EQS

Business Context and Reporting Period

Company: Equus II Incorporated (a Delaware corporation and Business Development Company)

Reporting Period: Quarterly period ended March 31, 1997

Business Overview: The Fund seeks capital appreciation by investing in equity and equity-oriented securities of privately-owned companies, primarily in leveraged buyouts and recapitalizations. It is registered under the Investment Company Act of 1940 and trades on the American Stock Exchange (Symbol: EQS).

Key Financial Metrics

Material Changes vs. Prior Period

• Expense Reduction: Total expenses decreased significantly from $3.62 million in Q1 1996 to $1.38 million in Q1 1997. This was primarily driven by a reduction in deferred management incentive fees (from $2.77 million to $0.43 million) and lower interest expense (from $240,555 to $77,767) due to lower average daily loan balances.
• Realized Losses: The Fund recorded a net realized loss of $3.94 million in Q1 1997, compared to a gain of $1.29 million in Q1 1996. The 1997 loss was largely due to the sale of the Midway Airlines investment.
• Unrealized Gains: Net unrealized appreciation increased by $6.35 million in Q1 1997, compared to an increase of $13.07 million in Q1 1996.
• Liquidity: Operating cash flow turned positive ($56,299) in Q1 1997, reversing a negative flow of $(514,939) in the prior year, largely due to increased interest received from portfolio companies.

Guidance, Outlook, and Material Events

• Management Agreement Change: On April 9, 1997, shareholders approved a new management agreement that eliminates incentive fees based on capital gains. The existing deferred incentive fee of $11.21 million will be paid in the second quarter of 1997 via the issuance of 459,973 unregistered shares of common stock.
• Subsequent Sales: Post-period, the Fund sold its investment in David's Supermarkets, Inc. for $5.55 million, realizing a net capital gain of $1.48 million.
• New Investments: In April and May 1997, the Fund made new investments in Cardiovascular Ventures, Inc., Hot & Cool Holdings, Inc., Healthcare Technology Delivery, Inc., AVIAN Healthcare Corporation, and Atlas Acquisition, Inc.
• Debt Repayment: Subsequent to March 31, 1997, the Fund repaid a net $68.64 million of notes payable to the bank.
• Legal Contingencies: An amended shareholder derivative action was filed in January 1997 alleging breaches of fiduciary duty. Management believes the resolution will not have a material adverse effect on the Fund.
• Dividends: No dividends were declared for the quarter. The Fund maintains a policy to distribute at least $0.50 per share annually.

Investor Verification Checklist

• Deferred Fee Settlement: Verify the issuance of 459,973 shares to settle the $11.21 million deferred incentive fee and its impact on share count and dilution.
• Valuation Discounts: Review the $20.1 million discount applied to publicly traded securities to reflect sale restrictions, as this significantly impacts reported fair value.
• Debt Structure: Confirm the terms of the $30 million revolving line of credit and the $65 million promissory note, noting the extension to April 1998.
• Portfolio Concentration: Assess the risk associated with the Fund's controlling interests in several portfolio companies (e.g., Brazos Sportswear, Drypers Corporation) and the lack of public financial data for private holdings.
• Subsequent Realized Gains: Account for the $1.48 million gain on the David's Supermarkets sale which occurred after the reporting period.