NOTES TO FINANCIAL STATEMENTS
DECEMBER
31, 2019, 2018 AND 2017
|
(1)
|
ORGANIZATION AND BUSINESS
PURPOSE
|
Equus
Total Return, Inc. (“we,” “us,” “our,” “Equus” the “Company” and the
“Fund”), a Delaware corporation, 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. Our shares trade on the NYSE under the symbol ‘EQS’. On August 11, 2006, our shareholders approved the change
of the Fund’s investment strategy to a total return investment objective. This
strategy seeks to provide the highest total return, consisting of capital appreciation
and current income. In connection with this strategic investment change, the shareholders
also approved the change of name from Equus II Incorporated to Equus
Total Return, Inc.
We
attempt to maximize the return to stockholders in the form of current investment income and long-term capital gains by investing
in the debt and equity securities of companies with a total enterprise value between
$5.0 million and $75.0 million, although we may engage in transactions with smaller
or larger investee companies from time to time. We seek to invest primarily in companies
pursuing growth either through acquisition or organically, leveraged buyouts, management buyouts and recapitalizations of existing
businesses or special situations. Our income-producing investments consist principally of debt securities including subordinated
debt, debt convertible into common or preferred stock, or debt combined with warrants
and common and preferred stock. Debt and preferred equity financing may also be used to create long-term capital appreciation through
the exercise and sale of warrants received in connection with the financing. We seek
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. Given market conditions over the past several years and the performance of our
portfolio, our Management and Board of Directors believe it prudent to continue to
review alternatives to refine and further clarify the current strategies.
We
elected to be treated as a BDC under the 1940 Act, although our shareholders have
authorized us to withdraw this election during 2019 and the first quarter of 2020 and have done so previously in our efforts to
achieve a transformational Consolidation (see “Significant Developments –
Authorization to Withdraw BDC Election”
above). We currently qualify as a regulated investment company RIC for federal income
tax purposes and, therefore, are not
required to pay corporate income taxes on any income or gains that we distribute to our stockholders. We have certain wholly owned
taxable subsidiaries (“Taxable Subsidiaries”) each of which holds one
or more portfolio investments listed on our Schedules of Investments. The purpose of these
Taxable Subsidiaries is to permit us to hold
certain income-producing investments or portfolio companies organized as limited liability
companies, or LLCs, (or other forms of pass-through entities) and still satisfy the RIC tax requirement that at least 90% of our
gross revenue for income tax purposes must consist of investment income. Absent the Taxable Subsidiaries, a portion
of the gross income of these income-producing investments or of any LLC (or other
pass-through entity) portfolio investment, as the case may be, would flow through directly to us for
the 90% test. To the extent that such income did not consist of investment income,
it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur
significant federal income taxes. The income of the LLCs (or other pass-through entities) owned by Taxable Subsidiaries is
taxed to the Taxable Subsidiaries and does not flow through to us, thereby helping us preserve
our RIC status and resultant tax advantages. We do not consolidate the Taxable Subsidiaries for income tax purposes and they may
generate income tax expense because of the Taxable Subsidiaries’ ownership of the portfolio
companies. We reflect any such income tax expense on our Statements of Operations.
|
(2)
|
LIQUIDITY AND FINANCING ARRANGEMENTS
|
As
of December 31, 2019, we had cash and cash equivalents of $4.0 million. We had $40.6
million of our net assets of $46.0 million invested in portfolio securities. We also had $29.3 million of temporary cash investments
and restricted cash, including primarily the proceeds of a quarter-end margin loan that we incurred to maintain the diversification
requirements applicable to a RIC. Of this amount, $29.0 million was invested in U.S. Treasury bills and $0.3 million represented
a required 1% brokerage margin deposit. These securities were held by a securities brokerage firm and pledged along with other
assets to secure repayment of the margin loan. The U.S. Treasury bills matured
January
7, 2020 and we subsequently repaid this
margin loan. The margin interest was paid on February 5, 2020.
As
of December 31, 2018, we had cash and cash equivalents of $7.4 million. We had $35.0 million of our
net assets of $43.5 million invested in portfolio
securities. We also had $27.3 million of temporary cash investments
and restricted cash, including primarily the proceeds of a quarter-end
margin loan that we incurred to maintain
the diversification requirements applicable to a RIC. Of this
amount, $27.0 million was invested in U.S. Treasury bills and $0.3 million represented
a required 1% brokerage margin deposit. These securities were held by a securities
brokerage firm and pledged along with other assets to secure repayment of the margin loan. The U.S. Treasury bills were sold on
January 2, 2019 and we
subsequently repaid this margin loan. The margin interest was paid on February 5,
2019.
During
2019 and 2018, we borrowed sufficient funds to maintain the Fund’s RIC status
by utilizing a margin account with a securities
brokerage firm. There is no assurance that such arrangement will be available in the future. If we are unable to borrow funds to
make qualifying investments, we may no longer qualify as a RIC.
We would then be subject to corporate income tax on the Fund’s net investment income and realized capital gains, and distributions
to stockholders would be subject to income tax as ordinary dividends. If we
continue to be a BDC, failure to continue
to qualify as a RIC could be material
to us and our stockholders.
|
(3)
|
SIGNIFICANT ACCOUNTING POLICIES
|
The following
is a summary of significant accounting policies followed by the Fund in the preparation
of its financial statements:
Use
of Estimates—The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions
that affect the reported amounts and disclosures in the financial statements. Although
we believe the estimates and assumptions used in preparing these financial statements
and related notes are reasonable in light of known facts and circumstances, actual
results could differ from those estimates.
Valuation
of Investments—For most
of our investments, market quotations are not available. With respect to investments for
which market quotations are not readily available or when such market quotations are
deemed not to represent fair value, our Board has approved a multi-step valuation
process each quarter, as described below:
|
1.
|
Each portfolio company or investment is
reviewed by our investment professionals;
|
|
2.
|
With respect to investments with
a fair value exceeding $2.5 million that have been held for more than one year, we engage
independent valuation firms to assist our investment professionals. These independent valuation firms conduct independent valuations
and make their own independent assessments;
|
|
3.
|
Our Management produces a report
that summarized each of our portfolio investments and recommends a fair value of each
such investment as of the date of the
report;
|
|
4.
|
The Audit Committee of our
Board reviews and discusses the preliminary valuation of our portfolio investments
as recommended by Management in their report and any reports or recommendations of the independent valuation firms, and then approves
and recommends the fair values of our investments so determined to our Board for final approval; and
|
|
5.
|
The Board discusses valuations and determines the fair
value of each portfolio investment in good faith based on the input of our Management,
the respective independent valuation firm, as applicable, and the Audit Committee.
|
During
the first twelve months after an investment is made, we rely
on the original investment amount to determine the fair value unless significant developments
have occurred during this twelve month period which would indicate a material effect
on the portfolio company (such as results of operations or changes in general market
conditions).
Investments
are valued utilizing a yield analysis, enterprise value (“EV”) analysis,
net asset value analysis, liquidation analysis, discounted cash flow analysis, or a combination
of methods, as appropriate. The yield analysis uses loan spreads and other relevant information implied by market data involving
identical or comparable assets or liabilities. Under the EV analysis, the EV of a portfolio
company is first determined and allocated over the portfolio company’s securities in order of their preference relative to
one another (i.e., “waterfall” allocation).
To determine the EV, we typically use a market multiples approach that considers relevant
and applicable market trading data of guideline public companies, transaction metrics
from precedent M&A transactions and/or a discounted cash flow analysis. The net
asset value analysis is used to derive a value
of an underlying investment (such as real estate property) by dividing a relevant
earnings stream by an appropriate capitalization rate. For this purpose, we consider
capitalization rates for similar properties as may be obtained from guideline public companies and/or relevant transactions. The
liquidation analysis is intended to approximate the net recovery value of an investment
based on, among other things, assumptions regarding liquidation proceeds based on a hypothetical
liquidation of a portfolio company’s assets. The discounted cash flow analysis
uses valuation techniques to convert future cash flows or earnings to a range
of fair values from which a single estimate may be derived
utilizing an appropriate discount rate. The measurement is based on the net present value indicated by current market expectations
about those future amounts.
In
applying these methodologies, additional factors that we consider in fair
value pricing our investments may include, as we deem relevant: security covenants, call protection provisions, and information
rights; the nature and realizable value of any collateral; the portfolio company’s ability to make payments; the principal
markets in which the portfolio company does business; publicly available financial ratios of peer companies; the principal
market; and enterprise values, among other factors. Also, any failure by a portfolio company to achieve its business plan or obtain
and maintain its financing arrangements could result in increased volatility and result in a significant and rapid change in its
value.
Our
general intent is to hold our loans to maturity when appraising our privately held
debt investments. As such, we believe that the fair value will not exceed the cost of the investment. However, in addition to the
previously described analysis involving allocation of value to the
debt instrument, we perform a yield analysis
assuming a hypothetical current sale of the security to determine if a debt
security has been impaired. The yield analysis considers changes in interest rates and changes in leverage levels of the
portfolio company as compared to the market interest rates and leverage levels. Assuming the credit quality of the
portfolio company remains stable, the Fund will use the value determined by the yield analysis as the fair value for that security
if less than the cost of the investment.
We
record unrealized depreciation on investments when we determine that the fair value of a security
is less than its cost basis, and will record unrealized appreciation when we determine that the fair value is greater than its
cost basis.
Fair
Value Measurement—Fair value is the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction
between market participants at the measurement date and sets out a fair value hierarchy.
The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities
(Level 1) and the lowest priority to
unobservable inputs (Level 3). Inputs are broadly defined as assumptions market participants would use in pricing an asset or liability.
The three levels of the fair value hierarchy are described below:
Level
1—Unadjusted quoted prices in active markets for identical assets or liabilities
that the reporting entity has the ability to access at the measurement date.
Level
2—Inputs other than quoted prices within Level 1 that are observable for the
asset or liability, either directly or indirectly; and fair value is determined through the use of models or other valuation methodologies.
Level
3—Inputs are unobservable for the asset or liability and include situations where there is little, if any,
market activity for the asset or liability. The inputs into the determination
of fair value are based upon the best information
under the circumstances and may require significant management judgment or estimation.
In
certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such
cases, an investment’s level within the fair value hierarchy is based on the lowest
level of input that is significant to the fair value measurement. Our assessment of the significance of a particular
input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.
Investments
for which prices are not observable are generally private investments in the debt and equity securities of operating companies.
One of the primary valuation methods used to estimate the fair value of these Level
3 investments is the discounted cash flow method (although a liquidation
analysis, option theoretical, or other methodology may be used when more appropriate). The discounted cash flow approach to determine
fair value (or a range of fair values)
involves applying an appropriate discount rate(s) to the estimated future cash flows using
various relevant factors depending on investment type, including comparing the latest arm’s length or market transactions
involving the subject security to the selected benchmark credit spread, assumed growth rate (in cash flows), and capitalization
rates/multiples (for determining terminal values of underlying portfolio companies). The valuation based on the inputs determined
to be the most reasonable and probable is used as the fair value of the investment.
The determination of fair value using these methodologies may take into consideration
a range of factors including, but not limited to, the price
at which the investment was acquired, the nature of the investment, local market conditions,
trading values on public exchanges for comparable securities, current and projected
operating performance, financing transactions subsequent to the acquisition of the
investment and anticipated financing transactions after the valuation date
To
assess the reasonableness of the discounted cash flow approach, the fair value of equity securities, including warrants, in portfolio
companies may also consider the market approach—that is, through analyzing and applying to the underlying portfolio companies,
market valuation multiples of publicly-traded
firms engaged in businesses similar to those of the portfolio companies. The market approach to determining the fair value of
a portfolio company’s equity security (or securities) will typically involve: (1) applying
to the portfolio company’s trailing twelve months (or current year projected)
EBITDA, a low to high range of enterprise value to EBITDA multiples that are derived
from an analysis of publicly-traded comparable companies, in order to arrive
at a range of enterprise values for the
portfolio company;
(2) subtracting
from the range of calculated enterprise values the outstanding balances of any debt
or equity securities that would be senior in right of payment to the equity securities we hold; and (3) multiplying the range of
equity values derived therefrom by our ownership share of such equity tranche in order to
arrive at a range of fair values for our equity security (or securities). Application
of these valuation methodologies involves a significant degree of judgment by
Management.
Due
to the inherent uncertainty of determining the fair value of Level 3 investments
that do not have a readily available
market value, the fair value of the investments may differ significantly from the values that would have been used had a
ready market existed for such investments and
may differ materially from the values that may ultimately be received or settled. Further, such investments are generally subject
to legal and other restrictions or otherwise are less liquid than publicly traded instruments. If we were required to liquidate
a portfolio investment in a forced or
liquidation sale, we might realize significantly less than the value at which such investment had previously been recorded. With
respect to Level 3 investments, where sufficient market quotations are not readily
available or for which no or an insufficient number of indicative prices from pricing
services or brokers or dealers have been received, we undertake, on a quarterly
basis, our valuation process as described above.
We
assess the levels of the investments at each measurement date, and transfers between levels are recognized on the subsequent measurement
date closest in time to the actual date of the event or change in circumstances that caused the transfer. There were no transfers
among Level 1, 2 and 3 for the years
ended December 31, 2019 and 2018.
As
of December 31, 2019, investments measured at fair value on a recurring basis are
categorized in the tables below based on the lowest level of significant input to
the valuations:
|
|
Fair Value Measurements as of December 31, 2019
|
(in thousands)
|
|
Total
|
|
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
|
|
Significant Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Control investments
|
$
|
8,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
8,000
|
|
Affiliate investments
|
|
26,500
|
|
|
|
—
|
|
|
|
—
|
|
|
|
26,500
|
|
Non-affiliate investments - related party
|
|
5,171
|
|
|
|
5,171
|
|
|
|
—
|
|
|
|
—
|
|
Non-affiliate investments
|
|
977
|
|
|
|
—
|
|
|
|
—
|
|
|
|
977
|
|
Total investments
|
|
40,648
|
|
|
|
5,171
|
|
|
|
—
|
|
|
|
35,477
|
|
Temporary cash investments
|
|
28,991
|
|
|
|
28,991
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
$
|
69,639
|
|
|
$
|
34,162
|
|
|
$
|
—
|
|
|
$
|
35,477
|
|
As
of December 31, 2018, investments measured at fair value on a recurring basis are
categorized in the tables below based on the lowest level of significant input to
the valuations:
|
|
Fair Value Measurements as of December 31, 2018
|
(in thousands)
|
|
Total
|
|
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
|
|
Significant Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Control investments
|
$
|
9,210
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,210
|
|
Affiliate investments
|
|
20,500
|
|
|
|
—
|
|
|
|
—
|
|
|
|
20,500
|
|
Non-affiliate investments - related party
|
|
4,328
|
|
|
|
4,328
|
|
|
|
—
|
|
|
|
—
|
|
Non-affiliate investments
|
|
977
|
|
|
|
—
|
|
|
|
—
|
|
|
|
977
|
|
Total investments
|
|
35,015
|
|
|
|
4,328
|
|
|
|
—
|
|
|
|
30,687
|
|
Temporary cash investments
|
|
26,981
|
|
|
|
26,981
|
|
|
|
—
|
|
|
|
—
|
|
Total investments and temporary cash investments
|
$
|
61,996
|
|
|
$
|
31,309
|
|
|
$
|
—
|
|
|
$
|
30,687
|
|
The
following table provides a reconciliation of fair
value changes during 2019 for all investments for which we determine fair value using significant unobservable (Level 3)
inputs:
|
|
|
Fair value measurements using significant unobservable inputs (Level 3)
|
(in thousands)
|
|
Control Investments
|
|
Affiliate Investments
|
|
Non-affiliate Investments
|
|
Total
|
Fair value as of January 1, 2019
|
|
|
|
|
|
$
|
9,210
|
|
|
$
|
20,500
|
|
|
$
|
977
|
|
|
$30,687
|
Realized losses
|
|
|
|
|
|
|
(2,789
|
)
|
|
|
—
|
|
|
|
—
|
|
|
(2,789)
|
Change in unrealized appreciation
|
|
|
|
|
|
|
1,790
|
|
|
|
6,000
|
|
|
|
—
|
|
|
7,790
|
Proceeds from sales/dispositions
|
|
|
|
|
|
|
(211
|
)
|
|
|
—
|
|
|
|
—
|
|
|
(211)
|
Fair value as of December 31, 2019
|
|
|
|
|
|
$
|
8,000
|
|
|
$
|
26,500
|
|
|
$
|
977
|
|
|
$35,477
|
The
following table provides a reconciliation of fair
value changes during 2018 for all investments for which we determine fair value using significant unobservable (Level 3)
inputs:
|
|
|
|
Fair value measurements using significant unobservable inputs (Level 3)
|
(in thousands)
|
|
Control Investments
|
|
Affiliate Investments
|
|
Non-affiliate Investments
|
|
Total
|
Fair value as of January 1, 2018
|
|
|
|
|
|
$
|
8,212
|
|
|
$
|
16,686
|
|
|
$
|
977
|
|
|
$25,875
|
Change in unrealized appreciation
|
|
|
|
|
|
|
998
|
|
|
|
3,814
|
|
|
|
—
|
|
|
4,812
|
Fair value as of December 30, 2018
|
|
|
|
|
|
$
|
9,210
|
|
|
$
|
20,500
|
|
|
$
|
977
|
|
|
$30,687
|
The following table provides a reconciliation
of fair value changes during 2017 for all investments for which we determine fair value using significant unobservable (Level 3)
inputs:
|
|
|
|
Fair value measurements using significant unobservable inputs (Level 3)
|
(in thousands)
|
|
Control Investments
|
|
Affiliate Investments
|
|
Non-affiliate Investments
|
|
Total
|
Fair value as of January 1, 2017
|
|
|
|
|
|
$
|
6,462
|
|
|
$
|
16,200
|
|
|
$
|
2,978
|
|
|
$25,640
|
Change in unrealized appreciation
|
|
|
|
|
|
|
1,750
|
|
|
|
486
|
|
|
|
—
|
|
|
2,236
|
Purchases of portfolio securities
|
|
|
|
|
|
|
—
|
|
|
|
—
|
|
|
|
12
|
|
|
12
|
Proceeds from sales/dispositions
|
|
|
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(2,013
|
)
|
|
(2,013)
|
Fair value as of December 31, 2017
|
|
|
|
|
|
$
|
8,212
|
|
|
$
|
16,686
|
|
|
$
|
977
|
|
|
$25,875
|
Fair
value measurements can be sensitive to changes in one or more of the
valuation inputs. Changes in discount rates, EBITDA or EBITDA multiples (or revenue or revenue multiples), each in isolation, may
change the fair value of certain of our investments. Generally, an increase/(decrease)
in market yields, discount rates, or an increase/(decrease) in EBITDA or EBITDA multiples
(or revenue or revenue multiples) may result in a corresponding
increase/(decrease), respectively, in the fair value of certain of our investments.
The
following table summarizes the significant non-observable inputs in the fair value
measurements of our level 3 investments by category
of investment and valuation technique as of December 31, 2019:
|
|
|
|
|
|
|
|
Range
|
(in thousands)
|
|
Fair Value
|
|
Valuation Techniques
|
|
Unobservable Inputs
|
|
Minimum
|
|
Maximum
|
Secured and subordinated debt
|
|
$
|
977
|
|
|
Yield analysis
|
|
Discount for lack of marketability
|
|
|
0
|
%
|
|
|
0
|
%
|
Common stock
|
|
|
26,500
|
|
|
Income/Market approach
|
|
EBITDA Multiple/Discount for lack of marketability/Control premium
|
|
|
10
|
%
|
|
|
32.5
|
%
|
Limited liability company investments
|
|
|
8,000
|
|
|
Asset approach
Discounted cash flow; Guideline transaction method; Market approach
|
|
Recovery rate
Reserve adjustment factors
|
|
|
75
|
%
|
|
|
100
|
%
|
|
|
$
|
35,477
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Because
of the inherent uncertainty of the valuation of portfolio securities which do not have readily ascertainable market values,
amounting to $37.0 million and $30.7 million as of December 31, 2019 and 2018, respectively,
our fair value determinations may materially differ from the values that would have been used had a ready
market existed for the securities.
We
adjust our net asset value for the changes in the value of our publicly held securities,
if applicable, and material changes in the value of private
securities, generally determined on a quarterly basis or as announced in a
press release, and report those amounts to Lipper Analytical Services, Inc. Our net asset
value appears in various publications, including Barron’s and The Wall Street Journal.
Foreign
Exchange—We record temporary changes in foreign exchange rates of portfolio securities denominated in foreign currencies
as changes in fair value. These changes are therefore reflected as unrealized gains or losses until realized.
Investment
Transactions—Investment transactions are recorded on the accrual method. Realized gains and losses on investments sold
are computed on a specific identification basis.
We
classify our investments in accordance with the requirements of the 1940 Act. Under
the 1940 Act, “Control Investments” are defined as investments in companies
in which the Fund owns more than 25% of the voting securities or maintains greater
than 50% of the board representation. Under the 1940 Act, “Affiliate Investments” are defined as those non-control
investments in companies in which we own
between 5% and 25% of the voting securities. Under the 1940 Act, “Non-affiliate
Investments” are defined as investments that are neither Control Investments nor Affiliate Investments.
Interest
and Dividend Income Recognition—We record interest income, adjusted for amortization of premium and accretion of discount,
on an accrual basis to the extent that we expect to collect such amounts. We accrete
or amortize discounts and premiums on securities purchased over the life of the respective security using the effective yield method.
The amortized cost of investments represents the original cost adjusted for the accretion of discount and/or amortization of premium
on debt securities. We stop accruing interest on investments when we determine that interest is no longer
collectible. We may also impair the accrued interest when
we determine that all or a portion of the current accrual is uncollectible. If we
receive any cash after determining that interest is no longer collectible, we treat such cash as payment on the principal balance
until the entire principal balance has been repaid, before we recognize any additional
interest income. We will write off uncollectible interest upon the occurrence of a definitive
event such as a sale, bankruptcy, or reorganization of the relevant portfolio interest.
Dividend income is recorded as dividends are declared by the portfolio company or at the
point an obligation exists for the portfolio company to make a distribution.
Payment
in Kind Interest (PIK)—We have loans in our portfolio that may pay PIK interest. We add PIK interest, if any, computed
at the contractual rate specified in each loan agreement, to the principal balance
of the loan and recorded as interest income. To maintain our status as a RIC,
we must pay out to stockholders this non-cash source of income in the
form of dividends even if we have not yet collected any cash in respect of such investments.
We will continue to pay out net investment income and/or realized capital gains, if
any, on an annual
basis as required
under the 1940 Act.
Cash
Flows—For purposes of the Statements of Cash Flows, we consider
all highly liquid temporary cash investments purchased with an original maturity of three months or less to be cash equivalents.
We include our investing activities within cash flows from operations. We exclude “Restricted Cash and Temporary Cash Investments”
used for purposes of complying with RIC requirements from cash equivalents.
Taxes—We
intend to comply with the requirements of the Code necessary to qualify as a RIC and,
as such, will not be subject to federal income taxes on otherwise
taxable income (including net realized capital gains) which is distributed to stockholders.
Therefore, no provision for federal income taxes is recorded in the financial statements. We borrow money from time to time
to maintain our tax status under the Code as a RIC.
See Note 1 for discussion of Taxable Subsidiaries and see Note 2 for
further discussion of the Fund’s RIC borrowings.
All
corporations incorporated in the State of Delaware are required to file an Annual
Report and to pay a franchise tax. As
a result, we paid Delaware Franchise tax in the amount of $0.03
million for the year ended December 31, 2019 and $0.02 million, for each of the years
ended December 31, 2018 and 2017.
Texas
margin tax applies to legal entities conducting business in Texas. The margin tax is based on our Texas sourced
taxable margin. The tax is calculated by applying
a tax rate to a base that considers
both revenue and expenses and therefore has the characteristics of an income tax. For the year ended December 31, 2019, no
state income tax is expected. We paid state income tax of $1 thousand and $3 thousand for the years ended December 31, 2018
and 2017, respectively.
Share-Based
Incentive Compensation—On June 13, 2016, our
shareholders approved the adoption of our 2016 Equity Incentive Plan
(“Incentive Plan”). On January 10, 2017, the SEC issued an order approving the Incentive Plan and certain awards
intended to be made thereunder. The Incentive Plan is intended to promote
the interests of the Fund by encouraging officers, employees, and directors of the Fund and its affiliates to acquire
or increase their equity interest in the Fund and to provide a means whereby
they may develop a proprietary interest in the development and financial
success of the Fund, to encourage them to remain with and devote their best efforts to
the business of the Fund, thereby advancing the interests of the Fund and its
stockholders. The Incentive Plan is also intended to enhance the ability of the
Fund and its affiliates to attract and retain the services of individuals who
are essential for the growth and profitability of the Fund. The Incentive Plan permits the award of restricted stock as well
as common stock purchase options. The maximum number of shares of common stock
that are subject to awards granted under the Incentive Plan is 2,434,728 shares. The term of the Incentive Plan will expire
on June 13, 2026. On March 17, 2017, we granted awards of restricted stock under
the Plan to certain of our directors and executive officers in the aggregate amount of 844,500 shares. The awards are each
subject to a vesting requirement over a 3-year
period unless the recipient thereof is terminated or removed from their position as a director
or executive officer without “cause”, or as a result of constructive
termination, as such terms are defined in the respective award agreements entered into by each of the recipients and the
Fund. As of December 31, 2019, 140,000 shares remain unvested. We account for share-based compensation using the fair value
method, as prescribed by ASC 718, Compensation—Stock Compensation. Accordingly, for restricted stock awards, we measure
the grant date fair value based upon the market price of our common stock on the
date of the grant and amortize the fair value of the awards as share-based compensation expense over the requisite service
period, which is generally the vesting term. For the years ended December 31, 2019, 2018, and 2017, we recorded
compensation expense of $0.3 million, $0.4 million and $1.1 million,
respectively, in connection with these awards.
|
(4)
|
RELATED PARTY TRANSACTIONS AND AGREEMENTS
|
MVC
Capital, Inc. – Share Exchange. On
May 14, 2014, we announced that the Fund intended to effect a reorganization pursuant
to Section 2(a)(33) of the 1940 Act (“Plan of Reorganization”). As a
first step to consummating the Plan or
Reorganization, we sold to MVC 2,112,000 newly-issued
shares of the Fund’s common stock in exchange for 395,839 shares of MVC (such transaction is hereinafter referred
to as the “Share Exchange”). MVC is a BDC
traded on the New York Stock Exchange that provides long-term debt and equity investment capital to fund growth, acquisitions and
recapitalizations of companies in a variety of industries.
The Share Exchange was calculated based on the Fund’s and MVC’s respective
net asset value per share. At the time of the Share Exchange, the number of MVC shares
received by Equus represented approximately 1.73% of MVC’s total outstanding shares of common stock. During 2019, we received
36,756 additional shares in the form of dividend payments. As of December 31, 2019,
we valued our 563,894 MVC shares at $5.2 million, an increase from $4.3 million at
December 31, 2018. The value of our MVC shares was based on MVC’s closing trading price on the
NYSE as of such dates. Due to the ownership relationship between the Company and MVC,
the investment and amounts due to and from MVC have been identified and disclosed as “related party(ies)” in our Consolidated
Financial Statements.
Agreement
to Acquire Portfolio Company of MVC—On April 24, 2017, we entered into a Stock
Purchase Agreement and Plan of Merger (“Merger Agreement”) with ETR Merger Sub, Inc., a newly-formed
wholly-owned subsidiary of Equus, certain shareholders of USG&E, and MVC as a
selling shareholder of U.S. Gas & Electric,
Inc. (“USG&E”) and as representative of the selling USG&E shareholders.
On May 30, 2017, USG&E and MVC notified us that they had accepted a proposal from
Crius Energy Trust, that was considered by the respective boards of directors of USG&E
and MVC to constitute a “Superior Proposal” (as such term is defined in
the Merger Agreement) to the terms and conditions of the Merger Agreement, and, accordingly, provided us with a notice
of termination pursuant to the Merger Agreement. Further, pursuant to the Merger Agreement, USG&E paid us a termination
fee of $2.5 million.
Except
as noted below, as compensation for services to the Fund, each Independent Director receives an annual fee of $40,000 paid quarterly
in arrears, a fee of $2,000 for each meeting of the Board of Directors
or committee thereof attended in person, a fee
of $1,000 for participation in each telephonic meeting of the Board or committee thereof, and reimbursement of all out-of-pocket
expenses relating to attendance at such meetings. The chair of each of our standing committees (audit, compensation, and nominating
and governance) also receives an annual fee of $50,000, payable quarterly in arrears. We may also pay other one-time or recurring
fees to members of our Board of Directors in special circumstances. None of our interested
directors receive annual fees for their service on the Board of Directors. We may also pay other one-time or recurring fees to
members of our Board of Directors in special circumstances. None of our interested
directors receive annual fees for their service on the Board of Directors.
In
November 2011, Equus Energy, LLC (“Equus Energy”), a wholly-owned subsidiary
of the Fund, entered into a consulting agreement with Global Energy Associates, LLC
(“Global Energy”) to provide consulting services for energy related
investments. Henry W. Hankinson, Director of the
Fund, is a managing partner and co-founder of Global Energy. For the year ended December
31, 2017, payments to Global Energy totaled $45,000. The agreement ended in July 2017.
In
respect of services provided to the Fund by members of the Board not in connection
with their roles and duties as directors, the Fund pays a rate of $300 per hour for
services rendered. During 2019, 2018 and 2017, we paid Kenneth I. Denos,
P.C., a professional corporation owned by Kenneth
I. Denos, a director of the Fund, $0.3
million, $0.4 million and $0.6 million, respectively, for services provided to the Fund during these years.
|
(5)
|
PLAN OF REORGANIZATION
|
Share
Exchange with MVC—On May 14, 2014, we announced that the Fund intended to
effect a Plan of Reorganization. As a first
step to consummating the Plan of Reorganization, we executed a Share
Exchange with MVC, wherein we sold to MVC 2,112,000 newly-issued shares of our common stock in exchange
for 395,839 newly-issued shares of MVC. We also announced that, pursuant to the Plan
of Reorganization, our intention was for Equus to pursue a Consolidation
with an operating company.
Authorization
to Withdraw BDC Election—As a consequence of our Plan of Reorganization,
on November 19, 2019, holders of a majority
of the outstanding common stock of the Fund approved our cessation as a BDC
under the 1940 Act and authorized our Board of Directors to cause the Fund’s withdrawal of its election to be classified
as a BDC, each effective as of a date
designated by the Board and our Chief Executive Officer on or before March 31, 2020.
Notwithstanding these authorizations to withdraw our BDC election, we will not submit
any such withdrawal unless and until we are reasonably confident that such Consolidation will be completed.
Agreement
to Acquire U.S. Gas & Electric, Inc.—On
April 24, 2017, we entered into the Merger Agreement with ETR Merger Sub, Inc., a
newly-formed wholly-owned subsidiary of Equus, certain shareholders of USG&E, and MVC
as a selling shareholder of USG&E
and as representative of the selling USG&E shareholders. On May 30, 2017, USG&E and MVC notified us that they had accepted
a proposal from Crius Energy Trust, that was considered by the respective boards of
directors of USG&E and MVC to constitute
a “Superior Proposal” (as such term is defined in the Merger Agreement)
to the terms and conditions of the Merger Agreement, and, accordingly, provided
us with a notice of termination
pursuant to the Merger Agreement. Further, pursuant to the Merger Agreement, USG&E paid us a termination
fee of
$2.5 million.
Intention
to Continue to Pursue Consolidation—Notwithstanding
the termination of the Merger Agreement with USG&E described above, we intend to pursue a Consolidation
and the completion of our Plan of Reorganization with another operating company or the transformation of Equus into a permanent
capital vehicle, and in each case, withdraw our BDC election as authorized by our
stockholders. While we are presently evaluating various opportunities that could enable
us to accomplish a Consolidation, we
cannot assure you that we will be able to do so within any particular time period or at all. Moreover, we cannot assure you that
the terms of any such transaction that would embody a potential Consolidation
would be acceptable to us.
|
(6)
|
FEDERAL INCOME TAX MATTERS
|
As a RIC, our tax liability is dependent upon
whether an election is made to distribute taxable investment income and capital gains above any statutory requirement. As we have
incurred net investment losses and have had no realized gains for 2019, no distributions were required or made.
Our year-end for determining capital gains
for purposes of Section 4982 of the Code is October 31.
There are no material book to tax differences
for net investment income/losses, realized gains or unrealized appreciation/depreciation. As of December 31, 2019, we had approximately
$18.5 million in capital losses of which can be carried forward indefinitely.
Reclassification of returns of capital had
no material book to tax differences for the three years ended December 31, 2019 and therefore has no material book to tax differences
impacting accumulated earnings during that three-year period.
We believe that any aggregate exposure for
uncertain tax positions should not have a material impact on our financial statements as of December 31, 2019 or December 31, 2018.
An uncertain tax position is measured as the largest amount of tax return benefits that does not have a greater than 50% likelihood
of being realized upon ultimate settlement. We have not recorded an adjustment to our financial statements related to any uncertain
tax positions. We will continue to evaluate our tax positions and recognize any future impact of uncertain tax positions as a charge
to income in the applicable period in accordance with promulgated standards.
The Fund’s accounting policy related
to income tax penalties and interest assessments is to accrue for these costs and record a charge to expenses during the period
that the Fund takes an uncertain tax position through resolution with the taxing authorities or expiration of the applicable statute
of limitations.
All of the Fund’s federal and state tax
returns for 2016 through 2019 remain open to examination (the State of Texas may be longer). We believe that there are no tax positions
taken or expected to be taken that would significantly increase or decrease unrecognized tax benefits within 12 months of the reporting
date.
|
(7)
|
COMMITMENTS AND CONTINGENCIES
|
Lease
Commitments. We had an operating lease for office space that expired in September 2014. Our current office space lease is month-to-month.
Rent expense under the operating lease agreement, inclusive of common area maintenance costs, was
$111,000, $111,000
and $109,000 for the years ended December 31, 2019, December 31, 2018 and December 31, 2017, respectively.
Portfolio
Companies. As of December 31, 2019 and 2018, we had no outstanding commitments to our portfolio company investments; however,
under certain circumstances, we may be
called on to make follow-on investments in certain portfolio companies. If we do not
have sufficient funds to make follow-on investments, the portfolio company in need of the investment may be negatively impacted.
Also, our equity interest in the estimated fair value of the portfolio company could
be reduced. Follow-on investments may include capital infusions which are expenditures made directly to the portfolio company
to ensure that operations are completed, thereby allowing the portfolio company to generate
cash flows to service the debt.
Legal
Proceedings–Shareholder Complaint. On November 16, 2016, Samuel Zalmanoff filed a lawsuit
against the Fund and members of the Board of Directors
in the Court of Chancery in the State
of Delaware. The lawsuit was filed in connection with the Fund’s 2016 Equity Incentive Plan (“Incentive Plan”)
which was adopted by the Board of Directors on April 15, 2016, approved by
the Equus shareholders on June 13, 2016, and
approved, with certain standard exceptions, by the Securities and Exchange Commission on January 10, 2017. Mr. Zalmanoff’s
complaint, which purported to be on behalf of all non-affiliate Equus shareholders
entitled to vote for the Incentive Plan, alleged a breach
by the Board of Directors of its fiduciary duties of disclosure
in connection with the Incentive Plan, and sought an order from the court: (i) enjoining
implementation of the Incentive Plan, (ii) requiring the Fund to revise its disclosures
relating to the Incentive Plan, and (iii) for an award of costs, attorneys’ fees, and expenses. We believe that this lawsuit,
and the allegations included therein, was without merit. Accordingly, on September 22, 2017, we filed a motion
for summary judgment regarding this action which was granted by the Chancery Court
on November 13, 2018. Mr. Zalmanoff appealed the Chancery Court ruling to the Delaware Supreme Court and, on May 16, 2019, the
Delaware Supreme Court affirmed the Chancery Court decision and terminated the proceedings.
From
time to time, the Fund is also a party
to certain proceedings incidental to the normal course of our business including the
enforcement of our rights under contracts with our portfolio companies. While the outcome
of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a
material effect upon the Fund’s financial condition or results of operations.
(8) PORTFOLIO SECURITIES
2019 Portfolio Activity
During
the year ended December 31, 2019, we received 10,338 shares of MVC in the form of
stock dividend payments. The following table summarizes significant investment activity during the year ended December 31, 2019
(in thousands):
|
|
Investment
Activity
|
|
|
|
|
New
Investments
|
|
Existing
Investments
|
|
|
Portfolio
Company
|
|
Cash
|
|
Non-Cash
|
|
Follow-On
|
|
Dividend
|
|
Total
|
MVC Capital, Inc.
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
333
|
|
|
$
|
333
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
333
|
|
|
$
|
333
|
|
During 2019,
we realized net capital gains of $53 thousand
due to the disposition of temporary cash investments.
|
(i)
|
During 2019, we recorded an increase of $8.3 million in net unrealized appreciation, from $17.1
million at December 31, 2018 to $25.4 millionIncrease in the fair value of our shareholding in MVC of $0.8 million due to an increase
in the share price of MVC and the receipt of dividend payments in the form of additional shares of MVC during the year;
|
|
(ii)
|
Increase in fair value of our shareholding in PalletOne, Inc. of $6.0 million due to improved
operating performance;
|
|
(iii)
|
Transfer of unrealized depreciation to realized loss of our holdings in EMDC of $2.8 million
in connection with the dissolution of EMDC and the transfer of its assets to the Fund; and
|
|
(iv)
|
Decrease in the fair value of our holdings in Equus Energy, LLC of $1.0 million, principally
due to decreases in gas prices and decreases in the short and long term forward pricing curve for oil.
|
2018 Portfolio Activity
During
the year ended December 31, 2018, we received 30,930 shares of MVC in the form of
stock dividend payments. The following table summarizes significant investment activity during the year ended December 31, 2018
(in thousands):
|
|
Investment Activity
|
|
|
|
|
|
New Investments
|
|
|
|
Existing Investments
|
|
|
|
|
|
Portfolio Company
|
|
|
Cash
|
|
|
|
Non-Cash
|
|
|
|
Follow-On
|
|
|
|
PIK/Dividend
|
|
|
|
Total
|
|
MVC Capital, Inc.
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
303
|
|
|
|
303
|
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
303
|
|
|
$
|
303
|
|
During 2018,
we realized net capital gains of $9 thousand
due to the disposition of temporary cash investments.
During
2018, we recorded an increase of $3.6 million in net unrealized appreciation, from
$13.5 million at December 31, 2017 to $17.1 million at December 31, 2018, in our portfolio securities. Such increase resulted primarily
from the following changes:
|
(i)
|
Decrease in the fair value of our shareholding in MVC
of $1.2 million due to a decrease in the MVC
share price during 2018, which was partially offset by the receipt of dividend payments in the form of additional
shares of MVC;
|
|
(ii)
|
Increase in fair value of our
shareholding in PalletOne, Inc. (“PalletOne”) of $3.8 million
due to an overall improvement in comparable industry sectors, as well as
continued revenue increases; and
|
|
(iii)
|
Increase in the fair value of our holdings in Equus Energy
of $1.0 million, principally due to an increase in comparable transactions for mineral
leases.
|
Equus
Energy, LLC (“Equus Energy”) was formed in November 2011 as
a wholly-owned subsidiary of the Fund to make
investments in companies in the energy sector, with particular emphasis on income-producing oil & gas
properties. In December 2011, we contributed $250,000 to the capital of Equus Energy. On December 27, 2012, we
invested an additional $6.8 million in Equus Energy for the purpose of additional working capital and to fund the purchase of
$6.6 million in working interests presently consisting of 141 producing and non- producing oil and gas wells. The working
interests include associated development rights of approximately 21,520 acres situated on 11
separate properties in Texas and Oklahoma. The working interests range from a de minimus amount
to 50% of the leasehold that includes these wells.
The
wells are operated by a number of operators,
including Chevron USA, Inc., which has operating responsibility for all of Equus Energy’s 22 producing well interests located
in the Conger Field, a productive oil and gas field on the edge of the Permian Basin
that has experienced successful gas and hydrocarbon extraction in multiple formations. Equus Energy, which holds a 50%
working interest in each of these Conger Field wells, is working with Chevron in a recompletion
program of existing Conger Field wells to the Wolfcamp formation, a zone containing
oil as well as gas and natural gas liquids. Part of Equus Energy’s acreage rights described above also includes a
50% working interest in possible new drilling to the base of the Canyon formation (appx.
8,500 feet) on 2,400 acres in the Conger Field. Also included in the interests acquired
by Equus Energy are working interests of 7.5%
and 2.5% in the Burnell and North Pettus Units, respectively, which collectively comprise approximately 13,000 acres located
in the area known as the “Eagle Ford Shale” play.
Below
is selected financial information from the audited financial statements of Equus Energy as of December 31, 2019 and 2018, and for
the years ended December 31, 2019, 2018 and 2017 (in thousands):
EQUUS
ENERGY, LLC and SUBSIDIARY
Unaudited
Condensed Consolidated Balance Sheets
|
|
December 31,
|
|
December 31,
|
|
|
2019
|
|
2018
|
Assets
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
553
|
|
|
$
|
966
|
|
Accounts receivable
|
|
|
65
|
|
|
|
127
|
|
Other current assets
|
|
|
34
|
|
|
|
34
|
|
Total current assets
|
|
|
652
|
|
|
|
1127
|
|
Oil and gas properties
|
|
|
8,031
|
|
|
|
8,008
|
|
Less: accumulated depletion, depreciation and amortization
|
|
|
(7,789
|
)
|
|
|
(7,772
|
)
|
Net oil and gas properties
|
|
|
242
|
|
|
|
236
|
|
Total assets
|
|
$
|
894
|
|
|
$
|
1,363
|
|
|
|
|
|
|
|
|
|
|
Liabilities and member's equity
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable and other
|
|
$
|
82
|
|
|
$
|
131
|
|
Due to affiliate
|
|
|
561
|
|
|
|
561
|
|
Total current liabilities
|
|
|
643
|
|
|
|
692
|
|
Asset retirement obligations
|
|
|
201
|
|
|
|
195
|
|
Total liabilities
|
|
|
844
|
|
|
|
887
|
|
|
|
|
|
|
|
|
|
|
Total member's equity
|
|
|
49
|
|
|
|
476
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and member's equity
|
|
$
|
894
|
|
|
$
|
1,363
|
|
EQUUS
ENERGY, LLC and SUBSIDIARY
Unaudited
Condensed Consolidated Statements of Operations
|
|
Year Ended December 31
|
|
|
2019
|
|
2018
|
|
2017
|
Operating revenue
|
|
$
|
704
|
|
|
$
|
1,085
|
|
|
$
|
861
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct operating expenses
|
|
|
857
|
|
|
|
787
|
|
|
|
554
|
|
Gain on sale of oil and gas properties
|
|
|
—
|
|
|
|
(619
|
)
|
|
|
—
|
|
General and administrative
|
|
|
251
|
|
|
|
285
|
|
|
|
278
|
|
Depletion, depreciation, amortization and accretion
|
|
|
23
|
|
|
|
344
|
|
|
|
295
|
|
Impairment of oil and gas properties
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total operating expenses
|
|
|
1,131
|
|
|
|
796
|
|
|
|
1,127
|
|
Income (loss) before income tax expense
|
|
|
(426
|
)
|
|
|
289
|
|
|
|
(266
|
)
|
Income tax expense, net
|
|
|
1
|
|
|
|
1
|
|
|
|
—
|
|
Net income (loss)
|
|
$
|
(427
|
)
|
|
$
|
288
|
|
|
$
|
(266
|
)
|
EQUUS
ENERGY, LLC and SUBSIDIARY
Unaudited
Condensed Consolidated Statements of Cash Flows
|
|
Year ended December 31,
|
|
|
2019
|
|
2018
|
|
2017
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(427
|
)
|
|
$
|
288
|
|
|
$
|
(266
|
)
|
Adjustments to reconcile net income (loss) to
|
|
|
|
|
|
|
|
|
|
|
|
|
net cash (used in) provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depletion, depreciation and amortization
|
|
|
17
|
|
|
|
338
|
|
|
|
289
|
|
Gain on sale of oil and gas properties
|
|
|
—
|
|
|
|
(619
|
)
|
|
|
—
|
|
Accretion expense
|
|
|
6
|
|
|
|
6
|
|
|
|
6
|
|
Impairment
|
|
|
—
|
|
|
|
—
|
|
|
|
265
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
62
|
|
|
|
(26
|
)
|
|
|
(10
|
)
|
Prepaid expenses and other current assets
|
|
|
—
|
|
|
|
(1
|
)
|
|
|
(1
|
)
|
Affiliate payable/receivable
|
|
|
—
|
|
|
|
(25
|
)
|
|
|
(25
|
)
|
Accounts payable and other
|
|
|
(49
|
)
|
|
|
24
|
|
|
|
32
|
|
Net cash (used in) provided by operating
activities
|
|
|
(391
|
)
|
|
|
(15
|
)
|
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in oil & gas properties
|
|
|
(22
|
)
|
|
|
(173
|
)
|
|
|
(9
|
)
|
Sale of oil & gas properties
|
|
|
—
|
|
|
|
847
|
|
|
|
—
|
|
Net cash provided by (used in) investing activities
|
|
|
(22
|
)
|
|
|
674
|
|
|
|
(9
|
)
|
Net increase (decrease) in cash
|
|
|
(413
|
)
|
|
|
659
|
|
|
|
16
|
|
Cash and cash equivalents at beginning of period
|
|
|
966
|
|
|
|
307
|
|
|
|
291
|
|
Cash and cash equivalents at end of period
|
|
$
|
553
|
|
|
$
|
966
|
|
|
$
|
307
|
|
|
(10)
|
RECENT ACCOUNTING PRONOUNCEMENTS
|
Accounting Standards Recently Adopted— In March
2019, the Securities Exchange Commission (the “SEC”) adopted the final rule under SEC Release No. 33-10618, Fast Act
Modernization and Simplification of Regulation S-K, amending certain disclosure requirements. The amendments are intended to simplify
certain disclosure requirements and to provide for a consistent set of rules to govern incorporating information by reference and
hyperlinking, improve readability and navigability of disclosure documents, and discourage repetition and disclosure of immaterial
information. The Company adopted the final rule under SEC Release No. 33-10618 as of December 31, 2019. The Company has evaluated
the impact of the amendments and determined the effect of the adoption of the simplification rules on financial statements will
be limited to the modification and removal of certain disclosures.
In August 2018, the SEC adopted the final rule under
SEC Release No. 33-10532 (the “Rule”), Disclosure Update and Simplification, amending certain disclosure requirements
that were redundant, outdated or superseded. The Rule is intended to facilitate the disclosure of information to investors and
simplify compliance. The Company has adopted the Rule. The Rule included amendments to Regulation S-X (the “Amendments”),
including revisions to Rule 6-04.17 under Regulation S-X to remove the requirement to separately state the book basis
components of net assets on the Consolidated Statement of Assets and Liabilities: undistributed (over distribution of) net investment
income, accumulated undistributed net realized gains (losses), and net unrealized appreciation (depreciation). Instead, consistent
with GAAP, funds are required to disclose total distributable earnings.
The components that make up distributable earnings (accumulated
undistributed deficit) on the Statement of Assets and Liabilities as of December 31, 2019 and 2018 are as follows:
|
|
As of December 31, 2019
|
|
As of December 31, 2018
|
Accumulated undistributed net investment losses
|
|
|
(35,445
|
)
|
|
|
(29,327
|
)
|
Unrealized appreciation of portfolio securities, net
|
|
|
27,100
|
|
|
|
19,310
|
|
Unrealized depreciation of portfolio securities, net - related party
|
|
|
(1,741
|
)
|
|
|
(2,251
|
)
|
Accumulated undistributed net capital gains
|
|
|
—
|
|
|
|
9
|
|
Accumulated undistributed deficit
|
|
|
(10,086
|
)
|
|
|
(12,259
|
)
|
The Company’s Balance Sheets and Statements of Changes
in Net Assets for the current and comparative reporting period have been modified to conform to the rule.
In December 2016, the FASB issued ASU 2016-19, Technical
Corrections and Improvements, which makes minor corrections and clarifications that affect a wide variety of topics in the Accounting
Standards Codification, including an amendment to ASC Topic 820, Fair Value Measurement, which clarifies the difference between
a valuation approach and a valuation technique when applying the guidance of that Topic. The amendment also requires an entity
to disclose when there has been a change in either or both a valuation approach and/or a valuation technique. The transition guidance
for the ASC Topic 820 amendment must be applied prospectively because it could potentially involve the use of hindsight that includes
fair value measurements. The new guidance is effective for annual reporting periods beginning after December 15, 2017, including
interim periods within those years. Early application is permitted for any fiscal year or interim period for which the entity’s
financial statements have not yet been issued. There was no impact on the financial position or financial statement disclosures.
In November 2016, the FASB issued ASU No. 2016-18, Statement
of Cash Flows (Topic 230) — Restricted Cash. This standard provides guidance on the presentation of restricted cash and restricted
cash equivalents in the statement of cash flows. Restricted cash and restricted cash equivalents should be included with cash and
cash equivalents when reconciling the beginning-of-period and end-of-period amounts shown on the statements of cash flows. The
amendments of this ASU should be applied using a retrospective transition method and are effective for reporting periods beginning
after December 15, 2017, with early adoption permitted. Other than the revised statement of cash flows presentation of restricted
cash, the adoption of ASU 2016-18 did not have an impact on our financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of
Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force),
which addresses the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement
of cash flows under ASC 230, Statement of Cash Flows, and other topics. ASU 2016-15 provides guidance on eight specific cash flow
issues including the statement of cash flows treatment of beneficial interests in securitized financial transactions as well as
the treatment of debt prepayment and extinguishment costs. ASU 2016-15 also provides guidance on the predominance principle to
clarify when cash receipts and cash payments should be separated into more than one class of cash flows. ASU 2016-15 is effective
for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal
years. Early adoption is permitted, including adoption in an interim period. There was no impact on our statements of cash flows.
In February 2016, the FASB issued ASU 2016-02, Leases, which
requires lessees to recognize on the balance sheet a right of use asset, representing its right to use the underlying asset for
the lease term, and a lease liability for all leases with terms greater than 12 months and the use of practical expedient for leases
less than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing,
and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach,
which includes a number of optional practical expedients that entities may elect to apply. The new guidance was adopted effective
January 1, 2019. The adoption of ASU 2016-02 did not have an impact on our financial statements as we currently have no operating
leases as our principal offices are under a month-to-month lease arrangement for annual periods beginning after December 15, 2018,
and interim periods therein.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts
with Customers (Topic 606). ASU 2014-09 supersedes the revenue recognition requirements under ASC 605, Revenue Recognition, and
most industry-specific guidance throughout the Industry Topics of the ASC. The core principle of the guidance is that an entity
should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration
to which an entity expects to be entitled in exchange for those goods or services. Under the new guidance, an entity is required
to perform the following five steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in
the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract,
and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance will significantly enhance
comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets. Additionally, the
guidance requires improved disclosures as to the nature, amount, timing and uncertainty of revenue that is recognized.
In March 2016, the FASB issued ASU 2016-08, Revenue from
Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarified
the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from
Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarified the implementation guidance
regarding performance obligations and licensing arrangements.
In May 2016, the FASB issued ASU No. 2016-12, Revenue from
Contracts with Customers (Topic 606)—Narrow-Scope Improvements and Practical Expedients, which clarified guidance on assessing
collectability, presenting sales tax, measuring noncash consideration, and certain transition matters.
In December 2016, the FASB issued ASU No. 2016-20, Revenue
from Contracts with Customers (Topic 606)—Technical Corrections and Improvements, which provided disclosure relief, and clarified
the scope and application of the new revenue standard and related cost guidance. The new guidance will be effective for the annual
reporting period beginning after December 15, 2017, including interim periods within that reporting period. Early adoption would
be permitted for annual reporting periods beginning after December 15, 2016. We completed our initial assessment in evaluating
the potential impact on our financial statements and based on our assessment, determined that our financial instruments are excluded
from the scope of ASU 2014-09 and ASC 606. As a result of the scope exception for financial instruments, our management has determined
that there was no material changes to the recognition timing and classification of revenues and expenses; additionally, there was
no significant impact to pretax income or on financial statement disclosures upon adoption.
Accounting
Standards Not Yet Adopted—In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes.
The new standard is effective for the Company beginning on January 1, 2021. The Company is evaluating the effect ASU 2019-12 will
have on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value
Measurement (Topic 820), which is intended to improve fair value disclosure requirements by removing disclosures that are not cost-beneficial,
clarifying disclosures’ specific requirements, and adding relevant disclosure requirements. The amendments take effect for
all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption
is permitted. We believe that the impact of the adoption of this standard will not have a material impact on our financial statements.
In June 2016, the FASB issued ASU
2016-13, Financial Instruments Credit Losses (Topic 326) —Measurement of Credit Losses on Financial Instruments, which amends
the financial instruments impairment guidance so that an entity is required to measure expected credit losses for financial assets
based on historical experience, current conditions and reasonable and supportable forecasts. As such, an entity will use forward-looking
information to estimate credit losses. ASU 2016-13 also amends the guidance in FASB ASC 325 - 40, Investments Other, Beneficial
Interests in Securitized Financial Assets, related to the subsequent measurement of accretable yield recognized as interest income
over the life of a beneficial interest in securitized financial assets under the effective yield method. We believe that the impact
of the adoption of this standard will not have a material impact on our financial statements as we do not have any financial instruments
that are subject to this standard.
|
(11)
|
SELECTED QUARTERLY DATA
|
(in thousands, except per share amounts)
|
|
Year Ended December 31, 2019
|
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Total investment income
|
|
$
|
16
|
|
|
$
|
91
|
|
|
$
|
90
|
|
|
$
|
154
|
|
|
$
|
351
|
|
Net investment loss
|
|
|
(989
|
)
|
|
|
(798
|
)
|
|
|
(826
|
)
|
|
|
(775
|
)
|
|
|
(3,388
|
)
|
Increase in net assets resulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from operations
|
|
|
2,977
|
|
|
|
1,300
|
|
|
|
1,011
|
|
|
|
(3,115
|
)
|
|
|
2,175
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings per share (1)
|
|
|
0.22
|
|
|
|
0.10
|
|
|
|
0.07
|
|
|
|
(0.23
|
)
|
|
|
0.16
|
|
(in thousands, except per share amounts)
|
|
Year Ended December 31, 2018
|
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Total investment income
|
|
$
|
113
|
|
|
$
|
117
|
|
|
$
|
85
|
|
|
$
|
164
|
|
|
$
|
480
|
|
Net investment loss
|
|
|
(991
|
)
|
|
|
(936
|
)
|
|
|
(722
|
)
|
|
|
(906
|
)
|
|
|
(3,555
|
)
|
Increase in net assets resulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from operations
|
|
|
56
|
|
|
|
793
|
|
|
|
2,358
|
|
|
|
(3,156
|
)
|
|
|
51
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings per share (1)
|
|
|
0.00
|
|
|
|
0.06
|
|
|
|
0.17
|
|
|
|
(0.23
|
)
|
|
|
0.00
|
|
(in thousands, except per share amounts)
|
|
Year Ended December 31, 2017
|
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
Quarter Ended
|
|
|
|
|
March 31,
|
|
June 30,
|
|
September 30,
|
|
December 31,
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Total investment income
|
|
$
|
190
|
|
|
$
|
2,637
|
|
|
$
|
112
|
|
|
$
|
121
|
|
|
$
|
3,059
|
|
Net investment loss
|
|
|
(2,480
|
)
|
|
|
(333
|
)
|
|
|
(441
|
)
|
|
|
(760
|
)
|
|
|
(4,013
|
)
|
Increase in net assets resulting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from operations
|
|
|
(1,802
|
)
|
|
|
87
|
|
|
|
(121
|
)
|
|
|
1,005
|
|
|
|
(830
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings per share (1)
|
|
|
(0.14
|
)
|
|
|
0.01
|
|
|
|
(0.01
|
)
|
|
|
0.07
|
|
|
|
(0.07
|
)
|
(1) The
sum of quarterly per share amount may not equal per share amounts reported for year-to-date periods due to changes in the number
of weighted average shares outstanding and the effects of
rounding.
Our
Management performed an evaluation of the Fund’s activity through the date the financial statements were issued, noting the
following subsequent events:
On January 2, 2019,
we sold our holding in $29.0 million in U. S. Treasury Bills and we repaid
our year-end margin loan.
Since February 2020, with the spread
of the coronavirus, we have implemented a number of directives to ensure the safety of our personnel and the continuity of our
operations. We have suspended all in-person meetings and have required all employees and service providers to work from a
remote location. We utilize a cloud-based storage and retrieval system for our records and can communicate electronically
or by telephone with third parties such as our financial institutions, legal and accounting advisors, and our portfolio companies.
We intend to monitor the situation as it evolves and take additional precautions as necessary.
On January 30, 2020, the World Health Organization (“WHO”)
announced a global health emergency because of a new strain of coronavirus (the “COVID-19 outbreak”) and the risks
to the international community as the virus spreads globally beyond its point of origin. In March 2020, the WHO classified the
COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The pandemic has adversely affected global economic
activity and greatly contributed to significant deterioration and volatility in financial markets across the world, including signals
of an uptick in illiquid or inactive markets, which may cause a change in valuation methodology and/or technique as well as the
observability of inputs to be used in valuation techniques. Depending on the severity and length of the outbreak, this pandemic
could present material uncertainty and risk with respect to the Fund, including an adverse effect on its portfolio companies’
operations and their financial condition, the ability of such portfolio companies to provide underlying financial information in
a timely manner, expected declines in the valuation of its investments in the portfolio companies, collectability of amounts due
from others, and its overall performance. The rapid development and fluidity of this situation precludes management from making
an estimate as to the ultimate adverse impact of the pandemic on the value of the Fund’s investments, liquidity, financial
condition, and results of operations for fiscal year 2020.
The adverse economic effects of the COVID-19 outbreak have
materially decreased the fair value of certain investments of the Fund due to the continued material adverse impact on economic
and market conditions of global economic slowdown. In addition, in March 2020, members of OPEC failed to agree on oil production
levels, which is expected to result in an increased supply of oil and has led to a substantial decline in oil prices and an increasingly
volatile market.
Although the Company cannot estimate the length or
gravity of the impact of the COVID-19 outbreak or reduced oil prices at this time, if the pandemic continues, it will have a
material adverse effect on the Fund’s results of future operations, financial position, and liquidity in fiscal
year 2020.