Business Context and Reporting Period
Company: Equus II Incorporated (a Delaware corporation, trading as EQUUS on the NYSE).
Reporting Period: Quarterly report (Form 10-Q) for the period ended September 30, 1998.
Business Model: A Business Development Company (BDC) seeking capital appreciation through investments in equity and equity-oriented securities of privately owned companies, including leveraged buyouts and recapitalizations. The Fund provides significant managerial assistance to 92% of its portfolio value.
Key Financial Metrics
| Metric | Nine Months Ended Sep 30, 1998 | Nine Months Ended Sep 30, 1997 |
|---|---|---|
| Total Assets | $235,300,075 | $228,094,939 |
| Net Assets | $120,168,221 | $144,470,752 |
| Net Assets Per Share | $24.89 | $29.92 |
| Total Investment Income | $2,847,029 | $3,198,372 |
| Total Expenses | $4,252,428 | $3,814,357 |
| Net Investment Loss | $(1,405,399) | $(615,985) |
| Realized Gain on Sales | $4,995,079 | $4,812,355 |
| Unrealized Appreciation (Decrease) | $(27,759,534) | $36,522,589 |
| Total Change in Net Assets from Operations | $(24,169,854) | $40,718,959 |
| Cash and Cash Equivalents | $80,058,868 | $85,456,678 |
| Notes Payable to Bank | $114,275,000 | $81,900,000 |
Material Changes vs. Prior Period
- Net Asset Decline: Net assets decreased by approximately $24.3 million (16.8%) compared to a $51.9 million increase in the prior year. This was driven primarily by a $27.8 million decrease in unrealized appreciation of portfolio securities.
- Increased Leverage and Interest Expense: Notes payable increased from $81.9 million to $114.3 million. Consequently, interest expense rose significantly to $1.27 million (from $415k), contributing to a larger net investment loss.
- Investment Activity: The Fund invested $13.6 million in three new companies and made $25.1 million in follow-on investments during the nine-month period.
- Portfolio Valuation: While the Fund realized gains of $5.0 million on sales, the fair value of the portfolio declined due to decreases in the estimated value of ten portfolio companies, offsetting increases in ten others.
Guidance, Outlook, and Risks
- Dividend Policy: The Fund declared a dividend of $0.65 per share subsequent to the period end, payable in December 1998. This consists of unpaid net capital gains from 1997 and the ten months ended October 31, 1998. The Fund aims to distribute at least $0.50 per share annually.
- Liquidity: The Fund maintains a $50 million revolving line of credit ($34.3 million outstanding) and a $150 million line of credit ($80 million outstanding, repaid October 1, 1998). Management believes cash and borrowings are sufficient to meet commitments of approximately $15.2 million.
- Management Fee Structure: Incentive fees based on capital gains were eliminated effective April 1, 1997. The management fee remains at 2% of net assets annually.
- Risks:
- Valuation Uncertainty: A significant portion of the portfolio ($147 million) lacks readily ascertainable market values and relies on appraisals.
- Concentration: The Fund has controlling interests in 14 portfolio companies and affiliated interests in two others.
- Year 2000 Issue: Potential operational disruptions if service providers or portfolio companies fail to update computer systems, though management anticipates no material expenses.
Investor Verification Checklist
- Debt Repayment: Verify the repayment of the $80 million line of credit noted as a subsequent event (October 1, 1998) and its impact on future interest expenses.
- Dividend Composition: Confirm the tax characterization of the $0.65 per share dividend (capital gains vs. ordinary income) and the election process for cash vs. stock.
- Portfolio Valuations: Review the specific appraisals for the ten portfolio companies that experienced decreases in fair value, as these drove the majority of the unrealized loss.
- Commitments: Assess the Fund's ability to fund the remaining $15.2 million in investment commitments given the current cash position and credit lines.
- Subsequent Sales: Note the November 1998 sale of Allied Waste Industries shares for a $2.86 million gain, which may impact Q4 results.