Business Context and Reporting Period
Company: EQUUS TOTAL RETURN, INC. (Equus)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2017
Business Overview: Equus is a Delaware corporation operating as a Business Development Company (BDC) and a Regulated Investment Company (RIC). Its strategy seeks total return through capital appreciation and current income by investing in debt and equity securities of companies with enterprise values between $5.0 million and $75.0 million. The company is currently pursuing a "Plan of Reorganization" to consolidate with an operating company and withdraw its BDC election, authorized by shareholders effective September 28, 2017.
Key Financial Metrics
| Metric | Sept 30, 2017 | Dec 31, 2016 |
|---|---|---|
| Net Assets | $41,999,000 | $42,740,000 |
| Net Asset Value (NAV) per Share | $3.11 | $3.37 |
| Total Investments (Fair Value) | $29,274,000 | $29,661,000 |
| Cash and Cash Equivalents | $12,390,000 | $11,961,000 |
| Borrowings (Margin Account) | $17,992,000 | $29,994,000 |
| Investment Income (9 Months) | $439,000 | $556,000 |
| Net Investment Loss (9 Months) | ($3,254,000) | ($1,755,000) |
| Net Change in Net Assets (9 Months) | ($1,837,000) | $4,198,000 |
Liquidity: The company maintains liquidity through cash on hand and temporary cash investments. As of September 30, 2017, it held $18.0 million in U.S. Treasury bills collateralizing a margin loan used to maintain RIC diversification requirements. This loan was repaid on October 2, 2017.
Material Changes vs. Prior Period
- Net Asset Value Decline: NAV per share decreased 7.7% from $3.37 to $3.11 over the nine-month period.
- Increased Expenses: Total expenses for the nine months ended September 30, 2017, were $3.69 million (net of a merger termination fee), compared to $2.31 million in the prior year. This increase was driven primarily by $1.1 million in share-based compensation expense related to the 2016 Equity Incentive Plan and higher professional fees.
- Merger Termination Fee: In the prior year (2016), the company recorded a $2.5 million merger termination fee. No such fee was recorded in the current period, though a fee was received in 2017 (see below).
- Portfolio Composition: The company received full payment ($2.4 million) on a senior secured promissory note from Biogenic Reagents, LLC. The portfolio remains heavily concentrated in PalletOne, Inc. (39.8% of net assets).
- Unrealized Gains: Net unrealized appreciation increased by $1.4 million during the period, primarily due to value increases in MVC Capital, Inc. and PalletOne, Inc. holdings.
Guidance, Outlook, and Risks
Management Commentary and Outlook
Management continues to pursue a consolidation with an operating company to effectuate its Plan of Reorganization. While a proposed merger with U.S. Gas & Electric, Inc. (USG&E) was terminated in May 2017 due to a superior proposal from a third party, Equus received a $2.5 million termination fee. The company intends to continue evaluating consolidation opportunities and has been authorized to withdraw its BDC election by December 31, 2017, contingent on completing a consolidation.
Management believes operating cash flow and cash on hand are sufficient to meet requirements for the next twelve months. The company has shifted strategy from originating new debt/equity investments to preserving liquidity and monetizing legacy holdings.
Risks and Contingencies
- Reorganization Risk: There is no assurance that a consolidation will be completed within a specific timeframe or at all. Failure to consolidate could impact the company's ability to withdraw its BDC election.
- Concentration Risk: The portfolio is non-diversified. PalletOne, Inc. represents 39.8% of net assets. Performance of this single entity significantly impacts NAV.
- Valuation Uncertainty: A significant portion of the portfolio ($24.4 million) consists of Level 3 assets (unobservable inputs), making fair value determinations subject to management judgment and potential volatility.
- Legal Proceedings: A shareholder lawsuit regarding the 2016 Equity Incentive Plan is pending. The company filed a motion for summary judgment and intends to defend vigorously.
Investor Verification Checklist
- Reorganization Status: Verify if a new consolidation target has been identified to replace the terminated USG&E deal.
- BDC Election Withdrawal: Confirm the timeline and conditions for withdrawing the BDC election by the December 31, 2017 deadline.
- Expense Ratios: Monitor the impact of the new equity incentive plan on future expense ratios, which rose to 14.62% for the nine-month period.
- Portfolio Concentration: Assess the financial health of PalletOne, Inc., given its 39.8% weighting in the portfolio.
- Liquidity Management: Review the company's ability to maintain RIC status without relying on quarter-end margin loans if investment opportunities arise.