Business Context and Reporting Period
Company: Equus II Incorporated (a Delaware corporation and Business Development Company).
Reporting Period: Fiscal year ended December 31, 1995.
Business Model: The Fund seeks capital appreciation by investing in equity and equity-oriented securities of privately-owned companies, primarily in leveraged buyouts and recapitalizations. It provides significant managerial assistance to portfolio companies. The Fund is a "non-diversified" closed-end fund and qualifies for pass-through tax treatment as a regulated investment company (RIC).
Key Financial Metrics
| Metric | 1995 | 1994 |
|---|---|---|
| Total Assets | $132,450,176 | $109,941,211 |
| Net Assets | $61,853,289 | $60,880,364 |
| Net Asset Value (NAV) per Share | $19.71 | $19.94 |
| Total Investment Income | $3,075,234 | $1,921,136 |
| Net Investment Income (Loss) | $(668,114) | $518,473 |
| Realized Gain (Loss) on Sales | $7,668,524 | $(350,309) |
| Unrealized Appreciation (Depreciation) | $(1,280,549) | $(2,562,801) |
| Total Increase in Net Assets from Operations | $5,719,861 | $(2,394,637) |
| Dividends Declared | $5,814,990 ($2.00/share) | $763,268 ($0.25/share) |
| Debt (Notes Payable to Bank) | $65,750,000 | $45,600,000 |
| Temporary Cash Investments | $60,232,594 | $45,474,560 |
| Expense Ratio (to Avg Net Assets) | 6.10% | 2.23% |
Material Changes vs. Prior Period
- Profitability: The Fund reported a net investment loss of $(668,114) in 1995 compared to income of $518,473 in 1994. This was primarily due to the accrual of $1,277,595 in deferred management incentive fees resulting from realized gains and unrealized appreciation.
- Realized Gains: A significant turnaround occurred in realized gains, moving from a loss of $(350,309) in 1994 to a gain of $7,668,524 in 1995. Major contributors included sales of Garden Ridge Corp ($2.9M gain), NCI Building Systems ($2.8M gain), and Allied Waste Industries ($0.5M gain).
- Leverage: Debt increased significantly to $65.75 million in 1995 from $45.6 million in 1994. This included a $60 million note payable utilized to maintain diversification requirements for RIC tax status (repaid Jan 2, 1996).
- Portfolio Activity: The Fund invested $11.9 million in five new portfolio companies and made $2.7 million in follow-on investments in 1995.
- Share Repurchases: The Fund repurchased and cancelled 145,500 shares in 1995 for $1.99 million, at an average discount of 33.61% from NAV.
Guidance, Outlook, and Risks
- Capital Raise: Management intends to issue transferable subscription rights to existing shareholders in Q2 1996 (1 right for every 3 shares owned) to raise capital for debt repayment and new investments.
- Dividend Policy: The Fund adopted a policy in 1995 to distribute at least $0.50 per share annually. The 1995 dividend of $2.00 per share was paid in cash or stock.
- Valuation Risks: A significant portion of the portfolio ($68.1 million) consists of securities valued by the Sub-Adviser in the absence of readily ascertainable market values. The filing notes that these estimates may differ significantly from actual market values.
- Liquidity and Leverage: The Fund relies on borrowings to facilitate investments and maintain tax status. High leverage magnifies the effect of changes in portfolio value. Many portfolio securities are illiquid and restricted from public sale.
- Tax Status: The Fund risks losing its pass-through tax treatment if it fails to meet diversification requirements or fails to distribute sufficient income and gains.
Investor Verification Checklist
- Deferred Incentive Fees: Verify the impact of the $4.3 million accrued deferred management incentive fee liability on future cash flows and NAV.
- Debt Maturity: Confirm the repayment status of the $60 million note (repaid Jan 1996) and the terms of the new $20 million revolving credit line.
- Valuation Discounts: Review the $5.6 million aggregate discount applied to publicly traded securities (Allied, Champion, Drypers, Garden Ridge) due to transfer restrictions.
- Commitments: Assess the Fund's ability to fund $9.6 million in existing follow-on commitments and $8.6 million in new company commitments.
- Market Discount: Note that shares have historically traded at a discount to NAV (e.g., repurchases in 1995 were at a 33.61% discount).