FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1997
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-19509
EQUUS II INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 76-0345915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2929 Allen Parkway, Suite 2500
Houston, Texas 77019-2120
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (713) 529-0900
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
on which registered
Common Stock American Stock Exchange
------------ -----------------------
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Approximate aggregate market value of common stock held by non-affiliates of the
registrant: $73,737,318 computed on the basis of $17.50 per share, closing price
of the common stock on the American Stock Exchange, Inc. on May 13, 1997. For
the purpose of calculating this amount only, all Directors and executive
officers of the registrant have been treated as affiliates. There were 4,300,682
shares of the registrant's common stock, $.001 par value, outstanding, as of May
13, 1997. The net asset value of a share at March 31, 1997 was $24.37.
Documents incorporated by reference: None
<PAGE>
EQUUS II INCORPORATED
(A Delaware Corporation)
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1 Financial Statements
Balance Sheets
- March 31, 1997 and December 31, 1996.................... 1
Statements of Operations
- For the three months ended March 31, 1997 and 1996 ..... 2
Statements of Changes in Net Assets
- For the three months ended March 31, 1997 and 1996 ..... 3
Statements of Cash Flows
- For the three months ended March 31, 1997 and 1996 ..... 4
Selected Per Share Data and Ratios
- For the three months ended March 31, 1997 and 1996 ..... 6
Schedule of Portfolio Securities
- March 31, 1997.......................................... 7
Notes to Financial Statements............................. 12
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 18
PART II. OTHER INFORMATION
Item 4 Submission of Matters to a Vote of Security Holders ...... 21
Item 6 Exhibits and Reports on Form 8-K ......................... 22
SIGNATURE ................................................................. 22
ii
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EQUUS II INCORPORATED
BALANCE SHEETS
MARCH 31, 1997 AND DECEMBER 31, 1996
(Unaudited)
1997 1996
------------- ------------
ASSETS
Investments in portfolio securities
at fair value (cost $72,964,211
and $69,388,024, respectively) .......... $ 120,983,260 $111,059,488
Temporary cash investments, at cost which
approximates fair value ................. 65,498,239 69,129,290
Accounts receivable .......................... 35,729 1,326
Accrued interest receivable .................. 372,296 897,065
Deposit on pending investment ................ 337,500 --
Commitment fees .............................. -- 17,500
Deferred reorganization costs ................ 5,865 11,730
------------- ------------
Total assets ....................... 187,232,889 181,116,399
------------- ------------
LIABILITIES AND NET ASSETS
Liabilities:
Accounts payable ........................ 225,672 208,231
Dividend payable ........................ -- 1,209,850
Due to management company ............... 579,908 390,982
Deferred management incentive fee ....... 11,210,529 10,784,028
Notes payable to bank ................... 70,400,000 65,300,000
------------- ------------
Total liabilities .................. 82,416,109 77,893,091
------------- ------------
Commitments and contingencies
Net assets:
Preferred stock, $.001 par value,
5,000,000 shares authorized, no
shares issued or outstanding ......... -- --
Common stock, $.001 par value,
10,000,000 shares authorized,
4,300,682 shares issued and
outstanding .......................... 4,301 4,301
Additional paid-in capital .............. 57,116,147 57,934,306
Undistributed net investment income ..... -- --
Undistributed net capital gains ......... (322,717) 3,613,237
Unrealized appreciation of portfolio
securities, net ...................... 48,019,049 41,671,464
------------- ------------
Total net assets ................... $ 104,816,780 $103,223,308
============= ============
Net assets per share ............... $ 24.37 $ 24.00
============= ============
The accompanying notes are an integral part of these
financial statements.
1
<PAGE>
EQUUS II INCORPORATED
STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(Unaudited)
1997 1996
------------ ------------
Investment income:
Income from portfolio securities ............ $ 513,859 $ 479,888
Interest from temporary cash investments .... 49,869 29,471
------------ ------------
Total investment income ................ 563,728 509,359
------------ ------------
Expenses:
Management fee .............................. 524,084 365,503
Management incentive fee .................... 55,824 99,158
Deferred management incentive fee ........... 426,501 2,771,489
Director fees and expenses .................. 48,929 50,649
Professional fees ........................... 164,953 27,064
Administrative fees ......................... 12,500 12,500
Mailing, printing and other expenses ........ 46,906 36,212
Interest expense ............................ 77,767 240,555
Franchise taxes ............................. 18,558 6,340
Amortization ................................ 5,865 5,865
------------ ------------
Total expenses ......................... 1,381,887 3,615,335
------------ ------------
Net investment loss .............................. (818,159) (3,105,976)
------------ ------------
Realized gain (loss) on sales of
portfolio securities, net ...................... (3,935,954) 1,285,835
------------ ------------
Unrealized appreciation of portfolio
securities, net:
End of period ............................... 48,019,049 21,042,668
Beginning of period ......................... 41,671,464 7,975,268
------------ ------------
Increase in unrealized appreciation, net ... 6,347,585 13,067,400
------------ ------------
Total increase in net assets from operations $ 1,593,472 $ 11,247,259
============ ============
The accompanying notes are an integral part of these
financial statements.
2
<PAGE>
EQUUS II INCORPORATED
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(Unaudited)
1997 1996
------------- ------------
Operations:
Net investment loss ........................ $ (818,159) $ (3,105,976)
Realized gain (loss) on sales of portfolio
securities, net ........................ (3,935,954) 1,285,835
Increase in unrealized appreciation of
portfolio securities, net .............. 6,347,585 13,067,400
------------- ------------
Increase in net assets from operations .......... 1,593,472 11,247,259
Net assets at beginning of period ............... 103,223,308 61,853,289
------------- ------------
Net assets at end of period ..................... $ 104,816,780 $ 73,100,548
============= ============
The accompanying notes are an integral part of these
financial statements.
3
<PAGE>
EQUUS II INCORPORATED
STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(Unaudited)
1997 1996
------------ ------------
Cash flows from operating activities:
Interest and dividends received ............. $ 781,953 $ 245,624
Cash paid to management company, directors,
bank and suppliers ....................... (725,654) (760,563)
------------ ------------
Net cash provided (used) by
operating activities ................... 56,299 (514,939)
------------ ------------
Cash flows from investing activities:
Purchase of portfolio securities ............ (7,511,000) (11,640,000)
Proceeds from sales of portfolio securities . -- 1,843,579
Principal payments from portfolio companies . 271,000 --
Deposit made on pending investment .......... (337,500) --
------------ ------------
Net cash used by investing
activities ............................. (7,577,500) (9,796,421)
------------ ------------
Cash flows from financing activities:
Advances from bank .......................... 70,400,000 70,152,477
Repayments to bank .......................... (65,300,000) (61,900,000)
Dividend payments ........................... (1,209,850) --
------------ ------------
Net cash provided by financing
activities ............................. 3,890,150 8,252,477
------------ ------------
Net decrease in cash and cash equivalents ........ (3,631,051) (2,058,883)
Cash and cash equivalents at beginning of period . 69,129,290 60,239,861
------------ ------------
Cash and cash equivalents at end of period ....... $ 65,498,239 $ 58,180,978
============ ============
The accompanying notes are an integral part of these
financial statements.
4
<PAGE>
EQUUS II INCORPORATED
STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(Unaudited)
(Continued)
1997 1996
------------ ------------
Reconciliation of increase in net assets from
operations to net cash provided (used)
by operating activities:
Increase in net assets from operations ........... $ 1,593,472 $ 11,247,259
Adjustments to reconcile increase in net
assets from operations to net cash
used by activities:
Realized gain (loss) on sale of portfolio
securities, net ......................... 3,935,954 (1,285,835)
Increase in unrealized appreciation, net .... (6,347,585) (13,067,400)
Increase in accounts receivable ............. (27,131) (5,759)
Accrued interest and dividends exchanged
for portfolio securities ................ (279,413) (86,497)
Increase in accrued interest receivable ..... 524,769 (171,479)
Amortization of commitment fee .............. 17,500 37,500
Commitment fees paid ........................ -- (70,000)
Amortization of reorganization costs ........ 5,865 5,865
Increase (decrease) in accounts payable ..... 17,441 (45,477)
Increase in due to management company ....... 615,427 2,926,884
------------ ------------
Net cash provided (used) by operating activities . $ 56,299 $ (514,939)
============ ============
The accompanying notes are an integral part of these
financial statements.
5
<PAGE>
EQUUS II INCORPORATED
SUPPLEMENTAL INFORMATION - SELECTED PER SHARE DATA AND RATIOS
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(Unaudited)
1997 1996
------------ ------------
Investment income .............................. $ 0.13 $ 0.16
Expenses ....................................... 0.32 1.15
------------ ------------
Net investment loss ....................... (0.19) (0.99)
Realized gain (loss) on sale of portfolio
securities, net .............................. (0.92) 0.41
Increase in unrealized appreciation of
portfolio securities, net .................... 1.48 4.16
------------ ------------
Increase in net assets from operations .... 0.37 3.58
Net assets at beginning of period .............. 24.00 19.71
------------ ------------
Net assets at end of period .................... $ 24.37 $ 23.29
============ ============
Ratio of expenses to average net assets ........ 1.33% 5.36%
Ratio of net investment loss to average
net assets ................................... (0.79)% (4.60)%
Ratio of increase in net assets from
operations to average net assets ............. 1.53% 16.67%
The accompanying notes are an integral part of these
financial statements.
6
<PAGE>
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
MARCH 31, 1997
(Unaudited)
<TABLE>
<CAPTION>
Date of
Portfolio Company Initial Investment Cost Fair Value
- ------------------------------------------------------------ ------------- ---------- -----------
<S> <C> <C> <C>
A. C. Liquidating Corporation .............................. February 1985 -- --
-4,885 shares of 10% Series C
cumulative preferred stock .............................. -- $ 488,500 $ --
-10% secured promissory notes ............................ -- 188,014 --
Allied Waste Industries, Inc. (NASDAQ - AWIN) ............. March 1989 -- --
-1,351,449 shares of common stock ....................... -- 5,109,808 10,132,199
-Warrants to buy up to 125,000 shares of common
stock at $5.00 per share through August 1999 ............ -- 25,000
American Residential Services, Inc. (NYSE - ARS) .......... December 1995 -- --
-1,221,035 shares of common stock ....................... -- 3,057,100 19,386,620
-Warrants to buy up to 100,000 shares of common
stock at $15 per share through September 2001 ........... -- -- --
Brazos Sportswear, Inc. (NASDAQ - BRZS) ................... February 1989 -- --
-2,160,308 shares of common stock ....................... -- 1,331,187 15,446,202
-3,639,894 shares of 8% Series B1 preferred stock ....... -- 3,639,894 3,639,894
-1,237,883 shares of 8% Series B2 preferred stock ....... -- 1,237,883 1,237,883
-1,030,000 shares of 8% Series B3 preferred stock ....... -- 1,030,000 1,030,000
-Warrants to buy up to 30,261 and 140,578 shares
of common stock at $4.62 and $6.59 per share
through August 2006 and March 2007, respectively ....... -- -- 154,821
-1,000 shares of common stock of GCS RE, Inc. ........... -- 132,910 300,000
Cardiovascular Ventures, Inc. ............................. November 1991 -- --
-150,000 shares of Series A convertible
preferred stock ......................................... -- 375,000 375,000
-214,286 shares of Series B convertible
preferred stock ......................................... -- 750,001 750,001
-56,717 shares of Series C convertible
preferred stock ......................................... -- 248,137 248,137
</TABLE>
The accompanying notes are an integral part of these
financial statements.
7
<PAGE>
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
MARCH 31, 1997
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
Date of
Portfolio Company Initial Investment Cost Fair Value
- ------------------------------------------------------------ ------------- ---------- -----------
<S> <C> <C> <C>
Carruth-Doggett Industries, Inc. .......................... December 1995 -- --
-10% senior subordinated promissory note ................. -- $2,250,000 $ 2,250,000
-Warrant to buy up to 33,333 shares of common
stock at $0.01 per share through December 2005 .......... -- -- 250,000
-Warrant to buy up to 249 shares of common
stock of CDE Corp. at $0.01 per share through
December 2005 ........................................... -- -- --
Coach USA, Inc. (NASDAQ - TOUR) ........................... August 1996 -- --
-143,112 shares of common stock ......................... -- 1,863,357 3,531,079
Container Acquisition, Inc. ............................... February 1997 -- --
-1,370,000 shares of common stock ....................... -- 1,370,000 1,370,000
-45,100 shares of preferred stock ....................... -- 4,510,000 4,510,000
-Warrant to buy up to 370,588 shares of common
stock at $.01 per share through February 2007 ........... -- 1,000 1,000
David's Supermarkets, Inc. ................................ February 1990 -- --
-735,000 shares of common stock ......................... -- 735,000 2,212,350
-333,445 shares of 3.5% junior preferred stock .......... -- 3,334,450 3,334,450
-Warrants to buy up to 538,462 shares of common
stock at $1 per share through April 2000 ................ -- -- --
Drypers Corporation (NASDAQ - DYPR) ........................ July 1991 -- --
-1,096,892 shares of common stock ....................... -- 6,400,132 3,792,044
-25,000 shares of 7.5% convertible preferred stock ...... -- 2,500,000 6,918,574
-Warrants to buy up to 10,990 shares of common
stock at $2.41 per share through June 1998 .............. -- -- 3,874
Garden Ridge Corporation (NASDAQ - GRDG) ................... July 1992 -- --
-474,942 shares of common stock ......................... -- 685,030 4,229,940
</TABLE>
The accompanying notes are an integral part of these
financial statements.
8
<PAGE>
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
MARCH 31, 1997
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
Date of
Portfolio Company Initial Investment Cost Fair Value
- ------------------------------------------------------------ ------------- ---------- -----------
<S> <C> <C> <C>
Hot & Cool Holdings, Inc. ................................. March 1996 -- --
-9% increasing rate subordinated
promissory note ......................................... -- $1,300,000 $ 1,300,000
-10% subordinated note ................................... -- 650,000 650,000
-Warrants to buy up to 14,942 shares of common
stock at $.01 per share through March 2006 ............. -- -- 280,000
Industrial Equipment Rentals, Inc. ........................ June 1993 -- --
-182,230 shares of common stock ......................... -- 1,822 1,349,960
-5,371 shares of junior preferred stock ................. -- 537,100 537,100
-67,500 shares of Series B senior convertible
preferred stock ......................................... -- 250,050 500,040
-12% subordinated debenture .............................. -- 1,077,778 1,077,778
-9% senior subordinated debenture ........................ -- 499,950 499,950
NCI Building Systems, Inc. (NASDAQ - BLDG) ................ April 1989 -- --
-100,000 shares of common stock ......................... -- 159,784 3,237,500
Paracelsus Healthcare Corporation (NYSE - PLS) ............. December 1990 -- --
-1,263,058 shares of common stock ........................ -- 5,278,748 3,663,323
Restaurant Development Group, Inc. ........................ June 1987 -- --
-610,909 shares of Class A common stock ................. 2,891,156 800,000
-Prime +2% promissory note ............................... -- 108,000 108,000
-Warrants to buy up to 62,500 shares of
common stock at $3 per share through
April 1998 .............................................. -- -- --
Sovereign Business Forms, Inc. ............................. August 1996 -- --
-11,000 shares of preferred stock ........................ -- 1,100,000 1,100,000
-15% promissory note ...................................... -- 550,000 550,000
-Warrant to buy 551,894 shares of common
stock at $1 per share through August 2006 ............... -- -- --
</TABLE>
The accompanying notes are an integral part of these
financial statements.
9
<PAGE>
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
MARCH 31, 1997
(Unaudited)
(Continued)
<TABLE>
<CAPTION>
Date of
Portfolio Company Initial Investment Cost Fair Value
- ------------------------------------------------------------ -------------- ----------- ------------
<S> <C> <C> <C>
Strategic Holdings, Inc. ................................... September 1995 -- --
-3,089,751 shares of common stock ........................ -- $ 3,088,389 $ 3,088,389
-3,822,157 shares of Series B preferred stock ............ -- 3,820,624 3,820,624
-Warrants to buy 225,000 and 100,000 shares of
common stock at $0.4643 and $1.50 per share,
respectively, through August 2005 ...................... -- -- 100,000
-1,000 shares of SMIP, Inc. common stock ................. -- 150,000 150,000
-15% promissory note of SMIP, Inc. ....................... -- 175,000 175,000
Summit/DPC Partners, L.P. .................................. October 1995 -- --
-36.11% limited partnership interest ...................... -- 2,600,000 2,600,000
Travis International, Inc. ................................. December 1986 -- --
-66,784 shares of common stock ........................... -- 534,589 1,502,640
-104,500 shares of Class A common stock .................. -- 25,701 2,351,250
VRPI Spin Off, Inc. ........................................ January 1988 -- --
-100 shares of common stock ............................... -- 250,000 300,000
-10% secured promissory note .............................. -- 2,672,349 2,672,349
-12% secured promissory note .............................. -- 1,050,000 1,050,000
-10,000 shares of common stock of
Equus Video Corporation .................................. -- 25,000 20,000
WMW Industries, Inc. ....................................... October 1989 -- --
(formerly Williams & Mettle Co.)
-530,035 shares of common stock .......................... -- 1,024,309 463,830
-12% subordinated promissory note ......................... -- 893,883 893,883
-Junior participation in prime + 1.5% note ................ -- 1,012,576 1,012,576
-Warrant to buy 72,672 shares of common stock
at $0.01 per share through December 1999 ................. -- -- --
Total .................................................. -- $72,964,211 $120,983,260
</TABLE>
The accompanying notes are an integral part of these
financial statements.
10
<PAGE>
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
MARCH 31, 1997
(Unaudited)
(Continued)
Substantially all of the Fund's portfolio securities are restricted from
public sale without prior registration under the Securities Act of 1933. The
Fund negotiates certain aspects of the method and timing of the disposition of
the Fund's investment in each portfolio company, including registration rights
and related costs.
In connection with the investments in Allied Waste Industries, Inc.,
American Residential Services, Inc., Brazos Sportswear, Inc., Cardiovascular
Ventures, Inc., Coach USA, Inc., Drypers Corporation, Hot & Cool Holdings, Inc.,
Industrial Equipment Rentals, Inc., Paracelsus Healthcare Corporation, Sovereign
Business Forms, Inc. and Strategic Holdings, Inc., rights have been obtained to
demand the registration of such securities under the Securities Act of 1933,
providing certain conditions are met. The Fund does not expect to incur
significant costs, including costs of any such registration, in connection with
the future disposition of its portfolio securities.
As defined in the Investment Company Act of 1940, the Fund is considered
to have a controlling interest in A.C. Liquidating Corporation, Brazos
Sportswear, Inc., Container Acquisition, Inc., Drypers Corporation, Industrial
Equipment Rentals, Inc., Restaurant Development Group, Inc., Strategic Holdings,
Inc., Video Rental of Pennsylvania, Inc. and WMW Industries, Inc. In addition,
American Residential Services, Inc., Cardiovascular Ventures, Inc., David's
Supermarkets, Inc. and Travis International, Inc. are considered to be
affiliated entities of the Fund. The fair values of the Fund's investments in
publicly traded securities include discounts from the closing market prices to
reflect the estimated effects of restrictions on the sale of such securities at
March 31, 1997. Such discounts, as detailed below, total $20,094,848 or $4.67
per share as of March 31, 1997.
Allied Waste Industries, Inc. .......... $ 1,029,393
American Residential Services, Inc. .... 4,378,174
Brazos Sportswear, Inc. ................ 8,974,916
Coach USA, Inc. ........................ 672,836
Drypers Corporation .................... 4,592,522
Garden Ridge Corporation ............... 163,274
Paracelsus Healthcare Corporation ...... 283,733
-----------
Total discount ................... $20,094,848
===========
Income was earned in the amount of $411,415 and $357,571 for the three
months ended March 31, 1997 and 1996, respectively, on portfolio securities of
companies in which the Fund has a controlling interest.
As defined in the Investment Company Act of 1940, all of the Fund's
investments are in eligible portfolio companies. The Fund provides significant
managerial assistance to all of the portfolio companies in which it has invested
except Cardiovascular Ventures, Inc., Coach USA, Inc., Paracelsus Healthcare
Corporation and Summit/DPC Partners, L.P. The Fund provides significant
managerial assistance to portfolio companies that comprise 91% of the total
value of the investments in portfolio companies at March 31, 1997.
The accompanying notes are an
integral part of these financial statements.
11
<PAGE>
EQUUS II INCORPORATED
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1997 AND 1996
(Unaudited)
(1) ORGANIZATION AND BUSINESS PURPOSE
Equus II Incorporated (the "Fund"), a Delaware corporation with perpetual
existence, 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. The shares of the Fund trade on
the American Stock Exchange under the symbol EQS.
The Fund seeks 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. The Fund seeks to invest
primarily in companies which intend to acquire other businesses, including
leveraged buyouts. The Fund may also invest in recapitalizations of existing
businesses or special situations from time to time. The Fund's investments in
Portfolio Companies consist principally of equity securities such as common and
preferred stock, but also include other equity-oriented securities such as debt
convertible into common or preferred stock or debt combined with warrants,
options or other rights to acquire common or preferred stock. Current income is
not a significant factor in the selection of investments. The Fund has elected
to be treated as a business development company under the Investment Company Act
of 1940, as amended.
(2) MANAGEMENT
The Fund has entered into a management agreement with Equus Capital
Management Corporation, a Delaware corporation (the "Management Company").
Pursuant to such agreement, the Management Company performs certain services,
including certain management and administrative services necessary for the
operation of the Fund. The Management Company entered into a Sub- Adviser
Agreement with Equus Capital Corporation, a Delaware corporation (the
"Sub-Adviser"), pursuant to which the Sub-Adviser provides certain investment
advisory services for the Fund, including preparing the Fund's quarterly net
asset valuations. The Management Company receives a management fee at an annual
rate of 2% of the net assets of the Fund, paid quarterly in arrears. The
Management Company also receives compensation for providing certain investor
communication services, of which $12,500, is included in the accompanying
Statements of Operations for the three months ended March 31, 1997 and 1996.
Through March 31, 1997, the Management Company also received or reimbursed
a management incentive fee equal to 20% of net realized capital gains less
unrealized capital depreciation, computed on a cumulative basis over the life of
the Fund. The Sub-Adviser received a fee from the Management Company equal to
50% of the Management Company's net management incentive fee. The management
incentive fee was paid or reimbursed quarterly in arrears. Included in "Due to
Management" in the accompanying Balance Sheet at March 31, 1997, is $55,824 of
such management incentive fees. Pursuant to the vote of the stockholders at a
special meeting held on April 9, 1997, ("Special Meeting") the Fund entered into
a new management agreement with the Management Company which eliminates
incentive fees based on capital gains.
Included in "Deferred management incentive fees" in the accompanying
Balance Sheets are $11,210,529 and $10,784,028 of accrued management incentive
fees at March 31, 1997 and December 31,
12
<PAGE>
1996, respectively. Such fees were calculated on the net unrealized appreciation
of investments in portfolio securities, and were to be paid only when such
appreciation was realized. However, pursuant to the vote of the stockholders at
the Special Meeting, the deferred incentive fee of $11,210,529 at March 31,
1997, will be paid during the second quarter of 1997 by the issuance of 459,973
unregistered shares of common stock of the Fund, at a price of $24.37 per share,
the net asset value per share at March 31, 1997. Deferred management incentive
fee expense for the three months ended March 31, 1997 and 1996 totaled $426,501
and $2,771,489, respectively. The deferred management incentive fee was
reflected as an expense of the Fund when there was an increase in the Fund's net
unrealized appreciation of portfolio securities and was reflected as a reduction
in expense to the Fund when there was a decrease in the Fund's net appreciation
of portfolio securities. At December 31, 1996, $125,135 of incentive fees to be
reimbursed by the Management Company to the Fund are netted in "Due to
Management Company", against $516,117 of management fees due to the Management
Company.
The Sub-Adviser is a wholly-owned subsidiary of the Management Company and
the Management Company is controlled by a privately -owned corporation.
As compensation for services rendered to the Fund, each director who is
not an officer of the Fund receives an annual fee of $20,000 paid quarterly in
arrears, a fee of $2,000 for each meeting of the Board of Directors attended in
person, a fee of $1,000 for participation in each telephonic meeting of the
Board of Directors and for each committee meeting attended ($500 for each
committee meeting if attended on the same day as a Board Meeting), and
reimbursement of all out-of-pocket expenses relating to attendance at such
meetings. Certain officers and directors of the Fund serve as directors of
Portfolio Companies, and receive and retain fees in consideration for such
service.
(3) SIGNIFICANT ACCOUNTING POLICIES
Interim Financial Statements - The financial statements included herein
have been prepared without audit and include all adjustments which management
considers necessary for fair presentation.
Valuation of Investments - Portfolio investments are carried at fair value
with the net change in unrealized appreciation or depreciation included in the
determination of net assets. Investments in companies whose securities are
publicly traded are valued at their quoted market price, less a discount to
reflect the estimated effects of restrictions on the sale of such securities
("Valuation Discount"), if applicable. Cost is used to approximate fair value of
other investments until significant developments affecting an investment provide
a basis for use of an appraisal valuation. Thereafter, portfolio investments are
carried at appraised values as determined quarterly by the Sub-Adviser, subject
to the approval of the Board of Directors. The fair market values of debt
securities, which are generally held to maturity, are determined on the basis of
the terms of the debt securities and the financial condition of the issuer.
Because of the inherent uncertainty of the valuation of portfolio securities
which do not have readily ascertainable market values, $117,745,760 (including
$67,283,676 in publicly-traded securities, net of a $20,094,848 Valuation
Discount) and $107,604,488 (including $58,079,167 in publicly-traded securities,
net of a $15,599,614 Valuation Discount) at March 31, 1997 and December 31,
1996, respectively, the Sub-Adviser's estimate of fair value may significantly
differ from the fair value that would have been used had a ready market existed
for the securities. Appraised values do not reflect brokers' fees or other
normal selling costs or management incentive fees which might become payable on
disposition of such investments. Such management incentive fees are recorded in
total on the Fund's Balance Sheets. See Note 2 above.
On a weekly basis, the Fund adjusts its net asset value for changes in the
value of its publicly held securities and material changes in the value of its
private securities and reports those amounts to Lipper
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Analytical Services, Inc. Such weekly net asset values appear in various
publications, including BARRON'S and THE WALL STREET JOURNAL.
Investment Transactions - Investment transactions are recorded on the
accrual method. Realized gains and losses on investments sold are computed on a
specific identification basis.
Cash Flows - For purposes of the Statements of Cash Flows, the Fund
considers all highly liquid temporary cash investments purchased with an
original maturity of three months or less to be cash equivalents.
Income Taxes - No provision for Federal income taxes has been made in the
accompanying financial statements as the Fund has qualified for pass-through
treatment as a "regulated investment company" under Subchapter M of the Internal
Revenue Code of 1986. As such, all net income is allocable to the stockholders
for inclusion in their respective tax returns. Net capital losses are not
allocable to the shareholders but can be carried over to offset future earnings
of the Fund.
(4) BOOK TO TAX RECONCILIATION
The Fund accounts for dividends in accordance with Statement of Position
93-2 which relates to the amounts distributed by the Fund as net investment
income or net capital gains, which are often not equal to the corresponding
income or gains shown in the Fund's financial statements. The Fund had net
investment losses for tax purposes for the three months ended March 31, 1997 and
1996, and therefore has no net investment income to distribute. The following is
a reconciliation of the difference in the Fund's net realized capital gain on
the sale of portfolio securities for book and tax purposes for the three months
ended March 31, 1997 and 1996, respectively.
1997 1996
----------- -----------
Net realized gain (loss) on the sales of portfolio
securities, book ................................ $(3,935,954) $ 1,285,835
Management incentive fee ........................... (55,824) (99,158)
----------- -----------
Net realized gain (loss) on the sales of
portfolio securities, tax ....................... $(3,991,778) $ 1,186,677
=========== ===========
(5) DIVIDENDS
The Fund declared no dividends during the three months ended March 31,
1997 and 1996. The Fund has adopted a policy to make dividend distributions of
at least $0.50 per share on an annual basis. In the event that taxable income,
including realized capital gains, exceeds $0.50 per share in any year,
additional dividends may be declared to distribute such excess. Distributions
can be made payable by the Fund either in the form of a cash distribution or a
stock dividend. The Fund has not adopted any set policy concerning whether
dividends will be paid only in cash, only in stock or cash by specific election.
If the Fund does not have available cash to pay the minimum dividends it may
borrow the required funds or sell some of its portfolio investments.
(6) TEMPORARY CASH INVESTMENTS
Temporary cash investments, which represent the short-term utilization of
cash prior to investment in securities of portfolio companies, distributions to
the shareholders or payment of expenses, consist of money market accounts
earning interest at rates ranging from 3.50% to 4.84% at March 31, 1997.
14
<PAGE>
Substantially all of the Fund's temporary cash investments are invested at
NationsBank of Texas, N.A. at March 31, 1997 and December 31, 1996.
(7) PORTFOLIO SECURITIES
During the three months ended March 31, 1997, the Fund invested $5,881,000
in one new company and made follow-on investments of $1,909,413 in four
portfolio companies, including $279,413 in accrued interest and dividends
received in the form of additional portfolio securities. In addition, the Fund
realized a net capital loss of $3,935,954 during the three months ended March
31, 1997.
During the three months ended March 31, 1996, the Fund invested $8,600,000
in two new companies and made follow-on investments of $3,876,497 in five
portfolio companies, including $86,497 in accrued interest received in the form
of additional portfolio securities and $750,000 of common stock received through
the net exercise of common stock warrants. In addition, the Fund realized net
capital gains of $1,285,835 during the three months ended March 31, 1996.
(8) DEFERRED REORGANIZATION COSTS
The Fund paid $117,300 in expenses related to the formation of the Fund
and is amortizing such amount over 5 years. Accumulated amortization of such
expenses totaled $111,435 and $105,570 at March 31, 1997 and December 31, 1996,
respectively.
(9) NOTES PAYABLE TO BANK
In March 1996, the Fund entered into a $65,000,000 line of credit
promissory note with a bank, with interest payable at 1% over the rate earned in
its money market account. The Fund had $65,000,000 outstanding on such note at
March 31, 1997 and December 31, 1996, that was secured by $65,000,000 of the
Fund's temporary cash investments. The Fund paid a $50,000 commitment fee in
1996, which was capitalized and was amortized over the commitment period. The
note originally matured on April 4, 1997. On March 28, 1997, the note was
extended to April 1, 1998, and in April 1997, the Fund paid a $75,000 commitment
fee in connection with such extension which was capitalized and will be
amortized over the commitment period.
On March 18, 1996, the Fund entered into a $20,000,000 revolving line of
credit with a bank. The Fund had $5,400,000 and $300,000 outstanding under such
line of credit at March 31, 1997 and December 31, 1996, respectively, which is
secured by the Fund's investments in portfolio securities. The Fund paid a
$20,000 commitment fee in connection with such loan which was capitalized and
was amortized over the commitment period which ended April 4, 1997. The
outstanding balance on the loan bears interest at prime + 1/4% to 3/4%. The fund
also pays 1/4% interest on the unused portion of the line of credit. On March
28, 1997, the note was extended to April 1, 1998, and the line of credit was
increased to $30,000,000. In April 1997, the Fund paid a $10,000 commitment fee
in connection with such extension, which was capitalized and will be amortized
over the commitment period.
The average daily balances outstanding on the Fund's notes payable during
the three months ended March 31, 1997 and 1996, were $3,259,444 and $9,626,728,
respectively.
(10) COMMITMENTS AND CONTINGENCIES
The Fund has made commitments to invest, under certain circumstances, up
to an additional $1,250,000 in Cardiovascular Ventures, Inc., $565,500 in GCS
RE, Inc. and $850,000 in Hot & Cool Holdings, Inc. In connection with its
commitment to GCS RE, Inc., the Fund has committed to a bank to
15
<PAGE>
maintain at least $380,000 in temporary cash investments to fund such
commitment. In addition, the Fund has committed to invest up to $10,900,000 in
three new companies, and $337,500 of such amount for the Fund's investment in
Atlas Acquisition, Inc. is included in the accompanying balance sheet at March
31, 1997, in " Deposit on pending investment ".
On April 1, 1996, two stockholders of the Fund filed an action in federal
district court in Houston, Texas against the directors of the Fund, the
Management Company, and the Fund. In essence, their suit alleged that by
approving the rights offering which was announced in March 1996, the Management
Company and the directors of the Fund violated their fiduciary duties to the
Fund's stockholders under the Investment Company Act of 1940 and Delaware common
law. They also alleged that the Management Company aided and abetted these
breaches of fiduciary duty. The plaintiffs moved the court to certify their suit
as a class action on behalf of all stockholders of the Fund.
The court dismissed their suit in December 1996, but the plaintiffs have
made substantially similar claims in an amended shareholder derivative action
which they filed in January 1997. The plaintiffs have not specified the amount
of any damages in either suit. The plaintiffs have not yet made any demand on
the Fund that its directors take action regarding their derivative suit. In any
event, management of the Fund believes that the ultimate resolution of the
plaintiffs' claims will not have a material adverse effect on the Fund's
financial position or results of operations. During the three months ended March
31, 1997 and the year ended December 31, 1996, the Fund had incurred $22,303 and
$92,336, respectively, in legal expenses related to such action.
The Fund and certain of the portfolio companies are involved in asserted
claims and have the possibility for unasserted claims which may ultimately
affect the fair value of the Fund's portfolio investments. In the opinion of
Management, the financial position or operating results of the Fund will not be
materially affected by these claims.
(11) SUBSEQUENT EVENTS
Subsequent to March 31, 1997, the Fund sold its investment in David's
Supermarkets, Inc. for $5,546,800, realizing a net capital gain of $1,477,350 on
such sale.
In April 1997, in connection with its commitments disclosed above, the
Fund advanced $1,250,000 to Cardiovascular Ventures, Inc. in the form of a 10%
promissory note and received warrants to buy 83,956 shares of Cardiovascular
Ventures, Inc. common stock for $3 per share and advanced $850,000 to Hot & Cool
Holdings, Inc. in the form of a 10% promissory note and received warrants to buy
8,729 shares of Hot & Cool Holdings, Inc. common stock for $27.28 per share.
Subsequent to March 31, 1997, the Fund repaid a net $68,640,000 of notes
payable to the bank.
In April 1997, the Fund acquired 9,000 shares of common stock and 4,500
shares of 8% preferred stock of Healthcare Technology Delivery, Inc. ("HTD") for
$50,000 and $450,000, respectively. HTD was formed to acquire FutureTech, Inc.
and Medical Companies Alliance, Inc. In addition, the Fund acquired 300,000
shares of convertible preferred stock of AVIAN Healthcare Corporation ("AVIAN")
for $300,000 and advanced $350,000 to AVIAN under a $2,200,000 prime + 1/2%
promissory note. AVIAN was formed to create a leading national distributor of
medical products and related services to the health care market, principally
hospitals and surgical and diagnostic centers.
The Fund held a special meeting of shareholders on April 9, 1997. At the
meeting, shareholders approved a new management agreement between the Fund and
the Management Company. The shareholders also authorized the payment by the Fund
to the Management Company of the deferred incentive fee on the balance sheet of
the Fund at March 31, 1997, in shares of the Fund's common stock
16
<PAGE>
valued at net asset value at March 31, 1997, and approved the Equus II
Incorporated 1997 Stock Incentive Plan which authorizes the Fund to issue
options to the directors and officers of the Fund in an aggregate amount of up
to 20% of the outstanding shares of common stock of the Fund. Implementation of
these proposals was subject to the receipt of an exemptive order from the
Securities and Exchange Commission, which was received on May 8, 1997. On May
9,1997, the Compensation Committee of the Board of Directors of the Fund issued
options to the officers of the Fund to buy up to 830,136 shares of the Fund's
common stock at $17 per share.
In May 1997, the Fund acquired 32,000 shares of common stock and 19,680
shares of preferred stock of Atlas Acquisition, Inc. ("AAI") for $32,000 and
$1,968,000, respectively. The Fund previously recorded $337,500 of such amount
as a "Deposit on pending investment" in the accompanying balance sheet at March
31, 1997. AAI was formed to acquire Atlas Supply, Inc. a 68 year old distributor
of "Atlas" branded tires, batteries and accessories sold primarily to the auto
repair and full service gas station markets.
17
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
LIQUIDITY AND CAPITAL RESOURCES
Equus II Incorporated (the "Fund"), a Delaware corporation and business
development company, was formed as a successor to Equus Investments II, L.P.
(the "Partnership") pursuant to a reorganization in which all of the assets and
liabilities of the Partnership were transferred to the Fund on July 1, 1992, in
exchange for 1,866,132 shares of common stock of the Fund. Such shares were then
distributed on a pro rata basis to the partners of the Partnership, effectively
liquidating the Partnership. The Fund has qualified for pass-through tax
treatment as a "regulated investment company" under Subchapter M of the Internal
Revenue Code of 1986 each year since its organization. The Fund's shares of
common stock are listed for trading on the American Stock Exchange, under the
symbol "EQS".
At March 31, 1997, the Fund had $120,983,260 of its assets invested in
portfolio securities of 22 companies, and has committed to invest up to an
additional $2,665,500 in four of such companies and $10,900,000 in three
companies under certain conditions. Current temporary cash investments,
anticipated future investment income, proceeds from borrowings and proceeds from
the sale of existing portfolio securities are believed to be sufficient to
finance these commitments. At March 31, 1997, the Fund had $5,400,000
outstanding on a $30,000,000 revolving line of credit loan from a bank.
Net cash provided (used) by operating activities was $56,299 and
$(514,939) for the three months ended March 31, 1997 and 1996, respectively. An
increase in interest received from portfolio companies in 1997 accounted for the
majority of the increase in cash provided by operating activities.
At March 31, 1997, the Fund had $65,498,239 of its total assets of
$187,232,889 invested in temporary cash investments consisting of money market
securities. This amount includes proceeds from a $65,000,000 revolving line of
credit to a bank that is utilized to enable the Fund to achieve adequate
diversification to maintain its pass-through tax status as a regulated
investment company. Such amount was repaid to the bank on April 1, 1997.
The Fund has the ability to borrow funds and issue forms of indebtedness,
subject to certain restrictions. Net investment income and net realized gains
from the sales of portfolio investments are intended to be distributed at least
annually, to the extent such amounts are not reserved for payment of
contingencies or to make follow-on or new investments.
The Fund reserves the right to retain net long-term capital gains in
excess of net short-term capital losses for reinvestment or to pay contingencies
and expenses. Such retained amounts, if any, will be taxable to the Fund as
long-term capital gains and shareholders will be able to claim their
proportionate share of the federal income taxes paid by the Fund on such gains
as a credit against their own federal income tax liabilities. Stockholders will
also be entitled to increase the adjusted tax basis of their Fund shares by the
difference between their undistributed capital gains and their tax credit.
RESULTS OF OPERATIONS
INVESTMENT INCOME AND EXPENSE
Net investment loss after all expenses amounted to $818,159 and $3,105,976
for the three months ended March 31, 1997 and 1996, respectively. The large net
investment loss in 1996 was primarily attributable to the accrual of $99,158 in
management incentive fees and $2,771,489 in deferred management incentive fees
related to the realized gains from the sales of portfolio securities of
$1,285,835 and the increase in the net unrealized appreciation of portfolio
securities of $13,067,400 in 1996. Income
18
<PAGE>
from portfolio securities increased to $513,859 in 1997 as compared to $479,888
in 1997, due to the increase in amounts invested in interest-bearing portfolio
securities during 1997 as compared to 1996.
Interest expense decreased to $77,767 in 1997 as compared to $240,555 in
1996, due to the decrease of the average daily balances outstanding on the lines
of credit to $3,259,444 during the three months ended March 31, 1997, from
$9,626,728 in 1996.
The Management Company receives management fee compensation at an annual
rate of 2% of the net assets of the Fund. Such fees amounted to $524,084 and
$365,503 for the three months ended March 31, 1997 and 1996, respectively.
The Management Company also receives or must reimburse a management
incentive fee equal to 20% of net realized capital gains less unrealized capital
depreciation, computed on a cumulative basis over the life of the Fund.
Management incentive fees of $55,824 and $99,158 were accrued during the three
months ended March 31, 1997 and 1996, respectively. Deferred management
incentive fee expense for the three months ended March 31, 1997 and 1996 totaled
$426,501 and $2,771,489, respectively. Pursuant to the vote of the stockholders
at a special meeting held on April 9, 1997 ("Special Meeting"), the Fund entered
into a new management agreement with the Management Company which eliminates
incentive fees based on capital gains. The deferred management incentive fee is
reflected as an expense of the Fund when there is an increase in the Fund's net
unrealized appreciation of portfolio securities and is reflected as a reduction
in expense to the Fund when there is a decrease in the Fund's net appreciation
of the portfolio securities. The deferred management incentive fees are not paid
until such appreciation is realized. However, pursuant to the vote of the
stockholders at the Special Meeting, the deferred incentive fee of $11,210,529
at March 31, 1997, will be paid during the second quarter by the issuance of
459,973 unregistered shares of common stock of the Fund, at a price of $24.37
per share, the net asset value per share at March 31, 1997.
REALIZED GAINS AND LOSSES ON SALES OF PORTFOLIO SECURITIES
During the three months ended March 31, 1997, the Fund sold its investment
in Midway Airlines for $278,272 realizing a net capital loss of $3,935,954.
During the three months ended March 31, 1996, the Fund realized net
capital gains of $1,285,835 from the sale or disposition of securities of three
Portfolio Companies. The Fund sold 233,044 shares of Allied Waste Industries,
Inc. common stock for $1,563,678, realizing a capital gain of $461,919 and
32,789 shares of Tech-Sym Corporation for $1,029,901, realizing a capital gain
of $911,656. In addition, the Fund realized a capital loss of $87,740 on its
investment in Sports & Leisure, Inc. which filed for Chapter 11 bankruptcy in
February 1996.
UNREALIZED APPRECIATION AND DEPRECIATION OF PORTFOLIO SECURITIES
Net unrealized appreciation on investments increased $6,347,585 during the
three months ended March 31, 1997, from $41,671,464 to $48,019,049. Such net
increase resulted from increases in the estimated fair value of securities of
nine of the Fund's portfolio companies aggregating $11,038,351, a decrease in
the estimated fair value of securities of five portfolio companies of $8,633,992
and the transfer of $3,943,226 in net unrealized depreciation to net realized
losses.
Net unrealized appreciation on investments increased $13,067,400 during
the three months ended March 31, 1996, from $7,975,268 to $21,042,668. Such net
increase resulted from increases in the estimated fair value of securities of
seven of the Fund's Portfolio Companies aggregating $14,040,424, and the
transfer of $973,024 in net unrealized appreciation to net realized gains from
the sale of investments in three companies.
19
<PAGE>
DIVIDENDS
The Fund declared no dividends during the three months ended March 31,
1997 and 1996.
PORTFOLIO INVESTMENTS
During the three months ended March 31, 1997, the Fund invested $5,881,000
in one new company and made follow-on investments of $1,909,413 in four
portfolio companies, including $279,413 in accrued interest and dividends
received in the form of additional portfolio securities. In addition, the Fund
realized a net capital loss of $3,935,954 during the three months ended March
31, 1997.
In January 1997, the Fund rolled its $763,747, 12% subordinated promissory
note along with $130,136 of accrued interest due from WMW Industries, Inc. into
a new $893,883, 12% subordinated promissory note.
In February 1997, the Fund acquired 1,370,000 shares of common stock and
45,100 shares of preferred stock of Container Acquisition, Inc. ("CAI") for
$1,370,000 and $4,510,000, respectively. In addition, the Fund paid $1,000 for
warrants to buy 370,588 shares of common stock for $.01 per share through
February 2007. CAI is a logistics and maintenance services company serving
owners of international shipping containers.
In February 1997, the Fund acquired an additional 3,500 shares of
preferred stock of Sovereign Business Forms, Inc. ("Sovereign") for $350,000,
which allowed Sovereign to acquire its third company in the business forms
manufacturing business.
In March 1997, the Fund acquired 1,030,000 shares of Series B3 preferred
stock of BSI Holdings, Inc. ("BSI") for $1,030,000, and received warrants to
acquire 18,540 shares of BSI for $50 per share. Such investment allowed BSI to
complete its merger into Sun Sportswear, Inc., a publicly traded company. In
conjunction with the merger of BSI into Sun, the combined company was renamed
Brazos Sportswear, Inc. ("Brazos") and trades on the NASDAQ National Market
under the symbol BRZS. In exchange for each share of common stock of BSI, the
Fund received 7.5824504 shares of Brazos common stock, its preferred stocks of
BSI were exchanged for similar preferred stocks of Brazos, and its warrants were
adjusted to reflect the exchange ratio used in the merger. In addition, the Fund
received an additional 111,394 and 37,883 shares of Series B1 and B2 preferred
stock, respectively, in payment of $149,277 in dividends.
In March 1997, the Fund advanced $250,000 to Hot & Cool Holdings, Inc. in
exchange for a 10% subordinated promissory note to allow Hot & Cool to acquire
additional equipment.
During the three months ended March 31, 1996, the Fund invested $8,600,000
in two new Portfolio Companies and made follow-on investments in five Portfolio
Companies of $3,876,497, including $86,497 in accrued interest of WMW
Industries, Inc. received in the form of additional portfolio securities and
$750,000 of common stock received through the net exercise of common stock
warrants.
Of the companies in which the Fund has investments at March 31, 1997, only
Allied Waste Industries, Inc., American Residential Services, Inc., Brazos
Sportswear, Inc., Coach USA, Inc., Drypers Corporation, Garden Ridge
Corporation, NCI Building Systems, Inc. and Paracelsus Healthcare Corporation,
Inc. are publicly held. The others each have a small number of shareholders and
do not generally make financial information available to the public. However,
each company's operations and financial information are reviewed by Management
to determine the proper valuation of the Fund's investment.
20
<PAGE>
SUBSEQUENT EVENTS
Subsequent to March 31, 1997, the Fund sold its investment in David's
Supermarkets, Inc. for $5,546,800, realizing a net capital gain of $1,477,350 on
such sale.
In April 1997, the Fund advanced $1,250,000 to Cardiovascular Ventures,
Inc. in the form of a 10% promissory note and received warrants to buy 83,956
shares of Cardiovascular Ventures, Inc. common stock for $3 per share and
advanced $850,000 to Hot & Cool Holdings, Inc. in the form of a 10% promissory
note and received warrants to buy 8,729 shares of Hot & Cool Holdings, Inc.
common stock for $27.28 per share.
Subsequent to March 31, 1997, the Fund repaid a net $68,640,000 of notes
payable to the bank.
In April 1997, the Fund acquired 9,000 shares of common stock and 4,500
shares of 8% preferred stock of Healthcare Technology Delivery, Inc. ("HTD") for
$50,000 and $450,000, respectively. HTD was formed to acquire FutureTech, Inc.
and Medical Companies Alliance, Inc. In addition, the Fund acquired 300,000
shares of convertible preferred stock of AVIAN Healthcare Corporation ("AVIAN")
for $300,000 and advanced $350,000 to AVIAN under a $2,200,000 prime + 1/2%
promissory note. AVIAN was formed to create a leading national distributor of
medical products and related services to the health care market, principally
hospitals and surgical and diagnostic centers.
The Fund held a special meeting of shareholders on April 9, 1997. At the
meeting, shareholders approved a new management agreement between the Fund and
the Management Company. The shareholders also authorized the payment by the Fund
at March 31, 1997, to the Management Company of the deferred incentive fee on
the balance sheet of the Fund at March 31, 1997, in shares of the Fund's common
stock valued at net asset value at March 31, 1997, and approved the Equus II
Incorporated 1997 Stock Incentive Plan which authorizes the Fund to issue stock
options to its directors and officers in an aggregate amount up to 20% of the
outstanding shares of common stock of the Fund. Implementation of these
proposals was subject to the receipt of an exemptive order from the Securities
and Exchange Commission, which was received on May 8, 1997. On May 9, 1997, the
Compensation Committee of the Board of Directors of the Fund issued options to
the officers of the Fund to buy up to 830,136 shares of Fund's common stock at
$17 per share.
In May 1997, the Fund acquired 32,000 shares of common stock and 19,680
shares of preferred stock of Atlas Acquisition, Inc. ("AAI") for $32,000 and
$1,968,000, respectively. The Fund previously recorded $337,500 of such amount
as a "Deposit on pending investment" in the accompanying balance sheet at March
31, 1997. AAI was formed to acquire Atlas Supply, Inc. a 68 year old distributor
of "Atlas" branded tires, batteries and accessories sold primarily to the auto
repair and full service gas station markets.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Fund held a special meeting of shareholders on April 9, 1997. At the
meeting, shareholders voted on the approval and adoption of a new management
agreement between the Fund and the Management Company, authorization of the
payment by the Fund to the Management Company of the deferred incentive fee on
the balance sheet of the Fund in shares of the Fund's common stock valued at net
asset value and approval of the Equus II Incorporated 1997 Stock Incentive Plan.
21
<PAGE>
The table below sets forth, as to all other matters voted upon, the number
of shares voted for the proposal, shares voted against each proposal and shares
that abstained.
Votes Votes Shares
Proposal For Against Abstained
-------- --------- ------- ---------
Approval of new management agreement ... 1,810,923 527,046 91,074
Authorization of the payment of
the deferred incentive compensation .... 1,771,664 563,334 94,046
Approval of the Stock Incentive Plan ... 1,737,754 603,512 88,038
All proposals were approved.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits
10. Material Contracts
(h) Amended and restated loan agreement by and between Equus
II Incorporated and NationsBank of Texas, N.A., dated
March 28, 1997.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Fund during the
period for which this report is filed.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed by the
undersigned, thereunto duly authorized.
EQUUS II INCORPORATED
By: /s/ NOLAN LEHMANN
Nolan Lehmann, President,
Principal Financial and
Accounting Officer
Date: May 15, 1997
22
FIRST AMENDMENT TO AMENDED AND RESTATED LOAN AGREEMENT
THIS FIRST AMENDMENT TO AMENDED AND RESTATED LOAN AGREEMENT ("First
Amendment") is made and entered into as of the 28th day of March, 1997, by and
between Equus II Incorporated, a Delaware corporation, with offices and place of
business at 2929 Allen Parkway, Houston, Texas 77019 (hereinafter called
"Borrower") and NationsBank of Texas, N.A. a national banking association, with
offices at 700 Louisiana, Houston, Texas 77002 (hereinafter called "Lender").
For and in consideration of the mutual covenants and agreements herein
contained, Borrower and Lender hereby amend as of the date of this Agreement
that certain Amended and Restated Loan Agreement ("Loan Agreement") between
Borrower and Lender dated as of the 29th day of March 1996, in the following
respects:
Section 1. AMENDMENTS TO LOAN AGREEMENT.
(a) Section 1.1 of the Loan Agreement is hereby amended to read as
follows:
"1.1 INDEBTEDNESS. Upon the terms and conditions hereinafter set
forth, the Lender agrees to lend to and/or issue letters of credit for the
account of Borrower in an aggregate of up to $30,000,000.00 outstanding at
any time as evidenced by the Credit Facility to be extended to the
Borrower by the Lender as more specifically described in Section 1.3 and
Section 1.4 hereof."
(b) The definition of "Commitment Fee - Facility C" is hereby amended to
read as follows:
"(12) "Commitment Fee-Facility C" shall mean a fee in the amount of
$50,000, payable upon execution of this Agreement and a fee in the amount
of $75,000 payable on March 28, 1997."
<PAGE>
(c) The definition of "Maturity Date" is hereby amended to read as
follows:
"(36) "Maturity Date" means April 1, 1998."
(d) The first sentence of Section 1.3(a) of the Loan Agreement is hereby
amended to read as follows:
"(a) agrees to make Loans to Borrower pursuant to a revolving line
of credit up to but not in excess of an aggregate principal amount
outstanding at any time of $22,500,000.00, provided the aggregate amount
of Loans outstanding pursuant to this Section 1.3, when combined with the
amount of outstanding Credits, shall not exceed Borrowing Base A."
(e) Section 1.4(c) of the Loan Agreement is hereby amended to read as
follows:
"(c) In the event the Borrower completes an equity offering,
Borrower shall either (i) repay the outstanding principal balance of
Revolving Facility B in full or (ii) if the net proceeds are less than the
outstanding principal balance of Revolving Facility B, apply 100% of the
net proceeds of such offering to Revolving Facility B within ten (10) days
following completion of such offering and no advances shall be permitted
pursuant to Revolving Facility B for a period of one (1) Business Day
following such repayment."
(f) Section 1.7(a) and 1.7(b) of the Loan Agreement are hereby amended to
read as follows:
"1.7 FACILITY C. (a) The Lender, during the period from the date of
this Agreement until April 1, 1998, subject to the terms and conditions of
this Agreement, and subject to the condition that at the time of each
borrowing issuance hereunder no Default or Event of Default has occurred
and is then continuing to occur and that the representations and
warranties given by the Borrower in Section 2 as of the date of this
Agreement shall remain true and correct in all material respects (except
for representations and warranties (i) which are made as of a particular
date or (ii) as to which the facts which gave rise to the representation
or warranty have changed as a result of circumstances or transactions
which are contemplated or permitted pursuant to this Agreement), agrees to
make a loan to Borrower up to but not in excess of an aggregate principal
amount outstanding at any time of $65,000,000, on the same Business Day
upon receipt
-2-
<PAGE>
from Borrower on or before 1:00 p.m. Houston time of written applications
for the loan hereunder in the form attached as Exhibit "1.3.1".
(b) The Borrower's obligation to repay Facility C shall be evidenced
by a promissory note of the Borrower in substantially the form attached as
Exhibit "1.7" hereto, payable to the order of Lender. The Facility C Note
shall bear interest at a variable interest rate of one percent (1%) over
the Cash Collateral Account Rate per annum not to exceed the maximum
non-usurious interest rate permitted by applicable law with principal
amounts due on or before the fifth (5th) Business Day after each principal
advance, interest due monthly on the 15th of each month and concurrently
with principal payments, and the balance of principal plus accrued and
unpaid interest due and payable on or before April 1, 1998."
(g) Section 3.1(g) of the Loan Agreement is hereby amended to read as
follows:
"(g) on or before March 28, 1997, Borrower will provide Lender
updated summary information regarding the Portfolio Investments in form
and substance satisfactory to Lender, indicating information as of such
date relating to buy-sell rights and obligations, funding obligations,
restrictions on transfer, voting agreements, registration rights and such
similar information as Lender may reasonably request."
(h) Section 3.10(a) of the Loan Agreement is hereby amended to read as
follows:
"(a) The aggregate indebtedness pursuant to Revolving Facility A and
the amount of outstanding Credits shall never exceed Borrowing Base A. The
Borrowing Base A is the lesser of (i) $22,500,000 and (ii) fifty percent
(50%) of the Current Fair Market Value of Borrower's Eligible Public
Securities provided that the sum of (x) indebtedness pursuant to Revolving
Facility A plus (y) outstanding Credits plus (z) indebtedness pursuant to
Revolving Facility B shall not exceed thirty-three percent (33%) of
Borrower's Net Asset Value."
(i) Section 3.10(b) of the Loan Agreement is hereby amended to read as
follows:
"(b) The aggregate indebtedness pursuant to Revolving Facility B
shall never exceed Borrowing Base B. The Borrowing Base B is the least of
(i) $7,500,000, (ii) twenty-five percent (25%) of the Current Fair Market
Value of the Eligible Other Securities and (iii) Borrowing Base A,
provided that the
-3-
<PAGE>
sum of (x) indebtedness pursuant to Revolving Facility A plus (y)
outstanding Credits plus (z) indebtedness pursuant to Revolving Facility B
shall not exceed thirty-three percent (33%) of Borrower's Net Asset
Value."
(j) Section 4.1(b) of the Loan Agreement is hereby amended to read as
follows:
"(b) indebtedness for borrowed money and capitalized lease
obligations not to exceed, in the aggregate, $500,000 outstanding at any
time; and".
(k) Exhibit 2.4 to the Loan Agreement is hereby replaced with Exhibit 2.4
attached hereto, and all references in the Loan Agreement as amended by this
First Amendment to "Exhibit 2.4" shall refer to Exhibit 2.4 attached hereto.
(l) The reference in the Borrowing Base Certificate, attached as Exhibit
"3.10" to the Loan Agreement, to "$20,000,000" is hereby amended to read
"$30,000,000".
Section 2. CLOSING.
The closing of the transactions contemplated by this First Amendment is
subject to the satisfaction of the following conditions.
2.1 COUNSEL TO LENDER. All legal matters incident to the transactions
herein contemplated shall be satisfactory to Gardere Wynne Sewell & Riggs,
L.L.P., counsel to the Lender.
2.2 REQUIRED DOCUMENTS.
(a) The Lender shall have received certified copies of resolutions of the
Board of Directors of the Borrower in form and substance satisfactory to Lender
with respect to authorization of this First Amendment, the Facility A Promissory
Note of the Borrower dated the date hereof in favor of the Lender in the
-4-
<PAGE>
original principal amount of $22,500,000, the Facility B Promissory Note of the
Borrower dated the date hereof in favor of the Lender in the original principal
amount of $7,500,000, the Facility C Promissory Note of the Borrower dated the
date hereof in favor of the Lender in the original principal amount of
$65,000,000 (collectively, the "Notes"), the Ratification of Security Agreement
- - Pledge dated as of the date hereof (the "Ratification of Security Agreement"),
and the other corporate instruments provided for herein.
(b) The Lender shall have received a certificate of the Secretary of the
Borrower of the names of officers of the Borrower to sign this First Amendment,
the Notes, the Ratification of Security Agreement and the other instruments or
certificates related hereto together with the true signatures of such officers.
(c) The Lender shall have received fully executed copies of the First
Amendment, the Notes, and the Ratification of Security Agreement.
(d) The Lender shall have received originals of all certificates, notes or
other instruments subject to the Security Agreement - Pledge dated as of March
18, 1996 between Borrower and Lender, as ratified by the Ratification of
Security Agreement.
2.3 OPINION OF COUNSEL. The Lender shall have received from Porter &
Hedges, L.L.P., counsel to the Borrower, a written opinion, satisfactory to the
Lender and its counsel.
2.4 COMMITMENT FEE. The Lender shall have received a commitment fee from
the Borrower in the amount of $10,000.
-5-
<PAGE>
Section 3. RATIFICATION.
Except as amended hereby, the Loan Agreement shall remain unchanged and
the terms, conditions, representations, warranties, and covenants of said Loan
Agreement and the Security Instruments, including but not limited to the
Security Agreement, are true as of the date hereof, are ratified and confirmed
in all respects and shall be continuing and binding upon the parties.
Section 4. DEFINED TERMS.
All terms used in this First Amendment which are defined in the Loan
Agreement shall have the same meaning as in the Loan Agreement, except as
otherwise indicated in this First Amendment.
Section 5. MULTIPLE COUNTERPARTS.
This First Amendment may be executed by the parties hereto in several
separate counterparts, each of which shall be an original and all of which taken
together shall constitute one and the same agreement.
Section 6. APPLICABLE LAW.
This First Amendment shall be deemed to be a contract under and subject
to, and shall be construed for all purposes in accordance with the laws of the
State of Texas.
Section 7. FINAL AGREEMENT.
THE WRITTEN LOAN AGREEMENTS IN CONNECTION WITH THIS FIRST AMENDMENT
REPRESENT THE FINAL AGREEMENT BETWEEN THE BORROWER AND THE LENDER AND MAY NOT BE
CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL
AGREEMENTS OF THE BORROWER AND THE LENDER. THERE ARE NO UNWRITTEN ORAL
AGREEMENTS BETWEEN THE
-6-
<PAGE>
LENDER AND THE BORROWER.
IN WITNESS WHEREOF, the parties have caused this First Amendment to be
executed by their duly authorized officers as of the 28th day of March, 1997.
EQUUS II INCORPORATED
By: /s/ PATRICK M. CAHILL
Name: Patrick M. Cahill
Title: Vice President
NATIONSBANK OF TEXAS, N.A.
By: /s/ LARRY B. BELL
Name: Larry B. Bell
Title: Senior Vice President
-7-
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<ARTICLE> 6
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> MAR-31-1997
<INVESTMENTS-AT-COST> 138,462,450
<INVESTMENTS-AT-VALUE> 186,481,499
<RECEIVABLES> 408,025
<ASSETS-OTHER> 343,365
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<NET-INVESTMENT-INCOME> (818,159)
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<APPREC-INCREASE-CURRENT> 6,347,585
<NET-CHANGE-FROM-OPS> 1,593,472
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 0
<DISTRIBUTIONS-OF-GAINS> 0
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<NUMBER-OF-SHARES-SOLD> 0
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<ACCUMULATED-NII-PRIOR> 0
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