SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED)
For the fiscal period ended December 31, 1995
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
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 77019
HOUSTON, TEXAS -------------------
- ------------------------------- (Zip Code)
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[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in the definitive proxy or information statement
incorporated by reference in Part III of this 10-K. [ ]
Approximate aggregate market value of common stock held by non-affiliates of the
registrant: $47,439,839, computed on the basis of $15.375 per share, closing
price of the common stock on the American Stock Exchange, Inc. on February 23,
1996. For purposes of calculating this amount only, all Directors and executive
officers of the registrant have been treated as affiliates. There were 3,138,575
shares of the registrant's common stock, $.001 par value, outstanding as of
February 23, 1996. The net asset value of a share at December 31, 1995 was
$19.71.
Documents incorporated by reference: Proxy Statement for 1996 Annual Meeting of
Stockholders is incorporated by reference in Part III.
Part III, Item II
Index to Exhibits on Page 51
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business ......................................................................................... 1
Item 2. Properties ...................................................................................... 15
Item 3. Legal Proceedings ............................................................................... 16
Item 4. Submission of Matters to a Vote of Security Holders.............................................. 16
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters............................ 16
Item 6. Selected Financial Data.......................................................................... 18
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..............................................................19
Item 8. Financial Statements and Supplementary Data...................................................... 25
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.............................................................48
PART III
Item 10. Directors and Executive Officers of the Registrant............................................... 48
Item 11. Executive Compensation........................................................................... 48
Item 12. Security Ownership of Certain Beneficial Owners and Management................................... 48
Item 13. Certain Relationships and Related Transactions................................................... 48
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................. 48
ii
ITEM 1. BUSINESS.
Equus II Incorporated (the "Fund") is a Delaware corporation and the
successor to Equus Investments II, L.P. (the "Partnership" or "Predecessor
Entity") pursuant to a reorganization in which all assets and liabilities of the
Partnership were transferred to the Fund on July 1, 1992, in exchange for shares
of common stock of the Fund (the "Exchange"). References to the Fund are
intended to include the Partnership where the context requires. The Fund seeks
to achieve capital appreciation principally by making investments in equity and
equity-oriented securities issued by privately-owned companies in transactions
negotiated directly with such companies ("Portfolio 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 (the "Investment Company Act").
On June 30, 1993, Equus Investments Incorporated ("EQI"), a Delaware
corporation and business development company was merged with and into the Fund.
Pursuant to the Agreement and Plan of Merger dated March 26, 1993, as amended,
(the "Merger"), all outstanding shares of EQI were converted into 0.54 of a
share of the Fund's common stock. The Fund issued 1,147,137 shares of common
stock, net of 130 shares redeemed in lieu of fractional shares, in connection
with the Merger. The Merger of EQI into the Fund was recorded as a "pooling of
interests" for financial statement reporting purposes. Accordingly, the
financial statements of the Fund were restated to include operating results of
EQI for the year ended December 31, 1993, along with the selected per share data
and ratios for the three years ended December 31, 1993.
The Fund has eight directors. Five of such directors are disinterested
individuals (the "Independent Directors") as defined by the Investment Company
Act. The directors are responsible for providing overall guidance and
supervision of the Fund, approving the Fund's investments and performing various
duties imposed on directors of a business development company by the Investment
Company Act. Among other things, the Independent Directors supervise the
management arrangements for the Fund, the custody arrangements with respect to
portfolio securities, the selection of independent accountants, fidelity bonding
and any transactions with affiliates.
The Fund has engaged Equus Capital Management Corporation, a Delaware
corporation (the "Management Company"), to provide certain investment management
and administrative services to the Fund. Subject to the supervision of the
directors, the Management Company performs, or arranges for third parties to
perform, the management, administrative, certain investment advisory and other
services necessary for the operation of the Fund. The Management Company
identifies, evaluates, structures, monitors and disposes of the Fund's
investments. The Management Company also manages the Fund's cash and short-term,
interest-bearing investments and provides the Fund, at the Management Company's
expense, with the office space, facilities, equipment and personnel (whose
salaries and benefits are paid by the Management Company) necessary to enable
the Fund to conduct its business.
Equus Capital Corporation, a Delaware corporation (the "Sub-Adviser"),
is the subordinated investment adviser to the Fund and is responsible for
preparing the Fund's quarterly net asset valuations and providing certain
investment advice to the Fund.
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The Management Company, the Sub-Adviser, their officers and directors
and the officers of the Fund are collectively referred to herein as
"Management". The Fund's principal office is located at 2929 Allen Parkway,
Suite 2500, Houston, Texas 77019-2120, and the telephone number is (713)
529-0900.
BORROWING
The Fund may borrow funds to facilitate the making of new or follow-on
investments, to maintain its pass-through tax status as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986 (the "Code") or
to pay contingencies and expenses. The Fund is permitted under the Investment
Company Act to borrow funds if, immediately after the borrowing, it will have an
asset coverage (as defined in the Investment Company Act) of at least 200%. That
is, the Fund may borrow funds in an amount up to 50% of the value of its assets,
including investments made with borrowed funds. The amount and nature of any
Fund borrowings will depend upon a number of factors over which neither the
directors, the Management Company nor the Sub-Adviser has control, including
general economic conditions, conditions in the financial markets and the impact
of the financing on the tax treatment of the stockholders. The use of leverage
even on a short-term basis could have the effect of magnifying increases or
decreases in the Fund's net asset value.
LOSS OF CONDUIT TAX TREATMENT
It is intended that the Fund will continue to qualify for pass-through
tax treatment as a regulated investment company under Subchapter M of the Code,
as it has in 1995 and prior years. A regulated investment company maintains
essentially the same pass-through tax benefits as a partnership. The Fund may
cease to qualify for conduit tax treatment if it is unable to comply with the
diversification requirements contained in Subchapter M of the Code. Subchapter M
requires that at the end of each quarter (i) at least 50% of the value of the
Fund's assets must consist of cash, government securities and other securities
of any one issuer that do not represent more than 5% of the value of the Fund's
total assets and 10% of the outstanding voting securities of such issuer, and
(ii) no more than 25% of the value of the Fund's assets may be invested in the
securities of any one issuer (other than United States government securities),
or of two or more issuers that are controlled by the Fund and are engaged in the
same, similar or related trades or businesses. The Fund will borrow funds if
necessary to make qualifying investments to satisfy the foregoing
diversification requirements. If the Fund fails to satisfy such diversification
requirements and ceases to qualify for conduit tax treatment, the Fund will be
subject to income tax on its income and gains and stockholders will be subject
to income tax on distributions.
Failure by the Fund to distribute a sufficient portion of its net
investment income and net realized capital gains could result in a loss of
pass-through tax status or subject the Fund to a 4% excise tax. Under the
Investment Company Act, the Fund will not be permitted to make distributions to
stockholders unless it meets certain asset coverage requirements. See
"Regulation."
INVESTMENT PRACTICES
Substantially all of the net assets of the Fund are invested or
committed to be invested in securities of Portfolio Companies. Substantially all
amounts not invested in securities of Portfolio Companies are invested in
short-term, highly liquid investments consisting of interest-bearing bank
accounts, certificates of deposit or securities issued or guaranteed as to
interest and principal by the United States or by a person or entity controlled
or supervised by and acting as an instrumentality of the government of the
United States that have maturities of less than one year from the date of
investment or other short-term, highly liquid investments providing, in the
opinion of the Management Company, appropriate safety of principal.
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The Fund's investments in portfolio securities are usually structured
in private transactions negotiated directly with the owner or issuer of the
securities acquired. Such securities consist principally of common stock and
securities convertible into common stock, but may also consist of a combination
of debt and equity securities, warrants, options and other rights to acquire
such securities or partnership interests.
The Fund is concentrating its investment efforts on companies of a type
and size that, in management's view, provide opportunities for significant
capital appreciation, relative ease of acquisition and disposition, reduced
competition for investments and prudent diversification of risk.
The enterprise value of a Portfolio Company typically ranges from
$15,000,000 to $75,000,000, at the time of the Fund's initial investment. The
Fund's initial investment in a Portfolio Company typically ranges from
$2,000,000 to $7,000,000, depending on the investment. The balance of the
purchase price of a Portfolio Company is supplied by debt financing and other
equity investors, if necessary.
The Fund is attempting to reduce certain of the risks inherent in
private equity-oriented investments by investing in a portfolio of companies
involved in different industries. The Fund has limited its initial investment
(whether in the form of equity or debt securities, commitments to purchase
securities or debt guaranties) in any Portfolio Company to no more than 15% of
the Fund's net assets. However, if a follow-on investment is available or
required, as discussed below, the Fund's investment in a particular Portfolio
Company may exceed these initial investment limitations. Also, investments in
certain Portfolio Companies may be in excess of the Fund's initial investment
limitations due to increases in the value of such investments.
The Fund may make investments as a sole investor, with other
professional investors or with other persons. The Fund ordinarily will not be
the sole investor in a Portfolio Company. Joint equity participants may include
management of the Portfolio Company, other business development companies, small
business investment companies, other institutional or individual investors or
venture capital groups. The investment position of the Fund and its
co-investors, if any, in Portfolio Companies will typically involve a
substantial, and may constitute a controlling, interest in such companies.
INVESTMENT CRITERIA
Prospective investments are evaluated by Management based upon criteria
that may be modified from time to time. The criteria currently being used by
Management in determining whether to make an investment in a prospective
Portfolio Company include:
1. The presence or availability of competent management;
2. The existence of a substantial market for the products or
services of the company characterized by favorable growth
potential, or a substantial market position in a stable
industry;
3. The existence of a history of profitable operations or a
reasonable expectation that operations can be conducted at a
level of profitability acceptable in relation to the proposed
investment; and
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4. The willingness of the company to permit the Fund and its
co-investors, if any, to take a substantial position in the
company and have representation on its board of directors, so
as to enable the Fund to influence the selection of management
and basic policies of the company.
CO-INVESTMENTS
The Fund has coinvested in certain Portfolio Companies with Equus
Capital Partners, L.P., a Delaware limited partnership and an affiliate of the
Fund ("ECP"). The Fund and Management obtained an order from the Securities and
Exchange Commission (the "SEC") exempting the Fund from certain prohibitions
contained in the Investment Company Act relating to coinvestments by the Fund
and ECP. Under the terms of the order, Portfolio Securities purchased by the
Fund and ECP were required to meet certain guidelines or be approved in advance
by the Independent Directors and were required to satisfy certain conditions
established by the SEC.
INVESTMENT OPERATIONS
The investment operations of the Fund consist principally of the
following basic activities:
IDENTIFYING INVESTMENTS. Investment opportunities are identified for
the Fund by the Management Company, the Sub-Adviser and their respective
officers and directors. Investment proposals may, however, come to the Fund from
many other sources, and may include unsolicited proposals from the public and
referrals from banks, lawyers, accountants and members of the financial
community. Subject to the approval of the Board of Directors, the Fund may pay
such persons (including affiliates of Management other than directors, officers
and employees of the Sub-Adviser and the Management Company) finder's fees to
the extent permissible under applicable law and consistent with industry
practice.
EVALUATING INVESTMENT OPPORTUNITIES. Prior to committing funds to an
investment opportunity, due diligence is conducted to assess the prospects
and risks of the potential investment. See "Investment Criteria" above.
STRUCTURING INVESTMENTS. Portfolio Company investments typically are
negotiated directly with the prospective Portfolio Company or its affiliates.
The Management Company structures the terms of a proposed investment, including
the purchase price, the type of security to be purchased and the future
involvement of the Fund and affiliates in the Portfolio Company's business
(including representation on its board of directors). The Management Company
seeks to structure the terms of the investment so as to provide for the capital
needs of the Portfolio Company and at the same time maximize the Fund's
opportunities for capital appreciation in its investment.
PROVIDING MANAGEMENT ASSISTANCE AND MONITORING OF INVESTMENTS.
Successful private equity investments typically require active monitoring of,
and significant participation in, major business decisions of Portfolio
Companies. In most cases, officers of the Fund serve as members of the boards of
directors of Portfolio Companies. Such management assistance is required of a
business development company under the Investment Company Act and is intended to
enable the Fund to provide guidance and management assistance with respect to
such matters as capital structure, budgets, profit goals, diversification
strategy, financing requirements, management additions or replacements and
development of a public or private market for the securities of the Portfolio
Company. In connection with their service as directors of Portfolio Companies,
officers and directors of Management may receive and retain directors' fees or
reimbursement for expenses incurred. When necessary, the Management Company,
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on behalf of the Fund, may also assign staff professionals with financial or
management expertise to assist Portfolio Company management on specific
problems.
CURRENT PORTFOLIO COMPANIES
A. C. LIQUIDATING CORPORATION
A. C. Liquidating Corporation ("ACL"), Houston, Texas, has disposed of
its operating businesses and currently holds two parcels of real estate and a
note receivable. ACL is offering the real estate for sale and intends to
distribute the net proceeds of such sale, collections on the note receivable and
its remaining cash to its shareholders as soon as possible. At December 31,
1995, the Fund's investment in ACL consisted of $188,014 in 10% secured
promissory notes and $488,500 in 10% Series C cumulative preferred stock, and
the investment was valued at $188,014. Stock held by the Fund represents a 49%
fully-diluted equity interest in ACL. Mr. Lehmann, President of the Fund, serves
as a director of ACL.
ALLIED WASTE INDUSTRIES, INC. (NASDAQ: AWIN)
Allied Waste Industries, Inc. ("Allied"), Scottsdale, Arizona, is
involved in the acquisition and management of solid waste disposal operations.
The Company owns or operates 33 collection companies, 21 transfer stations, 18
landfills and 8 recycling facilities located in ten states. The December 31,
1995 closing price of Allied's common stock on the NASDAQ National Market was
$7.125 per share. At December 31, 1995, the Fund's investment in Allied, valued
at $8,768,825 with a cost of $5,316,834, consisted of 1,397,698 shares of
restricted common stock valued at an average of $6.27 per share, and warrants to
buy up to 303,044 shares of common stock at prices ranging from $4.60 to $13.50
per share. The valuation discount, due to restrictions on the Fund's ability to
sell the common stock and warrants, results in an aggregate reduction in value
recorded by the Fund from the market price on December 31, 1995, of $1,867,084.
The Fund's investment in Allied represents an approximate 3% fully-diluted
equity interest in Allied. Mr. Lehmann serves on Allied's Board of Directors.
AMERICAN RESIDENTIAL SERVICES, INC.
American Residential Services, Inc. ("ARS"), Houston, Texas, was
created to acquire existing businesses which provide plumbing, heating and air
conditioning and electrical services to the residential community. Through
December 31, 1995, the Fund had advanced $50,000 to ARS as partial funding
pursuant to a $200,000 prime rate promissory note. Subsequent to December 31,
1995, the Fund committed to invest up to an additional $1,400,000 in ARS,
subject to certain conditions.
BSI HOLDINGS, INC., FORMERLY BRAZOS SPORTSWEAR, INC., AND RELATED ENTITIES
BSI Holdings, Inc. ("BSI"), Cincinnati, Ohio, is a licensed sportswear
company with operating facilities in nine states. BSI sells to over 15,000
customers, including Wal-Mart, Target and JC Penney, under seven different
trademarks or labels. At December 31, 1995, the Fund's investment in BSI, valued
at $6,028,500 with a cost of $4,858,500, consisted of 166,250 shares of common
stock, $3,350,000 in a 12% senior subordinated debenture, $178,500 in a 10%
subordinated promissory note and warrants to buy up to 64,715 shares of common
stock for $0.01 per share. In addition, the Fund has committed to invest up to
an additional $5,000,000 in BSI, under certain circumstances. The Fund's
investment in BSI represents an approximate 58% fully-diluted equity interest.
Mr. Lehmann and Mr. Hale, a Vice President of the Fund, serve as directors of
BSI.
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GCS RE, Inc. ("GCS"), Houston, Texas, was formed to be a general
partner of a real estate partnership, which owns a warehouse that is leased to
BSI. At December 31, 1995, the Fund's investment in GCS consisted of 1,000
shares of common stock that was valued at $132,910, its original cost. The Fund
owns 100% of the stock of GCS, and GCS owns 50% of the real estate partnership.
In addition, the Fund has committed to invest up to an additional $565,500 in
GCS, under certain circumstances. Mr. Douglass, Chairman and CEO of the Fund,
and Mr. Lehmann serve on the Board of Directors of GCS.
Sports/Leisure, Inc. ("SLI"), Boca Raton, Florida, is a distributor of
leisure sporting wear. At December 31, 1995, the Fund's investment in SLI, which
was received in exchange for preferred stock of BSI, was valued at $5,881 with a
cost of $87,739 and consisted of 87,632 shares of common stock and $5,005
outstanding under an 8% unsecured promissory note. The Fund's investment in SLI
represents less than a 1% fully-diluted equity interest.
CARDIOVASCULAR VENTURES, INC.
Cardiovascular Ventures, Inc. ("CVI"), New Orleans, Louisiana, develops
and operates freestanding clinics for cardiac catheterization procedures. CVI
currently operates six clinics in Florida, Maryland and Texas. At December 31,
1995, the Fund's investment in CVI consisted of 150,000, 214,286 and 56,717
shares of Series A, Series B and Series C convertible preferred stock,
respectively, valued at $1,373,138, its original cost. The Fund's investment
represents an approximate 9% fully-diluted equity interest in CVI.
CARRUTH-DOGGETT INDUSTRIES, INC.
Carruth-Doggett Industries, Inc. ("CDI"), Houston, Texas, operates five
Case Equipment dealerships in the Houston area, which are involved in the sale
or rental of new and used equipment, parts and services. Case is the second
largest manufacturer of farm equipment in North America and the largest
manufacturer of light and medium-sized equipment in the world. At December 31,
1995, the Fund's investment in CDI, valued at its original cost of $2,250,000,
consisted of a $2,250,000, 10% senior subordinated promissory note, a warrant to
buy up to 33,333 shares of CDI for $.01 per share and a warrant to buy up to 333
shares of CDE Corp for $.01 per share. The Fund's investment in CDI represents a
25% fully-diluted equity interest. Mr. Forbes, a Vice President of the Fund,
serves on CDI's Board of Directors.
CHAMPION HEALTHCARE CORPORATION (AMEX: CHC)
Champion Healthcare Corporation ("CHC"), Houston, Texas, was organized
to acquire acute care hospitals in suburban markets, with primary emphasis given
to hospitals that have significant opportunity for improving market share and
cash flow. In December 1994, CHC merged into AmeriHealth Corporation, which was
renamed Champion Healthcare Corporation. Champion currently operates nine
hospitals in seven states. The December 31, 1995 closing price of CHC's common
stock on the American Stock Exchange was $5.3125 per share. At December 31,
1995, the Fund's investment in CHC, valued at $7,357,347 with a cost of
$6,436,207, consisted of 1,038,944 shares of restricted common stock, 3,601 and
83,333 shares of Series C and D convertible preferred stock, respectively, a
$1,500,000, 11% senior subordinated note and warrants to buy 50,246 shares of
common stock from $5.90 to $9.00 per share. The Series C and D preferred stock
are convertible into 7,202 and 166,666 shares of common stock, respectively. The
common stock of CHC was valued by the Fund at an average of $4.13 per share at
December 31, 1995, due to restrictions on the Fund's ability to sell such stock,
which resulted in an aggregate reduction in value from the market price on such
date of $1,226,855. The Fund's investment in CHC represents an approximate 6%
fully-diluted equity interest in CHC. Mr.
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Lehmann serves on CHC's Board of Directors.
DAVID'S SUPERMARKETS, INC.
David's Supermarkets, Inc. ("David's"), Grandview, Texas, operates a chain
of twenty-one grocery stores located in small towns in North Central Texas.
At December 31, 1995, the Fund's investment in David's, valued at
$3,334,450, with a cost of $4,069,450, consisted of 735,000 shares of
common stock, 333,445 shares of 3.5% junior preferred stock and warrants to
buy up to 538,462 shares of common stock for $1 per share. The Fund's
investment in David's represents a 14% fully-diluted equity interest. Mr.
Douglass and Mr. Forbes serve on David's Board of Directors.
DRYPERS CORPORATION (NASDAQ: DYPR)
Drypers Corporation ("Drypers"), Houston, Texas, manufactures and
distributes disposable diapers and baby wipes sold under the trade name Drypers.
Drypers is believed to be the third leading branded diaper manufacturer in the
United States, and has manufacturing facilities in Marion, Ohio; Vancouver,
Washington; Buenos Aires, Argentina and Puerto Rico. The December 31, 1995
closing price of Drypers' common stock on the NASDAQ National Market was $3.125
per share. At December 31, 1995, the Fund's investment in Drypers, valued at
$2,838,162 with a cost of $6,400,132, consisted of 1,096,892 shares of
restricted common stock and warrants to buy 6,634 shares of common stock for $4
per share. The stock was valued at an average of $2.59 per share of common stock
due to restrictions on the Fund's ability to sell such stock, which resulted in
an aggregate reduction in value from the market price on such date of $589,626.
The Fund's investment in Drypers represents an approximate 14% fully-diluted
equity interest in Drypers. Mr. Lehmann serves as a director of Drypers. The
Fund has committed to make a follow-on investment of up to $2,500,000 in Drypers
in 1996, subject to certain conditions.
GARDEN RIDGE CORPORATION (NASDAQ: GRDG)
Garden Ridge Corporation ("GRDG"), Houston, Texas, is a specialty
retailer of crafts and home decorative items. GRDG operates eleven megastores in
Kentucky, Oklahoma, Tennessee and Texas and is continuing its expansion into
other areas of the United States. GRDG completed an public offering of its
common stock in May 1995. The December 31, 1995 closing price of GRDG on the
NASDAQ National Market was $38.75 per share. At December 31, 1995, the Fund's
investment in GRDG, valued at $10,963,284 with a cost of $1,061,018, consisted
of 333,471 shares of common stock. The stock was valued at an average of $32.875
per share due to restrictions on the Fund's ability to sell such stock, which
resulted in an aggregate reduction in value from the market price on such date
of $1,958,717. The Fund's investment in GRDG represents an approximate 4%
fully-diluted equity interest in GRDG. Mr. Lehmann serves on GRDG's Board of
Directors.
INDUSTRIAL EQUIPMENT RENTALS, INC.
Industrial Equipment Rentals, Inc. ("IER"), Houma, Louisiana, rents
industrial equipment from locations in Texas, Louisiana, Alabama and
Mississippi, primarily to refineries, petrochemical plants and oil and gas
operations. At December 31, 1995, the Fund's investment in IER, valued at its
original cost of $2,366,700, consisted of 182,230 shares of common stock, 5,371
shares of junior preferred stock, 67,500 shares of Series B senior convertible
preferred stock, $1,077,778 in a 12% subordinated debenture and a $499,950, 9%
senior subordinated debenture. The Fund's investment in IER represents a 18%
fully-diluted equity interest. Mr. Lehmann and Mr. Hale serve on IER's Board of
Directors.
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MIDWAY AIRLINES CORPORATION
Midway Airlines Corporation ("Midway"), Chicago, Illinois, is a
commercial airline which began service out of Midway Airport in Chicago in the
fall of 1993. Midway now serves markets on the east coast of the U. S. from its
home base at the Raleigh-Durham Airport. At December 31, 1995, the Fund's
investment in Midway, valued at $771,000 with a cost of $4,214,226, consisted of
452,392 shares of Class C common stock, 274,761 shares of junior preferred
stock, $271,000 in a 12% subordinated note and warrants to buy up to 203,250
shares of Class C common stock for $.01 per share. The Fund's investment in
Midway represents an approximate 4.5% fully-diluted equity interest in Midway.
NCI BUILDING SYSTEMS, INC. (NASDAQ: BLDG)
NCI Building Systems, Inc. ("NCI"), Houston, Texas, manufactures and
distributes pre- engineered metal buildings and components. NCI operates
facilities in Alabama, Indiana, Mississippi, New Mexico, Tennessee and Texas.
The December 31, 1995 closing price of NCI's common stock on the NASDAQ National
Market was $24.75 per share. At December 31, 1995, the Fund's investment in NCI
consisted of 100,000 shares of common stock valued at $2,475,000 with a cost of
$159,783, which represents a 1.6% fully-diluted equity interest in NCI. Mr.
Forbes serves as a director of NCI.
RESTAURANT DEVELOPMENT GROUP, INC.
Restaurant Development Group, Inc. ("RDG"), Houston, Texas, was the
South Florida franchisee of Rally's Inc., a drive-through restaurant chain. RDG
sold its restaurants to Checkers Drive-in Restaurants, Inc. in 1994 for 676,751
shares of common stock of Checkers (NASDAQ: CHKR) and a note receivable in the
amount of $1,693,225. RDG intends to distribute to its shareholders any proceeds
from collections on the note receivable and the sale of Checkers stock. At
December 31, 1995, the Fund's investment in RDG, valued at $1,689,122 with a
cost of $3,805,278, consisted of 610,909 shares of Class A common stock, a
$639,122 prime +2% promissory note, a $350,000, 14% promissory note and warrants
to buy up to 212,500 shares of common stock for $2.80 to $3.00 per share. The
Fund's investment in RDG represents a 42% fully-diluted equity interest. Mr.
Douglass and Mr. Lehmann serve on RDG's Board of Directors.
STRATEGIC HOLDINGS, INC. AND RELATED ENTITY
Strategic Holdings, Inc. ("SHI"), Houston, Texas, was formed to acquire
Strategic Materials, Inc., formerly known as Allwaste Recycling, Inc., the glass
recycling division of Allwaste, Inc. SHI receives and processes used glass,
which is then sold to the container, fiberglass and bead industries as a raw
material source. At December 31, 1995, the Fund's investment in SHI was valued
at $6,692,308, its original cost. The Fund's investment in SHI consisted of
2,986,408 shares of common stock and 3,705,900 shares of Series B preferred
stock. Mr. Lehmann and Mr. Hale serve as directors of SHI.
SMIP, Inc. ("SMIP"), Houston, Texas, was formed to be the general
partner of a limited partnership which owns an 18% fully-diluted interest in
SHI. Management personnel of Strategic Materials, Inc. are the limited partners
of the partnership. At December 31, 1995, the Fund's investment in SMIP was
valued at $325,000, its original cost. The Fund's investment in SMIP consists of
1,000 shares of common stock and a $175,000, 15% promissory note. SMIP is
wholly-owned by the Fund.
Mr. Lehmann and Mr. Hale serve as directors of SMIP.
The Fund's investment in SHI and SMIP represents an approximate 50%
fully-diluted equity interest in SHI.
-8-
SUMMIT/DPC PARTNERS, L. P.
Summit/DPC Partners, L. P. ("DPC"), Houston, Texas, was formed to
invest in DPC Acquisition Corp, which was created to acquire Doane Products
Company, which is believed to be the largest manufacturer of private label dry
pet food in the United States. At December 31, 1995, the Fund's investment in
Summit/DPC was valued at $2,600,000, its original cost. The Fund's investment
consists of an approximate 36% limited partnership interest in DPC, which in
turn owns an approximate 17% fully-diluted interest in DPC Acquisition Corp.
TECH-SYM CORPORATION (NYSE:TSY)
CogniSeis Development, Inc. ("CogniSeis"), Houston, Texas, develops and
markets specialized computer systems consisting of geophysical application
software and appropriately configured computer equipment. On June 30, 1995,
CogniSeis was merged into Tech-Sym Corporation ("TSY"), a corporation engaged in
the design and manufacture of various products for the defense and electronics
industries. The Fund received 62,759 shares of TSY common stock in a tax-free
exchange for its CogniSeis common stock. The Fund sold 30,000 shares of TSY
during November 1995, and the remaining 32,759 shares in January 1996. The
closing market price of TSY on December 31, 1995, on the New York Stock Exchange
was $31.625. At December 31, 1995, the Fund's investment in TSY, valued at
$1,036,003 with a cost of $118,245, consisted of 32,759 shares of common stock,
which represents a fully-diluted equity interest in TSY of less than 1%.
TRAVIS INTERNATIONAL, INC.
Travis International, Inc. ("Travis"), Houston, Texas, distributes
specialty products for industrial and commercial use, including o-rings, gaskets
and sealants, builders' hardware and various other products used in the
construction industry. At December 31, 1995, the Fund's investment in Travis,
valued at $3,853,890 with a cost of $560,290, consisted of 171,284 shares of
common stock, which represents an approximate 15% fully-diluted equity interest
in Travis. Mr. Lehmann serves as a director of Travis.
VIDEO RENTAL OF PENNSYLVANIA, INC. AND RELATED ENTITY
Video Rental of Pennsylvania, Inc. ("VRP"), Houston, Texas, is the
general partner of a limited partnership that has franchise rights to operate
BLOCKBUSTER(R) Entertainment Corporation video cassette stores in the
Pittsburgh, Pennsylvania area. At December 31, 1995, the Fund's investment in
VRP, valued at $3,150,000 with a cost of $2,775,000, consisted of 125,000 shares
of common stock, 125,000 shares of 9% redeemable preferred stock and a
$2,525,000, 10% secured promissory note. The Fund's investment in VRP represents
a 50% fully-diluted equity interest. Messrs. Douglass, Lehmann, Tucker, a Vice
President of the Fund, and Dr. Williams, a director of the Fund, serve as
directors of VRP.
Equus Video Corporation ("Video"), Houston, Texas, was formed by the
Fund to own a 50% limited partnership interest in a partnership whose sole
general partner is a corporation owned by VRP. The limited partnership is
developing additional BLOCKBUSTER(R) Entertainment Corporation video cassette
stores in and around Pittsburgh. At December 31, 1995, the Fund's investment in
10,000 shares of common stock of Video was valued at $25,000, its original cost.
Mr. Douglass and Mr. Lehmann serve as directors of Video.
-9-
WILLIAMS & METTLE CO.
Williams & Mettle Co. ("W&M"), Houston, Texas, manufactures and
distributes wire cloth products and products used in industrial filtering and
screening applications in oil and gas production and in water pollution
monitoring wells. At December 31, 1995, the Fund's investment in W&M, valued at
$1,585,826 with a cost of $2,146,305, consisted of 657,895 shares of common
stock, 138,475 shares of Series A convertible preferred stock, 237,126 shares of
Series B convertible preferred stock, a $677,250, 12% subordinated promissory
note, a $512,576 junior participation in a prime +1.75% note and a warrant to
buy 456,718 shares of common stock for $0.01 per share. The fund's investment in
W&M represents an approximate 55% fully-diluted equity interest. Mr. Forbes
serves on the Board of Directors of W&M.
YELLOW CAB SERVICE CORPORATION
Yellow Cab Service Corporation, ("Yellow Cab"), Houston, Texas, is
engaged in taxi and transportation services in Houston and Austin, Texas and
Colorado Springs, Colorado, primarily through independent driver-owners. At
December 31, 1995, the Fund's investment in Yellow Cab, valued at $1,750,000
with a cost of $5,134,515, consisted of 1,006,701 shares of common stock and two
3% subordinated notes with principal balances totaling $5,172,097. The Fund's
investment in Yellow Cab represents an approximate 5% fully-diluted equity
interest in Yellow Cab.
TEMPORARY INVESTMENTS
Pending investment in Portfolio Companies, the Fund invests its
available funds in interest-bearing bank accounts, money market mutual funds,
U.S. Treasury securities and/or certificates of deposit with maturities of less
than one year (collectively, "Temporary Investments"). Temporary Investments may
also include commercial paper (rated or unrated) and other short-term
securities. Temporary Investments constituting cash, cash items, securities
issued or guaranteed by the U.S. Treasury or U.S. Government agencies and high
quality debt securities (commercial paper rated in the two highest rating
categories by Moody's Investor Services, Inc. or Standard & Poor's Corporation,
or if not rated, issued by a company having an outstanding debt issue so rated
with maturities of less than one year at the time of investment will qualify for
determining whether the Fund has 70% of its total assets invested in Managed
Companies (as hereafter defined) or in qualified Temporary Investments for
purposes of the business development company provisions of the Investment
Company Act. See "Regulation" below.
FOLLOW-ON INVESTMENTS
Following its initial investment in a Portfolio Company, the Fund may
be requested to make follow-on investments in the company. Follow-on investments
may be made to take advantage of warrants or other preferential rights granted
to the Fund or otherwise to increase the Fund's position in a successful or
promising Portfolio Company. The Fund may also be called upon to provide
additional equity or loans needed by a Portfolio Company to implement fully its
business plans, to develop a new line of business or to recover from unexpected
business problems. The Fund may make follow-on investments in Portfolio
Companies from funds on hand or may borrow all or a portion of the funds
required to make such follow-on investments.
DISPOSITION OF INVESTMENTS
The method and timing of the disposition of the Fund's portfolio
investments is critical to the realization of capital appreciation. The Fund
expects to dispose of its portfolio securities through a
-10-
variety of transactions, including sales of Portfolio Companies to third
parties, sales of portfolio securities in underwritten public offerings, public
sales of such securities pursuant to exemptions from registration requirements
and negotiated private sales of such securities to the Portfolio Company itself
or to other investors. In addition, the Fund may distribute its portfolio
securities in-kind to the shareholders. In structuring investments, the Fund
endeavors to reach such agreements or understandings with a prospective
Portfolio Company as may be appropriate with respect to the method and timing of
the disposition of the Fund's investment and, if appropriate, seeks to obtain
registration rights at the expense of the Portfolio Company. The Fund bears the
costs of disposing of investments to the extent not paid by the Portfolio
Company.
OPERATING EXPENSES
The Management Company, at its expense, provides the Fund with office
space, facilities, equipment and personnel (whose salaries and benefits are paid
by the Management Company) necessary for the conduct of the Fund's business and
pays all costs related to proposed acquisitions of portfolio securities that are
not completed, unless such proposed acquisitions have been previously approved
by the Board of Directors of the Fund.
The Fund is responsible for paying certain expenses relating to its
operations, including: management fees and incentive compensation to the
Management Company; fees and expenses of the Independent Directors; finder's
fees; direct costs of proposed investments in Portfolio Companies, whether or
not completed, if such proposed investments have been approved for acquisition
by the Fund by the Board of Directors of the Fund; depositary fees of
unaffiliated depositaries; fees of unaffiliated transfer agents, registrars and
disbursing agents; the administrative fee to the Management Company; portfolio
transaction expenses; interest; legal and accounting expenses; costs of printing
and mailing proxy materials and reports to shareholders; American Stock Exchange
fees; custodian fees; litigation costs; costs of disposing of investments
including brokerage fees and commissions; and other extraordinary or
nonrecurring expenses and other expenses properly payable by the Fund.
VALUATION
On a quarterly basis, the Sub-Adviser performs a valuation of the
investments in portfolio securities of the Fund, subject to the approval of the
Board of Directors of the Fund. Valuations of portfolio securities are done in
accordance with generally accepted accounting principles and the financial
reporting policies of the SEC. The applicable methods prescribed by such
principles and policies are described below.
The fair value of investments for which no market exists (including
most investments made by the Fund) is determined on the basis of procedures
established in good faith by the Board of Directors of the Fund. As a general
principle, the current "fair value" of an investment being valued by the
directors would be the amount the Fund might reasonably expect to receive for it
upon its current sale. There is a range of values that are reasonable for such
investments at any particular time. Generally, cost is the primary factor used
to determine fair value until significant developments affecting the Portfolio
Company (such as results of operations or changes in general market conditions)
provide a basis for use of an appraisal valuation.
Appraisal valuations are based upon such factors as the Portfolio
Company's earnings, cash flow and net worth, the market prices for similar
securities of comparable companies and an assessment of the company's future
financial prospects. In the case of unsuccessful operations, the appraisal may
be based upon liquidation value. Appraisal valuations are necessarily
subjective.
-11-
The Fund may also use, when available, third-party transactions in a
Portfolio Company's securities as the basis of valuation (the "private market
method"). The private market method will be used only with respect to completed
transactions or firm offers made by sophisticated, independent investors.
Securities with legal, contractual or practical restrictions on transfer may be
valued at a discount from their value determined by the foregoing method to
reflect such restrictions.
Fund investments for which market quotations are readily available and
which are freely transferable will be valued as follows: (i) securities traded
on a securities exchange or the NASDAQ National Market are valued at the closing
price on the date of valuation and (ii) securities traded in the
over-the-counter market are valued at the average of the closing bid and asked
prices on the date of valuation. For securities which are in a class of public
securities but are restricted from free trading (such as Rule 144 stock),
valuation is set by discounting the closing sales or bid price to reflect the
illiquidity caused by such restrictions. The fair 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. Certificates
of deposit purchased by the Fund generally will be valued at their face value,
plus interest accrued to the date of valuation.
The Directors review the valuation policies on a quarterly basis to
determine their appropriateness and may also hire independent firms to review
the Sub-Adviser's methodology of valuation or to conduct an independent
valuation.
On a weekly basis, the Fund adjusts its net asset value for the 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 Analytical
Services, Inc. Such weekly net asset values appear in various publications,
including BARRON'S and THE WALL STREET JOURNAL.
COMPETITION FOR INVESTMENTS
The Fund encounters competition from other persons and entities with
similar investment objectives. These competitors include other leveraged buyout
partnerships, other business development companies, investment partnerships and
corporations, small business investment companies, large industrial and
financial companies investing directly or through affiliates, foreign investors
of various types and individuals, and may include Management or its affiliates.
Many of these competitors may have substantially more experience, greater
financial resources and more personnel than the Fund.
CUSTODIAN
The Fund acts as the custodian of its securities to the extent
permitted under the Investment Company Act and is subject to the restrictions
imposed on self-custodians by the Investment Company Act and the rules and
regulations thereunder. The Fund has entered into an agreement with Southwest
Guaranty Trust Company, Houston, Texas, with respect to the safekeeping of such
securities. The principal business office of such trust company is 2121 Sage
Road, Suite 150, Houston, Texas 77056.
TRANSFER AND DISBURSING AGENT
The Fund employs First Interstate Bank of Texas, N. A. ("First Interstate")
as its transfer agent to record transfers of the shares, maintain proxy
records and to process distributions. The principal business office of
First Interstate is 1000 Louisiana Street, Suite 700, Houston, Texas 77002.
-12-
RISK FACTORS
An investment in shares of the Fund involves a number of risks due to
the nature of the Fund's investment portfolio. Leveraged buyout and private
equity investments involve a high degree of business and financial risk and can
result in substantial losses. In the event that a Portfolio Company cannot
generate adequate cash flow to meet its debt service, the Fund's equity
investment could be reduced or eliminated through foreclosure on the Portfolio
Company's assets or the Portfolio Company's reorganization or bankruptcy. The
portfolio securities acquired by the Fund generally require four to seven years
to reach maturity and generally are illiquid. This lack of liquidity may
preclude or delay any disposition of such securities, or reduce proceeds that
might otherwise be realized from any such dispositions. After its initial
investment in a Portfolio Company, the Fund may be called upon from time to time
to provide additional funds to such company. There can be no assurance that the
Fund will have sufficient funds, or be willing to make such investments. The
Fund's inability or unwillingness to make a follow-on investment could adversely
affect an investment in a portfolio security. The Fund is a "non-diversified"
company as defined in the Investment Company Act. The Fund is not limited in the
proportion of its assets that may be invested in securities of a single issuer,
and, accordingly, an investment in the Fund may, under certain circumstances,
present greater risk to an investor than an investment in a diversified company.
Also see "Borrowing" and "Loss of Conduit Tax Treatment".
Shares of closed-end funds frequently trade at a discount from net
asset value. This characteristic of shares of a closed-end fund is a risk
separate and distinct from the risk that the Fund's net asset value will
decrease. The risk of purchasing shares of a closed-end fund that might trade at
a discount is more pronounced for investors who wish to sell their shares in a
relatively short period of time because for those investors, realization of a
gain or loss on their investments is likely to be more dependent upon the
existence of a premium or discount than upon portfolio performance. The Fund's
shares have traded at a discount to net asset value since inception. See "Market
for Registrant's Common Equity and Related Stockholder Matters".
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, 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. Because of the inherent uncertainty of the valuation of
portfolio securities which do not have readily ascertainable market values, 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.
REGULATION
The Investment Advisers Act generally prohibits investment advisers
from entering into investment advisory contracts with an investment company that
provide for compensation to the investment adviser on the basis of a share of
capital gains or capital appreciation of the portfolio investments or any
portion of the funds of the investment company. The Investment Advisers Act,
however, does permit the payment of compensation based on capital gains in an
investment advisory contract between an investment adviser and a business
development company. The Fund has elected to be treated as a business
development company under the Investment Company Act in order to provide for
incentive compensation to the Management Company and the Sub-Adviser based on
the capital appreciation of the Fund's investments.
-13-
The Fund may not withdraw its election to be treated as a business
development company without first obtaining the approval of a majority in
interest of its shareholders. The following brief description of the Investment
Company Act is qualified in its entirety by reference to the full text of the
Investment Company Act and the rules thereunder.
A business development company must be operated for the purpose of
investing in the securities of certain present and former "eligible Portfolio
Companies" or certain bankrupt or insolvent companies and must make available
significant managerial assistance to Portfolio Companies. An eligible Portfolio
Company generally is a company that (i) is organized under the laws of, and has
its principal place of business in, any state or states, (ii) is not an
investment company and (iii)(a) does not have a class of securities registered
on an exchange or included in the Federal Reserve Board's over-the-counter
margin list, (b) is actively controlled by the business development company
acting either alone or as part of a group acting together and an affiliate of
the business development company is a member of the Portfolio Company's board of
directors or (c) meets such other criteria as may be established by the SEC.
Control is presumed to exist where the business development company owns more
than 25% of the outstanding voting securities of a Portfolio Company.
"Making available significant managerial assistance" is defined under
the Investment Company Act to mean (i) any arrangement whereby a business
development company, through its directors, officers or employees, offers to
provide and, if accepted, does provide significant guidance and counsel
concerning the management, operations or business objectives or policies of a
Portfolio Company or (ii) the exercise of a controlling influence over the
management or policies of a Portfolio Company by the business development
company acting individually or as part of a group of which the business
development company is a member acting together which controls such company
("Managed Company"). A business development company may satisfy the requirements
of clause (i) with respect to a Portfolio Company by purchasing securities of
such a company as part of a group of investors acting together if one person in
such group provides the type of assistance described in such clause. However,
the business development company will not satisfy the general requirement of
making available significant managerial assistance if it only provides such
assistance indirectly through an investor group. A business development company
need only extend significant managerial assistance with respect to Portfolio
Companies which are treated as Qualifying Assets (as defined below) for the
purpose of satisfying the 70% test discussed below.
The Investment Company Act prohibits or restricts the Fund from
investing in certain types of companies, such as brokerage firms, insurance
companies, investment banking firms and investment companies. Moreover, the
Investment Company Act limits the type of assets that the Fund may acquire to
"Qualifying Assets" and certain assets necessary for its operations (such as
office furniture, equipment and facilities) if, at the time of the acquisition,
less than 70% of the value of the Fund's total assets consists of qualifying
assets. Qualifying Assets include (i) securities of companies that were eligible
Portfolio Companies at the time that the Fund acquired their securities; (ii)
securities of companies that are actively controlled by the Fund; (iii)
securities of bankrupt or insolvent companies that are not otherwise eligible
Portfolio Companies; (iv) securities acquired as follow-on investments in
companies that were eligible Portfolio Companies at the time of the Fund's
initial acquisition of their securities but are no longer eligible Portfolio
Companies, provided that the Fund has maintained a substantial portion of its
initial investment in such companies; (v) securities received in exchange for or
distributed on or with respect to any of the foregoing; and (vi) cash items,
government securities and high-quality, short-term debt. The Investment Company
Act also places restrictions on the nature of the transactions in which, and the
persons from whom, securities can be purchased in order for such securities to
be considered Qualifying Assets. As a general matter, Qualifying Assets may only
be purchased from the issuer or an affiliate in a transaction not constituting a
public offering. The Fund may not purchase any
-14-
security on margin, except such short-term credits as are necessary for the
clearance of portfolio transactions, or engage in short sales of securities.
The Fund is permitted by the Investment Company Act, under specified
conditions, to issue multiple classes of senior debt and a single class of
preferred stock senior to the common stock if its asset coverage, as defined in
the Investment Company Act, is at least 200% after the issuance of the debt or
the senior stockholders' interests. In addition, provisions must be made to
prohibit any distribution to common shareholders for the repurchase of any
shares unless the asset coverage ratio is at least 200% at the time of the
distribution or repurchase.
The Fund generally may sell its securities at a price that is below the
prevailing net asset value per share only upon the approval of the policy by
shareholders holding a majority of the shares issued by the Fund, including a
majority of shares held by nonaffiliated shareholders. The Fund may in
accordance with certain conditions established by the SEC sell shares below net
asset value in connection with the distribution of rights to all of its
stockholders.
Since the Fund is a closed-end business development company,
stockholders have no right to present their shares to the Fund for redemption.
Recognizing the possibility that the Fund's shares might trade at a discount,
the Board of Directors of the Fund has determined that it would be in the best
interest of stockholders for the Fund to be authorized to attempt to reduce or
eliminate a market value discount from net asset value. Accordingly, the Fund
from time to time may, but is not required to, repurchase its shares (including
by means of tender offers) to attempt to reduce or eliminate any discount or to
increase the net asset value of its shares, or both.
The Fund may repurchase its shares, subject to the restrictions of the
Investment Company Act. On June 22, 1994, the Fund's Board of Directors approved
a stock repurchase program pursuant to which the Fund repurchased and cancelled
46,200 shares of its stock for $640,159 in 1994. Such stock was repurchased at
an average discount of 28.74% from its net asset value. From March 1995 until
August 1995, pursuant to authorization from the Board of Directors, the Fund
repurchased and cancelled an additional 145,500 shares of its stock for
$1,993,642. The stock repurchased in 1995 was repurchased at an average discount
of 33.61% from its net asset value.
Many of the transactions involving the Fund and its affiliates (as well
as affiliates of such affiliates) require the prior approval of a majority of
the Independent Directors and a majority of the Independent Directors having no
financial interest in the transactions. However, certain transactions involving
closely affiliated persons of the Fund, including its Sub-Adviser and the
Management Company, require the prior approval of the SEC. In general (a) any
person who owns, controls or holds with power to vote more than 5% of the
outstanding shares, (b) any director or executive officer and (c) any person who
directly or indirectly controls, is controlled by or is under common control
with such person, must obtain the prior approval of a majority of the
Independent Directors and, in some situations, the prior approval of the SEC,
before engaging in certain transactions involving the Fund or any company
controlled by the Fund. In accordance with the Investment Company Act, a
majority of the directors must be persons who are not "interested persons" as
defined in such act. Except for certain transactions which must be approved by
the Independent Directors, the Investment Company Act generally does not
restrict transactions between the Fund and its Portfolio Companies.
ITEM 2. PROPERTIES.
The Fund does not have an interest in any physical properties.
-15-
ITEM 3. LEGAL PROCEEDINGS.
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 results of operations of the Fund will not be materially
affected by these claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the
fourth quarter of 1995.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Fund's shares of common stock began trading on the American Stock
Exchange on September 11, 1992, under the symbol "EQS". Prior to such date,
there was no established public trading market for the Fund's common stock. The
Fund had approximately 7,200 shareholders at February 16, 1996, 2,128 of which
were registered holders. Registered holders do not include those shareholders
whose stock has been issued in street name. The net asset value per share of the
Fund's common stock at December 31, 1995, was $19.71.
The following table reflects the high and low sales prices per share of
the Fund's common stock on the American Stock Exchange for the two years ended
December 31, 1995, by quarter.
Quarter
ENDED HIGH LOW
3/31/94 $18.250 $14.750
6/30/94 15.500 13.250
9/30/94 14.625 13.250
12/31/94 13.875 12.625
3/31/95 13.125 12.250
6/30/95 14.750 12.250
9/30/95 16.000 13.875
12/31/95 15.875 13.000
Historically, net investment income and net realized gains from the
sale of portfolio investments have been distributed at least annually, to the
extent such amounts were not reserved for payment of contingencies or to make
follow-on or new investments.
As a regulated investment company under Subchapter M of the Code, the
Fund is required to distribute to its shareholders, in a timely manner, at least
90% of its taxable net investment income each year. If the Fund distributes in a
timely manner, 98% of its taxable net capital gains and 98% of its taxable net
investment income each year (as well as any portion of the respective 2%
balances not distributed in the previous year), it will not be subject to the 4%
non-deductible Federal excise tax on certain undistributed income of regulated
investment companies. Under the Investment Company Act, the Fund is not
permitted to pay dividends to shareholders unless it meets certain asset
coverage requirements.
The Fund declared dividends of $5,814,990 ($2.00 per share), $763,268
($0.25 per share) and $2,049,038 ($0.68 per share) during 1995, 1994 and 1993,
respectively. The Fund adopted a policy
-16-
effective in 1995, 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. The 1994 dividend was paid in cash and represented a
return of capital. The 1995 and 1993 dividends, which represented the Fund's net
capital gains for tax purposes, were paid in additional shares of common stock
or in cash by specific election of the shareholders in December 1995 and January
1994. The Fund paid $2,753,180 and $662,594 in cash and issued 231,080 and
85,981 additional shares of stock at $13.25 and $16.125 per share in December
1995 and January 1994, respectively, in connection with such dividends.
The Fund is investing in companies that it believes have a high
potential for capital appreciation and the Fund intends to realize the majority
of its profits upon the sale of its investments in Portfolio Companies.
Consequently, most of the companies in which the Fund invests do not have
established policies of paying annual dividends.
A portion of the investments made by the Fund in portfolio securities
is comprised of interest-bearing subordinated debt securities or dividend-paying
preferred stock. The Fund will continue to distribute taxable net investment
income earned on these investments from time to time, to the extent not retained
for follow-on investments, expenses and contingencies. If taxable net investment
income is retained, the Fund will be subject to Federal income tax.
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.
-17-
ITEM 6. SELECTED FINANCIAL DATA.
Following is a summary of selected financial data and per share data of
the Fund and its predecessors for the five years ended December 31, 1995.
1995 1994 1993 1992 1991
Total investment income $ 3,075,234 $ 1,921,136 $ 1,552,410 $ 1,796,143 $ 2,814,188
Net investment income (loss) $ (668,114) $ 518,473 $ (2,812,912) $ (1,403,449) $ 1,091,375
Realized gain (loss) on sales
of portfolio securities, net $ 7,668,524 $ (350,309) $ (2,457,906) $ 10,744,375 $ (1,896,309)
Increase (decrease) in
unrealized appreciation
of portfolio securities, net $ (1,280,549) $ (2,562,801) $ 11,178,304 $ (6,033,639) $ 7,029,153
Total increase (decrease) in
net assets from operations $ 5,719,861 $ (2,394,637) $ 5,907,486 $ 3,307,287 $ 6,224,219
Dividends $ 5,814,990 $ 763,268 $ 2,049,038 $ 3,228,253 $ -
Total assets at end of year $ 132,450,176 $ 109,941,211 $ 114,411,374 $ 105,613,771 $ 85,705,097
Net assets at end of year $ 61,853,289 $ 60,880,364 $ 64,679,325 $ 59,435,596 $ 57,750,397
Net cash provided (used)
by operating activities $ (672,150) $ (185,849) $ (1,962,354) $ (324,954) $ 175,955
Shares outstanding at end
of year 3,138,575 3,053,017 3,099,272 3,013,291 2,879,654
Average shares outstanding
during year 2,968,001 3,083,581 3,013,291 2,879,654 2,879,654
PER SHARE DATA:
1995 1994 1993 1992 1991
Net investment
income (loss) $ (0.22) $ 0.17 $ (0.93) $ (0.49) $ 0.38
Realized gain (loss) on
sales of portfolio
securities, net $ 2.58 $ (0.12) $ (0.82) $ 3.73 $ (0.66)
Increase (decrease) in
unrealized apprecia-
tion of portfolio
securities, net $ (0.43) $ (0.83) $ 3.71 $ (2.10) $ 2.44
Dividends $ 2.00 $ 0.25 $ 0.68 $ 1.12 $ -
Net asset value (including
unrealized appreciation),
end of year $ 19.71 $ 19.94 $ 20.87 $ 19.72 $ 20.05
-18-
ITEM 7. 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" or "Predecessor Entity") 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 (the "Exchange"). Such shares were then distributed on a pro rata basis
to the partners of the Partnership, effectively liquidating the Partnership.
Each Limited Partner received one share of common stock of the Fund for each
unit of partnership interest owned. The Fund has qualified for pass-through tax
treatment as a "regulated investment company" under Subchapter M of the Internal
Revenue Code of 1986. On September 11, 1992, the Fund's shares of common stock
were listed for trading on the American Stock Exchange, under the symbol "EQS".
On March 26, 1993, the Fund and Equus Investments Incorporated ("EQI")
entered into an Agreement and Plan of Merger, as amended, which called for the
merger of EQI with and into the Fund (the "Merger"). Pursuant to this agreement,
on June 30, 1993, the Fund issued 1,147,137 additional shares of common stock,
net of 130 shares redeemed in lieu of fractional shares, to the stockholders of
EQI in a tax free exchange to acquire all of the outstanding common stock of
EQI. Each share of EQI was converted into 0.54 of a share of the Fund's common
stock.
At December 31, 1995, the Fund had $71,610,360 of its assets invested
in portfolio securities of 21 companies, and has committed to invest up to an
additional $9,615,500 in four of such companies and $8,600,000 in two new
companies under certain conditions. Current temporary cash investments,
anticipated future investment income, proceeds from borrowings, proceeds from
the sale of existing portfolio securities and proceeds from a proposed rights
offering of additional common stock are believed to be sufficient to finance
these commitments. At December 31, 1995, the Fund had $5,750,000 outstanding on
a $13,000,000 revolving line of credit loan from a bank. Subsequent to December
31, 1995, the Fund received a commitment for a new $20,000,000 revolving line of
credit with another bank which will replace the prior revolving line of credit.
The Fund intends to issue transferable subscription rights to existing
shareholders during the second quarter of 1996. Under the rights offering, the
Fund would effectively issue each existing shareholder a right to buy one share
of stock for every three shares currently owned. It is anticipated that the
shares would be offered at a discount from the market price at the beginning of
the offering period. In addition, it is anticipated there will be an
over-subscription privilege. This over-subscription privilege may allow
shareholders the opportunity to subscribe for additional shares at the same
discount price. The proceeds from the rights offering will be used to repay debt
and to fund the commitments the Fund has made for new and follow-on investments.
Proceeds from a rights offering may reduce the Fund's expense ratio, thus
benefiting both participating and non-participating shareholders. However,
non-participating shareholders will suffer dilution as they will own a smaller
proportional interest in the Fund.
On June 22, 1994, the Board of Directors of the Fund approved a stock
repurchase program, pursuant to which the Fund repurchased on the open market
and cancelled 46,200 shares of its stock for $640,159 in 1994. Such stock was
repurchased at an average discount of 28.74% from its net asset value. In 1995,
the Fund repurchased and cancelled 145,500 shares of its stock for $1,993,642.
The stock repurchased in 1995 was repurchased at an average discount of 33.61%
from its net asset value. The Fund has not repurchased any stock since August
1995.
-19-
Net cash used by operating activities was $402,820, $185,849 and
$1,962,354 for the three years ended December 31, 1995. Increased expenses paid
during 1993 included $1,346,839 in incentive fees to the Management Company that
were accrued by EQI as of December 31, 1992, and $454,040 in expenses related to
the June 30, 1993 merger of EQI with and into the Fund.
At December 31, 1995, the Fund had $60,232,594 of its total assets of
$132,450,176 invested in temporary cash investments consisting of money market
securities. This amount includes proceeds from a $60,000,000 note payable 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 January 2, 1996.
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 income (loss) after all expenses amounted to $(668,114),
$518,473, and $(2,812,912) for the three years ended December 31, 1995. Income
from portfolio securities increased to $2,859,707 in 1995 as compared to
$1,613,414 in 1994 and $1,184,121 in 1993, due to the increase in amounts
invested in interest and dividend-bearing portfolio securities during 1995 and
1994. The Fund also received $593,665 in dividends and payments to induce the
Fund to convert preferred stock to common stock of Champion Healthcare
Corporation in 1995, which paid none in 1994 or 1993. In addition, the Fund
accrued $185,850 of interest income on one portfolio security in 1995 which had
been completely reserved in 1994 as uncollectible. Interest income from
temporary cash investments was $215,527 in 1995, $307,722 in 1994 and $368,289
in 1993. The decrease in 1995 as compared to 1994 and 1993 was a result of lower
investable balances throughout the year.
The net investment losses in 1995 and 1993 were primarily attributable
to the accrual of $1,277,595 and $1,947,330, respectively, in deferred
management incentive fees caused by the realized gains from the sales of
portfolio securities in 1995 and an increase in the net unrealized appreciation
of portfolio securities during 1993. Also, in 1993, the Fund recorded
non-recurring expenses of $454,040 related to the Merger.
Mailing, printing and other expenses increased to $338,434 during 1995,
as compared to $165,330 during 1994 and $171,308 during 1993, due to the higher
cost for the preparation and distribution of the annual report and proxy
statement for the annual shareholder meeting held in June 1995. Interest expense
increased to $318,048 in 1995 as compared to $135,252 in 1994 and $157,317 in
1993, due to the increase of the average daily balances outstanding on the lines
of credit to $2,839,315 in 1995, from $994,520 in 1994 and $821,918 in 1993.
-20-
The Management Company receives management fee compensation at an
annual rate of 2% of the net assets of the Fund. Such fees amounted to
$1,237,775, $1,212,457 and $1,243,559 in 1995, 1994 and 1993, 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.
Incentive fee reimbursements of $203,250 were received during the year ended
December 31, 1993. Deferred management incentive fee expense (income) for 1995,
1994 and 1993 totaled $1,277,595, $(582,622) and $1,947,330, respectively. The
deferred management incentive fee expense (income) relates to the increase
(decrease) in net unrealized appreciation of portfolio securities and will not
be paid until such appreciation is realized.
REALIZED GAINS AND LOSSES ON SALES OF PORTFOLIO SECURITIES
During the year ended December 31, 1995, the Fund realized net capital
gains of $7,668,524 from the sale of securities of six Portfolio Companies. The
Fund sold 116,590 shares of Allied Waste Industries, Inc. common stock for
$1,049,310, realizing a capital gain of $490,032; 96,000 shares of Garden Ridge
Corporation common stock for $2,928,000, realizing a capital gain of $2,906,667;
175,000 shares of NCI Building Systems, Inc. common stock for $3,064,685,
realizing a capital gain of $2,785,063; 30,000 shares of Tech-Sym Corporation
for $909,433, realizing a capital gain of $801,142 and 49,444 shares of USA
Waste Services, Inc. for $899,218, realizing a capital gain of $685,620.
During the year ended December 31, 1994, the Fund realized $350,309 of
net capital losses from the sale of its investments in the securities of five
Portfolio Companies. During 1994 the Fund sold 37,501 shares of NCI for
$637,517, realizing a net capital gain of $577,596 on such sale. In addition,
the Fund received $213,944 from the escrow account related to the sale of Denver
Technologies, Inc. and received a final payment of $22,138 related to the sale
of Gulf Coast Entertainment Corporation. Such amounts were recorded as capital
gains. On July 19, 1994, the Fund sold its investment in MidCon Bottlers, L. P.
for $950,000, realizing a $910,968 capital gain. The Fund also sold 28 shares of
Travis International, Inc. preferred stock for $28,000 and 5,855 shares of
Garden Ridge Corporation common stock for $5,855, in each case at the Fund's
cost. During 1994, a loss of $2,074,955 on the Fund's investment in Springtime,
Inc. I, was realized when Springtime declared bankruptcy.
During the year ended December 31, 1993, the Fund realized $2,457,906
of net capital losses from the sale or disposition of its investments of nine
Portfolio Companies. The Fund sold 223,333 shares of A.C. Liquidating
Corporation, 228,076 shares of EnClean, Inc., 441,776 shares of NCI Building
Systems, Inc., 427,000 shares of Springtime, Inc. I, 20,000 shares of USA Waste
Services, Inc., 50,000 shares of Williams & Mettle Co. and 8,439,739 shares of
Yellow Cab Service Corporation ("Yellow Cab"), realizing net capital gains
(losses) of $(1,449,999), $(4,898), $4,725,580, $(1,070,607), $182,350,
$(944,500) and $(4,369,692), respectively. The Fund also wrote off its remaining
514,887 shares of A.C. Liquidating Corporation common stock realizing a capital
loss of $316,140. In addition, $710,000 and $80,000 of payments were received
from Gulf Coast Entertainment Corporation and La Prairie, Inc. and recorded as
capital gains.
UNREALIZED APPRECIATION AND DEPRECIATION OF PORTFOLIO SECURITIES
Net unrealized appreciation on investments decreased $1,280,549 during
the year ended December 31, 1995, from $9,255,817 to $7,975,268. Such net
decrease resulted from increases in the estimated fair value of securities of
six of the Fund's Portfolio Companies aggregating $13,601,466, decreases in the
estimated fair value of securities of five portfolio Companies aggregating
$10,971,005 and the transfer
-21-
of $3,911,010 in net unrealized appreciation to net realized gains from the sale
of investments in five companies.
Net unrealized appreciation on investments decreased $2,562,801 during
the year ended December 31, 1994, from $11,818,618 to $9,255,817. Such net
decrease resulted from increases in the estimated fair value of securities of
four of the Fund's Portfolio Companies aggregating $5,432,740, decreases in the
estimated fair value of securities of ten Portfolio Companies aggregating
$9,041,307 and a net transfer of $1,045,766 from unrealized losses to realized
losses from the disposition of investments in three companies.
Net unrealized appreciation on investments increased $11,178,304 during
the year ended December 31, 1993, from $640,314 to $11,818,618. Such net
increase resulted from increases in the estimated fair value of securities of
ten of the Fund's Portfolio Companies aggregating $11,498,594, decreases in the
estimated fair value of securities of six Portfolio Companies aggregating
$4,573,073 and a net transfer of $4,252,783 from unrealized to realized losses
from the disposition of investments in seven companies.
DIVIDENDS
The Fund declared dividends of $5,814,990 ($2.00 per share), $763,268
($0.25 per share) and $2,049,038 ($0.68 per share) during 1995, 1994 and 1993,
respectively. The Fund adopted a policy effective in 1995, 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. The 1994
dividend was paid in cash and represented a return of capital. The 1995 and 1993
dividends, which represented the Fund's net capital gains for tax purposes, were
paid in additional shares of common stock or in cash by specific election of the
shareholders in December 1995 and January 1994. The Fund paid $2,753,180 and
$662,594 in cash and issued 231,080 and 85,981 additional shares of stock at
$13.25 and $16.125 per share, in December 1995 and January 1994, respectively,
in connection with such dividends.
PORTFOLIO INVESTMENTS
During the year ended December 31, 1995, the Fund invested $11,917,308
in five new Portfolio Companies and made follow-on investments in seven
Portfolio Companies of $2,734,411, including $865,909 in accrued interest and
dividends and conversion inducement payments received in the form of additional
portfolio securities.
On May 9, 1995, Garden Ridge Corporation ("GRDG") effected a 4.5-for-1
stock split of its outstanding common stock in connection with an initial public
offering ("IPO") of its common stock. The number of shares held by the Fund has
been adjusted to reflect such stock split. During June 1995, the fund exercised
warrants and options to acquire an additional 107,694 shares of GRDG common
stock for $407,172. Concurrent with the IPO, GRDG redeemed the 59,207 shares of
preferred stock for $355,242 and repaid the $3,195,671 in subordinated notes
held by the Fund.
On June 30, 1995, CogniSeis Development, Inc. was merged into Tech-Sym
Corporation. The Fund received 62,759 shares of Tech-Sym Corporation common
stock in a tax-free exchange for its CogniSeis Development, Inc. common stock.
In addition, on June 30, 1995, Allied Waste Industries, Inc. ("Allied") repaid
in full the $1,000,000 bridge note owed to the Fund. The accrued interest of
$67,494 on the bridge loan was paid to the Fund in August 1995 in the form of
13,864 shares of Allied common stock.
-22-
In May 1995, the Fund invested $271,000 in Midway Airlines Corporation
("Midway") in exchange for a 12% subordinated note and $71,000 in A. C.
Liquidating Corporation. in exchange for a 10% promissory note. In connection
with the Midway note, the Fund received warrants to buy up to 203,250 shares of
Class C common stock of Midway for $.01 per share through April 2002. During
June 1995, the Fund reacquired 80,662 shares of Class C common stock and 48,990
shares of junior preferred stock of Midway which it had previously recorded as
sold under a contract for sale to certain other shareholders of Midway.
In July 1995, the Fund acquired 67,500 shares of Series B senior
convertible preferred stock of Industrial Equipment Rentals, Inc. ("IER") for
$250,050 and advanced $499,950 to IER in exchange for a 9% senior subordinated
debenture.
During the third quarter of 1995, the Fund advanced an additional
$100,000 to Williams & Mettle Co. on the junior participation prime + 1.75%
note. In addition, the Fund's $204,750 in accrued interest receivable on the
Williams & Mettle Co. 12% subordinated promissory note was rolled into a new
$677,250, 12% subordinated promissory note.
In September 1995, the Fund acquired 2,986,408 shares of common stock
and 3,705,900 shares of Series B preferred stock of Strategic Holdings, Inc.,
for $2,986,408 and $3,705,900, respectively. In addition, the Fund acquired
1,000 shares of SMIP, Inc. for $150,000 and invested $175,000 in a 15%
promissory note of SMIP, Inc. Strategic Holdings, Inc. was formed to acquire
Strategic Materials, Inc., formerly known as Allwaste Recycling, Inc., the glass
recycling division of Allwaste, Inc.
In October 1995, the Fund invested $2,600,000 in exchange for a 36.11%
limited partnership interest in Summit/DPC Partners, L. P., a limited
partnership created to invest in DPC Acquisition Corp., which was created to
acquire Doane Products Company, which is believed to be the largest manufacturer
in the United States of dry pet food for private label customers. Summit
currently owns approximately 17.5% of the equity of DPC Acquisition Corp.
During December 1995, the Fund invested $2,250,000 in Carruth-Doggett
Industries, Inc. ("CDI"), in exchange for a 10% senior subordinated promissory
note. In addition, the Fund received warrants to buy 33,333 shares of common
stock of CDI for $.01 per share through December 14, 2005, and 333 shares of
common stock of CDE Corp for $.01 per share through December 14, 2005. CDI
operates five Case Equipment dealerships in and around the Houston area.
In December 1995, the Fund advanced $50,000 on a $200,000 prime rate
promissory note to American Residential Services, Inc., a company formed to
acquire existing businesses which provide plumbing, heating and air conditioning
and electrical services to the residential community.
On December 31, 1995, the Fund converted its Series C, Series D and 9%
cumulative preferred stock of Allied Waste Industries, Inc. ("AWIN") into
149,250, 398,335 and 421,802 shares of AWIN common stock, respectively. In
addition, the Fund exercised its warrants to buy 48,438 and 22,000 shares of
AWIN common stock for $175,830 and $93,500 respectively.
Also on December 31, 1995 the Fund converted its Series A and Series B
preferred stock of Champion Healthcare Corporation ("CHC") into 603,327 and
58,404 shares of CHC common stock respectively. In addition, the Fund received
171,921 shares of CHC common stock, valued at $593,665, in payment of preferred
stock dividends and as inducement to enter into the transaction and to forego
any additional dividends on the Series C and Series D preferred stock of CHC.
-23=
During the year ended December 31, 1994, the Fund made follow-on
investments of $9,532,649 in nine Portfolio Companies.
During the year ended December 31, 1993, the Fund made follow-on
investments of $11,285,430 in six Portfolio Companies and invested $3,974,700 in
two new Portfolio Companies.
For a description of the business of each Portfolio Company in which
the Fund has invested, see "Current Portfolio Companies".
Of the companies in which the Fund has investments at December 31,
1995, only AWIN, CHC, Drypers Corporation, GRDG, NCI Building Systems, Inc.,
Sports and Leisure and Tech-Sym Corporation 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. See "Valuation".
SUBSEQUENT EVENTS
Subsequent to December 31, 1995, the Fund sold 32,759 shares of
Tech-Sym Corporation for $1,029,900, realizing a net capital gain of $911,655 on
such sale.
On January 2, 1996, the Fund exercised its warrants to acquire 163,044
shares of AWIN on a net exercise basis. This resulted in the Fund receiving
56,054 shares of AWIN, which were paid for by tendering the remaining 106,990
shares to AWIN. On January 26, 1996, the Fund sold the 56,054 shares of common
stock along with an additional 70,000 shares of AWIN common stock in AWIN'S
secondary stock offering. The Fund received proceeds of $813,679, resulting in a
realized capital gain of $461,917.
In January 1996, the Fund advanced an additional $100,000 to American
Residential Services, Inc. pursuant to the terms of a $200,000 prime rate
promissory note.
Subsequent to December 31, 1995, the Fund repaid $61,900,000 of notes
payable to the bank.
Subsequent to December 31, 1995, the Fund intends to file a
registration statement for a rights offering. Under the proposed rights
offering, the Fund would issue each existing shareholder rights to buy one share
of stock for every three shares currently owned. It is anticipated that the
rights offering shares would be offered at a discount from the market price at
the beginning of the offering period. The proceeds from the rights offering
would be used to repay debt and to fund the commitments the Fund has made for
new and follow-on investments.
-24-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Public Accountants
To the Board of Directors of
Equus II Incorporated:
We have audited the accompanying balance sheets of Equus II
Incorporated (a Delaware corporation), including the schedules of portfolio
securities, as of December 31, 1995 and 1994, and the related statements of
operations, changes in net assets and cash flows for each of the three years in
the period ended December 31, 1995, and the selected per share data and ratios
for each of the five years in the period ended December 31, 1995. These
financial statements, selected per share data and ratios are the responsibility
of the management of Equus II Incorporated. Our responsibility is to express an
opinion on these financial statements, selected per share data and ratios based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and selected per
share data and ratios are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included physical verification or
confirmation of securities owned as of December 31, 1995 and 1994. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and selected per share data
and ratios referred to above present fairly, in all material respects, the
financial position of Equus II Incorporated as of December 31, 1995 and 1994,
the results of its operations, changes in net assets and cash flows for each of
the three years in the period ended December 31, 1995, and the selected per
share data and ratios for each of the five years in the period ended December
31, 1995, in conformity with generally accepted accounting principles.
As discussed in Note 3, the financial statements include investment
securities valued at $68,098,481 (110% of net assets) and $58,813,951 (97% of
net assets) as of December 31, 1995 and 1994, respectively, whose values have
been estimated by Equus Capital Corporation (the "Sub-Adviser") and approved by
the Board of Directors of Equus II Incorporated in the absence of readily
ascertainable market values. We have reviewed the procedures used by the
Sub-Adviser in arriving at their estimates of value of such securities and have
inspected the underlying documentation, and in the circumstances we believe the
procedures are reasonable and the documentation appropriate. However, because of
the inherent uncertainty of valuation, the Sub-Adviser's estimates of values may
differ significantly from the values that would have been used had a ready
market existed for the securities and the differences could be material.
/s/Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Houston, Texas
February 16, 1996
-25-
EQUUS II INCORPORATED
BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
1995 1994
------------ ------------
ASSETS
Investments in portfolio securities at fair value
(cost of $63,635,092 and $54,864,309, respectively) ......................... $ 71,610,360 $ 64,120,126
Temporary cash investments, at cost which
approximates fair value ..................................................... 60,232,594 45,474,560
Cash ............................................................................. 7,267 1,407
Accounts receivable .............................................................. 1,326 440
Accrued interest receivable ...................................................... 525,939 257,903
Commitment fees .................................................................. 37,500 28,125
Deferred reorganization costs, net ............................................... 35,190 58,650
------------ ------------
Total assets ............................................................ 132,450,176 109,941,211
------------ ------------
LIABILITIES AND NET ASSETS
Liabilities:
Accounts payable ............................................................ 242,286 137,175
Due to management company ................................................... 309,266 305,932
Deferred incentive fee due to management company ............................ 4,295,335 3,017,740
Notes payable to bank ....................................................... 65,750,000 45,600,000
------------ ------------
Total liabilities ....................................................... 70,596,887 49,060,847
------------ ------------
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, 3,138,575 and 3,053,017 shares issued
and outstanding, respectively ............................................. 3,139 3,053
Additional paid-in capital .................................................. 51,291,676 50,891,822
Undistributed net investment income ......................................... -- --
Undistributed net capital gains ............................................. 2,583,206 729,672
Unrealized appreciation of portfolio securities, net ........................ 7,975,268 9,255,817
------------ ------------
Total net assets ........................................................ $ 61,853,289 $ 60,880,364
============ ============
Net assets per share .................................................... $ 19.71 $ 19.94
============ ============
The accompanying notes are an integral part of these financial statements.
-26-
EQUUS II INCORPORATED
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
1995 1994 1993
----------- ------------ ------------
Investment income:
Income from portfolio securities ............................... $ 2,859,707 $ 1,613,414 $ 1,184,121
Interest on temporary cash investments ......................... 215,527 307,722 368,289
----------- ------------ ------------
Total investment income ..................................... 3,075,234 1,921,136 1,552,410
----------- ------------ ------------
Expenses:
Management fee ................................................. 1,237,775 1,212,457 1,243,559
Management incentive fee ....................................... -- -- (203,250)
Deferred management incentive fee .............................. 1,277,595 (582,622) 1,947,330
Director fees and expenses ..................................... 206,124 157,327 195,288
Merger expenses ................................................ -- -- 454,040
Professional fees .............................................. 251,770 209,845 204,715
Administrative fees ............................................ 50,000 50,000 72,370
Mailing, printing and other expenses ........................... 338,434 165,330 171,308
Interest expense ............................................... 318,048 135,252 157,317
Franchise taxes ................................................ 40,142 31,614 29,185
Amortization ................................................... 23,460 23,460 93,460
----------- ------------ ------------
Total expenses .............................................. 3,743,348 1,402,663 4,365,322
----------- ------------ ------------
Net investment income (loss) ...................................... (668,114) 518,473 (2,812,912)
----------- ------------ ------------
Realized gain (loss) on sales of portfolio
securities, net ................................................ 7,668,524 (350,309) (2,457,906)
----------- ------------ ------------
Unrealized appreciation of portfolio securities, net:
End of year .................................................... 7,975,268 9,255,817 11,818,618
Beginning of year .............................................. 9,255,817 11,818,618 640,314
----------- ------------ ------------
Increase (decrease) in unrealized appre-
ciation of portfolio securities, net ...................... (1,280,549) (2,562,801) 11,178,304
----------- ------------ ------------
Total increase (decrease) in net assets from
operations ..................................................... $ 5,719,861 $ (2,394,637) $ 5,907,486
=========== ============ ============
The accompanying notes are an integral part of these financial statements.
-27-
EQUUS II INCORPORATED
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
1995 1994 1993
------------ ------------ ------------
Operations:
Net investment income (loss) .................................. $ (668,114) $ 518,473 $ (2,812,912)
Realized gain (loss)
on sales of portfolio securities, net ....................... 7,668,524 (350,309) (2,457,906)
Increase (decrease) in unrealized
appreciation of portfolio securities, net ................... (1,280,549) (2,562,801) 11,178,304
------------ ------------ ------------
Increase (decrease) in net assets from
operations .................................................. 5,719,861 (2,394,637) 5,907,486
------------ ------------ ------------
Capital transactions:
Redemptions of fractional shares .............................. (114) (897) (1,163)
Stock repurchased and retired
under common stock repurchase plan .......................... (1,993,642) (640,159) --
Dividends ..................................................... (5,814,990) (763,268) (2,049,038)
Shares issued in common stock dividend ........................ 3,061,810 -- 1,386,444
------------ ------------ ------------
Decrease in net assets from
capital share transactions .................................. (4,746,936) (1,404,324) (663,757)
------------ ------------ ------------
Increase (decrease) in net assets ................................ 972,925 (3,798,961) 5,243,729
Net assets, at beginning of year ................................. 60,880,364 64,679,325 59,435,596
------------ ------------ ------------
Net assets, at end of year ....................................... $ 61,853,289 $ 60,880,364 $ 64,679,325
============ ============ ============
The accompanying notes are an integral part of these financial statements.
-28-
EQUUS II INCORPORATED
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
1995 1994 1993
------------- ------------- -------------
Cash flows from operating activities:
Interest received .................................................... $ 1,940,403 $ 1,801,962 $ 1,903,363
Cash paid to management company, directors,
a bank and suppliers ............................................... (2,343,223) (1,987,811) (3,865,717)
------------- ------------- -------------
Net cash used by operating activities ................................ (402,820) (185,849) (1,962,354)
------------- ------------- -------------
Cash flows from investing activities:
Purchase of portfolio securities ..................................... (13,785,810) (9,512,649) (15,164,362)
Proceeds from sales of portfolio securities .......................... 8,850,646 1,857,460 8,282,232
Principal payments from portfolio securities ......................... 4,698,814 156,582 5,808,189
Purchase of temporary cash investments with
original maturities of greater than three months ................... -- (300,000) (2,879,246)
Maturity of temporary cash investments with
original maturities of greater than three months ................... 300,000 200,000 5,161,751
Notes receivable proceeds ............................................ -- -- 4,070,000
Repayment of advances from portfolio
companies .......................................................... -- -- (101,497)
------------- ------------- -------------
Net cash provided (used) by investing activities ....................... 63,650 (7,598,607) 5,177,067
------------- ------------- -------------
Cash flows from financing activities:
Advances from bank ................................................... 273,650,000 152,600,000 181,000,000
Repayments to bank ................................................... (253,500,000) (152,000,000) (176,750,000)
Dividends paid ....................................................... (2,753,180) (1,425,862) (1,649,305)
Repurchase of common stock ........................................... (1,993,642) (640,159) --
Redemptions of fractional shares ..................................... (114) (897) (1,163)
------------- ------------- -------------
Net cash provided (used) by financing activities ..................... 15,403,064 (1,466,918) 2,599,532
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents ................. 15,063,894 (9,251,374) 5,814,245
Cash and cash equivalents at beginning of year ......................... 45,175,967 54,427,341 48,613,096
------------- ------------- -------------
Cash and cash equivalents at end of year, excluding $300,000
and $200,000 of temporary cash investments with original
maturities of greater than three months at December 31,
1994 and 1993, respectively .......................................... $ 60,239,861 $ 45,175,967 $ 54,427,341
============= ============= =============
The accompanying notes are an integral part of these financial statements.
-29-
EQUUS II INCORPORATED
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
(Continued)
1995 1994 1993
------------- ------------- -------------
Reconciliation of increase (decrease) in net assets from
operations to net cash used by operating activities:
Increase (decrease) in net assets from operations ...................... $ 5,719,861 $ (2,394,637) $ 5,907,486
Adjustments to reconcile increase (decrease) in net assets
from operations to net cash used by operating activities:
Realized (gain) loss on sales of portfolio securities, net .......... (7,668,524) 350,309 2,457,906
Decrease (increase) in unrealized appreciation, net ................. 1,280,549 2,562,801 (11,178,304)
Fees received in stock .............................................. -- (20,000) --
Decrease (increase) in accounts receivable .......................... (886) 1,464 1,432
Accounts receivable from portfolio company written off .............. -- -- 171,551
Decrease (increase) in accrued interest receivable .................. (268,036) (100,638) 177,970
Accrued interest or dividends exchanged for portfolio
securities ........................................................ (865,909) -- --
Commitment fees paid ................................................ (75,000) (56,250) (56,250)
Amortization of commitment fee ...................................... 65,625 56,250 70,313
Amortization of deferred reorganization costs ....................... 23,460 23,460 93,460
Increase (decrease) in accounts payable ............................. 105,111 (5,925) (4,803)
Increase (decrease) in due to management company .................... 1,280,929 (602,683) 396,885
------------- ------------- -------------
Net cash used by operating activities .................................. $ (402,820) $ (185,849) $ (1,962,354)
============= ============= =============
The accompanying notes are an integral part of these financial statements.
-30-
EQUUS II INCORPORATED
SUPPLEMENTAL INFORMATION - SELECTED PER SHARE DATA AND RATIOS
FOR THE FIVE YEARS ENDED DECEMBER 31, 1995
1995 1994 1993 1992 1991
------------ ----------- ------------ ------------ ------------
Investment income .................................. $ 1.04 $ 0.62 $ 0.52 $ 0.62 $ 0.98
Expenses ........................................... 1.26 0.45 1.45 1.11 0.60
------------ ----------- ------------ ------------ ------------
Net investment income (loss) ....................... (0.22) 0.17 (0.93) (0.49) 0.38
Realized gain (loss) on sales
of portfolio securities, net ..................... 2.58 (0.12) (0.82) 3.73 (0.66)
Increase (decrease) in unrealized
appreciation of portfolio securities, net ........ (0.43) (0.83) 3.71 (2.10) 2.44
------------ ----------- ------------ ------------ ------------
Increase (decrease) in net assets
from operations .................................. 1.93 (0.78) 1.96 1.14 2.16
------------ ----------- ------------ ------------ ------------
Capital transactions:
Dividends .......................................... (2.00) (0.25) (0.68) (1.12) --
Effect of common stock repurchases ................. 0.35 0.10 -- -- --
Dilutive effect of shares issued
in common stock dividend ......................... (0.51) -- (0.13) (0.35) --
Deferred management company
incentive fees ................................... -- -- -- -- (0.63)
------------ ----------- ------------ ------------ ------------
Net decrease in net assets from
capital transactions ............................. (2.16) (0.15) (0.81) (1.47) (0.63)
------------ ----------- ------------ ------------ ------------
Net increase (decrease) in net assets .............. (0.23) (0.93) 1.15 (0.33) 1.53
Net assets at beginning of year .................... 19.94 20.87 19.72 20.05 18.52
------------ ----------- ------------ ------------ ------------
Net assets at end of year .......................... $ 19.71 $ 19.94 $ 20.87 $ 19.72 $ 20.05
============ =========== ============ ============ ============
Weighted average number of shares
outstanding during year in thousands ............. 2,968 3,083 3,013 2,880 2,880
Ratio of expenses to average net assets ............ 6.10% 2.23% 7.03% 5.46% 3.10%
Ratio of net investment income
(loss) to average net assets ..................... (1.09)% 0.83% (4.53)% (2.40)% 1.96%
Ratio of increase (decrease) in net assets
from operations to average net assets ............ 9.32% (3.81)% 9.52% 5.64% 11.21%
The accompanying notes are an integral part of these financial statements.
-31-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1995
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
A.C. Liquidating Corporation February 1985
-4,885 shares of 10% Series C
cumulative preferred stock $ 488,500 $ -
-10% secured promissory notes 188,014 188,014
Allied Waste Industries, Inc. (NASDAQ - AWIN) March 1989
-1,397,698 shares of common stock 5,316,834 8,763,730
-Warrants to buy up to 163,044, 125,000 and
15,000 shares of common stock at $4.60, $5.00
and $13.50 per share, respectively through May
1998, August 1999 and February 1997, respectively - 5,095
American Residential Services, Inc. December 1995
-Prime rate promissory note 50,000 50,000
BSI Holdings, Inc., (formerly Brazos Sportswear, Inc.)
-166,250 shares of common stock 1,330,000 1,800,000
-12% senior subordinated debenture 3,350,000 3,350,000
-10% subordinated promissory note 178,500 178,500
-Warrants to buy up to 64,715 shares of common stock
at $0.01 per share through December 2004 - 700,000
-1,000 shares of common stock of GCS RE, Inc. 132,910 132,910
-87,632 shares of common stock of Sports/Leisure, Inc. 82,734 876
-8% unsecured promissory note, due from
Sports/Leisure, Inc. 5,005 5,005
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
The accompanying notes are an integral part of these financial statements.
-32-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1995
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
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 14, 2005 - -
-Warrant to buy up to 333 shares of
common stock of CDE Corp at $0.01
per share through December 14, 2005 - -
Champion Healthcare Corporation
(AMEX - CHC) December 1990
-1,038,944 shares of common stock 3,371,395 4,292,535
-3,601 shares of Series C convertible
preferred stock 64,818 64,818
-83,333 shares of Series D convertible
preferred stock 1,499,994 1,499,994
-11% senior subordinated note 1,500,000 1,500,000
-Warrants to buy up to 5,246 shares of
common stock at $5.90 per share through
June 1, 1999 - -
-Warrants to buy up to 45,000 shares of
common stock at $9 per share through
December 31, 2003 - -
David's Supermarkets, Inc. February 1990
-735,000 shares of common stock 735,000 -
-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 21, 2000 - -
Drypers Corporation (NASDAQ - DYPR) July 1991
-1,096,892 shares of common stock 6,400,132 2,838,162
-Warrants to buy up to 6,634 shares
of common stock at $4 per share
through June 30, 1998 - -
The accompanying notes are an integral part of these financial statements.
-33-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1995
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
Garden Ridge Corporation (NASDAQ - GRDG) July 1992
-333,471 shares of common stock $ 1,061,018 $ 10,963,284
Industrial Equipment Rentals, Inc. June 1993
-182,230 shares of common stock 1,822 1,822
-5,371 shares of junior preferred stock 537,100 537,100
-67,500 shares of Series B senior convertible
preferred stock 250,050 250,050
-12% subordinated debenture 1,077,778 1,077,778
-9% senior subordinated debenture 499,950 499,950
Midway Airlines Corporation August 1993
-452,392 shares of Class C common stock 1,195,616 -
-274,761 shares of junior preferred stock 2,747,610 500,000
-12% subordinated note 271,000 271,000
-Warrants to buy up to 203,250 shares of
Class C common stock at $.01 per
share through April 2002 - -
NCI Building Systems, Inc. (NASDAQ - BLDG) April 1989
-100,000 shares of common stock 159,783 2,475,000
Restaurant Development Group, Inc. June 1987
-610,909 shares of Class A common stock 2,891,156 700,000
-14% promissory note, face amount $350,000 275,000 350,000
-Prime +2% promissory note 639,122 639,122
-Warrants to buy up to 150,000 and 62,500
shares of common stock at $2.80 and $3
per share through November 1996 and
April 1998, respectively - -
Strategic Holdings, Inc. September 1995
-2,986,408 shares of common stock 2,986,408 2,986,408
-3,705,900 shares of Series B preferred stock 3,705,900 3,705,900
-1,000 shares of SMIP, Inc. common stock 150,000 150,000
-15% promissory note of SMIP, Inc. 175,000 175,000
The accompanying notes are an integral part of these financial statements.
-34-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1995
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
Summit/DPC Partners, L.P. October 1995
-36.11% limited partnership interest $ 2,600,000 $ 2,600,000
Tech-Sym Corporation (NYSE - TSY) March 1987
-32,759 shares of common stock 118,245 1,036,003
Travis International, Inc. December 1986
-171,284 shares of common stock 560,290 3,853,890
Video Rental of Pennsylvania, Inc. January 1988
-125,000 shares of common stock 125,000 500,000
-125,000 shares of 9% redeemable
preferred stock 125,000 125,000
-10% secured promissory note 2,525,000 2,525,000
-10,000 shares of common stock
of Equus Video Corporation 25,000 25,000
Williams & Mettle Co. October 1989
-657,895 shares of common stock 6,579 -
-138,475 shares of Series A convertible
preferred stock 553,900 -
-237,126 shares of Series B convertible
preferred stock 396,000 396,000
-12% subordinated promissory note 677,250 677,250
-Junior participation in prime + 1.75% note 512,576 512,576
-Warrant to buy 456,718 shares of common
stock at $0.01 per share through December
21, 1999 - -
Yellow Cab Service Corporation December 1985
-1,006,701 shares of common stock 51,432 -
-3% subordinated promissory note,
face amount aggregating $1,655,014 1,566,000 -
-3% subordinated promissory note 3,517,083 1,750,000
------------ ------------
Total $63,635,092 $71,610,360
=========== ===========
The accompanying notes are an integral part of these financial statements.
-35-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1995
(Continued)
Substantial amounts 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.,
BSI Holdings, Inc., Cardiovascular Ventures, Inc., Champion Healthcare
Corporation, Industrial Equipment Rentals, Inc. and Strategic Holdings, Inc.,
investment 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, BSI
Holdings, Inc., Industrial Equipment Rentals, Inc., Restaurant Development
Group, Inc., Strategic Holdings, Inc., Video Rental of Pennsylvania, Inc. and
Williams & Mettle Co. In addition, Cardiovascular Ventures, Inc., David's
Supermarkets, Inc., Drypers Corporation and Travis International, Inc. are
considered to be affiliated entities of the Fund. The fair value of the
investments in Allied Waste Industries, Inc., Champion Healthcare Corporation,
Drypers Corporation and Garden Ridge Corporation include discounts from closing
market prices of approximately $1,867,084, $1,226,855, $589,626 and $1,958,717,
respectively, to reflect the effects of restrictions on the sale of such
securities at December 31, 1995. Such discounts total $5,642,282 or $1.80 per
share as of December 31, 1995. Income was earned in the amount of $1,349,420,
$1,213,320 and $611,549 for the years ended December 31, 1995, 1994 and 1993,
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., Midway Airlines Corporation, Summit/DPC
Partners, L.P., Tech-Sym Corporation and Yellow Cab Service Corporation. The
Fund provides significant managerial assistance to Portfolio Companies that
comprise 89.5% of the total value of the investments in Portfolio Companies at
December 31, 1995.
The accompanying notes are an integral part of these financial statements.
-36-
[NO HARD COPY FOR THIS PAGE]???????????????????????????????????????????????????
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1994
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
A.C. Liquidating Corporation February 1985
-4,885 shares of 10% Series C
cumulative preferred stock $ 488,500 $ 250,000
-10% secured promissory notes 200,000 200,000
Allied Waste Industries, Inc. (NASDAQ - AWIN) March 1989
-460,599 shares of common stock 1,594,282 1,711,563
-150,000 shares of Series C convertible
preferred stock 750,000 750,000
-79,667 shares of 8% Series D convertible
preferred stock 1,195,005 1,195,005
-2,012 shares of 9% cumulative convertible
preferred stock 2,000,000 2,012,000
-9% subordinated bridge loan 1,000,000 1,000,000
-Warrants to buy up to 48,438, 125,000, 150,000,
22,000 and 15,000 shares of common stock at $3.63,
$5.00, $5.00, $6.00 and $13.50 per share, respectively
through June 1997, August 1999, May 1998, February 1998 and
February 1997, respectively - -
Brazos Sportswear, Inc. February 1989
-166,250 shares of common stock 1,330,000 1,800,000
-12% senior subordinated debenture 3,350,000 3,350,000
-10% subordinated promissory note 178,500 178,500
-1,000 shares of common stock of GCS RE, Inc. 132,910 132,910
-87,632 shares of common stock of Sports/Leisure, Inc. 82,734 11,392
-8% unsecured promissory note, due from
Sports/Leisure, Inc. 9,296 9,296
-Warrants to buy up to 64,715 shares of common stock
at $0.01 per share through December 2004 - 700,000
The accompanying notes are an integral part of these financial statements.
-37-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1994
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
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
Champion Healthcare Corporation December 1990
(AMEX-CHC)
-205,292 shares of common stock 129,761 1,334,398
-2,303,380 shares of Series A convertible
preferred stock 2,303,380 3,921,625
-29,202 shares of Series B convertible
preferred stock 344,589 379,626
-3,601 shares of Series C convertible
preferred stock 64,818 64,818
-83,333 shares of Series D convertible
preferred stock 1,499,994 1,499,994
-11% senior subordinated note 1,500,000 1,500,000
-Warrants to buy up to 5,246 shares of
common stock at $5.90 per share through
June 1, 1999 - 3,148
-Warrants to buy up to 45,000 shares of
common stock at $9 per share through
December 31, 2003 - -
CogniSeis Development, Inc. March 1987
-183,819 shares of common stock 185,074 816,973
-41,181 shares of Series A
convertible preferred stock 41,462 183,027
David's Supermarkets, Inc. February 1990
-735,000 shares of common stock 735,000 -
-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 21, 2000 - -
The accompanying notes are an integral part of these financial statements.
-38-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1994
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
Drypers Corporation (NASDAQ - DYPR) July 1991
-1,096,892 shares of common stock $ 6,400,132 $10,968,920
-Warrants to buy up to 6,634 shares
of common stock at $4 per share
through June 30, 1998 - 39,804
Garden Ridge Corporation(formerly July 1992
Garden Ridge Pottery Corp.)
-71,506 shares of common stock 675,179 1,966,415
-59,207 shares of preferred stock 355,242 355,242
-12% senior subordinated promissory note 666,660 666,660
-Prime +3%, minimum 9.5% per annum
subordinated promissory notes 2,529,011 2,529,011
-Options to acquire up to 17,266 shares of
common stock at $12 per share through
July 16, 2002 - 267,623
-Warrants to buy 6,666 shares of common stock
at $30 per share through December 20, 2003 - -
Industrial Equipment Rentals, Inc. June 1993
-182,230 shares of common stock 1,822 1,822
-5,371 shares junior preferred stock 537,100 537,100
-12% subordinated debenture 1,077,778 1,077,778
Midway Airlines Corporation August 1993
-371,730 shares of common stock 1,205,516 -
-225,771 shares of junior preferred stock 2,257,710 -
-7% secured note due from other shareholders 480,000 480,000
NCI Building Systems, Inc. (NASDAQ - BLDG) April 1989
-275,000 shares of common stock 439,405 4,743,750
The accompanying notes are an integral part of these financial statements.
-39-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1994
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
Restaurant Development Group, Inc. June 1987
-610,909 shares of Class A common stock $2,891,156 $1,300,000
-14% promissory note, face amount $350,000 275,000 350,000
-Prime +2% promissory note 639,122 639,122
-Warrants to buy up to 150,000 and 62,500
shares of common stock at $2.80 and $3
per share through November 1996 and
April 1998, respectively - -
Travis International, Inc. December 1986
-171,284 shares of common stock 560,290 3,853,890
USA Waste Services, Inc. (NYSE - UW) December 1990
-49,444 shares of common stock 213,598 562,425
Video Rental of Pennsylvania, Inc. January 1988
-125,000 shares of common stock 125,000 500,000
-125,000 shares of 9% redeemable
preferred stock 125,000 125,000
-14% promissory notes 40,625 40,625
-10% secured promissory note 2,545,000 2,545,000
-10,000 shares of common stock
of Equus Video Corporation 25,000 25,000
Williams & Mettle Co. October 1989
-657,895 shares common stock 6,579 -
-138,475 shares Series A convertible
preferred stock 553,900 -
-237,126 shares Series B convertible
preferred stock 396,000 198,000
-12% subordinated promissory note 472,500 472,500
-Junior participation in prime + 1.75% note 412,576 412,576
-Warrant to buy 456,718 shares of common
stock at $0.01 per share through December
21, 1999 - -
The accompanying notes are an integral part of these financial statements.
-40-
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1994
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
- --------------------- ------------------ ------------ -----------
Yellow Cab Service Corporation December 1985
-1,006,701 shares of common stock $ 51,432 $ -
-3% subordinated promissory note,
face amount aggregating $1,655,014 1,566,000 -
-3% subordinated promissory note 3,517,083 1,750,000
------------ ------------
Total $54,864,309 $64,120,126
=========== ===========
The accompanying notes are an integral part of these financial statements.
-41-
EQUUS II INCORPORATED
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1994 AND 1993
(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.
On June 30, 1993, Equus Investments Incorporated ("EQI"), a Delaware
corporation and corporate business development company was merged with and into
the Fund. Each share of EQI was converted into 0.54 of a share of the Fund's
common stock. The Fund issued 1,147,137 additional shares of common stock, net
of 130 shares redeemed in lieu of fractional shares, in connection with the
merger. The merger of EQI into the Fund was recorded as a pooling of interests
for financial statement reporting purposes.
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 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 $50,000, $50,000 and $72,370, are included in
the accompanying Statements of Operations for the years ended December 31, 1995,
1994 and 1993, 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. The
Sub-Adviser receives a fee from the Management Company equal to 50% of the
Management Company's net management incentive fee. The management incentive fee
is paid or reimbursed quarterly in arrears.
Included in "Deferred management incentive fees" in the accompanying
Balance Sheets are $4,295,335 and $3,017,740 of accrued management incentive
fees at December 31, 1995 and 1994, respectively. Such fees are calculated on
the net unrealized appreciation of investments in portfolio
-42-
securities and will not be paid until such appreciation is realized. Deferred
management incentive fee expense (income) of $1,277,595, $(582,622) and
$1,947,330 related to increases (decreases) in unrealized appreciation on
portfolio securities are included in the accompanying Statements of Operations
for the three years ended December 31, 1995. Current management incentive fee
expense reimbursement of $203,250 is included in the accompanying Statement of
Operations for the year ended December 31, 1993.
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
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 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 conditions of the issuer.
Because of the inherent uncertainty of the valuation of portfolio securities
which do not have readily ascertainable market values, $68,098,481 (including
$26,862,806 in publicly-traded securities, net of a $5,642,282 Valuation
Discount) and $58,813,951 (including $18,359,084 in publicly-traded securities,
net of a $4,723,312 Valuation Discount) at December 31, 1995 and 1994,
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.
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.
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(4) BOOK TO TAX RECONCILIATION
During 1993, the Fund adopted 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 income during 1995
of $188,304 for tax purposes. A dividend of such income will be declared and
distributed during 1996. The Fund had a net investment loss for tax purposes for
the years ended December 31, 1994 and 1993, and therefore distributed no net
investment income. The Fund, for book purposes, has undistributed net capital
gains of $2,583,206 in the accompanying Balance Sheet at December 31, 1995.
However, for tax purposes, the Fund has distributed all of its net realized
capital gains except for $9,995 which the Fund anticipates will be distributed
in 1996. The following is a reconciliation of the difference in the Fund's net
realized gain (loss) on the sale of portfolio securities for book and tax
purposes.
1995 1994 1993
----------- ----------- -----------
Net realized gain (loss) on the sales of portfolio
securities, book .................................................. $ 7,668,524 $ (350,309) $(2,457,906)
EQI net realized loss through date of merger ........................ -- -- 5,819,691
Reversal of amounts previously written off .......................... 48,838 -- --
Tax basis in Gulf Coast Entertainment Corporation ................... -- -- (220,223)
Utilization of capital loss carryforwards ........................... (1,892,377) -- (2,637,211)
Effect of EQI Section 382 limitation on capital
loss carryforwards ................................................ -- -- 1,542,065
----------- ----------- -----------
Net realized gain (loss) on the sales of
portfolio securities, tax ......................................... $ 5,824,985 $ (350,309) $ 2,046,416
=========== =========== ===========
(5) DIVIDENDS
The Fund declared dividends of $5,814,990 ($2.00 per share), $763,268
($0.25 per share) and $2,049,038 ($0.68 per share) during 1995, 1994 and 1993,
respectively. The Fund adopted a policy effective in 1995, 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. The 1994
dividend was paid in cash and represented a return of capital. The 1995 and 1993
dividends, which represented the Fund's net capital gains for tax purposes, were
paid in additional shares of common stock or in cash by specific election of the
shareholders in December 1995 and January 1994. The Fund paid $2,753,180 and
$662,594 in cash and issued 231,080 and 85,981 additional shares of stock at
$13.25 and $16.125 per share, in December 1995 and January 1994, respectively,
in connection with such dividends.
(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 5.30% at December 31, 1995. The
following is a list of temporary cash investments at December 31, 1995:
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Broadcort Money Plus ...................................... $ 1,338
Dreyfus Cash Management Fund .............................. 58,141
Dreyfus Treasury Cash Management Fund ..................... 60,026,074
First Interstate Bank of Texas, N.A ....................... 85,353
Great Hall Money Market ................................... 8,211
Pitkin County Bank ........................................ 53,477
-----------
Total money market accounts ........................... $60,232,594
(7) PORTFOLIO SECURITIES
During the year ended December 31, 1995, the Fund invested $11,917,308
in five new companies and made follow-on investments of $2,734,411 in seven
portfolio companies, including $865,909 in accrued interest, dividends and
conversion inducement payments received in the form of additional portfolio
securities. In addition, the Fund realized capital gains of $7,668,524 during
the year ended December 31, 1995.
During the year ended December 31, 1994, the Fund made follow-on
investments of $9,532,649 in nine portfolio companies, and realized $350,309 of
net capital losses from the sale of a portion of its investment in five
portfolio companies.
During the year ended December 31, 1993, the Fund made follow-on
investments of $11,285,430 in six portfolio companies and invested $3,974,700 in
two new companies. The Fund realized $2,457,906 of net capital losses from the
sale or disposition of all or a portion of its investments in nine portfolio
companies during the year ended December 31, 1993.
(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. The Fund also paid $100,000 in
expenses related to the formation of EQI. At the time of the merger into the
Fund, EQI had $60,000 of such expenses which had not been amortized. The Fund
amortized such balance in full on June 30, 1993. Accumulated amortization of
such expenses totaled $182,110 and $158,650 at December 31, 1995 and 1994,
respectively.
(9) NOTES PAYABLE TO BANK
The Fund had a $60,000,000 line of credit promissory note with a bank,
with interest payable at the prime rate, at December 31, 1995. The prime rate
was 8.5% at December 31, 1995. This note matures on July 15, 1996. The Fund had
$60,000,000 and $45,000,000 outstanding on such note at December 31, 1995 and
1994, respectively, that was secured by $60,000,000 and $45,000,000 of the
Fund's temporary cash investments at December 31, 1995 and 1994. The average
daily balance outstanding on such line of credit during 1995, 1994 and 1993 was
$2,079,452, $978,082 and $821,918, respectively. The Fund paid $75,000, $56,250
and $56,250 in commitment fees on such notes in 1995, 1994 and 1993, which were
deferred and are being amortized over the twelve month commitment period.
Amortization expense related to such fees is included in "Interest expense" in
the accompanying Statements of Operations for each of the three years ended
December 31, 1995.
The Fund also had a $13,000,000 revolving line of credit from a bank,
with interest payable at prime. The outstanding balance on such line of credit
was $5,750,000 and $600,000 at December 31, 1995 and 1994, respectively. The
revolving line of credit is due on December 31, 1996. The average
-45-
daily balance outstanding on such note during 1995 and 1994 was $759,863 and
$16,438, respectively. The Fund paid facility fees of $3,125 and $6,250 to the
bank for such revolving line of credit during 1995 and 1994, respectively, which
are included in interest expense for the years ended December 31, 1995 and 1994.
The line of credit is secured by a portion of the Fund's investment in Allied
Waste Industries, Inc., Champion Healthcare Corporation, Drypers Corporation,
Garden Ridge Corporation and NCI Building Systems, Inc. Subsequent to December
31, 1995, the Fund received a commitment for a new $20,000,000 revolving line of
credit with another bank which will replace its $13,000,000 line of credit.
(10) COMMITMENTS AND CONTINGENCIES
On June 22, 1994, the Board of Directors of the Fund approved a stock
repurchase program. Stock acquired under the repurchase program is cancelled.
Through December 31, 1994, the Fund repurchased on the open market and cancelled
46,200 shares of its stock for $640,159. Such stock was repurchased at an
average discount of 28.74% from its net asset value. During 1995, the Board of
Directors of the Fund authorized the repurchase of additional stock, and the
Fund repurchased and cancelled 145,500 shares of its stock for $1,993,642. The
stock repurchased in 1995 was repurchased at an average discount of 33.61% from
its net asset value.
The Fund has made commitments to invest, under certain circumstances,
up to an additional $1,550,000 in American Residential Services, Inc.,
$5,000,000 in BSI Holdings, Inc., $2,500,000 in Drypers Corporation and $565,500
in GCS RE, Inc. In connection with its commitment to GCS RE, Inc., the Fund has
committed to a bank to maintain at least $380,000 in temporary cash investments
to fund such commitment. In addition, the Fund has committed to invest up to
$8,600,000 in two new companies.
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 December 31, 1995, the Fund sold 32,759 shares of
Tech-Sym Corporation for $1,029,900, realizing a net capital gain of $911,655 on
such sale.
On January 2, 1996, the Fund exercised its warrants to acquire 163,044
shares of Allied Waste Industries, Inc. ("AWIN") on a net exercise basis. This
resulted in the Fund receiving 56,054 shares of AWIN which were paid for by
tendering the remaining 106,990 shares to AWIN. On January 26, 1996, the Fund
sold the 56,054 shares of common stock along with an additional 70,000 shares of
AWIN common stock in AWIN'S secondary offering. The Fund received proceeds of
$813,679 resulting in a realized capital gain of $461,917.
In January 1996, the Fund advanced an additional $100,000 to American
Residential Services, Inc. under a $200,000 prime rate promissory note.
Subsequent to December 31, 1995, the Fund repaid $61,900,000 of notes
payable to the bank.
Subsequent to December 31, 1995, the Fund intends to file a
registration statement for a rights offering. Under the proposed rights
offering, the Fund would issue each existing shareholder a right to
-46-
buy one share of stock for every three shares currently owned. It is anticipated
that the rights offering shares would be offered at a discount from the market
price at the beginning of the offering period. The proceeds from the rights
offering would be used to repay debt and to fund the commitments the Fund has
made for new and follow-on investments.
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[NO HARD COPY FOR THIS PAGE]????????????????????????????????????????????????????
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
None.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information about the Directors and Executive Officers of the
Registrant is incorporated by reference to the Fund's Definitive Proxy Statement
for the 1996 Annual Meeting of Stockholders, to be filed pursuant to Regulation
14A under the Securities and Exchange Act of 1934, as amended, prior to April
30, 1996 (the "1996 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding Executive Compensation is incorporated by
reference to the Fund's 1996 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
Information regarding Security Ownership of Certain Beneficial Owners
and Management is incorporated by reference to the Fund's 1996 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding Certain Relationships and Related Transactions is
incorporated by reference to the Fund's 1996 Proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K.
(a)(1) FINANCIAL STATEMENTS PAGES
Report of Independent Public Accountants ....................... 25
Balance Sheets
at December 31, 1995 and 1994 .................................. 26
Statements of Operations for the years
ended December 31, 1995, 1994 and 1993 ......................... 27
Statements of Changes in Net Assets for the
years ended December 31, 1995, 1994 and 1993 ................... 28
Statements of Cash Flows for the years ended
December 31, 1995, 1994 and 1993 ............................... 29
Supplemental Information-Selected Per Share
Data and Ratios for the five years ended
December 31, 1995 .............................................. 31
-49-
Schedule of Portfolio Securities
at December 31, 1995 ........................................... 32
Schedule of Portfolio Securities
at December 31, 1994 ........................................... 37
Notes to Financial Statements .................................. 42
All other information required in the financial statement schedules has
been incorporated in the financial statements or notes thereto or has been
omitted since the information is not applicable, not present or not present in
amounts sufficient to require submission of the schedule.
(a)(3) EXHIBITS
3. Articles of Incorporation and by-laws
(a) Restated Certificate of Incorporation of the Fund dated March
4, 1992. [Exhibit 3(a) to Registrant's Annual Report on Form
10-K for the year ended December 31, 1991]
(b) Certificate of Merger dated June 30, 1993, between the Fund
and Equus Investments Incorporated [Exhibit 3(c) to
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1993]
(c) Amended and Restated Bylaws of the Fund.
10. Material Contracts
(a) Form of Management Agreement between the Fund and Equus
Capital Management Corporation. [Form N-14, Exhibit 6(c) to
the Registration Statement file number 33- 60118]
(b) Form of Sub-Adviser Agreement between Equus Capital Management
Corporation and Equus Capital Corporation. [Form N-14, Exhibit
5(c) to the Registration Statement, file number 33-42621]
(c) Agreement and Plan of Merger dated March 26, 1993 [Form N-14,
Exhibit A to the Joint Proxy Statement and Prospectus, file
number 33-60118]
(d) First Amendment to Agreement and Plan of Merger, dated May 5,
1993 [Form N-14, Exhibit B to the Registration Statement, file
number 33-60118]
(e) Second Amendment to Agreement and Plan of Merger, dated June
15, 1993 [Exhibit 10(e) to Registrant's Annual Report on Form
10-K for the year ended December 31, 1993]
(f) Form of Safekeeping Agreement with Southwest Guaranty Trust
Company. [Form N-14, exhibit 6 to the Registration Statement,
file number 33-42621]
(b) REPORTS ON FORM 8-K
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[NO HARD COPY FOR THIS PAGE]????????????????????????????????????????????????????
No reports on Form 8-K were filed by the Fund during the last
quarter of the period covered by this report.
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
/S/ NOLAN LEHMANN
Date: February 29, 1996 Nolan Lehmann, President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/S/GREGORY J. FLANAGAN Director February 29, 1996
(Gregory J. Flanagan)
/S/ROBERT L. KNAUSS Director February 29, 1996
(Robert L. Knauss)
/S/GARY R. PETERSEN Director February 29, 1996
(Gary R. Petersen)
/S/JOHN W. STORMS Director February 29, 1996
(John W. Storms)
/S/FRANCIS D. TUGGLE Director February 29, 1996
(Francis D. Tuggle)
/S/EDWARD E. WILLIAMS Director February 29, 1996
(Edward E. Williams)
/S/NOLAN LEHMANN President and Director February 29, 1996
(Nolan Lehmann) (principal financial
and accounting officer)
/S/SAM P. DOUGLASS Chairman of the Board and February 29, 1996
(Sam P. Douglass) Chief Executive Officer
(principal executive officer)
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INDEX TO EXHIBITS
3. Articles of Incorporation and by-laws PAGE
(a) Restated Certificate of Incorporation of the Fund
dated March 4, 1992. [Exhibit 3(a) to Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1991]
(b) Certificate of Merger dated June 30, 1993, between
the Fund and Equus Investments Incorporated
[Exhibit 3(c) to Registrant's Annual Report on Form
10-K for the year ended December 31, 1993]
(c) Amended and Restated Bylaws of the Fund..........................52
10. Material Contracts
(a) Form of Management Agreement between the Fund and
Equus Capital Management Corporation. [Form N-14,
Exhibit 6(c) to the Registration Statement file
number 33-60118]
(b) Form of Sub-Adviser Agreement between Equus Capital
Management Corporation and Equus Capital
Corporation. [Form N-14, Exhibit 5(c) to the
Registration Statement, file number 33-42621]
(c) Agreement and Plan of Merger dated March 26, 1993
[Form N-14, Exhibit A to the Joint Proxy Statement
and Prospectus, file number 33- 60118]
(d) First Amendment to Agreement and Plan of Merger,
dated May 5, 1993 [Form N-14, Exhibit B to the
Registration Statement, file number 33- 60118]
(e) Second Amendment to Agreement and Plan of Merger,
dated June 15, 1993 [Exhibit 10(e) to Registrant's
Annual Report on Form 10-K for the year ended
December 31, 1993]
(f) Form of Safekeeping Agreement with Southwest
Guaranty Trust Company. [Form N-14, exhibit 6 to
the Registration Statement, file number 33-42621]
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