-----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, KFYYsRJYNwHsfMAbvrBXk/OJoqwF40h5yOPzKIPhLSHRw3JB+OHxI9gu+t3r24Zl gs53xQfx0jjxNudkwywbzg== 0000890566-99-000647.txt : 19990514 0000890566-99-000647.hdr.sgml : 19990514 ACCESSION NUMBER: 0000890566-99-000647 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990513 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: 99620717 BUSINESS ADDRESS: STREET 1: 2929 ALLEN PKWY STE 2500 CITY: HOUSTON STATE: TX ZIP: 77019 BUSINESS PHONE: 7135290900 MAIL ADDRESS: STREET 1: 2929 ALLEN PARKWAY STREET 2: STE 2500 CITY: HOUSTON STATE: TX ZIP: 77019 10-Q 1 FORM 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-19509 EQUUS II INCORPORATED (Exact name of registrant as specified in its charter) DELAWARE 76-0345915 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2929 Allen Parkway, Suite 2500 HOUSTON, TEXAS 77019-2120 (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code: (713) 529-0900 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered COMMON STOCK NEW YORK STOCK EXCHANGE ------------ ----------------------- Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Approximate aggregate market value of common stock held by non-affiliates of the registrant: $68,245,586 computed on the basis of $15.50 per share, closing price of the common stock on the New York Stock Exchange Inc. on May 11, 1999. For the purpose of calculating this amount only, all directors and executive officers of the registrant have been treated as affiliates. There were 4,954,304 shares of the registrant's common stock, $.001 par value, outstanding, as of May 11, 1999. The net asset value of a share at March 31, 1999 was $21.65. 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, 1999 and December 31, 1998........................1 Statements of Operations - For the three months ended March 31, 1999 and 1998......... 2 Statements of Changes in Net Assets - For the three months ended March 31, 1999 and 1998......... 3 Statements of Cash Flows - For the three months ended March 31, 1999 and 1998......... 4 Selected Per Share Data and Ratios - For the three months ended March 31, 1999 and 1998 ........ 6 Schedule of Portfolio Securities - March 31, 1999............................................. 7 Notes to Financial Statements................................12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................17 Item 3. Quantitative and Qualitative Disclosure about Market Risk....20 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K ............................21 SIGNATURE ............................................................... 21 ii PART I. FINANCIAL STATEMENTS ITEM 1. FINANCIAL STATEMENTS EQUUS II INCORPORATED BALANCE SHEETS MARCH 31, 1999 AND DECEMBER 31, 1998 (Unaudited)
1999 1998 ------------- ------------- ASSETS Investments in portfolio securities at fair value (cost $114,150,787 and $109,937,121, respectively) . $ 146,884,468 $ 154,248,818 Temporary cash investments, at cost which approximates fair value ............................ 57,238,562 60,214,266 Cash .................................................... 3,621 39,724 Accounts receivable ..................................... 45,569 393,235 Accrued interest receivable ............................. 753,452 675,851 Commitment fees ......................................... 21,875 31,250 ------------- ------------- Total assets .................................. 204,947,547 215,603,144 ------------- ------------- LIABILITIES AND NET ASSETS Liabilities: Accounts payable ................................... 242,271 367,341 Due to management company .......................... 536,345 580,775 Notes payable to bank .............................. 96,900,000 98,500,000 ------------- ------------- Total liabilities ............................. 97,678,616 99,448,116 ------------- ------------- Commitments and contingencies Net assets: Preferred stock, $.001 par value, 5,000,000 shares authorized, no shares issued .................... -- -- Common stock, $.001 par value, 10,000,000 shares authorized, 4,954,304 shares outstanding ........ 4,954 4,954 Additional paid-in capital ......................... 78,166,891 78,407,776 Undistributed net investment income ................ -- -- Undistributed net capital gains .................... (3,636,595) (6,569,399) Unrealized appreciation of portfolio securities, net 32,733,681 44,311,697 ------------- ------------- Total net assets .............................. $ 107,268,931 $ 116,155,028 ============= ============= Net assets per share .......................... $ 21.65 $ 23.45 ============= =============
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, 1999 AND 1998 (Unaudited)
1999 1998 ------------ ------------ Investment income: Income from portfolio securities ...................... $ 1,152,787 $ 1,177,929 Interest from temporary cash investments .............. 23,050 16,924 ------------ ------------ Total investment income .......................... 1,175,837 1,194,853 ------------ ------------ Expenses: Management fees ....................................... 536,345 763,540 Director fees and expenses ............................ 51,675 59,119 Professional fees ..................................... 62,381 83,162 Administrative fees ................................... 12,500 12,500 Mailing, printing and other expenses .................. 24,031 26,462 Interest expense ...................................... 718,170 317,631 Franchise taxes ....................................... 11,620 15,900 ------------ ------------ Total expenses ................................... 1,416,722 1,278,314 ------------ ------------ Net investment loss ........................................ (240,885) (83,461) ------------ ------------ Realized gain on sales of portfolio securities, net ........ 2,932,804 265,743 ------------ ------------ Unrealized appreciation of portfolio securities, net: End of period ......................................... 32,733,681 73,948,287 Beginning of period ................................... 44,311,697 65,893,353 ------------ ------------ Increase (decrease) in unrealized appreciation, net ... (11,578,016) 8,054,934 ------------ ------------ Total increase (decrease) in net assets from operations $ (8,886,097) $ 8,237,216 ============ ============
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, 1999 AND 1998 (Unaudited)
1999 1998 ------------- ------------- Operations: Net investment loss ............................. $ (240,885) $ (83,461) Realized gain on sales of portfolio securities, net .............................. 2,932,804 265,743 Increase (decrease) in unrealized appreciation of portfolio securities, net .................... (11,578,016) 8,054,934 ------------- ------------- Increase (decrease) in net assets from operations .... (8,886,097) 8,237,216 Net assets at beginning of period .................... 116,155,028 144,470,752 ------------- ------------- Net assets at end of period .......................... $ 107,268,931 $ 152,707,968 ============= =============
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, 1999 AND 1998 (Unaudited)
1999 1998 ------------ ------------ Cash flows from operating activities: Interest and dividends received ................... $ 578,356 $ 428,899 Cash paid to management company, directors, bank and suppliers ............................. (1,576,847) (1,316,703) ------------ ------------ Net cash used by operating activities .......... (998,491) (887,804) ------------ ------------ Cash flows from investing activities: Purchase of portfolio securities .................. (5,704,578) (6,493,947) Proceeds from sales of portfolio securities ....... 4,022,245 462,072 Principal payments from portfolio companies ....... 1,043,500 1,012,576 Advance to portfolio company ...................... (24,483) -- Repayment from portfolio company .................. 250,000 -- ------------ ------------ Net cash used by investing activities .......... (413,316) (5,019,299) ------------ ------------ Cash flows from financing activities: Advances from bank ................................ 59,750,000 84,075,000 Repayments to bank ................................ (61,350,000) (77,350,000) Dividend payments ................................. -- (828,556) ------------ ------------ Net cash provided (used) by financing activities (1,600,000) 5,896,444 ------------ ------------ Net decrease in cash and cash equivalents .............. (3,011,807) (10,659) Cash and cash equivalents at beginning of period ....... 60,253,990 75,180,742 ------------ ------------ Cash and cash equivalents at end of period ............. $ 57,242,183 $ 75,170,083 ============ ============
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, 1999 AND 1998 (Unaudited) (Continued)
1999 1998 ------------ ----------- Reconciliation of increase (decrease) in net assets from operations to net cash used by operating activities: Increase (decrease) in net assets from operations ............................. $ (8,886,097) $ 8,237,216 Adjustments to reconcile increase (decrease) in net assets from operations to net cash used by operating activities: Realized gain on sale of portfolio securities, net ....................... (2,932,804) (265,743) (Increase) decrease in unrealized appreciation, net ...................... 11,578,016 (8,054,934) Accrued interest and dividends exchanged for portfolio securities ................................................. (519,880) (770,972) Decrease (increase) in accrued interest receivable ....................... (77,601) 5,018 Amortization of commitment fee ........................................... 9,375 18,750 Decrease in accounts payable ............................................. (125,070) (98,325) Increase (decrease) in due to management company ......................... (44,430) 41,186 ------------ ----------- Net cash used by operating activities ......................................... $ (998,491) $ (887,804) ============ ===========
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, 1999 AND 1998 (Unaudited)
1999 1998 -------- -------- Investment income ........................................ $ 0.24 $ 0.25 Expenses ................................................. 0.29 0.27 -------- -------- Net investment loss ................................. (0.05) (0.02) Realized gain on sale of portfolio securities, net ....... 0.59 0.06 Increase (decrease) in unrealized appreciation of portfolio securities, net ....................... (2.34) 1.67 -------- -------- Increase (decrease) in net assets from operations ... (1.80) 1.71 Net assets at beginning of period ........................ 23.45 29.92 -------- -------- Net assets at end of period .............................. $ 21.65 $ 31.63 ======== ======== Ratio of expenses to average net assets .................. 1.27% 0.86% Ratio of net investment loss to average net assets ....... (0.22)% (0.06)% Ratio of increase (decrease) in net assets from operations to average net assets ............................... (7.95)% 5.54%
The accompanying notes are an integral part of these financial statements 6 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1999 (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. (NYSE - AW) March 1989 -875,000 shares of common stock 2,970,721 12,254,253 -Warrants to buy up to 125,000 shares of common stock at $5 per share through August 1999 - 719,539 American Residential Services, Inc. (NYSE - ARS) December 1995 -1,125,000 shares of common stock 3,000,272 5,865,469 -Warrants to buy up to 100,000 shares of common stock at $15 per share through September 2001 - - Atlas Acquisition, Inc. May 1997 -Junior participation in prime + 1.5% note 850,000 100,000 Carruth-Doggett Industries, Inc. December 1995 -10% senior subordinated promissory note 2,250,000 2,250,000 -Warrant to buy up to 33,333 shares of common stock at $0.01 per share through December 2005 - 3,250,000 -Warrant to buy up to 249 shares of common stock of CDE Corp. at $0.01 per share through December 2005 - - CDI Rental Services February 1999 -10% senior subordinated promissory note 2,000,000 2,000,000 -Warrant to buy up to 12,500 shares of common stock at $0.01 per share through February 2009 - - -Warrant to buy up to 21,250 shares of common stock at $0.0127 per share through February 2009 - - Champion Acquisition, Inc. March 1999 -499 shares of common stock 499 499 Container Acquisition, Inc. February 1997 -1,370,000 shares of common stock 1,370,000 1,370,000 -55,411 shares of preferred stock 5,541,100 5,541,100 -Warrant to buy up to 370,588 shares of common stock at $0.01 per share through June 2003 1,000 1,000
The accompanying notes are an integral part of these financial statements 7 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1999 (Unaudited) (Continued)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ ---- ---------- CRC Holdings, Corp. June 1997 -59,891 shares of common stock $ 5,474,037 $ 20,961,850 -12% subordinated promissory note 959,700 959,700 The Drilltec Corporation August 1998 -1,400,000 shares of common stock 1,400,000 - -62,450 shares of preferred stock 6,245,000 - Drypers Corporation (NASDAQ - DYPR) July 1991 -3,677,906 shares of common stock 9,328,556 6,486,235 Equicom, Inc. (formerly Texrock Radio, Inc.) July 1997 -452,000 shares of common stock 141,250 141,250 -618,061 shares of preferred stock 6,180,610 6,180,610 -10% promissory note 1,638,500 1,638,500 Garden Ridge Corporation (NASDAQ - GRDG) July 1992 -474,942 shares of common stock 685,030 3,235,780 GCS RE, Inc. February 1989 -1,000 shares of common stock 132,910 300,000 Hot & Cool Holdings, Inc. March 1996 -9% increasing rate subordinated promissory note 1,120,000 1,120,000 -10% subordinated notes 2,200,000 2,200,000 -12% senior unsecured promissory note 1,000,000 1,000,000 -19,647 shares of Series A 8% preferred stock 785,897 785,897 -Warrants to buy up to 14,942 shares of common stock at $0.01 per share through March 2006 - 280,000 -Warrants to buy up to 16,316 shares of common stock at $26.00 per share through April, 2007 - - HTD Corporation April 1997 -1,251,944 shares of common stock 8,165,000 10,015,552 -0% promissory note 1,355,550 1,355,550 NCI Building Systems, Inc. (NYSE - NCS) April 1989 -200,000 shares of common stock 159,784 4,700,000
The accompanying notes are an integral part of these financial statements 8 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1999 (Unaudited) (Continued)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ ---- ---------- Paracelsus Healthcare Corporation (NYSE - PLS) December 1990 -1,263,058 shares of common stock $ 5,278,748 $ 1,612,617 Petrocon Engineering, Inc. September 1998 -887,338 shares of common stock 635 635 -8% Series B junior subordinated promissory note 2,659,332 2,659,332 -12% promissory note 4,663,356 4,663,356 -Warrant to buy up to 1,552,571 shares of common stock at $0.01 per share through March 2009 - - Raytel Medical Corporation (NASDAQ - RTEL) August 1997 -33,073 shares of common stock 330,730 136,426 Sovereign Business Forms, Inc. August 1996 -13,702 shares of preferred stock 1,370,200 1,370,200 -15% promissory notes 800,000 800,000 -Warrant to buy 551,894 shares of common stock at $1 per share through August 2006 - 1,440,818 -Warrant to buy 25,070 shares of common stock at $1.25 per share through October 2007 - 59,182 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 $0.01 per share through September 2007 - 2,000,000 Strategic Holdings, Inc. September 1995 -3,089,751 shares of common stock 3,088,389 1,795,035 -3,822,157 shares of Series B preferred stock 3,820,624 3,820,624 -15% promissory note 6,750,000 6,750,000 -Warrants to buy 225,000 shares of common stock at $0.4643 per share through August 2005 - 26,249 -Warrant to buy 100,000 shares of common stock at $1.50 per share through August 2005 - - -Warrant to buy 2,219,237 shares of common stock at $0.01 per share through November 2005 - 1,267,105 -1,000 shares of SMIP, Inc. common stock 150,000 150,000 -15% promissory note of SMIP, Inc. 175,000 175,000
The accompanying notes are an integral part of these financial statements 9 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1999 (Unaudited) (Continued)
DATE OF PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE ----------------- ------------------ ---- ---------- Summit/DPC Partners, L.P. October 1995 -36.11% limited partnership interest $ 2,600,000 $ 4,600,000 Travis International, Inc. December 1986 -66,784 shares of common stock 534,589 2,537,792 -104,500 shares of Class A common stock 25,701 3,971,000 Tulsa Industries, Inc. December 1997 -27,500 shares of common stock 33,846 - -546,615 shares of Series A preferred stock 5,466,154 - -8.75% junior participation in promissory note 655,769 655,769 -Warrants to buy 31,731 shares of common stock at $0.001 per share - - United Industrial Services, Inc. July 1998 -35,000 shares of preferred stock 3,500,000 3,500,000 -Warrants to buy 63,637 shares of common stock at $0.01 through June 2008 100 100 United States Filter Corporation (NYSE - USF) October 1989 -55,172 shares of common stock 608,383 1,689,643 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 $ 114,150,787 $ 146,884,468 ============= =============
The accompanying notes are an integral part of these financial statements 10 EQUUS II INCORPORATED SCHEDULE OF PORTFOLIO SECURITIES MARCH 31, 1999 (Unaudited) (Continued) 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., Container Acquisition, Inc., CRC Holdings, Corp., The Drilltec Corporation, Drypers Corporation, HTD Corporation, Hot & Cool Holdings, Inc., Sovereign Business Forms, Inc., Strategic Holdings, Inc. and United Industrial Services, Inc. rights have been obtained to demand the registration of such securities under the Securities Act of 1933, providing certain conditions are met. The Fund does not expect to incur significant costs, including costs of any such registration, in connection with the future disposition of its portfolio securities. As defined in the Investment Company Act of 1940, at March 31, 1999, the Fund was considered to have a controlling interest in Atlas Acquisition, Inc., Champion Acquisition, Inc., Container Acquisition, Inc., CRC Holdings, Corp., The Drilltec Corporation, Drypers Corporation, Equicom, Inc., Petrocon Engineering, Inc., Sovereign Business Forms, Inc., Strategic Holdings, Inc., Tulsa Industries, Inc., United Industrial Services, Inc. and VRPI Spin Off, Inc. In addition, HTD Corporation and Travis International, Inc. are considered to be affiliated entities of the Fund. The fair values of the Fund's investments in publicly traded securities include discounts from the closing market prices to reflect the estimated effects of restrictions on the sale of such securities at March 31, 1999. Such discounts, shown in the following table, total $2,588,033 or $0.52 per share as of March 31, 1999. Discount from Market Value ------------- Allied Waste Industries, Inc. ....................... $ 839,209 American Residential Services, Inc. ................. 181,406 Drypers Corporation ................................. 1,443,330 Paracelsus Healthcare Corporation ................... 124,088 ---------- Total discount ................................... $2,588,033 ========== Income was earned in the amount of $742,654 and $456,648 for the three months ended March 31, 1999 and 1998, respectively, on portfolio securities of companies in which the Fund had a controlling interest. As defined in the Investment Company Act of 1940, all of the Fund's investments are in eligible portfolio companies. The Fund provides significant managerial assistance to all of the portfolio companies in which it has invested, except Garden Ridge Corporation, Raytel Medical Corporation, Summit/DPC Partners, L.P. and United States Filter Corporation. The Fund provides significant managerial assistance to portfolio companies that comprise 93% of the total value of the investments in portfolio companies at March 31, 1999. The accompanying notes are an integral part of these financial statements 11 EQUUS II INCORPORATED NOTES TO FINANCIAL STATEMENTS MARCH 31, 1999 AND 1998 (Unaudited) (1) ORGANIZATION AND BUSINESS PURPOSE Equus II Incorporated (the "Fund"), a Delaware corporation with perpetual existence, was formed by Equus Investments II, L.P. (the "Partnership") on August 16, 1991. On July 1, 1992, the Partnership was reorganized and all of the assets and liabilities of the Partnership were transferred to the Fund in exchange for shares of common stock of the Fund. The shares of the Fund trade on the New York Stock Exchange under the symbol EQS. The Fund seeks to achieve capital appreciation by making investments in equity and equity-oriented securities issued by privately-owned companies in transactions negotiated directly with such companies ("Portfolio 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 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 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, 1999 and 1998. 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 granted incentive stock options to purchase shares of the Fund's stock from time to time. (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. 12 (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 $137,122,619 (including $26,938,113 in publicly-traded securities, net of a $2,588,033 Valuation Discount) and $143,689,403 (including $40,505,183 in publicly-traded securities, net of a $4,382,822 Valuation Discount) at March 31, 1999 and December 31, 1998, 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 the 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. Weekly and daily net asset values appear in various publications, including BARRON'S and THE WALL STREET JOURNAL and the Fund's website, www.equuscap.com. Investment Transactions - Investment transactions are recorded on the accrual method. Realized gains and losses on investments sold are computed on a specific identification basis. Cash Flows - For purposes of the Statements of Cash Flows, the Fund considers all highly liquid temporary cash investments purchased with an original maturity of three months or less to be cash equivalents. Income Taxes - No provision for federal income taxes has been made in the accompanying financial statements as the Fund has qualified for pass-through treatment as a "regulated investment company" under Subchapter M of the Internal Revenue Code of 1986. As such, all net income is allocable to the stockholders for inclusion in their respective tax returns. Net capital losses are not allocable to the shareholders but can be carried over to offset future earnings of the Fund. (4) BOOK TO TAX RECONCILIATION The Fund accounts for dividends in accordance with Statement of Position 93-2 which relates to the amounts distributed by the Fund as net investment income or net capital gains, which are often not equal to the corresponding income or gains shown in the Fund's financial statements. The Internal Revenue Service approved the Fund's request, effective October 31, 1998, to change its year-end for determining capital gains for federal income tax purposes from December 31 to October 31, which allows current year dividends to be paid prior to the end of the calendar year. For tax purposes, the Fund distributed net capital gains of $3,127,756 for the ten months ended October 31, 1998 in December 1998. The Fund had $6,558,635 in undistributed net capital losses for the period from November 1, 1998 to December 31, 1998. For the three months ended March 31, 1999, the Fund realized net capital gains of $2,932,804. Therefore, for tax purposes, the Fund had net capital losses of $3,625,831 for the five months ended March 31, 1999 of the 1999 tax year. The Fund had a net investment loss for tax purposes 13 of $(240,885) and $(83,461) for the three months ended March 31, 1999 and 1998, respectively; therefore no investment income was distributed. The following is a reconciliation of the difference in the Fund's net realized gain or loss on the sale of portfolio securities for book and tax purposes. 1999 1998 ----------- -------- Net realized gain on the sales of portfolio securities, book .......... $ 2,932,804 $265,743 Undistributed 1998 net capital losses .... (6,558,635) -- ----------- -------- Net realized gain (loss) on the sales of portfolio securities, tax ........... $(3,625,831) $265,743 =========== ======== (5) DIVIDENDS The Fund declared no dividends during the three months ended March 31, 1999 and 1998, 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, payment of expenses, or payment of notes payable to the bank consist of $57,238,562 in money market accounts with NationsBank, N.A. earning interest at a rate of 3.24% at March 31, 1999. (7) ACCOUNTS RECEIVABLE Accounts receivable at March 31, 1999 and December 31, 1998 included $19,760 in proceeds from the 1998 liquidation of Restaurant Development Group, Inc. The balance at March 31, 1999 also included $24,483 in receivables due from Petrocon Engineering, Inc. for expenses related to its merger with OEI International, Inc. The remaining balance in "Accounts receivable" at December 31, 1998 consisted primarily of a $250,000 cash advance to Tulsa Industries which was repaid to the Fund in March 1999, and $122,148 in escrow related to the 1997 sale of the Fund's investment in Industrial Equipment Rentals which was received in January 1999. (8) PORTFOLIO SECURITIES During the three months ended March 31, 1999, the Fund invested $2,000,499 in two new companies and made follow-on investments of $4,223,959 in eight portfolio companies. These follow-on investments include $519,880 in accrued interest and dividends received in the form of additional portfolio securities and accretion of original issue discount on a promissory note. In addition, the Fund realized a net capital gain of $2,932,804 during the three months ended March 31, 1999. 14 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. (9) NOTES PAYABLE TO BANK The Fund has a $150,000,000 line of credit promissory note with NationsBank N.A., with interest payable at 1/2% over the rate earned in its money market account. The Fund had $55,000,000 and $60,000,000 outstanding on such note at March 31, 1999 and December 31, 1998, respectively, that was secured by $55,000,000 and $60,000,000 of the Fund's temporary cash investments. The Fund paid $37,500 in commitment fees in November 1998, which were capitalized and are being amortized over the commitment period. Effective April 1, 1999, the Fund extended the line of credit promissory note to June 1, 1999. The Fund has a $50,000,000 revolving line of credit with NationsBank, N.A. that expires on April 1, 1999. However, effective April 1, 1999, the maturity of the line of credit was also extended to June 1, 1999. The Fund had $41,900,000 and $38,500,000 outstanding under such line of credit at March 31, 1999 and December 31, 1998, respectively, which is secured by the Fund's investments in portfolio securities. The interest rate ranges from prime - 1/2 % to prime + 1/4% or libor + 1.65%. The Fund also pays 1/4% interest on the unused portion of the line of credit. The average daily balances outstanding on the Fund's notes payable during the three months ended March 31, 1999 and 1998, were $40,179,444 and $13,399,722, respectively. (10) STOCK OPTION PLAN The Equus II Incorporated 1997 Stock Incentive Plan ("Stock Incentive Plan") 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. 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 was not an officer of the Fund was, on the first business day following the annual meeting, granted an incentive stock option to purchase 2,000 shares of the Fund's common stock. Under the 1997 Stock Incentive Plan, options to purchase 939,131 and 927,131 shares of the Fund's common stock were outstanding at March 31, 1999 and 1998, respectively. Outstanding options at March 31, 1999 have exercise prices ranging from $17 to $27.44 and expire in May 2007 through May 2008. During the three months ended March 31, 1999 and 1998, no options were exercised. As of March 31, 1999, all options outstanding were "out of the money" and would have an anti-dilutive effect on net assets per share if exercised. If all options granted had been 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 $6,900,000 in Champion Acquisition, Inc. and $245,500 in Equicom, Inc. 15 In addition, the Fund has committed to invest up to $4,000,000 in one new portfolio 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, 1999, the Fund repaid a net $55,000,000 of notes payable to the bank. On April 29, 1999, the Fund sold its investment in American Residential Services, Inc. of 1,125,000 shares of common stock, in connection with a cash tender offer, for $6,468,750, realizing a capital gain of $3,468,478. On April 30, 1999, the Fund also sold its investment of 55,172 common shares of United States Filter Corporation common stock, in connection with a cash tender offer, for $1,737,918, realizing a capital gain of $1,129,535. On May 5, 1999, the Fund sold 100,000 common shares of Allied Waste Industries, Inc. for $1,832,112, realizing a capital gain of $1,357,956. 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. LIQUIDITY AND CAPITAL RESOURCES At March 31, 1999, the Fund had $146,884,468 of its assets invested in portfolio securities of 29 companies, and has committed to invest up to an additional $7,145,500 in three of such companies and $4,000,000 in one 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, 1999, the Fund had $41,900,000 outstanding on a $50,000,000 revolving line of credit loan from a bank. Net cash used by operating activities was $998,491 and $887,804 for the three months ended March 31, 1999 and 1998, respectively. At March 31, 1999, the Fund had $57,238,562 of its total assets of $204,947,547 invested in temporary cash investments consisting of money market securities. This amount includes proceeds of $55,000,000 from a $150,000,000 note payable 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, 1999. The Fund has the ability to borrow funds and issue forms of senior securities representing indebtedness or stock, such as preferred stock, subject to certain restrictions. Net investment income and net realized gains from the sales of portfolio investments are intended to be distributed at least annually, to the extent such amounts are not reserved for payment of contingencies or to make follow-on or new investments. Management believes that the availability under its line of credit, as well as the ability to sell its investments in publicly traded securities, are adequate to provide payment for any expenses and contingencies of the Fund. 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 stockholders 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 $240,885 and $83,461 for the three months ended March 31, 1999 and 1998, respectively. The increase in net investment loss in 1999 as compared to 1998 was primarily attributed to the increase in interest expense from $317,631 in 1998 to $718,170 in 1999. Interest expense increased due to the increase of the average daily balances outstanding on the lines of credit to $40,179,444 during the three months ended March 31, 1999 from $13,399,722 during the comparable period in 1998. Professional fees decreased to $62,381 during the three months ended March 31, 1999 as compared to $83,162 during 1998, due primarily to lower fees incurred by the Fund from its transfer agent and safekeeping agent. 17 The Management Company receives management fee compensation at an annual rate of 2% of the net assets of the Fund paid quarterly in arrears. Such fees amounted to $536,345 and $763,540 during the three months ended March 31, 1999 and 1998, respectively. The decrease was due to a reduction in the total net assets of the Fund from $152,707,968 at March 31, 1998 to $107,268,931 at March 31, 1999. Under the 1997 Stock Incentive Plan, options to purchase 939,131 and 927,131 shares of the Fund's common stock were outstanding at March 31, 1999 and 1998, respectively. Outstanding options at March 31, 1999 have exercise prices ranging from $17 to $27.44 and expire in May 2007 through May 2008. During the three months ended March 31, 1999 and 1998, no options were exercised. As of March 31, 1999, all options outstanding were "out of the money" and would have an anti-dilutive effect on net assets per share if exercised. If all options granted had been 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. REALIZED GAINS AND LOSSES ON SALES OF PORTFOLIO SECURITIES During the three months ended March 31, 1999, the Fund realized net capital gains of $2,932,804 from the sale of securities of two Portfolio Companies. The Fund sold its investment of 54,334 shares of common stock in United Rentals, Inc. for $1,738,036, realizing a capital gain of $1,737,639 and 80,300 common shares of United States Filter Corporation for $2,147,060, realizing a capital gain of $1,195,165. 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. UNREALIZED APPRECIATION AND DEPRECIATION OF PORTFOLIO SECURITIES Net unrealized appreciation on investments decreased $11,578,016 during the three months ended March 31, 1999, from $44,311,697 to 32,733,681. Such net decrease resulted from decreases in the estimated fair value of securities of seven of the Fund's Portfolio Companies aggregating $14,066,146, an increase in the estimated fair value of securities of four Portfolio Companies of $5,172,514, and the transfer of $2,684,384 in net unrealized appreciation to net realized gains from the sale of investments in two Portfolio Companies. 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 Portfolio Company. DIVIDENDS The Fund declared no dividends during the three months ended March 31, 1999 and 1998. PORTFOLIO INVESTMENTS During the three months ended March 31, 1999, the Fund invested $2,000,499 in two new companies and made follow-on investments of $4,223,959 in eight portfolio companies. These follow-on 18 investments include $519,880 in accrued interest and dividends received in the form of additional portfolio securities and accretion of original issue discount on a promissory note. On January 29, 1999, Brazos Sportswear, Inc. filed voluntary petitions under Chapter 11 of the Bankruptcy Code. The Fund's investment in Brazos Sportswear, Inc. was written off as of December 31, 1998. In February 1999, co-investors in Equicom, Inc. ("Equicom") purchased 48,000 shares of Equicom's common stock at its original cost of $15,000 from the Fund. Co-investors in Equicom also purchased $1,043,500 of the $2,682,000 in principal in its 10% promissory note due to the Fund. The Fund then invested $748,310 in Equicom and received 74,831 shares of preferred stock. In February 1999, the Fund invested $2,000,000 in CDI Rental Services, Inc., a company primarily focused on acquiring existing construction equipment rental businesses. The Fund's investment consisted of a 10% senior subordinated promissory note and warrants to buy up to 12,500 and 21,250 shares of common stock for $0.01 and $0.0127 per share, respectively, through February 2009. In March 1999, OEI International, Inc. ("OEI") merged into Petrocon Engineering, Inc. ("Petrocon"). The Fund exchanged its investment in OEI of $2,500,000 in a promissory note and accrued interest of $159,332, its investment in Petrocon of $2,500,000 in a promissory note and accrued interest of $163,356, warrants to purchase 1,000,000 common shares of Petrocon and $2,000,000 in a cash advance for the purchase from Petrocon of $4,663,356 in a 12% senior subordinated note, $2,659,332 in an 8% series B junior subordinated note and warrants to purchase 1,552,571 shares of Petrocon common stock. The Fund also exchanged its investment in 566,201 common shares of OEI for 887,338 shares of Petrocon common stock at a rate of 1.567178 Petrocon shares for each OEI share. In March 1999, the Fund acquired 499 common shares of Champion Acquisition, Inc. ("Champion") for $499. Champion was formed to acquire the assets of a company that manufactures aluminum windows. In March 1999, the Fund received 5,172 in additional common shares of U.S. Filter Corporation ("U.S. Filter") related to a purchase price adjustment from the 1998 sale of WMW Industries, Inc. to U.S. Filter. The transaction with U.S. Filter in 1998 was a tax-free exchange; therefore the Fund did not realize a capital gain from the receipt of these additional common shares. In the first quarter of 1999, the Fund acquired an additional 7,500 shares of series A 8% preferred stock from Hot & Cool Holdings, Inc. for $300,000. During the quarter ended March 31, 1999, the Fund advanced $655,769 to Tulsa Industries, Inc. under a 8.75% junior participation in a promissory note. Through March 31, 1999, the Fund received an additional 1,333 and 302 shares of preferred stock of Container Acquisition, Inc. and Sovereign Business Forms, Inc. in payment of $133,300 and $30,200 in dividends, respectively. During the three months ended March 31, 1999, the original issue discount accretion for the discounted $2,025,000 non-interest bearing note due from HTD Corporation amounted to $18,020. Such original issue discount is being accreted over the life of the note. 19 Of the companies in which the Fund has investments at March 31, 1999, only ARS, AW, DYPR, GRDG, NCS, PLS, RTEL and USF are publicly held. The others each have a small number of shareholders and do not generally make financial information available to the public. However, each company's operations and financial information are reviewed by Management to determine the proper valuation of the Fund's investment. YEAR 2000 Many computer software systems in use today cannot properly process date-related information from and after January 1, 2000. Should any of the computer systems employed by the Management Company, any of the Fund's other major service providers, or companies in which the Fund has an investment, fail to process this type of information properly, that could have a negative impact on the Fund's operations and the services provided to the Fund's stockholders. The Management Company has identified its computer systems to be replaced and modified for Year 2000 compliance with installation anticipated to be completed by June 30, 1999. In addition, the Fund has made inquiries of its major service providers as well as its Portfolio Companies to determine if they are in the process of reviewing their systems for Year 2000 compliance. The Fund has received assurances from all of its major service providers that they are preparing for Year 2000. The Fund has received assurances from a majority of its Portfolio Companies, representing approximately 87% of the Fund's total value in portfolio securities at March 31, 1999, and is continuing its process of obtaining assurances from the remaining Portfolio Companies. While the Fund has received assurances from major services providers and a majority of the Portfolio Companies regarding Year 2000 compliance, there can be no guarantee that Year 2000 problems originating from these third parties, whose systems effect the Fund, will not occur. The Fund does not expect to incur any expenses related to Year 2000 issues as such costs are primarily the responsibility of the Management Company. The Fund will develop a contingency plan if significant risks related to Year 2000 are identified. SUBSEQUENT EVENTS Subsequent to March 31, 1999, the Fund repaid a net $55,000,000 of notes payable to the bank. On April 29, 1999, the Fund sold its investment in American Residential Services, Inc. of 1,125,000 shares of common stock, in connection with a cash tender offer, for $6,468,750, realizing a capital gain of $3,468,478. On April 30, 1999, the Fund also sold its investment of 55,172 common shares of United States Filter Corporation common stock, in connection with a cash tender offer, for $1,737,918, realizing a capital gain of $1,129,535. On May 5, 1999, the Fund sold 100,000 common shares of Allied Waste Industries, Inc. for $1,832,112, realizing a capital gain of $1,357,956. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK There have been no material changes in the disclosure as defined in Item 7A of Form 10-K for fiscal year ended December 31, 1998. 20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) EXHIBITS 10. Material Contracts (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed by the Fund during the period for which this report is filed. 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 \s\ NOLAN LEHMANN Nolan Lehmann President and Principal Financial Date: May 12, 1999 and Accounting Officer EX-27.1 2
6 3-MOS DEC-31-1999 MAR-31-1999 171,389,349 204,123,030 799,021 25,496 0 204,947,547 0 0 97,678,616 97,678,616 29,102,040 78,166,891 4,954,304 4,954,304 0 0 (3,636,595) 0 32,733,681 107,268,931 226,064 931,023 18,750 1,416,722 (240,885) 2,932,804 (11,578,016) (8,886,097) 0 0 0 0 0 0 0 (8,886,097) 0 0 0 0 536,345 718,170 1,416,722 111,711,980 23.45 (0.05) (1.75) 0 0 0 21.65 1.27 40,179,444 8.11
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