACCOUNTING POLICIES Interim Financial Statements - The financial statements included herein have been prepared without audit and include all adjustments which management considers necessary for fair presentation. Valuation of Investments - Portfolio investments are carried at fair value with the net change in unrealized appreciation or depreciation included in the determination of net assets. Investments in companies whose securities are publicly traded are valued at their quoted market price, less a discount to reflect the estimated effects of restrictions on the sale of such securities ("Valuation Discount"), if applicable. Cost is used to approximate fair value of other investments until significant developments affecting an investment provide a basis for use of an appraisal valuation. Thereafter, portfolio investments are carried at appraised values as determined quarterly by the Management Company, subject to the approval of the Board of Directors. The fair market values of debt securities, which are generally held to maturity, are determined on the basis of the terms of the debt securities and the financial conditions of the issuer. Because of the inherent uncertainty of the valuation of portfolio securities which do not have readily ascertainable market values, amounting to $147,099,157 (including $44,858,702 in publicly-traded securities, net of a $9,491,271 Valuation Discount) and $147,899,786 (including $89,710,511 in publicly-traded securities, net of a $17,100,722 Valuation Discount) at September 30, 1998 and December 31, 1997, respectively, the Fund's estimate of fair value may significantly differ from the fair value that would have been used had a ready market existed for the securities. Appraised values do not reflect brokers' fees or other normal selling costs or management incentive fees which might become payable on disposition of such investments. On a daily basis, the Fund adjusts its net asset value for changes in the value of its publicly held securities and material changes in the value of its private securities and reports those amounts to Lipper Analytical Services, Inc. ("Lipper") and also publishes the daily net asset value on its web site at www.equuscap.com. On a weekly basis, such net asset values appear in various publications, including BARRON'S and THE WALL STREET JOURNAL. 15 Investment Transactions - Investment transactions are recorded on the accrual method. Realized gains and losses on investments sold are computed on a specific identification basis. Cash Flows - For purposes of the Statements of Cash Flows, the Fund considers all highly liquid temporary cash investments purchased with an original maturity of three months or less to be cash equivalents. Income Taxes - No provision for Federal income taxes has been made in the accompanying financial statements as the Fund has qualified for pass-through treatment as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986. As such, all net income is allocable to the stockholders for inclusion in their respective tax returns. Net capital losses are not allocable to the shareholders but can be carried over to offset future earnings of the Fund. (4) BOOK TO TAX RECONCILIATION The Fund accounts for dividends in accordance with Statement of Position 93-2 which relates to the amounts distributed by the Fund as net investment income or net capital gains, which are often not equal to the corresponding income or gains shown in the Fund's financial statements. The Fund had undistributed capital gains during 1997 of $132,677. A dividend of such income was declared on July 31, 1998, and will be paid prior to the end of the year. The Fund had a net investment loss for tax purposes for the nine months ended September 30, 1998 and 1997, and therefore distributed no net investment income. The following is a reconciliation of the difference in the Fund's net realized gain on the sale of portfolio securities for book and tax purposes for the nine months ended September 30, 1998 and 1997. 1998 1997 ---------- ----------- Net realized gain on the sales of portfolio securities, book ............................. $4,995,079 $ 4,812,355 Management incentive fee ....................... -- (7,530,385) ---------- ----------- Net realized gain (loss) on the sales of portfolio securities, tax .................... $4,995,079 $(2,718,030) ========== =========== (5) DIVIDENDS The Fund declared undistributed capital gains during 1997 of $ 132,677 as a dividend on July 31, 1998. Subsequent to September 30, 1998, the Fund declared undistributed net capital gains of $2,995,079 as a dividend for the ten months ended October 31, 1998. These capital gains dividends will be paid prior to the end of the year. No dividends were declared during the nine months ended September 30, 1997. The Fund has adopted a policy to make dividend distributions of at least $0.50 per share on an annual basis. In the event that taxable income, including realized capital gains, exceeds $0.50 per share in any year, additional dividends may be declared to distribute such excess. Distributions can be made payable by the Fund either in the form of a cash distribution or in stock by specific election. If the Fund does not have available cash to pay the minimum dividends, it may borrow the required funds or sell some of its portfolio investments. 16 (6) TEMPORARY CASH INVESTMENTS Temporary cash investments, which represent the short-term utilization of cash prior to investment in securities of portfolio companies, distributions to the shareholders or payment of expenses, consist of money market accounts at NationsBank, N.A., earning interest at rates ranging from 3.50% to 5.30% at September 30, 1998. (7) ACCOUNTS RECEIVABLE Included in "Accounts receivable" at September 30, 1998 and December 31, 1997 was $4,945 and $840,000, respectively, in royalties receivable from United Rentals, Inc. related to the sale of the Fund's investment in J&J Rental Service, Inc. During the nine months ended September 30, 1998, $622,076 of the royalty receivable was received and $212,980 was realized as a loss from the reduction in the value of the royalty receivable. In addition, the Fund received in January 1998, $90,712 as a partial distribution from the escrow related to the sale of the Fund's investment in Industrial Equipment Rentals, Inc. This amount was included in "Accounts receivable" at December 31, 1997. (8) PORTFOLIO SECURITIES During the nine months ended September 30, 1998, the Fund invested $13,645,100 in three new companies and made follow-on investments of $25,106,331 in eleven portfolio companies, including $1,376,305 in accrued interest and dividends received in the form of additional portfolio securities and accretion of original issue discount on a promissory note. In addition, the Fund realized a net capital gain of $4,995,079 from the sale of portfolio securities during the nine months ended September 30, 1998. During the nine months ended September 30, 1997, the Fund invested $19,161,738 in nine new companies and made follow-on investments of $4,722,046 in six portfolio companies, including $991,962 in dividends and accrued interest received in the form of additional portfolio securities and $330,730 in securities received upon the sale of securities of another portfolio company. In addition, the Fund realized a net capital gain of $4,812,355 from the sale of portfolio securities during the nine months ended September 30, 1997. (9) NOTES PAYABLE TO BANK The Fund has a $150,000,000 line of credit promissory note with NationsBank, N.A., with interest payable at 1% over the rate earned on its money market account. The Fund had $80,000,000 and $75,000,000 outstanding on such note at September 30, 1998 and December 31, 1997, respectively, that was secured by $80,000,000 and $75,000,000 of the Fund's temporary cash investments for each respective year. The Fund paid $75,000 in commitment fees in 1997, which was capitalized and amortized over the commitment period. Effective April 1, 1998, the Fund extended the line of credit promissory note to April 1, 1999, and lowered the rate to 1/2% over the rate earned on its money market account. In addition, the Fund has a revolving line of credit totaling $50,000,000 with NationsBank, N.A. that expires on April 1, 1999. The Fund had $34,275,000 and $6,900,000 outstanding under such line of credit at September 30, 1998 and December 31, 1997, respectively, which is secured by the Fund's investments in portfolio securities. The Fund also pays 1/4% interest on the unused portion of the line of credit. The interest rate was lowered during the year from a range of prime + 1/4% to 3/4% to a range of prime - 1/2% to prime + 1/4% or libor + 1.65%. 17 The average daily balances outstanding on the Fund's notes payable during the nine months ended September 30, 1998 and 1997, were $20,438,919 and $4,508,681, respectively. (10) STOCK OPTION PLAN At a special meeting of shareholders of the Fund on April 9, 1997, shareholders approved the Equus II Incorporated 1997 Stock Incentive Plan ("Stock Incentive Plan") which authorizes the Fund to issue options to the directors and officers of the Fund in an aggregate amount of up to 20% of the outstanding shares of common stock of the Fund. Implementation of this plan was subject to the receipt of an exemptive order from the Securities and Exchange Commission ("SEC"), which was received on May 8, 1997. The Stock Incentive Option Plan also provides that each director who is not an officer of the Fund be granted an incentive stock option to purchase 5,000 shares of the Fund's common stock. In addition, beginning with the 1998 annual meeting of shareholders, each director who is not an officer of the Fund will, annually on the first business day following the annual meeting, be granted an incentive stock option to purchase 2,000 shares of the Fund's common stock. Under the 1997 Stock Incentive Option Plan, options to purchase 939,131 shares of the Fund's common stock at prices ranging from $17 to $27.44 per share were outstanding at September 30, 1998. During the nine months ended September 30, 1998, no options were exercised. Outstanding options expire in May 2007 through May 2008. If all options granted were exercised as of September 30, 1998, excluding 108,955 shares due to their anti-dilutive effect if converted, there would have been dilution of net assets per share of approximately $0.19 per share, or 0.78%, as a result of such exercise, using the treasury stock method. (11) COMMITMENTS AND CONTINGENCIES The Fund has made commitments to invest, under certain circumstances, up to an additional $350,000 in Equicom, Inc., $355,000 in GCS RE, Inc., $5,228,269 in OEI International, Inc., $6,750,000 in Strategic Holdings, Inc., $2,000,000 in Sovereign Business Forms, Inc. and $500,000 in United Industrial Services, Inc. The Fund and certain of the portfolio companies are involved in asserted claims and have the possibility for unasserted claims which may ultimately affect the fair value of the Fund's portfolio investments. In the opinion of Management, the financial position or operating results of the Fund will not be materially affected by these claims. (12) SUBSEQUENT EVENTS Subsequent to September 30, 1998, the Fund repaid $80,000,000 of notes payable to the bank. In October 1998, the Fund advanced an additional $228,269 to OEI International, Inc. under a prime + 1/2% promissory note. OEI International, Inc. also completed a 0.487716 reverse stock split of its common stock In November 1998, the Fund sold 175,000 shares of Allied Waste Industries, Inc. for $3,686,099, realizing a capital gain of $2,856,326. 18 Subsequent to September 30, 1998, the Board of Directors of the Fund declared a dividend of $0.65 per share, payable on or about December 30, 1998, to shareholders of record as of November 16, 1998. The $0.65 per share is comprised of unpaid net capital gains for the year ended December 31, 1997 plus net capital gains for the ten months ended October 31, 1998. The Fund has filed with the Internal Revenue Service to change its year-end for determining capital gains for federal income tax purposes to October 31. Capital gains dividends were determined previously based on the taxable capital gains realized through December 31 of each year. The dividend will be paid in shares of common stock of the Fund or in cash by specific election. Such election must be made by shareholders prior to December 15, 1998. The number of shares to be issued in the dividend will be determined by the market value of the Fund's stock at the close of business on the New York Stock Exchange on December 15, 1998. Cash will be paid in lieu of issuing any fractional shares. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998, the Fund had $154,463,392 of its assets invested in portfolio securities of 30 companies, and has committed to invest up to an additional $15,183,269 in five of such companies. Current temporary cash investments, anticipated future investment income, proceeds from borrowings and proceeds from the sale of existing portfolio securities are believed to be sufficient to finance these commitments. At September 30, 1998, the Fund had $34,275,000 outstanding on a $50,000,000 revolving line of credit loan from a bank. Net cash used by operating activities was $3,192,330 and $380,642 for the nine months ended September 30, 1998 and 1997, respectively. An increase in interest expense in 1998 accounted for the majority of the increase in cash used by operating activities. At September 30, 1998, the Fund had $80,042,444 of its total assets of $235,300,075 invested in temporary cash investments consisting of money market securities. This amount includes proceeds from a $80,000,000 revolving line of credit to a bank that is utilized to enable the Fund to achieve adequate diversification to maintain its pass-through tax status as a regulated investment company. Such amount was repaid to the bank on October 1, 1998. The Fund has the ability to borrow funds and issue forms of senior securities representing indebtedness or stock, such as preferred stock, subject to certain restrictions. Net investment income and net realized gains from the sales of portfolio investments are intended to be distributed at least annually, to the extent such amounts are not reserved for payment of contingencies or to make follow-on or new investments. The Fund reserves the right to retain net long-term capital gains in excess of net short-term capital losses for reinvestment or to pay contingencies and expenses. Such retained amounts, if any, will be taxable to the Fund as long-term capital gains and shareholders will be able to claim their proportionate share of the federal income taxes paid by the Fund on such gains as a credit against their own federal income tax liabilities. Shareholders will also be entitled to increase the adjusted tax basis of their Fund shares by the difference between their undistributed capital gains and their tax credit amount. RESULTS OF OPERATIONS INVESTMENT INCOME AND EXPENSE Net investment loss after all expenses amounted to $1,405,399 and $615,985 for the nine months ended September 30, 1998 and 1997, respectively. The larger net investment loss in 1998 was primarily attributable to interest expense which increased to $1,269,206 in 1998 as compared to $415,495 in 1997. The increase of the average daily balances outstanding on the lines of credit to $20,438,919 during the nine months ended September 30, 1998, from $4,508,681 in 1997, which was offset partially by a decrease in the interest rate, resulted in the increased interest expense in 1998. Income from portfolio securities decreased to $2,811,865 in 1998 as compared to $3,121,712 in 1997 primarily due to the decrease in dividend income received from portfolio securities during 1998 as compared to 1997. The Management Company receives management fee compensation at an annual rate of 2% of the net assets of the Fund. Such fees amounted to $2,125,550 and $2,072,441 for the nine months ended September 30, 1998 and 1997, respectively. 20 Through March 31, 1997, the Management Company also received or reimbursed a management incentive fee equal to 20% of net realized capital gains less unrealized capital depreciation, computed on a cumulative basis over the life of the Fund. Management incentive fees of $55,824 were accrued during the three months ended March 31, 1997. Deferred management incentive fee expense for the three months ended March 31, 1997 totaled $426,501. Pursuant to the vote of the stockholders at a special meeting held on April 9, 1997, ("Special Meeting") the Fund entered into a new management agreement with the Management Company which does not provide for any incentive fees based on capital gains. The deferred management incentive fee was reflected as an expense of the Fund where there was an increase in the Fund's net unrealized appreciation of portfolio securities and was reflected as a reduction in expense to the Fund when there was a decrease in the Fund's net appreciation of the portfolio securities. The deferred management incentive fees were not paid until such appreciation was realized. However, pursuant to the vote of the stockholders at the Special Meeting, the deferred incentive fee of $11,210,529 at March 31, 1997, was paid on May 15, 1997 by the issuance of 459,973 unregistered shares of common stock of the Fund. The number of shares issued was determined by dividing the deferred incentive fee by $24.37, the net asset value per share at March 31, 1997. At the Special Meeting, shareholders also approved the Equus II Incorporated 1997 Stock Incentive Plan ("Stock Incentive Plan") which authorizes the Fund to issue options to the directors and officers of the Fund in an aggregate amount of up to 20% of the outstanding shares of common stock of the Fund. Implementation of this plan was subject to the receipt of an exemptive order from the Securities and Exchange Commission ("SEC"), which was received on May 8, 1997. The Stock Incentive Plan also provides that each director who is not an officer of the Fund be granted an incentive stock option to purchase 5,000 shares of the Fund's common stock. In addition, beginning with the 1998 annual meeting of shareholders, each director who is not an officer of the Fund is, on the first business day following each annual meeting, granted an incentive stock option to purchase 2,000 shares of the Fund's common stock. Under the 1997 Stock Incentive Option Plan, options to purchase 939,131 shares of the Fund's common stock at prices ranging $17 to $27.44 per share were outstanding at September 30, 1998. During the nine months ended September 30, 1998, no options were exercised. Outstanding options expire in May 2007 through May 2008. If all options granted were exercised as of September 30, 1998, excluding 108,955 shares due to their anti-dilutive effect if converted, there would have been a net dilution of net assets per share, using the treasury stock method, of approximately $0.19 per share, or 0.78%, as a result of such exercise. REALIZED GAINS AND LOSSES ON SALES OF PORTFOLIO SECURITIES During the nine months ended September 30, 1998, the Fund realized net capital gains of $4,995,079 from the sale of securities of seven Portfolio Companies. The Fund sold 143,112 shares of Coach USA, Inc. common stock for $6,620,305, realizing a capital gain of $4,756,947 and 32,128 shares of U.S. Filter Corporation common stock for $1,059,964, realizing a capital gain of $679,111. In addition, the Fund realized a capital gain due to the receipt of $6,825 in additional compensation from the escrow account related to the 1997 sale of Cardiovascular Ventures, Inc. The Fund realized a capital loss of $735,525 on the conversion of its prime + 1% note due from Triad Medical Inc. into a non-interest bearing loan due in 2005. The value of the note was discounted by the $735,525, representing original issue discount which will be accreted to income over the life of the loan. The Fund also realized a loss of $212,980 from the reduction in the value of the royalty receivable due from United Rentals, Inc. related to the 1997 sale of J&J Rental, Inc. The Fund realized a capital gain due to the receipt of additional compensation of $453,560 related to the 1997 sale of the Fund's investment in 21 Industrial Equipment Rentals, Inc. The Fund also realized a capital gain due to the receipt of $47,141, as payment on preferred stock of Springtime, Inc., which had been previously written off as having no value. During the nine months ended September 30, 1997, the Fund had a net realized gain of $4,812,355 from the sale of investments in three portfolio companies. UNREALIZED APPRECIATION AND DEPRECIATION OF PORTFOLIO SECURITIES Net unrealized appreciation on investments decreased $27,759,534 during the nine months ended September 30, 1998, from $65,893,353 to $38,133,819. Such net decrease resulted from decreases in the estimated fair value of securities of ten of the Fund's Portfolio Companies aggregating $45,340,326, an increase in the estimated fair value of securities of ten portfolio companies of $20,697,870, and the transfer of $3,117,078 in net unrealized appreciation to net realized gains from the sale of investments in two companies. Net unrealized appreciation on investments increased $36,522,589 during the nine months ended September 30, 1997, from $41,671,464 to $78,194,053. Such net increase resulted from increases in the estimated fair value of securities of thirteen of the Fund's portfolio companies aggregating $40,297,383, a decrease in the estimated fair value of securities of two portfolio companies of $4,385,495 and the transfer of $610,701 in net unrealized depreciation to net realized losses. DIVIDENDS Dividends of $132,677 were declared by the Fund during the nine months ended September 30, 1998. Subsequent to September 30, 1998, the Fund declared undistributed net capital gains of $2,995,079 as a dividend for the ten months ended October 31, 1998. The capital gains dividends will be paid prior to the end of the year. No dividends were declared during the nine months ended September 30, 1997. PORTFOLIO INVESTMENTS During the nine months ended September 30, 1998, the Fund invested $13,645,100 in three new companies and made follow-on investments of $25,106,331 in eleven portfolio companies, including $1,376,305 in accrued interest and dividends received in the form of additional portfolio securities and accretion of original issue discount on a promissory note. In January 1998, the Fund advanced $3,595,380 under a 10% promissory note to Equicom, Inc. ("Equicom"), in connection with the acquisition of 8 radio stations. On January 27, 1998, the Fund converted $6,372,586 in promissory notes along with $67,918 in accrued interest into 819,680 shares of common stock and 619,050 shares of preferred stock of Equicom. Subsequent to such conversion, the Fund acquired for $2,736,630 an additional 273,663 shares of preferred stock of Equicom. The Fund on June 30, 1998, advanced $2,400,000 to Equicom under a 10% subordinated promissory note. During the second quarter of 1998, Equicom completed a .976 for 1 reverse stock split of its common stock. On June 30, 1998, the Fund sold 300,000 shares of Equicom common stock and 389,223 shares of Equicom preferred stock to co-investors for $93,750 and $3,892,230, respectively, the original cost of each investment. In July 1998, the Fund advanced an additional $282,000 to Equicom under a 10% promissory note. The Fund also acquired an additional 19,740 shares of Equicom preferred stock for $197,400 on September 10, 1998. 22 During the nine months ended September 30, 1998, the Fund made additional investments by advancing $1,000,000, $2,205,550 and $373,035 to Hot & Cool Holdings, Inc., OEI International, Inc. and HTD Corporation (formerly Triad Medical Inc.), respectively, under subordinated promissory notes. In the first quarter of 1998, the Fund advanced an additional $850,000 in the form of a junior participation agreement to Atlas Acquisition, Inc. On January 15, 1998, the Fund exchanged its stock investment in WMW Industries, Inc. for 162,428 shares of United States Filter Corporation ("U.S. Filter") common stock. The Fund also received $1,012,576 in cash, to pay off its junior participation note. The Fund could receive up to an additional 41,560 shares of U.S. Filter common stock, which were placed in an escrow account as security for various representations made by the Fund. The transaction with U.S. Filter, which is traded on the New York Stock Exchange, was a tax-free exchange; therefore the Fund did not realize a capital gain from such transaction. On March 3, 1998, the Fund converted its 25,000 shares of 7.5% convertible preferred stock of Drypers Corporation into 2,500,000 shares of Drypers common stock. In addition, the Fund received 70,024 shares of Drypers common stock in payment of $401,938 in dividends on such preferred stock. Through September 30, 1998, the Fund received an additional 3,755 shares of preferred stock of Container Acquisition, Inc. in payment for $375,500 of dividends on the preferred stock. In 1998, the Fund received an additional 1,116 shares of Sovereign Business Forms, Inc. preferred stock in payment of $111,600 in dividends. Through September 30, 1998, the Fund has received an additional 240,530, 81,802 and 66,981 shares of Series B1, B2 and B3 preferred stock of Brazos Sportswear, Inc., respectively, in payment of $389,313 in dividends on the preferred stock. On May 27, 1998, the Fund acquired an additional 24,891 shares of CRC Holdings, Corp. for $2,275,037, as a follow-on investment to enable CRC to make an acquisition. On April 14, 1998, the Fund's investment in Triad Medical, Inc. ("Triad") was reduced from 449,213 shares of common stock to 196,808 shares (excluding 14,493 shares held in escrow) of common stock, as the result of a reverse stock split. On May 1, 1998, the Fund invested an additional $7,815,000 in Triad in exchange for 976,875 shares of common stock. In addition, on May 1, 1998, Triad acquired four companies in the specialty medical distribution business, including Healthcare Technology Delivery, Inc. ("HTD"), in which the Fund had an investment at September 30, 1998. The Fund received 78,261 shares of Triad common stock for its investment in HTD. In addition, the Fund's prime +1/2% promissory note due from Triad in the amount of $2,025,000 was renewed in the form of a non-interest bearing promissory note due in 2005. In connection with such renewal, the Fund forgave $102,232 of accrued interest receivable from Triad. In addition, the Fund discounted the non-interest bearing note to $1,289,475, realizing a capital loss of $735,525. Such original issue discount is being accreted to income over the life of the note. On July 1, 1998, the Fund acquired 35,000 shares of preferred stock of United Industrial Services, Inc. ("UIS") for $3,500,000, and paid $100 to acquire warrants to purchase up to 63,637 shares of common stock of UIS for $.01 per share through June 30, 2008. UIS, located in Houston, Texas, specializes in field services for the petrochemical and power generation industries. 23 On July 29, 1998, the initial public offering of OEI International, Inc. was postponed due to the market conditions and other factors. In August 1998, the Fund acquired 1,400,000 shares of common stock and 62,450 shares of preferred stock for $1,400,000 and $6,245,000, respectively, from The Drilltec Corporation ("Drilltec"). Drilltec provides protection and packaging of premium oil country tubular goods, drill pipe and line pipe and manufactures thread protectors for customers throughout the world. On August 10, 1998, the Fund received $453,560 as a partial distribution from escrow related to the 1997 sale of the Fund's investment in Industrial Equipment Rentals, Inc. Such amount will be recorded as a capital gain. On September 10, 1998, the Fund advanced $2,500,000 under a 15% promissory note with Petrocon Engineering, Inc. ("Petrocon"). Petrocon is an international engineering, systems and construction management contractor, servicing industrial customers with a primary focus in the process industries - oil, chemical, petrochemical and forest products. During the nine months ended September 30, 1997, the Fund invested $19,161,738 in nine new companies and made follow-on investments of $4,722,046 in six portfolio companies, including $991,962 in accrued interest and dividends received in the form of additional portfolio securities and $330,730 in securities received upon the sale of securities of another portfolio company. In addition, the Fund realized a net capital gain of $4,812,355 during the nine months ended September 30, 1997. Of the companies in which the Fund has investments at September 30, 1998, ten Portfolio Companies are publicly held. The others each have a small number of shareholders and do not generally make financial information available to the public. However, each company's operations and financial information are reviewed by Management to determine the proper valuation of the Fund's investment. YEAR 2000 Many computer software systems in use today cannot properly process date-related information from and after January 1, 2000. Should any of the computer systems employed by the Management Company, any of the Fund's other major service providers, or companies in which the Fund has an investment, fail to process this type of information properly, that could have a negative impact on the Fund's operations and the services provided to the Fund's stockholders. The Management Company is reviewing all of its own computer systems with the goal of modifying or replacing such systems to the extent necessary to prepare for the Year 2000. In addition, the Fund is in the process of inquiring of its major service providers as well its portfolio companies to determine if they are in the process of reviewing their systems with the same goals. Such assessment is expected to be complete prior to the end of the year. It is anticipated that the Fund will incur no material expenses related to the Year 2000 issues. SUBSEQUENT EVENTS Subsequent to September 30, 1998, the Fund repaid $80,000,000 of notes payable to the bank. In October 1998, the Fund advanced an additional $228,269 to OEI International, Inc. under a prime + 1/2% promissory note. OEI International, Inc. also completed a 0.487716 reverse stock split of its common stock. 24 In November 1998, the Fund sold 175,000 shares of Allied Waste Industries, Inc. for $3,686,099, realizing a capital gain of $2,856,326. Subsequent to September 30, 1998, the Board of Directors of the Fund declared a dividend of $0.65 per share, payable on or about December 30, 1998, to shareholders of record as of November 16, 1998. The $0.65 per share is comprised of unpaid net capital gains for the year ended December 31, 1997 plus net capital gains for the ten months ended October 31, 1998. The Fund has filed with the Internal Revenue Service to change its year-end for determining capital gains for federal income tax purposes to October 31. Capital gains dividends were determined previously based on the taxable capital gains realized through December 31 of each year. The dividend will be paid in shares of common stock of the Fund or in cash by specific election. Such election must be made by shareholders prior to December 15, 1998. The number of shares to be issued in the dividend will be determined by the market value of the Fund's stock at the close of business on the New York Stock Exchange on December 15, 1998. Cash will be paid in lieu of issuing any fractional shares. ITEM 6. EXHIBITS AND REPORTS ON FORM 8K (a) Exhibits 10. Material Contracts (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed by the Fund during the period for which this report is filed. SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed by the undersigned, thereunto duly authorized. EQUUS II INCORPORATED By: /S/ NOLAN LEHMANN Nolan Lehmann, President, Principal Financial and Accounting Officer Date: November 10, 1998 25 EX-27.1 2
6 9-MOS DEC-31-1998 SEP-30-1998 196,372,016 234,505,036 777,815 16,424 0 235,300,075 0 0 115,131,854 115,131,854 4,828 77,034,495 4,828,492 4,828,492 0 0 4,995,079 0 38,133,819 120,168,221 1,558,205 1,288,824 0 4,252,428 (1,405,399) 4,995,079 (27,759,534) (24,169,854) 0 0 (132,677) 0 0 0 0 (24,302,531) 0 0 0 0 2,125,550 1,269,206 4,252,428 132,319,487 29.92 (0.29) (4.71) 0.03 0 0 24.89 3.21 20,438,919 4.23
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