-----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, ISAiuD1VPjg91t2xDfXBF9pNnQ6k3zpqEvuciU+SHkTDUSZeGww2hW/TS8mPzo1t 2HxJKEslNjt2bxmSSJy8bw== 0000890566-98-000935.txt : 19980514 0000890566-98-000935.hdr.sgml : 19980514 ACCESSION NUMBER: 0000890566-98-000935 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980513 SROS: AMEX 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: 98617487 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 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 March 31, 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 on which registered Name of each exchange ------------------- ----------------------- COMMON STOCK AMERICAN 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: $119,019,020 computed on the basis of $27.875 per share, closing price of the common stock on the American Stock Exchange, Inc. on May 8, 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 May 13, 1998. The net asset value of a share at March 31, 1998 was $31.63. Documents incorporated by reference: None EQUUS II INCORPORATED (A Delaware Corporation) INDEX PART I. FINANCIAL INFORMATION PAGE ---- Item 1. Financial Statements Balance Sheets - March 31, 1998 and December 31, 1997 ........................ 1 Statements of Operations - For the three months ended March 31, 1998 and 1997 .......... 2 Statements of Changes in Net Assets - For the three months ended March 31, 1998 and 1997 .......... 3 Statements of Cash Flows - For the three months ended March 31, 1998 and 1997 .......... 4 Selected Per Share Data and Ratios - For the three months ended March 31, 1998 and 1997 .......... 6 Schedule of Portfolio Securities - March 31, 1998 .............................................. 7 Notes to Financial Statements ................................. 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ........................... 19 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K .............................. 23 SIGNATURE .................................................................. 23 ii PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS EQUUS II INCORPORATED BALANCE SHEETS MARCH 31, 1998 AND DECEMBER 31, 1997 (Unaudited)
1998 1997 ------------ ------------ ASSETS Investments in portfolio securities at fair value (cost $91,703,159 and $85,556,433, respectively) .......................... $165,651,446 $151,449,786 Temporary cash investments, at cost which approximates fair value ................................................... 75,154,317 75,164,751 Cash ........................................................................... 15,766 15,991 Accounts receivable ............................................................ 841,326 932,038 Accrued interest receivable .................................................... 508,605 513,623 Commitment fees ................................................................ -- 18,750 ------------ ------------ Total assets ......................................................... 242,171,460 228,094,939 ------------ ------------ LIABILITIES AND NET ASSETS Liabilities: Accounts payable .......................................................... 74,952 173,277 Dividend payable .......................................................... -- 828,556 Due to management company ................................................. 763,540 722,354 Notes payable to bank ..................................................... 88,625,000 81,900,000 ------------ ------------ Total liabilities .................................................... 89,463,492 83,624,187 ------------ ------------ Commitments and contingencies Net assets: Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued or outstanding ............................ -- -- Common stock, $.001 par value, 10,000,000 shares authorized, 4,828,492 shares issued and outstanding ............................................................ 4,828 4,828 Additional paid-in capital ................................................ 78,453,797 78,537,258 Undistributed net investment income ....................................... -- -- Undistributed net capital gains ........................................... 301,056 35,313 Unrealized appreciation of portfolio securities, net ..................................................................... 73,948,287 65,893,353 ------------ ------------ Total net assets ..................................................... $152,707,968 $144,470,752 ============ ============ Net assets per share ................................................. $ 31.63 $ 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 MARCH 31, 1998 AND 1997 (Unaudited)
1998 1997 ------------ ------------ Investment income: Income from portfolio securities ........................................ $ 1,177,929 $ 513,859 Interest from temporary cash investments ................................ 16,924 49,869 ------------ ------------ Total investment income ............................................ 1,194,853 563,728 ------------ ------------ Expenses: Management fee .......................................................... 763,540 524,084 Management incentive fee ................................................ -- 55,824 Deferred management incentive fee ....................................... -- 426,501 Director fees and expenses .............................................. 59,119 48,929 Professional fees ....................................................... 83,162 164,953 Administrative fees ..................................................... 12,500 12,500 Mailing, printing and other expenses .................................... 26,462 46,906 Interest expense ........................................................ 317,631 77,767 Franchise taxes ......................................................... 15,900 18,558 Amortization ............................................................ -- 5,865 ------------ ------------ Total expenses ..................................................... 1,278,314 1,381,887 ------------ ------------ Net investment loss .......................................................... (83,461) (818,159) ------------ ------------ Realized gain (loss) on sales of portfolio securities, net ............................................................ 265,743 (3,935,954) ------------ ------------ Unrealized appreciation of portfolio securities, net: End of period ........................................................... 73,948,287 48,019,049 Beginning of period ..................................................... 65,893,353 41,671,464 ------------ ------------ Increase in unrealized appreciation, net ................................ 8,054,934 6,347,585 ------------ ------------ Total increase in net assets from operations ............................ $ 8,237,216 $ 1,593,472 ============ ============ Basic earnings per common share .............................................. $ 1.71 $ 0.37 ============ ============ Diluted earnings per common share ............................................ $ 1.61 $ 0.37 ============ ============ Weighted average common shares outstanding - Basic ........................... 4,828,492 4,300,682 ============ ============ Weighted average common shares and common equivalent shares outstanding - Diluted ............................................ 5,124,606 4,300,682 ============ ============
The accompanying notes are an integral part of these financial statements 2 EQUUS II INCORPORATED STATEMENTS OF CHANGES IN NET ASSETS FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (Unaudited) 1998 1997 ------------- ------------- Operations: Net investment loss ...................... $ (83,461) $ (818,159) Realized gain (loss) on sales of portfolio securities, net ....................... 265,743 (3,935,954) Increase in unrealized appreciation of portfolio securities, net ............. 8,054,934 6,347,585 ------------- ------------- Increase in net assets from operations ........ 8,237,216 1,593,472 Net assets at beginning of period ............. 144,470,752 103,223,308 ------------- ------------- Net assets at end of period ................... $ 152,707,968 $ 104,816,780 ============= ============= The accompanying notes are an integral part of these financial statements 3 EQUUS II INCORPORATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (Unaudited) 1998 1997 ------------ ------------ Cash flows from operating activities: Interest and dividends received ............ $ 428,899 $ 781,953 Cash paid to management company, directors, bank and suppliers ...................... (1,316,703) (725,654) ------------ ------------ Net cash provided (used) by operating activities ............................ (887,804) 56,299 ------------ ------------ Cash flows from investing activities: Purchase of portfolio securities ........... (6,493,947) (7,511,000) Proceeds from sales of portfolio securities 462,075 -- Principal payments from portfolio companies 1,012,576 271,000 Deposit made on pending investment ......... -- (337,500) ------------ ------------ Net cash used by investing activities ... (5,019,299) (7,577,500) ------------ ------------ Cash flows from financing activities: Advances from bank ......................... 84,075,000 70,400,000 Repayments to bank ......................... (77,350,000) (65,300,000) Dividend payments .......................... (828,556) (1,209,850) ------------ ------------ Net cash provided by financing activities 5,896,444 3,890,150 Net decrease in cash and cash equivalents ....... 10,659 (3,631,051) Cash and cash equivalents at beginning of period 75,180,742 69,129,290 ------------ ------------ Cash and cash equivalents at end of period ...... $ 75,170,083 $ 65,498,239 ============ ============ The accompanying notes are an integral part of these financial statements 4 EQUUS II INCORPORATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (Unaudited) (Continued) 1998 1997 ----------- ----------- Reconciliation of increase in net assets from operations to net cash provided (used) by operating activities: Increase in net assets from operations ........... $ 8,237,216 $ 1,593,472 Adjustments to reconcile increase in net assets from operations to net cash used by operating activities: Realized gain (loss) on sale of portfolio securities, net ......................... (265,743) 3,935,954 Increase in unrealized appreciation, net .... (8,054,934) (6,347,585) Increase in accounts receivable ............. -- (27,131) Accrued interest and dividends exchanged for portfolio securities .................... (770,972) (279,413) Increase in accrued interest receivable ..... 5,018 524,769 Amortization of commitment fee .............. 18,750 17,500 Amortization of reorganization costs ........ -- 5,865 Increase (decrease) in accounts payable ..... (98,325) 17,441 Increase in due to management company ....... 41,186 615,427 ----------- ----------- Net cash provided (used) by operating activities . $ (887,804) $ 56,299 =========== =========== The accompanying notes are an integral part of these financial statements 5 EQUUS II INCORPORATED SUPPLEMENTAL INFORMATION - SELECTED PER SHARE DATA AND RATIOS FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997 (Unaudited) 1998 1997 -------- -------- Investment income ................................ $ 0.25 $ 0.13 Expenses ......................................... 0.27 0.32 -------- -------- Net investment loss ......................... (0.02) (0.19) Realized gain (loss) on sale of portfolio securities, net ................................ 0.06 (0.92) Increase in unrealized appreciation of portfolio securities, net ...................... 1.67 1.48 -------- -------- Increase in net assets from operations ...... 1.71 0.37 Net assets at beginning of period ................ 29.92 24.00 -------- -------- Net assets at end of period ...................... $ 31.63 $ 24.37 ======== ======== Ratio of expenses to average net assets .......... 0.86% 1.33% Ratio of net investment loss to average net assets ..................................... (0.06)% (0.79)% Ratio of increase in net assets from operations to average net assets ............... 5.54% 1.53% The accompanying notes are an integral part of these financial statements 6 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 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 26,641,656 -Warrants to buy up to 125,000 shares of common stock at $5.00 per share through August 1999 - 1,700,215 American Residential Services, Inc. (NYSE - ARS) December 1995 -1,125,000 shares of common stock 3,000,272 9,949,564 -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 850,000 850,000 Brazos Sportswear, Inc. (NASDAQ - BRZS) February 1989 -2,160,308 shares of common stock 1,331,187 10,180,452 -4,018,514 shares of 8% Series B1 preferred stock 4,018,514 4,018,514 -1,366,647 shares of 8% Series B2 preferred stock 1,366,647 1,366,647 -1,119,057 shares of 8% Series B3 preferred stock 1,119,057 1,119,057 -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 - 2,799 -1,000 shares of common stock of GCS RE, Inc. 132,910 300,000
The accompanying notes are an integral part of these financial statements 7 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1998 (Unaudited) (Continued)
Date of Portfolio Company Initial Investment Cost Fair Value ----------------- ------------------ ---- ---------- 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 - 1,500,000 -Warrant to buy up to 249 shares of common stock of CDE Corp. at $0.01 per share through December 2005 - - Coach USA, Inc. (NYSE - CUI) August 1996 -135,000 shares of common stock 1,757,737 5,696,325 Container Acquisition, Inc. February 1997 -1,370,000 shares of common stock 1,370,000 1,370,000 -50,202 shares of preferred stock 5,020,200 5,020,200 -Warrant to buy up to 370,588 shares of common stock at $.01 per share through February 2007 1,000 1,000 CRC Holdings, Corp. June 1997 -35,000 shares of common stock 3,199,000 3,199,000 -12% subordinated promissory note 959,700 959,700 Drypers Corporation (NASDAQ - DYPR) July 1991 -3,677,906 shares of common stock 9,328,556 18,506,521 Equicom, Inc. (formerly Texrock Radio, Inc.) July 1997 -819,680 shares of common stock 250,000 250,000 -703,184 shares of preferred stock 7,031,840 7,031,840 Garden Ridge Corporation (NASDAQ - GRDG) July 1992 -474,942 shares of common stock 685,030 9,962,502
The accompanying notes are an integral part of these financial statements 8 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1998 (Unaudited) (Continued)
Date of Portfolio Company Initial Investment Cost Fair Value ----------------- ------------------ ---- ---------- Healthcare Technology Delivery, Inc. April 1997 -9,000 shares of common stock $ 50,000 $ 50,000 Hot & Cool Holdings, Inc. March 1996 -9% increasing rate subordinated promissory note 1,300,000 1,300,000 -10% subordinated notes 2,700,000 2,700,000 -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 13,155 shares of common stock at $26 per share through April, 2007 - - NCI Building Systems, Inc. (NASDAQ - BLDG) April 1989 -100,000 shares of common stock 159,784 4,850,000 OEI International, Inc., October 1997 (formerly One Engineering, Inc.) -666.7 shares of common stock 667 667 -Prime + 1/2% promissory note 400,379 400,379 Paracelsus Healthcare Corporation (NYSE - PL December 1990 -1,263,058 shares of common stock 5,278,748 5,424,049 Raytel Medical Corporation (NASDAQ - RTEL) August 1997 -33,073 shares of common stock 330,730 237,950 Restaurant Development Group, Inc. June 1987 -610,909 shares of Class A common stock 2,891,156 700,000 -Warrants to buy up to 62,500 shares of common stock at $3 per share through April 1998 - -
The accompanying notes are an integral part of these financial statements 9 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1998 (Unaudited) (Continued)
Date of Portfolio Company Initial Investment Cost Fair Value ----------------- ------------------ ---- ---------- Sovereign Business Forms, Inc. August 1996 -12,535 shares of preferred stock $1,253,500 $ 1,253,500 -15% promissory notes 800,000 800,000 -Warrant to buy 551,894 shares of common stock at $1 per share through August 2006 - - 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 3,088,389 -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 - 100,000 -1,000 shares of SMIP, Inc. common stock 150,000 150,000 -15% promissory note of SMIP, Inc. 175,000 175,000 Summit/DPC Partners, L.P. October 1995 -36.11% limited partnership interest 2,600,000 2,600,000 Travis International, Inc. December 1986 -66,784 shares of common stock 534,589 1,803,168 -104,500 shares of Class A common stock 25,701 2,821,500 Triad Medical Inc. April 1997 -449,213 shares of common stock 300,000 300,000 -Prime + 1/2% promissory note 2,025,000 2,025,000
The accompanying notes are an integral part of these financial statements 10 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1998 (Unaudited) (Continued)
Date of Portfolio Company Initial Investment Cost Fair Value ----------------- ------------------ ---- ---------- 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 Rentals, Inc. (NYSE:URI) October 1997 -54,334 shares of common stock 397 1,370,303 United States Filter Corporation (NYSE:USF) October 1989 -162,428 shares of common stock 1,925,459 5,534,125 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 $91,703,159 $165,651,446 =========== ============
Substantially all 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., Coach USA, Inc., CRC Holdings, Corp., Drypers Corporation, Healthcare Technology Delivery, Inc., Hot & Cool Holdings, Inc., Paracelsus Healthcare Corporation, Sovereign Business Forms, Inc., Strategic Holdings, Inc. and Triad Medical 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. The accompanying notes are an integral part of these financial statements 11 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1998 (Unaudited) (Continued) 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., Drypers Corporation, OEI International, Inc., Restaurant Development Group, Inc., Strategic Holdings, Inc., Triad Medical Inc., Tulsa Industries, Inc., VRPI Spin Off, Inc. and WMW Industries, Inc. In addition, Healthcare Technology Delivery, Inc. 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 March 31, 1998. Such discounts, shown in the following table, total $16,419,365 or $3.40 per share as of March 31, 1998. DISCOUNT FROM MARKET VALUE ----------- Allied Waste Industries, Inc. ............................. $ 1,619,848 American Residential Services, Inc. ....................... 1,230,123 Brazos Sportswear, Inc. ................................... 5,651,350 Coach USA, Inc. ........................................... 176,175 Drypers Corporation ....................................... 6,779,082 Garden Ridge Corporation .................................. 308,119 Paracelsus Healthcare Corporation ......................... 417,594 Raytel Medical Corporation ................................ 23,534 United Rentals, Inc. ...................................... 42,381 United States Filter Corporation .......................... 171,159 ----------- Total discount ...................................... $16,419,365 =========== Income was earned in the amount of $456,648 and $411,415 for the three months ended March 31, 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 Coach USA, Inc., Paracelsus Healthcare 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 87% of the total value of the investments in portfolio companies at March 31, 1998. The accompanying notes are an integral part of these financial statements 12 EQUUS II INCORPORATED NOTES TO FINANCIAL STATEMENTS MARCH 31, 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 American 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 $12,500 is included in the accompanying Statements of Operations for each of the three months ended March 31, 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 13 net unrealized appreciation on portfolio securities has been included in the accompanying Statement of Operations for the three months ended March 31, 1997. Current management incentive fees of $55,825 were included in the accompanying Statement of Operations for the month ended March 31, 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 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 $147,899,786 (including $89,672,336 in publicly-traded securities, net of a $16,419,365 Valuation Discount) and $147,899,786 (including $89,710,511 in publicly-traded securities, net of a $17,100,722 Valuation Discount) at March 31, 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. Investment Transactions - Investment transactions are recorded on the accrual method. Realized gains and losses on investments sold are computed on a specific identification basis. Earnings Per Common Share - Earnings per common share is calculated by dividing total increase in net assets from operations by the weighted average number of shares of common shares outstanding during the period. Weighted average number of shares of common stock outstanding for diluted earnings per common share includes the dilutive effect of common stock equivalents. The only reconciling difference between the denominators for basic and diluted earnings per share is the impact of common stock options outstanding, calculated using the treasury stock method. 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. 14 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 $35,313. A dividend of such income was declared and will be distributed in late 1998 or early 1999. The Fund had a net investment loss for tax purposes for the three months ended March 31, 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. 1998 1997 -------- ----------- Net realized gain on the sales of portfolio securities, book ............................... $265,743 $(3,935,954) Management incentive fee ......................... -- (55,824) -------- ----------- Net realized gain on the sales of portfolio securities, tax ...................... $265,743 $(3,991,778) ======== =========== (5) DIVIDENDS The Fund declared no dividends during the three months ended March 31, 1998 and 1997, respectively. 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 a stock dividend. The Fund has not adopted any set policy concerning whether dividends will be paid only in cash, or in stock or cash 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. (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 Nations Bank of Texas, N.A., earning interest at rates ranging from 3.50% to 5.30% at March 31, 1998. 15 ACCOUNTS RECEIVABLE Included in "Accounts receivable" at March 31, 1998 and December 31, 1997 was $840,000 in royalties receivable from United Rentals, Inc. related to the sale of the Fund's investment in J&J Rental Service, Inc., $126,825 of which was received in April 1998. 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 three months ended March 31, 1998, the Fund made follow-on investments of $7,264,922 in nine portfolio companies, including $770,975 in accrued interest and dividends received in the form of additional portfolio securities. In addition, the Fund realized a net capital gain of $265,743 during the three months ended March 31, 1998. During the three months ended March 31, 1997, the Fund invested $5,881,000 in one new company and made follow-on investments of $1,989,413 in four portfolio companies, including $279,413 in dividends and accrued interest received in the form of additional portfolio securities. In addition, the Fund realized a net capital loss of $3,935,954 during the three months ended March 31, 1997. (9) NOTES PAYABLE TO BANK The Fund has a $150,000,000 line of credit promissory note with NationsBank of Texas, N.A., with interest payable at 1% over the rate earned on its money market account. The Fund had $75,000,000 outstanding on such note at March 31, 1998 and December 1997, that was secured by $75,000,000 of the Fund's temporary cash investments. 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, lowered the rate to 1/2% over the rate earned on its money market account and paid a $15,000 commitment fee, which will be capitalized and amortized over the commitment period. The Fund has a $30,000,000 revolving line of credit with NationsBank of Texas, N.A. that expires on April 1, 1998. The Fund had $13,625,000 and $6,900,000 outstanding under such line of credit at March 31, 1998 and December 31, 1997, respectively, which is secured by the Fund's investments in portfolio securities. The outstanding balance on the loan bears interest at prime + 1/4% to 3/4%. The fund also pays 1/4% interest on the unused portion of the line of credit. Effective April 1, 1998, the line of credit was increased to $40,000,000, the interest rate was lowered to prime - 1/2% to prime + 1/4% or libor + 1.65% and the maturity extended to April 1, 1999. The average daily balances outstanding on the Fund's notes payable during the three months ended March 31, 1998 and 1997, were $13,399,722 and $3,259,444, 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 16 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, on the first business day following the annual meeting, be granted a nonqualified stock option to purchase 2,000 shares of the Fund's common stock. Under the 1997 Stock Incentive Option Plan, options to purchase 927,131 shares of the Fund's common stock at prices ranging $17 to $24 per share were outstanding at March 31, 1998. During the three months ended March 31, 1998, no options were exercised. Outstanding options expire in May 2007 through November 2007. If all options granted were exercised as of March 31, 1998, there would have been dilution of net assets per share of approximately $2.18 per share, or 6.9%, as a result of such exercise. (11) COMMITMENTS AND CONTINGENCIES The Fund has made commitments to invest, under certain circumstances, up to an additional $1,000,000 in Equicom, Inc., $565,500 in GCS RE, Inc., $2,099,621 in OEI International, Inc., $2,000,000 in Sovereign Business Forms, Inc. and $175,000 in Triad Medical Inc. In connection with its commitment to GCS RE, Inc., the Fund has committed to a bank to maintain at least $380,000 in temporary cash investments to fund such commitment. In addition, the Fund has committed to invest up to $2,500,000 in one new company. 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 March 31, 1998, the Fund repaid a net $75,000,000 of notes payable to the bank. In April 1998, the Fund acquired for $639,270 an additional 63,927 shares of Equicom, Inc. preferred stock. In April 1998, the Fund sold 65,000 shares of Coach USA, Inc., for $3,110,050, realizing a capital gain of $2,263,733. On April 16, 1998, OEI International, Inc., filed a registration statement with the Securities and Exchange Commission in conjunction with the proposed initial public offering of its common stock. 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 4, 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 March 31, 1998. The Fund received 78,261 shares of Triad common stock for its investment in HTD. In addition, the Fund's prime +1/2% 17 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, which was included in the Fund's Balance Sheet at March 31, 1998. On May 7, 1998, the Fund filed an application to list its common stock on the New York Stock Exchange. Trading on the New York Stock Exchange under the symbol "EQS" is expected to commence May 20, 1998. 18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. LIQUIDITY AND CAPITAL RESOURCES At March 31, 1998, the Fund had $165,651,446 of its assets invested in portfolio securities of 29 companies, and has committed to invest up to an additional $5,840,121 in five of such companies and $2,500,000 in a new company under certain conditions. 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 March 31, 1998, the Fund had $13,625,000 outstanding on a $30,000,000 revolving line of credit loan from a bank. Such line of credit was increased to $40,000,000 effective April 1, 1998. Net cash provided (used) by operating activities was $(887,804) and $56,299 for the three months ended March 31, 1998 and 1997, respectively. Increases in management fees and interest expense in 1998 accounted for the majority of the decrease in cash provided by operating activities. At March 31, 1998, the Fund had $75,154,317 of its total assets of $242,171,460 invested in temporary cash investments consisting of money market securities. This amount includes proceeds from a $75,000,000 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 April 1, 1998. The Fund has the ability to borrow funds and issue forms of indebtedness, 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. Stockholders will also be entitled to increase the adjusted tax basis of their Fund shares by the difference between their undistributed capital gains and their tax credit. RESULTS OF OPERATIONS INVESTMENT INCOME AND EXPENSE Net investment loss after all expenses amounted to $83,461 and $818,159 for the three months ended March 31, 1998 and 1997, respectively. The large net investment loss in 1997 was primarily attributable to the accrual of $55,824 in management incentive fees and $426,501 in deferred management incentive fees related to the increase in the net unrealized appreciation of portfolio securities of $6,347,585 in 1997. Income from portfolio securities increased to $1,177,929 in 1998 as compared to $513,859 in 1997, due to the increase in amounts invested in interest-bearing portfolio securities during 1998 as compared to 1997 and $401,938 in dividends received upon conversion of preferred stock from one portfolio company in 1998. Interest expense increased to $317,631 in 1998 as compared to $77,767 in 1997, due to the increase of the average daily balances outstanding on the lines of credit to $13,399,722 during the three months ended March 31, 1998, from $3,259,444 in 1997. 19 The Management Company receives management fee compensation at an annual rate of 2% of the net assets of the Fund. Such fees amounted to $763,540 and $524,084 for the three months ended March 31, 1998 and 1997, respectively. Professional fees and Mailing , printing and other expenses decreased during the three months ended March 31, 1997 to the three months ended March 31, 1998. These higher expenses in 1997 were primarily due to the cost associated with the Special Meeting of Stockholders held on April 9, 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. 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 $24.07, 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 will, on the first business day following the annual meeting, be granted a nonqualified stock option to purchase 2,000 shares of the Fund's common stock. Under the 1997 Stock Incentive Option Plan, options to purchase 927,131 shares of the Fund's common stock at prices ranging $17 to $24 per share were outstanding at March 31, 1998. During the three months ended March 31, 1998, no options were exercised. Outstanding options expire in May 2007 through November 2007. If all options granted were exercised as of March 31, 1998, there would have been a net dilution of net assets per share of approximately $2.18 per share, or 6.9%, as a result of such exercise. REALIZED GAINS AND LOSSES ON SALES OF PORTFOLIO SECURITIES During the three months ended March 31, 1998, the Fund realized net capital gains of $265,743 from the sale of securities of two Portfolio Companies. The Fund sold 8,112 shares of Coach USA, Inc. common stock for $364,538, realizing a capital gain of $258,918. 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. 20 During the three months ended March 31, 1997, the Fund sold its investment in Midway Airlines for $278,272 realizing a net capital loss of $3,935,954. UNREALIZED APPRECIATION AND DEPRECIATION OF PORTFOLIO SECURITIES Net unrealized appreciation on investments increased $8,054,934 during the three months ended March 31, 1998, from $65,893,353 to $73,948,287. Such net increase resulted from increases in the estimated fair value of securities of nine of the Fund's Portfolio Companies aggregating $15,103,962, a decrease in the estimated fair value of securities of four portfolio companies of $6,891,049, and the transfer of $157,979 in net unrealized appreciation to net realized gains from the sale of investments in one company. Net unrealized appreciation on investments increased $6,347,585 during the three months ended March 31, 1997, from $41,671,464 to $46,408,710. Such net increase resulted from increases in the estimated fair value of securities of nine of the Fund's portfolio companies aggregating $11,038,351, a decrease in the estimated fair value of securities of five portfolio companies of $8,633,992 and the transfer of $3,943,226 in net unrealized depreciation to net realized losses. DIVIDENDS The Fund declared no dividends during the three months ended March 31, 1998 and 1997. PORTFOLIO INVESTMENTS During the three months ended March 31, 1998, the Fund made follow-on investments of $7,264,922 in nine portfolio companies, including $770,975 in accrued interest and dividends received in the form of additional portfolio securities. In January 1998, the Fund advanced an additional $3,595,380 under a 10% promissory note to Equicom, Inc., 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, Inc. In February and March 1998, the Fund acquired for $2,841,340 an additional 284,134 shares of Equicom, Inc. preferred stock. In January 1998, the Fund made additional investments by advancing $500,000, $334,198 and $173,035 to Hot & Cool Holdings, Inc., OEI International, Inc. and 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 sold its investment in WMW Industries, Inc. The Fund received $1,012,576 in cash, to pay off its junior participation note, and 162,428 shares of United States Filter Corporation ("U.S. Filter") common stock. 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 on the sale. In January 1998, initial public offerings of the common stock of Travis International, Inc. and Triad Medical, Inc. were postponed due to market conditions and other factors. 21 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 March 31, 1998, the Fund received an additional 1,208 shares of preferred stock of Container Acquisition, Inc. in payment for $120,800 of dividends on the preferred stock. In 1998, the Fund received an additional 545 shares of Sovereign Business Forms, Inc. preferred stock in payment of $54,500 in dividends. Through March 31, 1998, the Fund has received an additional 77,735, 26,437 and 21,647 shares of Series B1, B2 and B3 preferred stock of Brazos Sportswear, Inc., respectively, in payment of $125,819 in dividends on the preferred stock. During the three months ended March 31, 1997, the Fund invested $5,881,000 in one new company and made follow-on investments of $1,909,413 in four portfolio companies, including $279,413 in accrued interest and dividends received in the form of additional portfolio securities. In addition, the Fund realized a net capital loss of $3,935,954 during the three months ended March 31, 1997. Of the companies in which the Fund has investments at March 31, 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. SUBSEQUENT EVENTS Subsequent to March 31, 1998, the Fund repaid a net $75,000,000 of notes payable to the bank. In April 1998, the Fund acquired for $639,270 an additional 63,927 shares of Equicom, Inc. preferred stock. In April 1998, the Fund sold 65,000 shares of Coach USA, Inc., for $3,110,050, realizing a capital gain of $2,263,733. On April 16, 1998, OEI International, Inc., filed a registration statement with the Securities and Exchange Commission in conjunction with the proposed initial public offering of its common stock. 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 March 31, 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, which was included in the Fund's Balance Sheet at March 31, 1998. 22 On May 7, 1998, the fund filed an application to list its common stock on the New York Stock Exchange. Trading on the New York Stock Exchange under the symbol "EQS" is expected to commence May 20, 1998. ITEM 6. EXHIBITS AND REPORTS ON FORM 8K (a) Exhibits 10. Material Contracts (i) Fifth amendment to the Amended and restated loan agreement by and between Equus II Incorporated and NationsBank of Texas, N.A., dated March 31, 1998..........................................................24 (j) Safekeeping Agreement between Equus II Incorporated and Nation Bank of Texas, N.A., dated April 30, 1998.....................41 (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: May 13, 1998 23 EX-10.I 2 EXHIBIT 10(i) FIFTH AMENDMENT TO AMENDED AND RESTATED LOAN AGREEMENT THIS FIFTH AMENDMENT TO AMENDED AND RESTATED LOAN AGREEMENT ("Fifth Amendment") is made and entered into as of the 31st day of March, 1998, by and between Equus II Incorporated, a Delaware corporation, with offices and place of business at 2929 Allen Parkway, Houston, Texas 77019 (hereinafter called "Borrower") and NationsBank of Texas, N.A. a national banking association, with offices at 700 Louisiana, Houston, Texas 77002 (hereinafter called "Lender"). For and in consideration of the mutual covenants and agreements herein contained, Borrower and Lender hereby amend as of the date of this Agreement that certain Amended and Restated Loan Agreement ("Loan Agreement") between Borrower and Lender dated as of the 29th day of March 1996, as amended by the First Amendment to Amended and Restated Loan Agreement dated as of March 28, 1997, by the Second Amendment to Amended and Restated Loan Agreement dated as of June 30, 1997, by the Third Amendment to Amended and Restated Loan Agreement dated as of September 22, 1997 and the Fourth Amended and Restated Loan Agreement dated as of December 3, 1997 in the following respects: Section 1. AMENDMENTS TO LOAN AGREEMENT. (a) Section 1.1 of the Loan Agreement is hereby amended to read as follows: "1.1 INDEBTEDNESS. Upon the terms and conditions hereinafter set forth, the Lender agrees to lend to and/or issue letters of credit for the account of Borrower in an aggregate of up to $30,000,000.00 outstanding at any time pursuant to Revolving Facility A to be extended to the Borrower by the Lender as more specifically described in Section 1.3 hereof." (b) The definition of "Commitment Fee" is hereby amended to read as follows: "Commitment Fee" means fees payable by Borrower to Lender (i) in an amount equal to $10,000.00 payable upon execution of this Agreement and, where applicable, (ii) on the average daily unused portion of the Credit Facility from and including the date of the Fifth Amendment to the Maturity Date, at the rate of one-quarter of one percent (1/4%) per annum based on a 365 or 366 day year as applicable and the actual number of days elapsed, payable on the last day of each March, June, September and December, commencing on March 31, 1998. For purposes of calculation of the Commitment Fees, the unused portion of the 24 Credit Facility on any day will be equal to the amount of the Credit Facility on such day less the aggregate amount of Loans outstanding and the undrawn amount of all Credits on such date. (c) The definition of "Commitment Fee-Facility C" is hereby amended to read as follows: "Commitment Fee-Facility C" shall mean a fee in the amount of $15,000, payable upon execution of this Agreement." (d) The definition of "Facility A Note" in the Loan Agreement is hereby amended to read as follows: "Facility A Note" means the Facility A promissory note of the Borrower in the maximum principal amount of $30,000,000, in the form attached as Exhibit "1.3" to the Fifth Amendment. (e) The definition of "Facility B Note" in the Loan Agreement is hereby amended to read as follows: "Facility B Note" means the Facility B promissory note of the Borrower in the maximum principal amount of $10,000,000, in the form attached as Exhibit "1.4" to the Fifth Amendment. (f) The definition of "Facility C Note" in the Loan Agreement is hereby amended to read as follows: "Facility C Note" means the Facility C promissory note of the Borrower in the maximum principal amount of $150,000,000, in the form attached as Exhibit "1.7" to the Fifth Amendment. (g) The definition of "Fifth Amendment" is hereby added to the Loan Agreement and reads as follows: "Fifth Amendment" means the Fifth Amendment to Amended and Restated Loan Agreement between the Borrower and the Lender, dated as of March 31, 1998. (h) The definition of "Eurodollar Daily Floating Rate" is hereby added to the Loan Agreement and reads as follows: "Eurodollar Daily Floating Rate" shall mean on any day the fluctuating rate of interest equal to the one-month London Interbank Offered Rate as published in the "Money Rates" section of the Wall Street Journal on the immediately preceding Business Day, as adjusted from time to time in Lender's sole 25 discretion for then applicable reserve requirements, deposits insurance assessment rates and other regulatory costs. Interest will accrue on any day which is not a Business Day at the rate in effect on the immediately preceding Business Day. If no such quotes are generally available for such amount, then the Lender shall be entitled to determine the Eurodollar Daily Floating Rate by estimating in its reasonable judgment the per annum rate (as described above) that would be applicable if such quotes were generally available. (i) The definition of "Maturity Date" is hereby amended to read as follows: "Maturity Date" means April 1, 1999. (j) The first sentence of Section 1.3(a) of the Loan Agreement is hereby amended to read as follows: "(a) agrees to make Loans to Borrower pursuant to a revolving line of credit up to but not in excess of an aggregate principal amount outstanding at any time of $30,000,000.00, provided the aggregate amount of Loans outstanding pursuant to this Section 1.3, when combined with the amount of outstanding Credits, shall not exceed Borrowing Base A." (k) Section 1.3(c) of the Loan Agreement is hereby amended to read as follows: "(c) The Borrower's obligation to repay the Revolving Facility A shall be evidenced by a promissory note of the Borrower in substantially the form attached as Exhibit "1.3", payable to the order of Lender. The Revolving Note-A shall bear interest, at Borrower's option (to be exercised as set forth in Section 1.3(d) below) (i) at a variable interest rate of one-half of one percent (0.5%) below the Prime Rate per annum or (ii) the Eurodollar Daily Floating Rate plus one and 65/100ths percent (1.65%) per annum, not to exceed, in the case of either clause (i) or clause (ii), the maximum non-usurious interest rate permitted by applicable law with the balance of principal plus accrued and unpaid interest due and payable on or before the Maturity Date." (l) Section 1.3(d) is hereby added to the Loan Agreement and reads as follows: "(d) BORROWER'S INTEREST RATE ELECTION. No later than the last Business Day prior to the first day of each month, Borrower shall elect whether interest on loans made pursuant to Revolving Facility-A are to bear interest commencing on the first day of such month based upon the Prime Rate as provided in clause (i) of Section 1.3(c) (the "Prime Rate Option") or based upon the Eurodollar Daily Floating Rate as provided in clause (ii) of Section 1.3(a) (the "Eurodollar Option"). Each such election shall be made in writing, shall be irrevocable and shall be provided by Borrower to Lender pursuant to the notice procedures set forth under Section 7.2 hereof. Each such election shall continue to govern the interest rate on loans made under 26 Revolving Facility - A unless and until the Borrower provides to Lender a new notice changing such election from the Prime Rate Option to the Eurodollar Option or VICE versa. If Borrower fails to provide Lender with a notice of Borrower's election hereunder, Borrower shall be deemed to have elected the Prime Rate Option for the next succeeding month." (m) Sections 1.4(a) and (b) are hereby amended to read as follows: "(a) The Lender shall have, during the period from the date of this Agreement until the Maturity Date, subject to the terms and conditions of this Agreement, and subject to the condition that at the time of each borrowing hereunder no Default or Event of Default has occurred and is then continuing and that the representations and warranties given by the Borrower in Section 2 as of the date of this Agreement shall remain true and correct in all material respects (except for representations and warranties (i) which are made as of a particular date or (ii) as to which the facts which gave rise to the representation or warranty have changed as a result of circumstances or transactions which are contemplated or permitted pursuant to this Agreement), sole discretion to make Loans to Borrower pursuant to a revolving line of credit up to but not in excess of an aggregate principal amount outstanding at any time of $10,000,000.00, provided the aggregate amount outstanding pursuant to this Section 1.4 shall not exceed Borrowing Base B. Borrower shall make written request for each Loan pursuant to Revolving Facility B pursuant to a loan request in substantially the form of Exhibit "1.3.1" attached hereto. If Borrower's written request therefor is received by 1:00 p.m., Lender shall make each such Loan available to Borrower on the same Business Day Lender receives such request. If Borrower's loan request with respect to any such Loan is received after 1:00 p.m., Lender may defer the making of such Loan to the next Business Day. Each Loan shall be in an amount of not less than $100,000. (b) The Borrower's obligation to repay the Revolving Facility B shall be evidenced by a promissory note of the Borrower in substantially the form attached as Exhibit "1.4" to the Fifth Amendment, payable to the order of Lender. The Revolving Note-B shall bear interest at a variable interest rate of one quarter of one percent (1/4%) over the Prime Rate per annum not to exceed the maximum non-usurious interest rate permitted by applicable law with the balance of principal plus accrued and unpaid interest due and payable on or before the Maturity Date." (n) Section 1.7(a) of the Loan Agreement is hereby amended to read as follows: "1.7 FACILITY C. (a) The Lender, during the period from the date of this Agreement until April 1, 1999, subject to the terms and conditions of this Agreement, and subject to the condition that at the time of each borrowing issuance hereunder no Default or Event of Default has occurred and is then continuing to occur and that the representations and warranties given by the Borrower in Section 2 as of the date of this Agreement shall remain true and correct in all material respects (except for representations and warranties (i) which are made as of a particular date or (ii) as to which the facts which gave 27 rise to the representation or warranty have changed as a result of circumstances or transactions which are contemplated or permitted pursuant to this Agreement), agrees to make a loan to Borrower up to but not in excess of an aggregate principal amount outstanding at any time of $150,000,000, on the same Business Day upon receipt from Borrower on or before 1:00 p.m. Houston time of written applications for the loan hereunder in the form attached as Exhibit "1.3.1". (o) Section 1.5(f) of the Loan Agreement is hereby amended to read as follows: "(f) No Commitment Fee shall be payable by Borrower to Lender on the daily unused balance of Revolving Facility - B." (p) Section 1.7(b) of the Loan Agreement is hereby amended to read as follows: "(b) The Borrower's obligation to repay Facility C shall be evidenced by a promissory note of the Borrower in substantially the form attached as Exhibit "1.7" to the Fifth Amendment, payable to the order of Lender. The Facility C Note shall bear interest at a variable interest rate of one-half of one percent (0.5%) over the Cash Collateral Account Rate per annum not to exceed the maximum non-usurious interest rate permitted by applicable law with principal amounts due on or before the fifth (5th) Business Day after each principal advance, interest due monthly on the 15th of each month and concurrently with principal payments, and the balance of principal plus accrued and unpaid interest due and payable on or before April 1, 1999." (q) Exhibit 2.4 to the Loan Agreement is hereby replaced with Exhibit 2.4 attached hereto, and all references in the Loan Agreement as amended by this Fifth Amendment to "Exhibit 2.4" shall refer to Exhibit 2.4 attached hereto. (r) Section 3.1(g) of the Loan Agreement is hereby amended to read as follows: "(g) on or before the date of the Fifth Amendment, Borrower will provide Lender updated summary information regarding the Portfolio Investments in form and substance satisfactory to Lender, indicating information as of such date relating to buy-sell rights and obligations, funding obligations, restrictions on transfer, voting agreements, registration rights and such similar information as Lender may reasonably request." (s) Section 3.10(a) of the Loan Agreement is hereby amended to read as follows: "(a) The aggregate indebtedness pursuant to Revolving Facility-A and the amount of outstanding Credits shall never exceed Borrowing Base A. The Borrowing Base A is the lesser of (i) $30,000,000 and (ii) fifty percent (50%) of the Current Fair Market Value of Borrower's Eligible Public Securities provided that the sum of (x) indebtedness pursuant to Revolving Facility A plus 28 (y) outstanding Credits plus (z) indebtedness pursuant to Revolving Facility B shall not exceed thirty-three percent (33%) of Borrower's Net Asset Value." (t) Section 3.10(b) of the Loan Agreement is hereby amended to read as follows: "(b) The aggregate indebtedness pursuant to Revolving Facility B shall never exceed Borrowing Base B. The Borrowing Base B is the least of (i) $10,000,000, (ii) twenty-five percent (25%) of the Current Fair Market Value of the Eligible Other Securities and (iii) Borrowing Base A, provided that the sum of (x) indebtedness pursuant to Revolving Facility A plus (y) outstanding Credits plus (z) indebtedness pursuant to Revolving Facility B shall not exceed thirty-three percent (33%) of Borrower's Net Asset Value." (u) The reference in the Borrowing Base Certificate, attached as Exhibit "3.10" to the Loan Agreement, to "$30,000,000" is hereby amended to read "$40,000,000". Section 2. CLOSING. The closing of the transactions contemplated by this Fifth Amendment is subject to the satisfaction of the following conditions. 2.1 COUNSEL TO LENDER. All legal matters incident to the transactions herein contemplated shall be satisfactory to Gardere Wynne Sewell & Riggs, L.L.P., counsel to the Lender. 2.2 REQUIRED DOCUMENTS. (a) The Lender shall have received certified copies of resolutions of the Board of Directors of the Borrower in form and substance satisfactory to Lender with respect to authorization of this Fifth Amendment, the Revolving Facility A Promissory Note of the Borrower dated the date hereof in favor of the Lender in the original principal amount of $30,000,000 in the form of Exhibit "1.3" attached to this Fifth Amendment, the Revolving Facility B Promissory Note of the Borrower dated the date hereof in favor of the Lender in the original principal amount of $10,000,000 in the form of Exhibit "1.4" attached to this Fifth Amendment, the Facility C Promissory Note of the Borrower dated the date hereof in favor of the Lender in the original principal amount of $150,000,000 in the form of Exhibit "1.7" attached to this Fifth Amendment (the "Notes"), the Ratification of Security Agreement-Pledge dated as 29 of the date hereof (the "Ratification of Security Agreement"), and the other corporate instruments provided for herein. (b) The Lender shall have received a certificate of the Secretary of the Borrower of the names of officers of the Borrower to sign this Fifth Amendment, the Notes, the Ratification of Security Agreement and the other instruments or certificates related hereto together with the true signatures of such officers. (c) The Lender shall have received fully executed copies of the Fifth Amendment, the Notes, and the Ratification of Security Agreement. (d) The Lender shall have received originals of all certificates, notes or other instruments subject to the Security Agreement - Pledge dated as of March 18, 1996 between Borrower and Lender, as ratified by the Ratification of Security Agreement. 2.3 OPINION OF COUNSEL. The Lender shall have received from Porter & Hedges, L.L.P., counsel to the Borrower, a written opinion, satisfactory to the Lender and its counsel. Section 3. RATIFICATION. Except as amended hereby, the Loan Agreement shall remain unchanged and the terms, conditions, representations, warranties, and covenants of said Loan Agreement and the Security Instruments, including but not limited to the Security Agreement-Pledge, are true as of the date hereof, are ratified and confirmed in all respects and shall be continuing and binding upon the parties. Section 4. DEFINED TERMS. All terms used in this Fifth Amendment which are defined in the Loan Agreement shall have the same meaning as in the Loan Agreement, except as otherwise indicated in this Fifth Amendment. 30 Section 5. MULTIPLE COUNTERPARTS. This Fifth Amendment may be executed by the parties hereto in several separate counterparts, each of which shall be an original and all of which taken together shall constitute one and the same agreement. Section 6. APPLICABLE LAW. This Fifth Amendment shall be deemed to be a contract under and subject to, and shall be construed for all purposes in accordance with the laws of the State of Texas. Section 7. FINAL AGREEMENT. THE WRITTEN LOAN AGREEMENTS IN CONNECTION WITH THIS FIFTH AMENDMENT REPRESENT THE FINAL AGREEMENT BETWEEN THE BORROWER AND THE LENDER AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE BORROWER AND THE LENDER. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE LENDER AND THE BORROWER. IN WITNESS WHEREOF, the parties have caused this Fifth Amendment to be executed by their duly authorized officers as of the 31st day of March, 1998. EQUUS II INCORPORATED By: /s/ PATRICK M. CAHILL Name: PATRICK M. CAHILL Title: VICE PRESIDENT NATIONSBANK OF TEXAS, N.A. By: /s/ LARRY B. BELL Name: LARRY B. BELL Title: SENIOR VICE PRESIDENT 31 EXHIBIT "1.3" P R O M I S S O R Y N O T E [REVOLVING FACILITY-A] $30,000,000 March 31, 1998 FOR VALUE RECEIVED, after date, without grace, in the manner, on the dates and in the amounts so herein stipulated, the undersigned, EQUUS II INCORPORATED, a Delaware corporation, acting by and through its duly authorized officer, ("Borrower"), PROMISES TO PAY TO THE ORDER OF NATIONSBANK OF TEXAS, N.A. ("Lender"), in Houston, Harris County, Texas, the sum of THIRTY MILLION DOLLARS ($30,000,000) or, if less, the aggregate unpaid principal amount of advances made by Lender to Borrower pursuant to this Note, in lawful money of the United States of America, which shall be legal tender in payment of all debts and dues, public and private, at the time of payment, and to pay interest on the unpaid principal amount from date until maturity at a rate equal to, at Borrower's option (a) Lender's Prime Rate minus one-half of one percent (0.5%) per annum, floating daily or (b) the Eurodollar Daily Rate (as defined in the Loan Agreement described herein) plus 1.65% per annum (each the "Stated Rate"), not to exceed the maximum non-usurious interest rate permitted by applicable law from time to time in effect as such law may be interpreted, amended, revised, supplemented or enacted ("Maximum Rate"), provided that if at any time the Stated Rate exceeds the Maximum Rate then interest hereon shall accrue at the Maximum Rate. In the event the Stated Rate subsequently decreases to a level which would be less than the Maximum Rate or if the Maximum Rate applicable to this Note should subsequently be changed, then interest hereon shall accrue at a rate equal to the applicable Maximum Rate until the aggregate amount of interest so accrued equals the aggregate amount of interest which would have accrued at the Stated Rate without regard to any usury limit, at which time interest hereon shall again accrue at the Stated Rate. This Note is payable as follows: Interest shall be due and payable quarterly as it accrues, on the last day of March, June, September and December of 1998 and on the 1st day of April, 1999, when the entire balance of principal and accrued interest shall be due and payable. It is agreed that time is of the essence of this agreement. In the event of default in the payment of any installment of principal or interest when due or in the event of any other default hereunder, Lender may accelerate and declare this Note immediately due and payable without notice. Any failure to exercise this option shall not constitute a waiver by Lender of the right to exercise the same at any other time. In the event of default in the making of any payment herein provided, either of principal or interest, or in the event this Note is declared due, interest shall accrue at the Prime Rate plus 2% not to exceed the Maximum Rate. Borrower hereby agrees to pay all expenses incurred, including reasonable attorneys' fees, all of which shall become a part of the principal hereof, if this Note is placed in the hands of an attorney for collection or if collected by suit or through any probate, bankruptcy or any other legal proceedings. 32 Interest charges will be calculated on amounts advanced hereunder on the actual number of days these amounts are outstanding on the basis of a 360-day year, except for calculations of the Maximum Rate which will be on the basis of a 365-day or 366-day year, as is applicable. It is the intention of the parties hereto to comply with all applicable usury laws; accordingly, it is agreed that notwithstanding any provision to the contrary in this Note, or in any of the documents securing payment hereof or otherwise relating hereto, no such provision shall require the payment or permit the collection of interest in excess of the Maximum Rate. If any excess of interest in such respect is provided for, or shall be adjudicated to be so provided for, in this Note or in any of the documents securing payment hereof or otherwise relating hereto, then in such event (1) the provisions of this paragraph shall govern and control, (2) neither Borrower, endorsers or guarantors, nor their heirs, legal representatives, successors or assigns nor any other party liable for the payment hereof, shall be obligated to pay the amount of such interest to the extent that it is in excess of the Maximum Rate, (3) any such excess which may have been collected shall be either applied as a credit against the then unpaid principal amount hereof or refunded to Borrower, and (4) the provisions of this Note and any documents securing payment of this Note shall be automatically reformed so that the effective rate of interest shall be reduced to the Maximum Rate. For the purpose of determining the Maximum Rate, all interest payments with respect to this Note shall be amortized, prorated and spread throughout the full term of the Note so that the effective rate of interest on account of this Note is uniform throughout the term hereof. Borrower agrees that the Maximum Rate to be charged or collected pursuant to this Note shall be the applicable indicated rate ceiling as defined in the Texas Finance Code, as supplemented by Article 5069-1D.003 of the Texas Credit Title, provided that Lender may rely on other applicable laws, including without limitation laws of the United States, for calculation of the Maximum Rate if the application thereof results in a greater Maximum Rate. Except as provided above, the provisions of this Note shall be governed by the laws of the State of Texas. Each maker, surety, guarantor and endorser (i) waives demand, grace, notice, presentment for payment, notice of intention to accelerate the maturity hereof, notice of acceleration of the maturity hereof and protest, (ii) agrees that this Note and the liens securing its payment may be renewed, and the time of payment extended from time to time, without notice and without releasing any of the foregoing, and (iii) agrees that without notice or consent from any maker, surety, guarantor, or endorser, Lender may release any collateral which may from time to time be pledged to secure repayment of this Note, or may release any party who might be liable for this Note. Borrower grants to Lender a lien on any of Borrower's funds which may from time to time be deposited with Lender. Borrower may prepay this Note, in whole or in part, at any time prior to maturity without penalty, and interest shall cease on any amount prepaid. Any partial prepayment shall be applied toward the payment of the principal installments last maturing on the Note, that is, in the inverse order of maturity, without reducing the amount or time of payment of the remaining installments. The principal of this Note represents funds which Lender will advance to Borrower from time to time upon request of Borrower. Any part of the principal may be repaid by Borrower and thereafter reborrowed, provided the outstanding principal amount of this Note shall never exceed the face amount of this Note. Each advance shall constitute a part of the principal hereof and shall bear interest from the date of the advance. The provisions of Tex. Rev. Civ. Stat. Ann. art. 5069-15.01, ET seq., as may be amended, shall not apply to this Note or to any of the security documents executed in connection with this Note. 33 This Note is the Revolving Note-A referred to in, is subject to, and is entitled to the benefits of, the Amended and Restated Loan Agreement dated March 29, 1996 between Borrower and Lender, as that Amended and Restated Loan Agreement may be amended, modified or supplemented from time to time (the "Loan Agreement"). The Loan Agreement contains, among other things, provisions for the acceleration of the maturity hereof upon the occurrence of certain stated events. This Note is given in increase, replacement and extension of that certain promissory note of the Borrower dated March 26, 1997, in favor of the Lender and in the original principal amount of $22,500,000, which was given in increase, replacement and extension of that certain promissory note of the Borrower dated March 18, 1996, in favor of the Lender and in the original principal amount of $12,500,000, and the liens securing payment thereof are not released but are hereby ratified and carried forward to secure this Note. This Note is entitled to the benefits of and security afforded by the Security Agreement-Pledge dated March 18, 1996 between Borrower and Lender, as that Security Agreement-Pledge may be amended, modified or supplemented from time to time. This Note is subject to the provisions contained in the foregoing security instrument which, among other things, provides for acceleration of the maturity hereof upon the occurrence of certain events. Borrower represents and warrants that this loan is for business, commercial, investment or similar purpose and not primarily for personal, family, household or agricultural use, as such terms are used in Chapter One of the Texas Credit Code. EQUUS II INCORPORATED, A DELAWARE CORPORATION By: ________________________ Patrick M. Cahill, Vice President 34 EXHIBIT "1.4" P R O M I S S O R Y N O T E [REVOLVING FACILITY - B] $10,000,000 March 31, 1998 FOR VALUE RECEIVED, after date, without grace, in the manner, on the dates and in the amounts so herein stipulated, the undersigned, EQUUS II INCORPORATED, a Delaware corporation, acting by and through its duly authorized officer ("Borrower"), PROMISES TO PAY TO THE ORDER OF NATIONSBANK OF TEXAS, N.A. ("Lender"), in Houston, Harris County, Texas, the sum of TEN MILLION DOLLARS ($10,000,000) or, if less, the aggregate unpaid principal amount of advances made by Lender to Borrower pursuant to this Note, in lawful money of the United States of America, which shall be legal tender in payment of all debts and dues, public and private, at the time of payment, and to pay interest on the unpaid principal amount from date until maturity at a rate equal to Lender's Prime Rate (as defined in the Loan Agreement described herein) plus one quarter percent (1/4%) per annum, floating daily ("Stated Rate"), not to exceed the maximum non-usurious interest rate permitted by applicable law from time to time in effect as such law may be interpreted, amended, revised, supplemented or enacted ("Maximum Rate"), provided that if at any time the Stated Rate exceeds the Maximum Rate then interest hereon shall accrue at the Maximum Rate. In the event the Stated Rate subsequently decreases to a level which would be less than the Maximum Rate or if the Maximum Rate applicable to this Note should subsequently be changed, then interest hereon shall accrue at a rate equal to the applicable Maximum Rate until the aggregate amount of interest so accrued equals the aggregate amount of interest which would have accrued at the Stated Rate without regard to any usury limit, at which time interest hereon shall again accrue at the Stated Rate. This Note is payable as follows: Interest shall be due and payable quarterly as it accrues, on the last day of March, June, September and December of 1998 and on the 1st day of April, 1999, when the entire balance of principal and accrued interest shall be due and payable. It is agreed that time is of the essence of this agreement. In the event of default in the payment of any installment of principal or interest when due or in the event of any other default hereunder, Lender may accelerate and declare this Note immediately due and payable without notice. Any failure to exercise this option shall not constitute a waiver by Lender of the right to exercise the same at any other time. In the event of default in the making of any payment herein provided, either of principal or interest, or in the event this Note is declared due, interest shall accrue at Prime Rate plus 2% not to exceed the Maximum Rate. Borrower hereby agrees to pay all expenses incurred, including reasonable attorneys' fees, all of which shall become a part of the principal hereof, if this Note is placed in the hands of an attorney for collection or if collected by suit or through any probate, bankruptcy or any other legal proceedings. Interest charges will be calculated on amounts advanced hereunder on the actual number of days these amounts are outstanding on the basis of a 360-day year, except for calculations of the Maximum Rate which will be on the basis of a 365-day or 366-day year, as is applicable. It is the intention of the 35 parties hereto to comply with all applicable usury laws; accordingly, it is agreed that notwithstanding any provision to the contrary in this Note, or in any of the documents securing payment hereof or otherwise relating hereto, no such provision shall require the payment or permit the collection of interest in excess of the Maximum Rate. If any excess of interest in such respect is provided for, or shall be adjudicated to be so provided for, in this Note or in any of the documents securing payment hereof or otherwise relating hereto, then in such event (1) the provisions of this paragraph shall govern and control, (2) neither Borrower, endorsers or guarantors, nor their heirs, legal representatives, successors or assigns nor any other party liable for the payment hereof, shall be obligated to pay the amount of such interest to the extent that it is in excess of the Maximum Rate, (3) any such excess which may have been collected shall be either applied as a credit against the then unpaid principal amount hereof or refunded to Borrower, and (4) the provisions of this Note and any documents securing payment of this Note shall be automatically reformed so that the effective rate of interest shall be reduced to the Maximum Rate. For the purpose of determining the Maximum Rate, all interest payments with respect to this Note shall be amortized, prorated and spread throughout the full term of the Note so that the effective rate of interest on account of this Note is uniform throughout the term hereof. Borrower agrees that the Maximum Rate to be charged or collected pursuant to this Note shall be the applicable indicated rate ceiling as defined in the Texas Finance Code, as supplemented by Article 5069-1D.003 of the Texas Credit Title, provided that Lender may rely on other applicable laws, including without limitation laws of the United States, for calculation of the Maximum Rate if the application thereof results in a greater Maximum Rate. Except as provided above, the provisions of this Note shall be governed by the laws of the State of Texas. Each maker, surety, guarantor and endorser (i) waives demand, grace, notice, presentment for payment, notice of intention to accelerate the maturity hereof, notice of acceleration of the maturity hereof and protest, (ii) agrees that this Note and the liens securing its payment may be renewed, and the time of payment extended from time to time, without notice and without releasing any of the foregoing, and (iii) agrees that without notice or consent from any maker, surety, guarantor, or endorser, Lender may release any collateral which may from time to time be pledged to secure repayment of this Note, or may release any party who might be liable for this Note. Borrower grants to Lender a lien on any of Borrower's funds which may from time to time be deposited with Lender. Borrower may prepay this Note, in whole or in part, at any time prior to maturity without penalty, and interest shall cease on any amount prepaid. Any partial prepayment shall be applied toward the payment of the principal installments last maturing on the Note, that is, in the inverse order of maturity, without reducing the amount or time of payment of the remaining installments. The principal of this Note represents funds which Lender will advance to Borrower from time to time upon request of Borrower. Any part of the principal may be repaid by Borrower and thereafter reborrowed, provided the outstanding principal amount of this Note shall never exceed the face amount of this Note. Each advance shall constitute a part of the principal hereof and shall bear interest from the date of the advance. The provisions of Tex. Rev. Civ. Stat. Ann. art. 5069-15.01, ET seq., as may be amended, shall not apply to this Note or to any of the security documents executed in connection with this Note. This Note is the Revolving Note-B referred to in, is subject to, and is entitled to the benefits of, the Amended and Restated Loan Agreement dated March 29, 1996 between Borrower and Lender, as that Amended and Restated Loan Agreement may be amended, modified or supplemented from time to time (the "Loan Agreement"). The Loan Agreement contains, among other things, provisions for the 36 acceleration of the maturity hereof upon the occurrence of certain stated events. This Note is given in replacement and extension of that certain promissory note of the Borrower dated March 26, 1997 in favor of the Lender and in the original principal amount of $7,500,000, which was given in replacement and extension of that certain promissory note of the Borrower dated March 18, 1996 in favor of the Lender and in the original principal amount of $7,500,000, and the liens securing the payment thereof are not released but are hereby ratified and carried forward to secure this Note. This Note is entitled to the benefits of and security afforded by the Security Agreement-Pledge dated March 18, 1996 between Borrower and Lender, as that Security Agreement-Pledge may be amended, modified or supplemented from time to time. This Note is subject to the provisions contained in the foregoing security instrument which, among other things, provides for acceleration of the maturity hereof upon the occurrence of certain events. Borrower represents and warrants that this loan is for business, commercial, investment or similar purpose and not primarily for personal, family, household or agricultural use, as such terms are used in Chapter One of the Texas Credit Code. EQUUS II INCORPORATED, A DELAWARE CORPORATION By: _______________________________ Patrick M. Cahill, Vice President 37 EXHIBIT "1.7" P R O M I S S O R Y N O T E [FACILITY C NOTE] $150,000,000 March 31, 1998 FOR VALUE RECEIVED, after date, without grace, in the manner, on the dates and in the amounts so herein stipulated, the undersigned, EQUUS II INCORPORATED, a Delaware corporation, acting by and through its duly authorized officer ("Borrower"), PROMISES TO PAY TO THE ORDER OF NATIONSBANK OF TEXAS, N.A. ("Lender"), in Houston, Harris County, Texas, the sum of One Hundred Fifty Million and No/100 DOLLARS ($150,000,000) or, if less, the aggregate unpaid principal amount of advances made by Lender to Borrower pursuant to this Note, in lawful money of the United States of America, which shall be legal tender in payment of all debts and dues, public and private, at the time of payment, and to pay interest on the unpaid principal amount from date until maturity at a rate equal to Cash Collateral Account Rate plus one-half of one percent (0.5%) per annum, floating daily (as defined in, and subject to adjustment as set forth in Section 1.7(c) of, the Loan Agreement) ("Stated Rate"), not to exceed the maximum non-usurious interest rate permitted by applicable law from time to time in effect as such law may be interpreted, amended, revised, supplemented or enacted ("Maximum Rate"), provided that if at any time the Stated Rate exceeds the Maximum Rate then interest hereon shall accrue at the Maximum Rate. In the event the Stated Rate subsequently decreases to a level which would be less than the Maximum Rate or if the Maximum Rate applicable to this Note should subsequently be changed, then interest hereon shall accrue at a rate equal to the applicable Maximum Rate until the aggregate amount of interest so accrued equals the aggregate amount of interest which would have accrued at the Stated Rate without regard to any usury limit, at which time interest hereon shall again accrue at the Stated Rate. This Note is payable as follows: Interest shall be payable on the 15th day of each month and simultaneously with repayment of principal. Principal shall be payable on the fifth (5th) Business Day following each advance in an amount equal to such advance. The entire balance of principal and accrued interest shall be due and payable on April 1, 1999. It is agreed that time is of the essence of this agreement. In the event of default in the payment of any installment of principal or interest when due or in the event of any other default hereunder, Lender may accelerate and declare this Note immediately due and payable without notice. Any failure to exercise this option shall not constitute a waiver by Lender of the right to exercise the same at any other time. In the event of default in the making of any payment herein provided, either of principal or interest, or in the event this Note is declared due, interest shall accrue at Prime Rate plus two percent (2%) not to exceed the Maximum Rate. Borrower hereby agrees to pay all expenses incurred, including reasonable attorneys' fees, all of which shall become a part of the principal hereof, if this Note is placed in the hands of an attorney for collection or if collected by suit or through any probate, bankruptcy or any other legal proceedings. 38 Interest charges will be calculated on amounts advanced hereunder on the actual number of days these amounts are outstanding on the basis of a 360-day year, except for calculations of the Maximum Rate which will be on the basis of a 365-day or 366-day year, as is applicable. It is the intention of the parties hereto to comply with all applicable usury laws; accordingly, it is agreed that notwithstanding any provision to the contrary in this Note, or in any of the documents securing payment hereof or otherwise relating hereto, no such provision shall require the payment or permit the collection of interest in excess of the Maximum Rate. If any excess of interest in such respect is provided for, or shall be adjudicated to be so provided for, in this Note or in any of the documents securing payment hereof or otherwise relating hereto, then in such event (1) the provisions of this paragraph shall govern and control, (2) neither Borrower, endorsers or guarantors, nor their heirs, legal representatives, successors or assigns nor any other party liable for the payment hereof, shall be obligated to pay the amount of such interest to the extent that it is in excess of the Maximum Rate, (3) any such excess which may have been collected shall be either applied as a credit against the then unpaid principal amount hereof or refunded to Borrower, and (4) the provisions of this Note and any documents securing payment of this Note shall be automatically reformed so that the effective rate of interest shall be reduced to the Maximum Rate. For the purpose of determining the Maximum Rate, all interest payments with respect to this Note shall be amortized, prorated and spread throughout the full term of the Note so that the effective rate of interest on account of this Note is uniform throughout the term hereof. Borrower agrees that the Maximum Rate to be charged or collected pursuant to this Note shall be the applicable indicated rate ceiling as defined in the Texas Finance Code, as supplemented by Article 5069-1D.003 of the Texas Credit Code, provided that Lender may rely on other applicable laws, including without limitation laws of the United States, for calculation of the Maximum Rate if the application thereof results in a greater Maximum Rate. Except as provided above, the provisions of this Note shall be governed by the laws of the State of Texas. As used in this Note, the term "Cash Collateral Account Rate" shall mean the interest rate actually earned by Borrower on investments in that certain Cash Collateral Account (as such term is defined in the Loan Agreement) during the period principal amounts are owed pursuant to this Note. Each maker, surety, guarantor and endorser (i) waives demand, grace, notice, presentment for payment, notice of intention to accelerate the maturity hereof, notice of acceleration of the maturity hereof and protest, (ii) agrees that this Note and the liens securing its payment may be renewed, and the time of payment extended from time to time, without notice and without releasing any of the foregoing, and (iii) agrees that without notice or consent from any maker, surety, guarantor, or endorser, Lender may release any collateral which may from time to time be pledged to secure repayment of this Note, or may release any party who might be liable for this Note. Borrower grants to Lender a lien on any of Borrower's funds which may from time to time be deposited with Lender. Borrower may prepay this Note, in whole or in part, at any time prior to maturity without penalty, and interest shall cease on any amount prepaid. Any partial prepayment shall be applied toward the payment of the principal installments last maturing on the Note, that is, in the inverse order of maturity, without reducing the amount or time of payment of the remaining installments. The principal of this Note represents funds which Lender will advance to Borrower from time to time upon request of Borrower. Any part of the principal may be repaid by Borrower and thereafter reborrowed, provided the outstanding principal amount of this Note shall never exceed the face amount of this Note. Each advance shall constitute a part of the principal hereof and shall bear interest from the 39 date of the advance. The provisions of Tex. Rev. Civ. Stat. Ann. art. 5069-15.01, ET seq., as may be amended, shall not apply to this Note or to any of the security documents executed in connection with this Note. This Note is the Facility C Note referred to in, is subject to, and is entitled to the benefits of, the Amended and Restated Loan Agreement dated March 29, 1996 between Borrower and Lender, as that Amended and Restated Loan Agreement may be amended, modified or supplemented from time to time (the "Loan Agreement"). The Loan Agreement contains, among other things, provisions for the acceleration of the maturity hereof upon the occurrence of certain stated events. This Note is given in replacement and extension of that certain promissory Note of the Borrower dated September __, 1997 in favor of the Lender in the original principal amount of $150,000,000, which was given in replacement and extension of that certain promissory Note of the Borrower dated June 30, 1997 in favor of the Lender in the original principal amount of $90,000,000, which was given in replacement and extension of that certain promissory Note of the Borrower dated March 28, 1997 in favor of the Lender in the original principal amount of $65,000,000, which was given in replacement and extension of that certain promissory Note of the Borrower dated March 29, 1996 in favor of the Lender in the original principal amount of $65,000,000, and the liens securing the payment thereof are not released but are hereby ratified and carried forward as security for this Note. This Note is entitled to the benefits of and security afforded by the Security Agreement-Pledge (Facility C) dated March 29, 1996, between Borrower and Lender, as that Security Agreement-Pledge (Facility C) may be amended, modified or supplemented from time to time. This Note is subject to the provisions contained in the foregoing security instrument which, among other things, provides for acceleration of the maturity hereof upon the occurrence of certain events. Borrower represents and warrants that this loan is for business, commercial, investment or similar purpose and not primarily for personal, family, household or agricultural use, as such terms are used in Chapter One of the Texas Credit Code. EQUUS II INCORPORATED, A DELAWARE CORPORATION By: Patrick M. Cahill Vice President 40 EX-10.J 3 EXHIBIT 10(j) Equus II Incorporated 2929 Allen Parkway, Suite 2500 Houston, Texas 77019 April 30, 1998 NationsBank of Texas, N.A. 700 Louisiana Houston, Texas 77002 Re: Safekeeping Agreement Gentlemen: The purpose of this correspondence is to evidence that Equus II Incorporated, a Delaware corporation (the "Fund"), which has elected to be a business development company under Section 54 of the Investment Company Act of 1940, as amended (the "Investment Company Act"), has appointed NationsBank of Texas, N.A. , a national banking association (the "Bank"), and the Bank has agreed to serve, as the safekeeping agent for the securities and similar investments of the Fund. The Bank has been duly designated and appointed by the independent directors of the Fund, consisting of Dr. Francis D. Tuggle, Robert L. Knauss, John W. Storms, Gregory J. Flanagan, and Gary R. Petersen (collectively the "Independent Directors"), as the safekeeping agent for the Funds securities and similar investments pursuant to Rule 17f-2 of the rules and regulations of the Securities and Exchange Commission (the "Commission") promulgated under the Investment Company Act. Except as otherwise permitted under the Investment Company Act, the securities and similar investments of the Fund shall be deposited in the safekeeping of, or in a vault or other depository maintained by, the Bank, and the securities and similar investments so deposited shall be physically segregated at all times from those of any other persons, firms, or corporations; provided, however, that securities and similar investments shall not include cash or accounts (as defined in Section 4.104 of the Texas Business and Commerce Code) maintained by the Fund with the Bank.. In lieu thereof, any of such securities or similar investments as qualify may be maintained or deposited (and the income from such deposits, if requested by the Fund, shall be collected by the Bank and remitted to the Fund) in accounts established by the Bank that include only assets held by it for its customers in (i) the Federal Reserve/Treasury bookentry system for United States and Federal agency securities, its successor(s) or nominee(s) or (ii)with the Depository Trust Company, its successor(s) or nominee(s), or any other such person as is or becomes authorized to act as a securities depository under the Investment Company Act as is designated as such by a majority of the Independent Directors as evidenced by a written certificate executed by a majority of the Independent Directors, addressed to the Bank and specifically approving the maintaining or depositing of the qualifying securities or similar investments of the Fund therein. Any such maintenance or depositing shall be done in conformity with the applicable notice and other 41 provisions of Rule 17f-4 of the rules and regulations of the Commission promulgated under the Investment Company Act. In particular, the Bank shall comply with the confirmation and report notice provisions of Rule 17f-4(d)(3) and (4). In connection with the use of any such system or authorized depository, the Bank will be liable to the Partnership for any losses or damages relating to the failure to effectively enforce such rights as may exist against any such system or authorized depository. Any two of the persons, at least one of whom is an officer of the Fund (the "Designated Persons"), named in Exhibit A hereto (as from time to time modified by a majority of the Independent Directors of the Fund) are authorized and permitted to have access to the securities and similar investments so deposited, and such access to such securities and similar investments shall be had only by two or more of such persons jointly. Exhibit A shall not list more than five persons as Designated Persons. Access to such securities and similar investments shall also be permitted to the properly authorized officers and employees of the Bank. Access to such securities and similar investments shall be permitted, jointly with any two of the Designated Persons or with any officer or employee of the Bank, to an independent public accountant for the purpose of conducting the examinations of the Fund's securities and similar investments, as required by Rule 17f-2(f) of the rules and regulations Promulgated by the Commission under the Investment Company Act. Such securities and similar investments shall at all times be subject to inspection by the Commission through its authorized employees or agents, accompanied, unless otherwise directed by order of the Commission, by one or more of the Designated Persons or one or more of the officers or employees of the Bank. Each Designated Person when depositing such securities similar investments in or withdrawing them from the Bank or when ordering their withdrawal or delivery from the safekeeping of the Bank, shall sign a notation in duplicate with respect to such deposit, withdrawal or order which shall show (1) the date and time of deposit, withdrawal or order, (2) the title and amount of the securities or other investments deposited, withdrawn or ordered to be withdrawn, and an identification thereof by certificate numbers or otherwise, (3) the manner of acquisition of the securities or similar investments deposited or the purpose for which they have been withdrawn or ordered to be withdrawn, and (4) if withdrawn and delivered to any other person, the name of such person. A copy of such notation shall be transmitted promptly by the Bank to John W. Storms, c/o Storms & Critz, 1980 Post Oak Blvd., Suite 2110, Houston, Texas 77056 Sam P. Douglass, who shall not be a Designated Person. Such notation shall be on serially numbered forms and shall be preserved for at least one year. The Fund, through one or more of its Independent Directors, will give you written notice of any change in the Independent Directors of the Fund. Such securities and similar investments shall be verified by complete examination of an independent public accountant to be retained by the Fund, presently Arthur Andersen & Co., at least three times during each fiscal year, at least two of which times shall be chosen by such accountant 42 without prior notice to the Fund. The Fund, through one or more of its Independent Directors, will give you written notice of any change in the accountants retained by the Fund. The Independent Directors and each of them do hereby certify that the names and signatures subscribed below are the names and signatures of each of the Independent Directors of the Fund and that the signatures of the Designated Persons set opposite their names on Exhibit A are the genuine and correct signatures of the respective Designated Persons. The Fund shall pay you the fees set forth in Exhibit B attached hereto for the services to be rendered by you hereunder. In no event shall you be held liable for any loss with respect to the safekeeping and conditions of the Fund's securities or similar investments unless such loss is due to negligence, willful misconduct, or other malfeasance on your part or your agents or employees part. You shall be under no obligation or duty to provide or maintain insurance of any kind in connection with the securities or similar investments held pursuant to the terms of this Agreement nor shall you be held responsible for the genuineness, validity, or alteration of or any defect in any of the securities or similar investments. Either you or a majority of the Independent Directors may terminate this Agreement upon 90 days prior written notice to the other party of the desire to terminate. After such notice of termination, but until such time as your successor shall have been appointed by the Independent Directors, you shall continue to serve hereunder upon the same terms and subject to the same conditions as are applicable to your service in the circumstances set forth in Exhibit B hereto. From time to time the fee schedule set forth in Exhibit B may be amended by written notice thereof to the Independent Directors by you and the acceptance thereof by a majority of the Independent Directors within 30 days of such notice. If the amended fee schedule is not so accepted, then you may resign upon the earlier of the designation of your successor by the Independent Directors or 90 days after your original notice to them. Until you have resigned, you shall continue to hold in safekeeping the Fund's securities and similar investments under the terms of this Agreement as hereafter amended from time to time and, in any event, shall continue to hold such securities and similar investments in safekeeping until a bank or other company whose functions and physical facilities are supervised by a Federal or State authority within the meaning of the Investment Company Act is appointed to assume your duties hereunder, whereupon the securities and similar investments held by you shall be turned over to the successor bank or other company. This Agreement shall be subject to the terms and provisions of the Security Agreement - Pledge dated as March 18, 1996, between the Fund and the Bank and in the event of any conflict between the terms and provisions of this Agreement and such Security Agreement - Pledge, the terms and provisions of the Security Agreement - Pledge shall control. If the above correctly states our understanding and Agreement would you kindly indicate your acceptance thereof by signing the name of the Bank, by its duly authorized officer, in the space provided below, and returning a copy of this Agreement to the Fund. 43 Very truly yours, EQUUS II INCORPORATED /s/ DR. FRANCIS D. TUGGLE DR. FRANCIS D. TUGGLE /s/ ROBERT L. KNAUSS ROBERT L. KNAUSS /s/ JOHN W. STORMS JOHN W. STORMS /s/ GREGORY J. FLANAGAN GREGORY J. FLANAGAN /s/ GARY R. PETERSEN GARY R. PETERSEN NATIONSBANK OF TEXAS, N.A. By: /s/ LARRY B. BELL Name: LARRY B. BELL Title: SENIOR VICE PRESIDENT 44 EXHIBIT A DESIGNATED PERSONS NAME AND TITLE SIGNATURE - -------------- --------- 1. Nolan Lehmann, /s/ NOLAN LEHMANN President of the Fund 2. Gary L. Forbes, /s/ GARY L. FORBES Vice President of the Fund 3. Randall B. Hale /s/ RANDALL B. HALE Vice President of the Fund 4. Patrick M. Cahill /s/ PATRICK M. CAHILL Treasurer of the Fund 5. Tracy H. Cohen /s/ TRACY H. COHEN Secretary of the Fund 45 EXHIBIT B FEE SCHEDULE 46 EX-27 4
6 3-MOS DEC-31-1998 MAR-31-1998 166,857,476 240,805,763 1,349,931 15,766 0 242,171,460 0 0 89,463,492 89,463,492 74,254,171 78,453,797 4,828,492 4,828,492 0 0 0 0 0 152,707,968 766,667 428,186 0 1,278,314 (83,461) 265,743 8,054,934 8,237,217 0 0 0 0 0 0 0 8,237,217 0 0 0 0 763,540 317,631 1,278,314 148,589,360 29.92 (0.02) 1.73 0 0 0 31.63 0.86 13,399,722 2.78
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