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, 1997
[ ] 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:
Name of each exchange
Title of each class 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: $109,950,260, computed on the basis of $25.75 per share, closing
price of the common stock on the American Stock Exchange, Inc. on February 23,
1998. For purposes of calculating this amount only, all directors and executive
officers of the registrant have been treated as affiliates. There were 4,828,492
shares of the registrant's common stock, $.001 par value, outstanding as of
February 23, 1998. The net asset value of a share at December 31, 1997 was
$29.92.
Documents incorporated by reference: Proxy Statement for 1998 Annual Meeting of
Stockholders is incorporated by reference in Part III.
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business ....................................................... 1
Item 2. Properties ...................................................... 17
Item 3. Legal Proceedings ............................................... 17
Item 4. Submission of Matters to a Vote of Security Holders ............. 17
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters ........................................... 17
Item 6. Selected Financial Data ......................................... 19
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................... 20
Item 7A. Quantitative and Qualitative Disclosure About Market Risk ....... 26
Item 8. Financial Statements and Supplementary Data...................... 27
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ........................... 49
PART III
Item 10. Directors and Executive Officers of the Registrant .............. 49
Item 11. Executive Compensation........................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and Management .. 49
Item 13. Certain Relationships and Related Transactions .................. 49
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.. 49
ii
ITEM 1. BUSINESS.
Equus II Incorporated (the "Fund") is a Delaware corporation that 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 information of the Fund included elsewhere herein were restated to
include the selected per share data and ratios for the year 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 valuation
procedures 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 public 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.
The Management Company, its 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.
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.
1
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 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.
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 $8,000,000, 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.
The Fund may borrow funds to make new or follow-on investments, to
maintain its pass through tax status, or to pay contingencies and expenses. See
"Borrowing" and "Loss of Conduit Tax Treatment" under "Factors that May Affect
Future Results, the Market Price of Common Stock, and the Accuracy of Forward
Looking Statements."
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
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.
2
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 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
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, and may participate in incentive stock option plans for
non-employee directors, if any. When necessary, the Management Company, 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
The following is a description of the Fund's investments in its 29
Portfolio Companies at December 31, 1997.
A. C. LIQUIDATING CORPORATION
A. C. Liquidating Corporation ("ACL"), Houston, Texas, has disposed of its
operating
3
businesses and currently holds two parcels of real estate. ACL is offering the
real estate for sale and intends to distribute the net proceeds from such sale
and its remaining cash, if any, to its shareholders as soon as possible. At
December 31, 1997, the Fund's investment in ACL consisted of $188,014 in 10%
secured promissory notes which was recorded at no value. Investments held by the
Fund represents no 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 a
vertically integrated solid waste management company providing non-hazardous
waste collection, transfer, recycling and disposable services to residential,
municipal and commercial customers. At December 31, 1997, the Fund's investment
in Allied, valued at $26,420,415 with a cost of $4,037,572, consisted of
1,100,000 shares of common stock valued at an average of $22.61 per share, and a
warrant to buy up to 125,000 shares of common stock at $5.00 per share. The
December 31, 1997 closing price of Allied's common stock on the NASDAQ National
Market was $23.31 per share. Due to restrictions on the Fund's ability to sell a
portion of the common stock and warrants, the aggregate value recorded by the
Fund was $1,512,398 less than the aggregate value based on the market price at
December 31, 1997. The Fund's investment in Allied represents an approximate 1%
fully-diluted equity interest in Allied. Mr. Lehmann serves on Allied's Board of
Directors.
AMERICAN RESIDENTIAL SERVICES, INC. (NYSE: ARS)
American Residential Services, Inc. ("ARS"), Houston, Texas, operates
businesses which provide heating and air conditioning, plumbing and electrical
installation and repair services. The December 31, 1997 closing price of ARS
common stock on the New York Stock Exchange was $15.63 per share. At December
31, 1997, the Fund's investment in ARS, valued at $14,395,793 with a cost of
$3,000,272, consisted of 1,125,000 shares of restricted common stock valued at
an average of $12.80 per share, and warrants to buy up to 100,000 shares of
common stock at $15 per share. Due to restrictions on the Fund's ability to sell
the common stock and warrants, the aggregate value recorded by the Fund was
$3,244,832 less than the aggregate value based on the market price at December
31, 1997. The Fund's investment in ARS represents an approximate 8%
fully-diluted equity interest in ARS. Mr. Lehmann and Mr. Hale, a Vice President
of the Fund, serve as directors of ARS.
ATLAS ACQUISITION, INC.
Atlas Acquisition, Inc. ("Atlas"), Atlanta, Georgia, acquired the
operations of a 68-year old distributor of "Atlas" branded tires, batteries and
accessories sold primarily to the auto repair and full service gas station
markets. At December 31, 1997, the Fund's investment in Atlas, valued at its
original cost of $2,000,000, consisted of 32,000 shares of common stock and
19,680 shares of preferred stock. The Fund has committed to invest up to an
additional $850,000 in Atlas under certain conditions. The Fund's investment in
Atlas represents an approximate 32% fully-diluted equity interest. Mr. Hale
serves on the Board of Directors of Atlas.
BRAZOS SPORTSWEAR, INC., AND RELATED ENTITIES (NASDAQ: BRZS)
Brazos Sportswear, Inc. ("BRZS"), Batavia, Ohio, designs, sources, prints
and markets moderately-priced sportswear, including sportswear featuring various
licensed character images. BRZS sells products to over 12,000 customers,
including Wal-Mart, Target and JC Penney. The December 31, 1997 closing price of
BRZS's common stock on the NASDAQ National Market was $7.50 per share. At
December 31, 1997, the Fund's investment in BRZS, valued at $16,917,617 with a
cost of $7,709,586, consisted of 2,160,308 shares of common stock valued at an
average of $4.88 per share, 3,940,779 shares of 8% Series B1 preferred stock,
1,340,210 shares of 8% Series B2 preferred stock, 1,097,410 shares of 8% Series
B3 preferred stock and warrants to buy up to 170,839 shares of common stock at
prices ranging from $4.62 to $6.59 per share. Due to restrictions on the Fund's
ability to sell the common stock and warrants, the aggregate value recorded by
the Fund was $5,878,170 less than the aggregate value based on the market price
at December 31, 1997. The Fund's investment in BRZS represents an
4
approximate 49% fully-diluted equity interest. Mr. Lehmann and Mr. Hale serve as
directors of BRZS.
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 BRZS. At
December 31, 1997, the Fund's investment in GCS consisted of 1,000 shares of
common stock that was valued at $300,000, with a cost of $132,910. 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.
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
and 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,
1997, the Fund's investment in CDI, valued at $3,750,000, with a 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 249 shares of CDE Corp., a sister company of CDI that owns the real
property leased by CDI, 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.
COACH USA, INC. (NYSE:CUI)
Coach USA, Inc. ("Coach"), Houston, Texas, is the largest provider of
motor coach charter, tour and sight seeing services and one of the largest
non-municipal providers of commuter and transit motor coach services in the
United States. The December 31, 1997 closing price of Coach's common stock on
the NASDAQ National Market was $33.50 per share. At December 31, 1997, the
Fund's investment in Coach, valued at $4,650,424 with a cost of $1,863,357,
consisted of 143,112 shares of restricted common stock valued at an average of
$32.49 per share. Due to restrictions on the Fund's ability to sell the stock,
the aggregate value recorded by the Fund was $143,828 less than the aggregate
value based on the market price at December 31, 1997. The Fund's investment in
Coach represents a less than 1% fully-diluted equity interest in Coach.
CONTAINER ACQUISITION, INC.
Container Acquisition, Inc. ("Container"), Houston, Texas, is a
logistics and maintenance services company serving owners of international
shipping containers. At December 31, 1997, the Fund's investment in
Container, valued at its original cost of $6,270,400, consisted of 1,370,000
shares of common stock, 48,994 shares of preferred stock and a warrant to buy
370,588 shares of common stock at $0.01 per share. The Fund's investment in
Container represents a 70% fully-diluted equity interest. Mr. Lehmann and Mr.
Forbes serve on Container's Board of Directors.
CRC HOLDINGS, CORP.
CRC Holdings, Corp. ("CRC"), Houston, Texas, was formed to acquire CRC
Evans Pipeline International, Inc. which designs, manufactures and services
specialized pipeline construction and automatic welding equipment, which it
rents and sells worldwide. At December 31, 1997, the Fund's investment in
CRC, valued at its original cost of $4,158,700, consisted of 35,000 shares of
common stock and a 12% subordinated promissory note in the amount of
$959,700. The Fund's investment in CRC represents an approximate 35%
fully-diluted equity interest. Mr. Lehmann and Mr. Forbes serve as directors
of CRC.
DRYPERS CORPORATION (NASDAQ: DYPR)
Drypers Corporation ("Drypers"), Houston, Texas, manufactures and
distributes disposable
5
diapers and baby wipes sold under the trade name Drypers(R). 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; Guadalajara, Mexico; Sao Paulo, Brazil and Puerto Rico. The
December 31, 1997 closing price of Drypers' common stock on the NASDAQ National
Market was $5.88 per share. At December 31, 1997, the Fund's investment in
Drypers, valued at $15,654,331 with a cost of $8,926,618, consisted of 1,107,882
shares of restricted common stock and 25,000 shares of 7.5% convertible
preferred stock which is convertible into 2,500,000 shares of common stock. The
common stock equivalents held by the Fund were valued at an average of $4.34 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 $5,541,975. The Fund's investment in Drypers represents an approximate 21%
fully-diluted equity interest in Drypers. Mr. Lehmann and Mr. Forbes serve as
directors of Drypers.
EQUICOM, INC. (FORMERLY TEXROCK RADIO, INC.)
Equicom, Inc. ("Equicom"), Austin, Texas, was formed to acquire radio
stations in small to medium sized cities in Texas. At December 31, 1997, Equicom
owned and operated five radio stations. At December 31, 1997, the Fund's
investment in Equicom, valued at its original cost of $2,777,207, consisted of a
10% promissory note. The Fund has committed to invest up to an additional
$9,350,000 in Equicom under certain circumstances. The Fund's investment in
Equicom represents no equity interest at December 31, 1997.
Mr. Hale serves on Equicom's Board of Directors.
GARDEN RIDGE CORPORATION (NASDAQ: GRDG)
Garden Ridge Corporation ("GRDG"), Houston, Texas, is a specialty retailer
of crafts and home decorative items. GRDG operates 21 megastores in 10 states
and is continuing its expansion into other areas of the United States. The
December 31, 1997 closing price of GRDG on the NASDAQ National Market was $14.25
per share. At December 31, 1997, the Fund's investment in GRDG, valued at
$6,458,830 with a cost of $685,030, consisted of 474,942 shares of common stock.
The stock was valued at an average of $13.60 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 $309,094. The Fund's investment
in GRDG represents an approximate 3% fully-diluted equity interest in GRDG. Mr.
Lehmann serves on GRDG's Board of Directors.
HEALTHCARE TECHNOLOGY DELIVERY, INC.
Healthcare Technology Delivery, Inc. ("HTD"), Bessemer, Alabama,
represents 10 manufacturers selling medical products within the operating room,
anesthesiology, critical care and cardiovascular/vascular markets in the
southeastern United States. In addition, HTD sells its proprietary Microvascular
Anastomatic System product line used in connection with the mechanical exterior
anastomosis of small blood vessels. At December 31, 1997, the Fund's investment
in HTD, valued at its original cost of $50,000, consisted of 9,000 shares of
common stock. The Fund's investment in HTD represents an approximate 10%
fully-diluted equity interest. Mr. Lehmann serves on HTD's Board of Directors.
HOT & COOL HOLDINGS, INC.
Hot & Cool Holdings, Inc. ("Hot & Cool"), Laredo, Texas, is a manufacturer
and distributor of automotive radiators and other heat transfer products. At
December 31, 1997, the Fund's investment in Hot & Cool, valued at $3,780,000
with a cost of $3,500,000, consisted of $1,300,000 in a 9% increasing rate
subordinated promissory note, $2,200,000 in 10% subordinated notes, warrants to
buy 13,155 shares of common stock for $26 per share and warrants to buy up to
14,942 shares of common stock for $0.01 per share. The Fund has committed to
invest up to an additional $500,000 in Hot & Cool under certain circumstances.
The Fund's investment represents an approximate 12% fully-diluted equity
interest in Hot & Cool. Mr. Lehmann serves on Hot & Cool's Board of Directors.
6
NCI BUILDING SYSTEMS, INC. (NASDAQ: BLDG)
NCI Building Systems, Inc. ("NCI"), Houston, Texas, manufactures and
markets metal building systems, components and roll up doors for non-residential
users. NCI operates facilities in 8 states. The December 31, 1997 closing price
of NCI's common stock on the NASDAQ National Market was $35.50 per share. At
December 31, 1997, the Fund's investment in NCI consisted of 100,000 shares of
common stock valued at $3,550,000 with a cost of $159,784, which represents an
approximate 1% fully-diluted equity interest in NCI. Mr. Forbes serves as a
director of NCI.
ONE ENGINEERING, INC.
One Engineering, Inc. ("One Engineering"), Houston, Texas, was formed to
acquire companies providing diversified engineering services and engineered
systems to a broad spectrum of industrial, commercial and institutional clients.
At December 31, 1997, the Fund's investment in One Engineering, valued at its
original cost of $66,847, consisted of 666.7 shares of common stock and $66,181
outstanding on a $2,500,000, prime + 1/2% promissory note. The Fund has
committed to invest up to an additional $2,433,819 in One Engineering under
certain circumstances. The Fund's investment in One Engineering represents an
approximate 67% fully-diluted equity interest at such date. Mr. Lehmann and Mr.
Forbes serve on One Engineering's Board of Directors.
PARACELSUS HEALTHCARE CORPORATION (NYSE: PLS)
Paracelsus Healthcare Corporation ("PLS"), Houston, Texas, owns or
operates, directly or through hospital partnerships, 28 hospitals and four
skilled nursing facilities in 9 states. The December 31, 1997 closing price of
PLS's common stock on the New York Stock Exchange was $3.38 per share. At
December 31, 1997, the Fund's investment in PLS, valued at $3,958,090 with a
cost of $5,278,748, consisted of 1,263,058 shares of common stock. The common
stock of PLS was valued by the Fund at an average of $3.13 per share at December
31, 1997, 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 $304,731. The Fund's investment in PLS represents an approximate 2%
fully-diluted equity interest in PLS.
RAYTEL MEDICAL CORPORATION (NASDAQ: RTEL)
Raytel Medical Corporation ("RTEL"), San Mateo, California, is a leading
nationwide provider of alternate-site medical service to physicians, hospitals,
patients and managed care groups. The closing price of RTEL's common stock on
the NASDAQ National Market was $11.63 per share. At December 31, 1997, the
Fund's investment in RTEL, valued at $326,803 with a cost of $330,730, consisted
of 33,073 shares of common stock. The common stock of RTEL was valued by the
Fund at an average of $9.88 per share at December 31, 1997, 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 $57,671. The Fund's
investment in RTEL represents a less than 1% fully-diluted equity interest.
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. ("Checkers") in 1994 for
common stock of Checkers (NASDAQ: CHKR) and a note receivable. RDG intends to
distribute to its shareholders, proceeds from collections on the note receivable
in 1998. At December 31, 1997, the Fund's investment in RDG, valued at $700,000
with a cost of $2,891,156, consisted of 610,909 shares of Class A common stock
and warrants to buy up to 62,500 shares of common stock for $3.00 per share. The
Fund's investment represents a 50% fully-diluted equity interest in RDG. Mr.
Douglass and Mr. Lehmann serve on RDG's Board of Directors.
SOVEREIGN BUSINESS FORMS, INC.
Sovereign Business Forms, Inc. ("Sovereign"), Houston, Texas, is a
manufacturer of wholesale
7
business forms in 4 states. At December 31, 1997, the Fund's investment in
Sovereign, valued at its original cost of $1,999,000, consisted of 11,990 shares
of preferred stock, $800,000 in 15% promissory notes and warrants to buy up to
551,894 shares of common stock at $1 per share. The Fund has committed to invest
up to an additional $2,000,000 in Sovereign under certain circumstances. The
Fund's investment represents a 30% fully-diluted equity interest in Sovereign.
Mr. Forbes serves on Sovereign's Board of Directors.
STEPHEN L. LAFRANCE HOLDINGS, INC.
Stephen L. LaFrance Holdings, Inc. ("LaFrance"), Pine Bluff, Arkansas,
owns and operates 98 retail drug stores primarily in Arkansas, Mississippi and
Tennessee. At December 31, 1997, the Fund's investment in LaFrance, valued at
its original cost of $2,498,452, consisted of 2,498,452 shares of preferred
stock and a warrant to buy 269 shares of common stock at $0.01 per share. The
Fund's investment in LaFrance represents an approximate 15% fully-diluted equity
interest. Mr. Forbes serves on the Board of Directors of LaFrance.
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, 1997, the Fund's investment in SHI was valued
at $7,009,013, with a cost of $6,909,013. The Fund's investment in SHI consists
of 3,089,751 shares of common stock, 3,822,157 shares of Series B preferred
stock, and warrants to buy 225,000 and 100,000 shares of SHI at $0.4643 and
$1.50 per share, respectively. 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, 1997, 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 investments in SHI and SMIP represents an approximate 50%
fully-diluted equity interest in SHI.
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, 1997, the Fund's investment in 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.
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, 1997, the Fund's investment in Travis,
valued at $3,853,890 with a cost of $560,290, consisted of 66,784 shares of
common stock and 104,500 shares of Class A common stock, which represents an
approximate 15% fully-diluted equity interest in Travis. Mr. Lehmann serves as a
director of Travis.
8
TRIAD MEDICAL INC.
Triad Medical Inc. ("Triad"), headquartered in Park City, Utah, was formed
to create a leading national distributor of medical products and related
services to the healthcare market, principally hospitals and surgical and
diagnostic centers. At December 31, 1997, the Fund's investment in Triad, valued
at its original cost of $1,951,965, consisted of 449,213 shares of common stock
and $1,651,965 outstanding on a $2,200,000, prime + 1/2% promissory note. The
Fund has committed to invest up to an additional $548,035 in Triad, under
certain circumstances. The Fund's investment in Triad represents an approximate
50% fully-diluted equity interest. Mr. Lehmann serves as a director of Triad.
TULSA INDUSTRIES, INC.
Tulsa Industries, Inc. ("Tulsa"), Broken Arrow, Oklahoma, manufactures
equipment for the oil and gas industry. At December 31, 1997, the Fund's
investment in Tulsa, valued at its original cost of $5,500,000, consisted of
27,500 shares of common stock and 546,615 shares of Series A preferred stock and
warrants to buy up to 31,731 shares of common stock for $0.001 per share. The
Fund's investment in Tulsa represents an approximate 42% fully-diluted equity
interest. Mr. Forbes and Mr. Hale serve on Tulsa's Board of Directors.
UNITED RENTALS, INC. (NYSE: URI)
United Rentals, Inc. ("URI"), Greenwich, Connecticut, was formed in
September 1997 for the purpose of creating a large, geographically diversified
equipment rental company. URI commenced rental operations in October 1997 by
acquiring six established equipment rental companies, including J&J Equipment
Rental, a Portfolio Company of the Fund. At December 31, 1997, the Fund's
investment in URI, valued at $928,200, with a cost of $397, consisted of 62,149
shares of common stock, subject to adjustment. Due to restrictions on the Fund's
ability to sell the common stock, the aggregate value recorded by the Fund was
$108,023 less than the aggregate value based on the market price at December 31,
1997. The Fund's investment in URI represents a less than 1% fully-diluted
equity interest.
VRPI SPIN OFF, INC. AND RELATED ENTITY
VRPI Spin Off, Inc. ("VRS"), Houston, Texas, owns the rights to receive
over 50% of all general partner distributions from a limited partnership that
has franchise rights to operate 12 BLOCKBUSTER(R) Entertainment CorporatioN
video cassette stores in the Pittsburgh, Pennsylvania area. At December 31,
1997, the Fund's investment in VRS, valued at its original cost of $250,000,
consisted of 100 shares of common stock. VRS is wholly-owned by the Fund.
Messrs. Douglass, Lehmann and Dr. Williams, a director of the Fund, serve as
directors of VRS and Video Rental of Pennsylvania, Inc. ("VRP"), the managing
general partner of the limited partnership.
Equus Video Corporation ("Video"), Houston, Texas, owns an 80% limited
partnership interest in a partnership whose sole general partner is a
corporation owned by VRP. The limited partnership operates 8 additional
BLOCKBUSTER(R) Entertainment Corporation video cassette stores in and arounD
Pittsburgh. At December 31, 1997, the Fund's investment in 10,000 shares of
common stock of Video was valued at $20,000, with an original cost of $25,000.
In addition, the Fund has invested $2,672,349 in a 10% secured promissory note
and $1,050,000 in a 12% secured promissory note of such partnership. The notes
are guaranteed by VRP. Mr. Douglass and Mr. Lehmann serve as directors of Video.
WMW INDUSTRIES, INC.
WMW Industries, Inc. ("WMW"), 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, 1997, the Fund's investment in WMW, valued at $4,606,459 with a
cost of $2,938,035, consisted of 602,707 shares of common stock, $893,883 in a
12% subordinated promissory note and $1,012,576 junior participation in a prime
+1.5% note. The fund's investment in WMW represents an approximate 48%
fully-diluted equity interest. Mr. Forbes serves on
9
the Board of Directors of WMW. Subsequent to December 31, 1997, WMW was acquired
by United States Filter Corporation (NYSE - USF).
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 variety of
transactions, including 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 its 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 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 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;
10
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 Management Company 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.
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 are 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 Management Company'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.
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 NationsBank
11
of Texas, Houston, Texas, with respect to the safekeeping of such securities.
The principal business office of such company is 700 Louisiana Street, Suite
3200, Houston, Texas 77002.
TRANSFER AND DISBURSING AGENT
The Fund employs Chase Mellon Shareholders Services ("Chase Mellon") as
its transfer agent to record transfers of the shares, maintain proxy records and
to process distributions. The principal business office of Chase Mellon is 2323
Bryan Street, Suite 2300, Dallas, Texas 75201.
FACTORS THAT MAY AFFECT FUTURE RESULTS, THE MARKET PRICE OF COMMON STOCK, AND
THE ACCURACY OF FORWARD LOOKING STATEMENTS
In the normal course of its business, the Fund, in an effort to keep its
stockholders and the public informed about the Fund's operations and portfolio
of investments, may from time-to-time issue certain statements, either in
writing or orally, that contain or may contain forward-looking information.
Generally, these statements relate to business plans or strategies of the Fund
or Portfolio Companies in which it invests, projected or anticipated benefits or
consequences of such plans or strategies, projected or anticipated benefits of
new or follow-on investments made by or to be made by the Fund, or projections
involving anticipated purchases or sales of securities or other aspects of the
Fund's operating results. Forward looking statements are not guarantees of
future performance and are subject to risks and uncertainties that could cause
actual results to differ materially. As noted elsewhere in this report, the
Fund's operations and portfolio of investments are subject to a number of
uncertainties, risks, and other influences, many of which are outside the
control of the Fund, and any one of which, or a combination of which, could
materially affect the results of the Fund's operations or net asset value, the
market price of its common stock, and whether forward-looking statements made by
the Fund ultimately prove to be accurate.
The following discussion outlines certain factors that in the future could
affect the Fund's results for 1998 and beyond and cause them to differ
materially from those that may be set forth in any forward-looking statement
made by or on behalf of the Fund:
LONG-TERM OBJECTIVE. The Fund is intended for investors seeking long-term
capital growth. The Fund is not meant to provide a vehicle for those who wish to
play short-term swings in the stock market. The portfolio securities acquired by
the Fund generally require four to seven years to reach maturity and generally
are illiquid. An investment in shares of the Fund should not be considered a
complete investment program. Each prospective purchaser should take into account
his investment objectives as well as his other investments when considering the
purchase of shares of the Fund.
NON-DIVERSIFIED STATUS; NUMBER OF INVESTMENTS. The Fund is classified as a
"non-diversified" investment company under the Investment Company Act, which
means the Fund is not limited in the proportion of its assets that may be
invested in the securities of a single issuer. Generally, the Fund does not
intend to initially invest more than 15% of the value of its assets in a single
portfolio company. However, follow-on investments or a disproportionate increase
in the value of one portfolio company may result in greater than 15% of the
Fund's assets being invested in a single portfolio company. While these
restrictions limit the exposure of the capital of the Fund in any single
investment, to the extent the Fund takes large positions in the securities of a
small number of issuers, the Fund will be exposed to a greater risk of loss and
the Fund's net asset value and the market price of its common stock may
fluctuate as a result of changes in the financial condition, the stock price of,
or in the market's assessment of any single Portfolio Company to a greater
extent than would be the case if it were a "diversified" company holding
numerous investments. The Fund currently has investments in 29 Portfolio
Companies, of which three exceed 10% of the value of its net assets.
LEVERAGED PORTFOLIO INVESTMENTS. While leveraged buyout investments and
investments in highly leveraged companies offer the opportunity for significant
capital gains and current income, such investments involve a high degree of
business and financial risk and can result in substantial losses. The Fund's
Portfolio Companies incur substantial indebtedness in connection with leveraged
buyout or other highly leveraged transactions. Such indebtedness generally
represents from 66% to 90% of the
12
capitalization of a Portfolio Company. In the event a Portfolio Company cannot
generate adequate cash flow to meet the principal and interest payments on such
indebtedness, 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. A substantial portion of the indebtedness incurred
by Portfolio Companies may bear interest at rates that will fluctuate in
accordance with a stated interest rate index or the prime lending rate. The cash
flow of a Portfolio Company may not be sufficient to meet increases in interest
payments on its indebtedness. Accordingly, the profitability of the Fund's
Portfolio Companies, as well as appreciation of the investments in such
companies, will depend in a significant part upon prevailing interest rates.
LACK OF LIQUIDITY OF PORTFOLIO INVESTMENTS. The portfolio investments of
the Fund consist principally of securities that are subject to restrictions on
sale because they were acquired from the issuer in "private placement"
transactions or because the Fund is deemed to be an affiliate of the issuer.
Generally, the Fund will not be able to sell these securities publicly without
the expense and time required to register the securities under the Securities
Act, and applicable state securities law or unless an exemption from such
registration requirements is available. In addition, contractual or practical
limitations may restrict the Fund's ability to liquidate its securities in
Portfolio Companies since in many cases the securities of such companies will be
privately held and the Fund may own a relatively large percentage of the
issuer's outstanding securities. Sales may also be limited by securities market
conditions, which may be unfavorable for sales of securities of particular
issuers or issuers in particular industries. The above limitations on liquidity
of the Fund's securities could preclude or delay any disposition of such
securities or reduce the amount of proceeds that might otherwise be realized.
NEED FOR FOLLOW-ON INVESTMENTS IN PORTFOLIO COMPANIES. 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 or have the opportunity to increase
its investment in a successful situation, e.g., the exercise of a warrant to
purchase common stock. There is no assurance that the Fund will make, or have
sufficient funds to make, follow-on investments. Any decision by the Fund not to
make a follow-on investment or any inability on its part to make such an
investment may have a negative impact on a Portfolio Company in need of such an
investment or may result in a missed opportunity for the Fund to increase its
participation in a successful operation and may dilute the Fund's equity
interest in or reduce the expected yield on its investment.
COMPETITION FOR INVESTMENTS. The Fund encounters competition from other
persons or entities with similar investment objectives. These competitors
include 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. Some of these
competitors may have greater financial resources and more personnel than the
Fund and may be subject to different and frequently less stringent regulation.
BORROWING. The Fund may borrow funds to make new or follow-on investments,
to maintain its pass-through tax status as a regulated investment company under
Subchapter M of 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 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 the Fund has no
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. While the
"spread" between the current yield on the Fund's investments and the cost of any
loan would augment the stockholders' return from the Fund, if the spread narrows
(because of an increase in the cost of debt or insufficient income on the Fund's
investments), distributions to the stockholders would be adversely affected. If
the spread were reversed, the Fund might be unable to meet its obligations to
its lenders, which might then seek to cause the Fund to liquidate some or all of
its investments. There can be no assurance that the Fund would realize full
value for its investments or
13
recoup all of its capital if its portfolio investments were involuntarily
liquidated.
The costs of borrowing money may exceed the income from the portfolio
securities purchased by the Fund with the borrowed money. The Fund will suffer a
decline in net asset value if the investment performance of the additional
securities purchased with borrowed money fails to cover their cost to the Fund
(including any interest paid on the money borrowed). A decline in net asset
value could affect the ability of the Fund to make distributions on its common
stock. 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. See "Tax
Matters." If the asset coverage for debt securities issued by the Fund declines
to less than 200% (as a result of market fluctuations or otherwise), the Fund
may be required to sell a portion of its investments when it may be
disadvantageous to do so.
Because of the nature and size of its portfolio investments, the Fund
borrows money from time to time to make qualifying investments to maintain its
tax status under the Code. There can be no assurance that debt financing will be
available on terms that the Fund considers to be acceptable and in the best
interests of the Fund. If borrowing is unavailable, the Fund may be required to
make an untimely disposition of an investment or lose its pass-through tax
status. See "Loss of Conduit Tax Treatment" below.
LOSS OF CONDUIT TAX TREATMENT. 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 or 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. The Fund
may also cease to qualify for conduit tax treatment, or be subject to a 4%
excise tax, if it fails to distribute a sufficient portion of its net investment
income and net realized capital gains.
MARKET VALUE AND NET ASSET VALUE. The shares of the Fund's common stock
are listed on the AMEX. Shares of closed-end investment companies 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 they began trading. Investors desiring liquidity may trade their shares of
Common Stock on the AMEX at current market value, which may differ from the then
current net asset value. For information concerning the trading history of the
Fund's shares see "Market for Registrant's Common Stock and Related Stockholder
Matters."
VALUATION OF INVESTMENTS. The Fund's net asset value is based on the value
assigned to its portfolio investments. 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. The Fund adjusts its net asset value for changes in the value of its
publicly held securities on a daily basis. The value of the Fund's investments
in securities for which market quotations are not available is determined at the
end of each calendar quarter. Cost is used to approximate fair value of such
investments until significant developments affecting an investment provide a
basis for use of an appraisal valuation. Thereafter, such portfolio investments
are carried at appraised values as determined quarterly. Because of the inherent
uncertainty of the valuation of portfolio securities which do not have readily
ascertainable market values, the Fund's estimate of fair value may significantly
differ from the
14
fair value that would have been used had a ready market existed for the
securities. At December 31, 1997, approximately 39% of the Fund's net assets
were invested in securities for which market quotations were not readily
available. See "Valuation".
POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Fund's common
stock could be subject to significant fluctuations in response to variations in
the net asset value of the Fund, its quarterly operating results, and other
factors. The market price of the common stock may be significantly affected by
such factors as the announcement of new or follow-on investments in portfolio
companies, the sale or proposed sale of a portfolio investment, the results of
operations or fluctuations in the market prices or appraised value of one or
more of the Fund's portfolio companies, changes in earnings estimates by market
analysts, speculation in the press or analyst community and general market
conditions or market conditions specific to particular industries. From time to
time in recent years, the securities markets have experienced significant price
and volume fluctuations that have often been unrelated or disproportionate to
the operating performance of particular companies. These broad fluctuations may
adversely affect the market price of the common stock. In addition, the Fund is
subject to the risk of the securities markets in which the portfolio securities
of the Fund are traded. Securities markets are cyclical and the prices of the
securities traded in such markets rise and fall at various times. These cyclical
periods may extend over significant periods of time.
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 or pursuant to a stock option
plan. The Investment Advisers Act, however, does permit the payment of
compensation based on capital gains or the issuance of incentive stock options
to management 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. Accordingly, it
has provided for incentive compensation to the Management Company based on the
capital appreciation of the Fund's investments through March 31, 1997, and for
an incentive stock option plan thereafter.
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
15
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 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. The Fund repurchased and canceled 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. The Fund repurchased and canceled an additional
145,500 shares of its stock for $1,993,642 in 1995. The stock repurchased in
1995 was repurchased at an average discount of 33.61% from its net asset value.
No stock was repurchased in 1996 or 1997.
16
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 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.
ITEM 3. LEGAL PROCEEDINGS.
The Fund, its affiliates and certain of the Portfolio Companies are
involved in asserted claims and have the possibility for unasserted claims which
may ultimately affect the net asset value of the Fund or 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.
On April 1, 1996, two stockholders of the Fund filed an action in federal
district court in Houston, Texas against the directors of the Fund, the
Management Company, and the Fund. Their suit alleged that by approving the
rights offering, which was announced in March 1996, the Management Company and
the directors of the Fund violated their fiduciary duties to the Fund's
stockholders under the Investment Company Act and Delaware common law. They also
alleged that the Management Company aided and abetted these breaches of
fiduciary duty. The plaintiffs requested the court to certify their suit as a
class action on behalf of all stockholders of the Fund. The court dismissed
their suit in December 1996, but the plaintiffs made substantially similar
claims in an amended shareholder derivative action which they filed in January
1997. The plaintiffs did not specify the amount of any damages in either suit.
The derivative action lawsuit was also dismissed by the court on February 11,
1998; however, the plaintiffs have the right to appeal. During the years ended
December 31, 1997 and 1996, the Fund incurred $45,682 and $92,336, respectively,
in legal expenses related to such action.
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 1997.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Fund's shares of common stock trade on the American Stock Exchange
under the symbol "EQS". The Fund had approximately 8,200 shareholders at
December 31, 1997, 1,783 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, 1997, was
$29.92.
17
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, 1997, by quarter.
QUARTER
ENDED HIGH LOW
-------- ------- -------
03/31/96 $16.375 $13.125
06/30/96 16.250 14.250
09/30/96 16.750 12.250
12/31/96 17.750 15.125
03/31/97 17.375 16.000
06/30/97 21.750 16.000
09/30/97 25.500 20.438
12/31/97 27.313 19.500
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 $2,380,327 ($0.50 per share), $3,180,422
($0.76 per share) and $5,814,990 ($2.00 per share) during 1997, 1996 and 1995,
respectively. The Fund has adopted a policy to make dividend distributions of at
least $0.50 per share on an annual basis. In the event that taxable income,
including realized capital gains, exceeds $0.50 per share in any year,
additional dividends may be declared to distribute such excess. The 1997
dividend was paid in additional shares of common stock or in cash by specific
election of the shareholder in January 1998, and represented a return of
capital. The 1996 and 1995 dividends, which represented the Fund's net income
for tax purposes, were paid in additional shares of common stock or in cash by
specific election of the shareholders in January 1997 and December 1995. The
Fund paid $828,556, $1,209,850 and $2,753,180 in cash and issued 67,837, 115,916
and 231,080 additional shares of stock at $22.875, $17.00 and $13.25 per share
in January 1998, January 1997 and December 1995, 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 in portfolio securities held by the Fund 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.
18
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, 1997.
Amounts are in thousands except per share data.
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
Total investment income ........ $ 4,013 $ 2,590 $ 3,075 $ 1,921 $ 1,552
Net investment income (loss) ... $ (922) $ (8,267) $ (668) $ 518 $ (2,813)
Realized gain (loss) on sales
of portfolio securities, net $ 7,566 $ 4,037 $ 7,669 $ (350) $ (2,458)
Increase (decrease) in
unrealized appreciation of
portfolio securities, net ... $ 24,222 $ 33,696 $ (1,281) $ (2,563) $ 11,178
Total increase (decrease) in
net assets from operations .. $ 30,865 $ 29,467 $ 5,720 $ (2,395) $ 5,907
Dividends ...................... $ 2,380 $ 3,180 $ 5,815 $ 763 $ 2,049
Total assets at end of year .... $ 228,095 $ 181,166 $ 132,450 $ 109,941 $ 114,411
Net assets at end of year ...... $ 144,471 $ 103,223 $ 61,853 $ 60,880 $ 64,679
Net cash used by operating
activities .................. $ (1,043) $ (2,494) $ (403) $ (186) $ (1,962)
Shares outstanding at end
of year ..................... 4,828 4,301 3,139 3,053 3,099
Average shares outstanding
during year ................... 4,733 3,819 2,968 3,084 3,013
PER SHARE DATA:
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
Net investment
income (loss) ............... $ (0.19) $ (2.16) $ (0.22) $ 0.17 $ (0.93)
Realized gain (loss) on sales
of portfolio securities, net $ 1.60 $ 1.06 $ 2.58 $ (0.12) $ (0.82)
Increase (decrease) in
unrealized appreciation of
portfolio securities, net ... $ 5.11 $ 8.82 $ (0.43) $ (0.83) $ 3.71
Dividends ...................... $ 0.50 $ 0.76 $ 2.00 $ 0.25 $ 0.68
Net asset value (including
unrealized appreciation),
end of year ................. $ 29.92 $ 24.00 $ 19.71 $ 19.94 $ 20.87
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Fund had $151,449,786 of its assets invested in
portfolio securities of 29 companies, and has committed to invest up to an
additional $16,247,353 in seven of such companies and $2,500,000 in one new
company under certain conditions. Current temporary cash investments,
anticipated future investment income, proceeds from borrowings, and proceeds
from the sale of existing portfolio securities are believed to be sufficient to
finance these commitments. At December 31, 1997, the Fund had $6,900,000
outstanding on a $30,000,000 revolving line of credit loan from a bank.
Net cash used by operating activities was $1,043,710, $2,493,597 and
$402,820 for the three years ended December 31, 1997, respectively. Increased
expenses paid during 1996 were primarily due to increases in the management
incentive fees paid to the Management Company.
At December 31, 1997, the Fund had $75,164,751 of its total assets of
$228,094,939 invested in temporary cash investments consisting of money market
securities and commercial paper. This amount includes proceeds of $75,000,000
from a $150,000,000 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,
1998.
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 stockholders will be able to claim their
proportionate share of the federal income taxes paid by the Fund on such gains
as a credit against their own federal income tax liabilities. Stockholders will
also be entitled to increase the adjusted tax basis of their Fund shares by the
difference between their undistributed capital gains and their tax credit.
RESULTS OF OPERATIONS
INVESTMENT INCOME AND EXPENSE
Net investment loss after all expenses amounted to $922,117, $8,266,606
and $668,114 for the three years ended December 31, 1997. Income from portfolio
securities increased to $3,926,814 compared to $2,455,102 in 1996 and to
$2,859,707 in 1995. Amounts invested in interest and dividend-bearing portfolio
securities increased during 1997. Interest income from temporary cash
investments was $85,861 in 1997, $135,379 in 1996 and $215,527 in 1995. The
steady decrease in 1997 and 1996 as compared to 1995 was a result of lower
investable balances throughout the year.
The net investment losses in 1996 and 1995 were primarily attributable to
the accrual of $7,546,705 and $1,277,595, respectively, in current and deferred
management incentive fees due to the realized gains from the sales of portfolio
securities in 1996 and 1995 and an increase in the net unrealized appreciation
of portfolio securities during 1996.
Mailing, printing and other expenses were $337,531 during 1997 as compared
to $218,982 during 1996 and $338,434 during 1995, due to the higher cost for the
preparation and distribution of the annual report and proxy statement for the
special meeting of stockholders held on April 9, 1997 ("Special Meeting") and
annual shareholder's meeting held in May 1997. Interest expense was $429,940, as
compared to $582,884 in 1996 and to $318,048 in 1995, due to a decrease of the
average daily balances outstanding on the lines of credit to $4,284,027 in 1997,
from $5,956,570 in 1996 and $2,839,315 in 1995.
20
Professional fees increased to $520,161 during 1997 as compared to
$303,545 during 1996 and $251,770 during 1995, due primarily to the costs
associated with the Special Meeting of Stockholders held on April 9, 1997. The
costs included the Fund's portion of the independent third party appraisal of
the Fund's investment in portfolio securities and the legal expenses related to
the filing of the exemptive order with the SEC.
The Management Company receives management fee compensation at an annual
rate of 2% of the net assets of the Fund paid quarterly in arrears. Such fees
amounted to $2,794,795, $1,848,253 and $1,237,775 in 1997, 1996 and 1995,
respectively. The increases in 1997 and 1996 are due to the $30,865,471 and
$29,466,916 increase in net assets from operations during the years ended
December 31, 1997 and 1996, respectively, and the $11,210,529 and $13,112,953 in
net equity raised in 1997 and 1996, respectively.
Through March 31, 1997, the Management Company also received or reimbursed
a management incentive fee equal to 20% of net realized capital gains less
unrealized capital depreciation, computed on a cumulative basis over the life of
the Fund. Management incentive fees of $55,825 and $1,058,012 were accrued
during the years ended December 31, 1997 and 1996, respectively. Deferred
management incentive fee expense for the years ended December 31, 1997 and 1996
totaled $426,501 and $6,488,693, respectively. Pursuant to the vote of the
stockholders at the Special Meeting, the Fund entered into a new management
agreement with the Management Company which eliminated incentive fees based on
capital gains. The deferred management incentive fee was reflected as an expense
of the Fund when there was an increase in the Fund's unrealized appreciation of
portfolio securities and was reflected as a reduction in expense to the Fund
when there was a decrease in the Fund's appreciation of the portfolio
securities. The deferred management incentive fees were not paid until such
appreciation was realized. However, pursuant to the vote of the stockholders at
the Special Meeting, the deferred incentive fee of $11,210,529 at March 31,
1997, was paid on May 15, 1997, by the issuance of 459,973 unregistered shares
of common stock of the Fund. The number of shares issued was determined by
dividing the deferred incentive fee by $24.37 per share, the net asset value per
share at March 31, 1997.
At the Special Meeting, shareholders approved the Equus II Incorporated
1997 Stock Incentive Plan ("Stock Incentive Plan") which authorizes the Fund to
issue options to the directors and officers of the Fund in an aggregate amount
of up to 20% of the outstanding shares of common stock of the Fund.
Implementation of this plan was subject to the receipt of an exemptive order
from the SEC, which was received on May 8, 1997. On May 9, 1997, the
Compensation committee of the Board of Directors authorized the Fund to issue
options to the officers of the Fund to buy up to 830,136 shares of the Fund's
common stock at $17 per share. On July 1, 1997, the Fund issued options to the
officers of the Fund to buy up to 66,995 shares of the Fund's common stock at
$21.3125 per share.
The Stock Incentive Plan also provides that each director who is not an
officer of the Fund be granted an incentive stock option to purchase 5,000
shares of the Fund's common stock. In addition, beginning with the 1998 annual
meeting of shareholders, each director who is not an officer of the Fund will,
on the first business day following the annual meeting, be granted a
nonqualified stock option to purchase 2,000 shares of the Fund's common stock.
The initial 30,000 options to the directors were issued upon the receipt of an
exemptive order from the SEC on November 4, 1997, at a price of $24 per share.
Under the 1997 Stock Incentive Option Plan, options to purchase 927,131
shares of the Fund's common stock at prices ranging $17 to $24 per share were
outstanding at December 31, 1997. During the year ended December 31, 1997, no
options were exercised. Outstanding options expire in May 2007 through November
2007. If all options granted were exercised as of December 31, 1997, there would
have been dilution of net assets per share of approximately $1.28 per share, or
4.3%, as a result of such exercise.
REALIZED GAINS AND LOSSES ON SALES OF PORTFOLIO SECURITIES
During the year ended December 31, 1997 the Fund had net realized gains of
$7,565,699 from the sale of investments in eight portfolio companies. The Fund
sold 251,449 shares of Allied Waste
21
Industries, Inc. ("Allied") for $4,236,177 realizing a net capital gain of
$3,163,942, sold 96,035 shares of American Residential Services, Inc. ("ARS")
for $2,186,926 realizing a net capital gain of $2,130,098, sold its investment
in Industrial Equipment Rental, Inc. for $6,736,956 realizing a net capital gain
of $4,370,256, sold its investments in J&J Rental Service, Inc. for $2,137,400
in cash, an $840,000 receivable and 62,149 shares of United Rentals, Inc.,
realizing a capital gain of $977,400, sold its investment in Midway Airlines for
$271,000 realizing a net capital loss of $3,943,226, and sold its investment in
David's Supermarkets for $5,546,800 realizing a net capital gain of $1,477,350.
In August 1997, the Fund sold its investment in Cardiovascular Ventures, Inc. to
Raytel Medical Corporation ("Raytel") receiving cash proceeds of $2,170,891 and
33,073 shares of common stock, valued at $330,730, of Raytel. The Fund
recognized a capital loss of $121,621 on such sale. In December 1997, the Fund
realized a loss of $488,500 on its investment in A.C. Liquidating preferred
stock which was deemed worthless.
During the year ended December 31, 1996, the Fund realized net capital
gains of $4,037,326 from the sale or disposition of securities of seven
portfolio companies. The Fund sold 233,044 shares of Allied common stock for
$1,563,678, realizing a capital gain of $461,919; exchanged 5,000 shares of
Enterprises Holding Company preferred stock for $1,765,243 in cash and 238,933
shares of ARS common stock, realizing a capital gain of $1,765,243; sold 96,000
shares of Garden Ridge Corporation common stock for $4,719,360 realizing a
capital gain of $4,343,372; was repaid $350,000 on a note receivable from
Restaurant Development Group, Inc. which had a basis of $275,000, realizing a
capital gain of $75,000; sold 32,789 shares of Tech-Sym Corporation for
$1,029,901, realizing a capital gain of $911,656; and exchanged $5,083,083 of
notes receivable from Yellow Cab Service Corporation and $63,601 in cash for
71,440 shares of Coach USA, Inc. common stock, valued at $1,714,560, realizing a
capital loss of $3,432,124. In addition, the Fund realized a capital loss of
$87,740 on its investment in Sports & Leisure, Inc.
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 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.
UNREALIZED APPRECIATION AND DEPRECIATION OF PORTFOLIO SECURITIES
Net unrealized appreciation of investments increased $24,221,889 during
the year ended December 31, 1997, from $41,671,464 to $65,893,353. Such net
increase resulted from increases in the estimated fair value of securities of
twelve of the Fund's Portfolio Companies aggregating $33,857,604, a decrease in
the estimated fair value of securities of five Portfolio Companies of $9,475,904
and the transfer of $159,811 in net unrealized appreciation to net realized
gains from the sale of six companies.
Net unrealized appreciation on investments increased $33,696,196 during
the year ended December 31, 1996, from $7,975,268 to $41,671,464. Such net
increase resulted from increases in the estimated fair value of securities of
eleven of the Fund's Portfolio Companies aggregating $42,748,672, decreases in
the estimated fair value of the securities of four of the Fund's Portfolio
Companies aggregating $9,264,364, and the transfer of $211,888 in net unrealized
depreciation to net realized gains from the sale of investments in six
companies.
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 of $3,911,010 in net unrealized appreciation to net realized gains
from the sale of investments in five companies.
22
DIVIDENDS
The Fund declared dividends of $2,380,327 ($0.50 per share), $3,180,422
($0.76 per share) and $5,814,990 ($2.00 per share) during 1997, 1996 and 1995,
respectively. The Fund has adopted a policy to make dividend distributions of at
least $0.50 per share on an annual basis. In the event that taxable income,
including realized capital gains, exceeds $0.50 per share in any year,
additional dividends may be declared to distribute such excess. The 1997
dividend, which represented a return of capital and the 1996 and 1995 dividends,
which represented the Fund's net investment income and net capital gains for tax
purposes, were paid in additional shares of common stock or in cash by specific
election of the shareholders in January 1998, January 1997 and December 1995.
The Fund paid $828,556, $1,209,850 and $2,753,180 in cash and issued 67,837,
115,916 and 231,080 additional shares of stock at $22.875, $17.00 and $13.25 per
share, in January 1998, January 1997 and December 1995, respectively, in
connection with such dividends.
PORTFOLIO INVESTMENTS
During the year ended December 31, 1997, the Fund invested $27,664,901 in
eleven new companies and made follow-on investments of $5,952,669 in eight
portfolio companies, including $1,238,434 in accrued interest and dividends
received in the form of additional portfolio securities and the $330,730 in
Raytel stock received from the sale of Cardiovascular Ventures, Inc. discussed
above. In addition, the Fund realized a net capital gain of $8,054,199 during
the year ended December 31, 1997, which was offset for tax purposes by the
payment of management incentive fees discussed above.
In January 1997, the Fund rolled its $763,747, 12% subordinated promissory
note along with $130,136 of accrued interest due from WMW Industries, Inc. into
a new $893,883, 12% subordinated promissory note
In February 1997, the Fund acquired 1,370,000 shares of common stock and
45,100 shares of preferred stock of Container Acquisition, Inc. ("Container")
for $1,370,000 and $4,510,000, respectively. In addition, the Fund paid $1,000
for warrants to buy 370,588 shares of common stock for $.01 per share through
February 2007. Container is a logistics and maintenance services company serving
owners of international shipping containers. Through December 31, 1997, the Fund
received an additional 3,894 shares of preferred stock of Container in payment
for $389,400 of dividends on the preferred stock.
In February 1997, the Fund acquired an additional 3,500 shares of
preferred stock of Sovereign Business Forms, Inc. ("Sovereign") for $350,000,
which allowed Sovereign to acquire its third company in the business forms
manufacturing business. In August 1997, the Fund received an additional 990
shares of Sovereign preferred stock in payment of $99,000 in dividends. In
October 1997, the Fund advanced $250,000 to Sovereign under a 15% promissory
note.
In March 1997, the Fund acquired 1,030,000 shares of Series B3 preferred
stock of BSI Holdings, Inc. ("BSI") for $1,030,000, and received warrants to
acquire 18,540 shares of BSI common stock for $50 per share. Such investment
allowed BSI to complete its merger into Sun Sportswear, Inc., a publicly traded
company. In conjunction with the merger of BSI into Sun, the combined company
was renamed Brazos Sportswear, Inc. ("BRZS") and trades on the NASDAQ National
Market under the symbol BRZS. In exchange for each share of common stock of BSI,
the Fund received 7.5824504 shares of BRZS common stock, its preferred stocks of
BSI were exchanged for similar preferred stocks of BRZS, and its warrants were
adjusted to reflect the exchange ratio used in the merger. In addition, through
December 31, 1997, the Fund has received an additional 412,279, 140,210 and
67,410 shares of Series B1, B2 and B3 preferred stock, respectively, in payment
of $619,899 in dividends on the preferred stock.
In March 1997, the Fund advanced $250,000 to Hot & Cool Holdings, Inc.
("Hot & Cool") in exchange for a 10% subordinated promissory note to allow Hot &
Cool to acquire additional equipment. In April 1997, the Fund advanced $850,000
to Hot & Cool in the form of a 10% promissory note and received warrants to buy
8,729 shares of Hot & Cool common stock for $26 per share. In October 1997, the
Fund advanced $700,000 to Hot & Cool in the form of a 10% promissory note and
received warrants
23
to buy 4,426 shares of Hot & Cool common stock for $26 per share.
In April 1997, the Fund advanced $1,250,000 to Cardiovascular Ventures,
Inc. ("CVI") in the form of a 10% promissory note and invested $84 in warrants
to buy 83,956 shares of CVI common stock for $3 per share. Such note was repaid
in conjunction with the sale of CVI in August 1997.
In April 1997, the Fund acquired 9,000 shares of common stock and 4,500
shares of 8% preferred stock of Healthcare Technology Delivery, Inc. ("HTD") for
$50,000 and $450,000, respectively. HTD was formed to acquire FutureTech, Inc.
and Medical Companies Alliance, Inc. In addition, the Fund acquired 300,000
shares of convertible preferred stock of Triad Medical Inc. ("Triad") for
$300,000 and advanced $1,651,965 to Triad under a $2,200,000 prime + 1/2%
promissory note. Such preferred stock was converted in SeptembeR 1997 into
449,213 shares of common stock of Triad. Triad was formed to create a national
leader in the contract sales and distribution of specialty medical products
designed for the hospital and alternate site health care markets, including
sub-acute care facilities, home care companies and specialty physician groups.
HTD was one of the companies to be acquired by Triad. Triad filed a registration
statement in conjunction with the initial public offering of its common stock on
September 11, 1997. Such initial public offering was postponed during the first
quarter of 1998 due to market conditions.
In May 1997, the fund acquired 32,000 shares of common stock and 19,680
shares of preferred stock of Atlas Acquisition, Inc. ("Atlas") for $32,000 and
$1,968,000, respectively. Atlas was formed to acquire Atlas Supply, Inc., a
68-year old distributor of "Atlas" branded tires, batteries and accessories sold
primarily to the auto repair and full service gas station markets.
In June, 1997, the Fund acquired 35,000 shares of common stock of CRC
Holdings, Corp. for $3,199,000 and invested $959,700 in a 12% subordinated
promissory note. CRC Holdings, Corp. was formed to acquire CRC Evans
Pipeline International, Inc. which designs, manufactures and services
specialized pipeline construction and automatic welding equipment, which it
rents and sells worldwide.
In July 1997, the Fund invested $2,000,000 in a 10% subordinated
promissory note of J&J Rental Services, Inc. Pursuant to such investment, the
Fund received warrants to buy 22,500 and 10,715 shares of J&J Rental Services,
Inc. common stock for $.0129 and $.01 per share, respectively, through June 30,
2007. J&J Rental Services, Inc. is an industrial and construction equipment
rental business. In addition, the Fund received warrants to buy 22,500 and
10,715 shares of J&J Realty, Inc. common stock for $.0129 and $.01 per share
respectively, through June 30, 2007. J&J Realty, Inc. owns the real estate on
which J&J Rental Services, Inc. operates. In October 1997, the Fund exercised
its warrants to buy 33,215 shares of J&J Rental Service, Inc. ("J&J") for $397
then sold its investment in J&J receiving $2,000,000 in payment of its note and
62,149 shares of United Rentals, Inc. ("URI"). The number of shares is subject
to adjustment. In addition, the Fund received the right to receive up to an
additional $840,000 based on the revenues of J&J. URI was founded in September
1997 to create a geographically diversified equipment rental company in the
United States and Canada. URI offers for rent a broad range of equipment to
contractors, industrial and commercial customers, homeowners and others through
67 locations in 16 states and Canada. URI completed its initial public offering
on December 18, 1997.
In the third and fourth quarter of 1997, the Fund advanced $2,777,207
shares under a 10% promissory note to Equicom, Inc., (formerly Texrock Radio,
Inc.) which owns and operates five radio stations in small to medium sized towns
in Texas.
In September 1997, the fund acquired 2,498,452 shares of preferred stock
of Stephen L. LaFrance Holdings, Inc. ("LaFrance") for $2,498,452 and warrants
to buy up to 269 shares of LaFrance common stock for $.01 per share through
September 30, 2007. LaFrance owns and operates 98 retail drug stores in a 6
state area.
During 1997, the Fund exercised warrants to acquire 10,990 shares of
Drypers Corporation common stock for $26,486.
24
During the fourth quarter of 1997, the Fund acquired 666.7 shares of One
Engineering, Inc. ("One Engineering") for $667 and advanced $66,181 under a
prime +1/2%, $2,500,000 promissory note. One Engineering was formed to acquire
companies providing diversified engineering services and engineered systems to a
broad spectrum of industrial, commercial and institutional clients.
In December 1997, the Fund acquired 27,500 shares of common stock and
546,615 shares of Series A preferred stock of Tulsa Industries, Inc. ("Tulsa")
for $33,846 and $5,466,154, respectively. In addition, the Fund received
warrants to buy up to 31,731 shares of common stock of Tulsa for $0.001 per
share. Tulsa manufactures equipment for the oil and gas industries.
During the year ended December 31, 1996, the Fund invested $9,800,000 in
three new Portfolio Companies and made follow-on investments in nine Portfolio
Companies of $10,274,910, including $435,679 in accrued interest and dividends
received in the form of additional portfolio securities and $750,000 of common
stock received through the net exercise of common stock warrants.
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.
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, 1997,
only ARS, Allied, BRZS, Coach USA, Inc., Drypers Corporation, GRDG, NCI Building
Systems, Inc., PLS, Raytel Medical Corporation, and United Rentals, Inc. are
publicly held. The others each have a small number of shareholders and do not
generally make financial information available to the public. However, each
company's operations and financial information are reviewed by Management to
determine the proper valuation of the Fund's investment. See "Valuation".
SUBSEQUENT EVENTS
Subsequent to December 31, 1997, the Fund repaid a net $75,000,000 of
notes payable to the bank.
In January 1998, the Fund advanced an additional $3,595,380 under a 10%
promissory note to Equicom, Inc., in connection with the acquisition of 8
additional radio stations. On January 27, 1998, the Fund converted $6,372,586 in
promissory notes along with $67,919 in accrued interest into 819,680 shares of
common stock and 619,050 shares of preferred stock of Equicom, Inc. In February
1998, the Fund acquired for $145,000 an additional 14,500 shares of Equicom,
Inc. preferred stock.
In January 1998, the Fund made additional investments by advancing
$500,000, $46,246 and $148,035 to Hot & Cool, One Engineering and Triad,
respectively, under subordinated promissory notes.
In January 1998, the Fund advanced an additional $425,000 in the form of a
junior participation agreement to Atlas.
On January 15, 1998, the Fund sold its investment in WMW. The Fund
received $1,012,576 in cash, to pay off its junior participation note, and
162,428 shares of United States Filter Corp. ("U.S. Filter") common stock. The
Fund could receive up to an additional 41,560 shares of U.S. Filter common
stock, which were placed in an escrow account as security for various
representations made by the Fund. The transaction with U.S. Filter, which is
traded on the New York Stock Exchange, was a tax free exchange, therefore the
Fund did not realize a capital gain on the sale.
In January 1998, an initial public offering of the common stock of Travis
International, Inc. was postponed due to the market conditions.
25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not Applicable
26
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, 1997 and 1996, 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, 1997, and the selected per share data and ratios for each of the
five years in the period ended December 31, 1997. 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, 1997 and 1996. 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.
As discussed in Note 3, the financial statements include investment
securities valued at $147,899,786 (102% of net assets) and $107,609,488 (104% of
net assets) as of December 31, 1997 and 1996, respectively, whose values have
been estimated by Equus Capital Management Corporation (the "Management
Company") 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 Management Company 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
Management Company'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.
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, 1997 and 1996, the results
of its operations, changes in net assets and cash flows for each of the three
years in the period ended December 31, 1997, and the selected per share data and
ratios for each of the five years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Houston, Texas
February 16, 1998
27
EQUUS II INCORPORATED
BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
1997 1996
------------ ------------
ASSETS
Investments in portfolio securities at fair value
(cost $85,556,433 and $69,388,024, respectively) ........ $151,449,786 $111,059,488
Temporary cash investments, at cost which
approximates fair value ................................. 75,164,751 69,129,290
Cash ......................................................... 15,991 --
Accounts receivable .......................................... 932,038 1,326
Accrued interest receivable .................................. 513,623 897,065
Commitment fees .............................................. 18,750 17,500
Deferred reorganization costs ................................ -- 11,730
------------ ------------
Total assets ....................................... 228,094,939 181,116,399
------------ ------------
LIABILITIES AND NET ASSETS
Liabilities:
Accounts payable ........................................ 173,277 208,231
Dividend payable ........................................ 828,556 1,209,850
Due to management company ............................... 722,354 390,982
Deferred management incentive fee ....................... -- 10,784,028
Notes payable to bank ................................... 81,900,000 65,300,000
------------ ------------
Total liabilities .................................. 83,624,187 77,893,091
------------ ------------
Commitments and contingencies
Net assets:
Preferred stock, $.001 par value, 5,000,000 shares
authorized, no shares issued or outstanding .......... -- --
Common stock, $.001 par value, 10,000,000 shares
authorized, 4,828,492 and 4,300,682 shares outstanding 4,828 4,301
Additional paid-in capital .............................. 78,537,258 57,934,306
Undistributed net investment income ..................... -- --
Undistributed net capital gains ......................... 35,313 3,613,237
Unrealized appreciation of portfolio securities, net .... 65,893,353 41,671,464
------------ ------------
Total net assets ................................... $144,470,752 $103,223,308
============ ============
Net assets per share ............................... $ 29.92 $ 24.00
============ ============
The accompanying notes are an
integral part of these financial statements.
28
EQUUS II INCORPORATED
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995
------------ ------------ -----------
Investment income:
Income from portfolio securities ............... $ 3,926,814 $ 2,455,102 $ 2,859,707
Interest from temporary cash investments ....... 85,861 135,379 215,527
------------ ------------ -----------
Total investment income .................... 4,012,675 2,590,481 3,075,234
------------ ------------ -----------
Expenses:
Management fee ................................. 2,794,795 1,848,253 1,237,775
Management incentive fees ...................... 55,825 1,058,012 --
Deferred management incentive fee .............. 426,501 6,488,693 1,277,595
Director fees and expenses ..................... 201,385 203,324 206,124
Professional fees .............................. 520,161 303,545 251,770
Administrative fees ............................ 50,000 50,000 50,000
Mailing, printing and other expenses ........... 337,531 218,982 338,434
Interest expense ............................... 429,940 582,884 318,048
Franchise taxes ................................ 106,924 79,934 40,142
Amortization ................................... 11,730 23,460 23,460
------------ ------------ -----------
Total expenses ............................ 4,934,792 10,857,087 3,743,348
------------ ------------ -----------
Net investment loss ................................. (922,117) (8,266,606) (668,114)
------------ ------------ -----------
Realized gain on sales of portfolio
securities, net ................................ 7,565,699 4,037,326 7,668,524
------------ ------------ -----------
Unrealized appreciation of portfolio securities, net:
End of year .................................... 65,893,353 41,671,464 7,975,268
Beginning of year .............................. 41,671,464 7,975,268 9,255,817
------------ ------------ -----------
Increase (decrease) in unrealized
appreciation of portfolio securities, net ... 24,221,889 33,696,196 (1,280,549)
------------ ------------ -----------
Total increase in net assets
from operations ............................. $ 30,865,471 $ 29,466,916 $ 5,719,861
============ ============ ===========
The accompanying notes are an
integral part of these financial statements.
29
EQUUS II INCORPORATED
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995
------------- ------------- ------------
Operations:
Net investment loss ........................ $ (922,117) $ (8,266,606) $ (668,114)
Realized gain on sales of
portfolio securities, net ............... 7,565,699 4,037,326 7,668,524
Increase (decrease) in unrealized
appreciation of portfolio securities, net 24,221,889 33,696,196 (1,280,549)
------------- ------------- ------------
Increase in net assets from operations .......... 30,865,471 29,466,916 5,719,861
------------- ------------- ------------
Capital transactions:
Stock issued in payment of deferred
management incentive fee ................ 11,210,529 -- --
Proceeds from rights offering .............. -- 13,338,935 --
Rights offering expenses ................... -- (225,982) --
Redemptions of fractional shares ........... -- -- (114)
Stock repurchased and retired under
common stock repurchase plan ............ -- -- (1,193,642)
Dividends .................................. (2,380,327) (3,180,422) (5,814,990)
Shares issued in common stock dividend ..... 1,551,771 1,970,572 3,061,810
------------- ------------- ------------
Increase (decrease) in net assets from
capital share transactions .............. 10,381,973 11,903,103 (4,746,936)
------------- ------------- ------------
Increase in net assets .......................... 41,247,444 41,370,019 972,925
Net assets, at beginning of year ................ 103,223,308 61,853,289 60,880,364
------------- ------------- ------------
Net assets, at end of year ...................... $ 144,470,752 $ 103,223,308 $ 61,853,289
============= ============= ============
The accompanying notes are an
integral part of these financial statements.
30
EQUUS II INCORPORATED
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995
------------- ------------- -------------
Cash flows from operating activities:
Interest and dividends received ....................................... $ 3,157,683 $ 1,783,676 $ 1,940,403
Cash paid to management company,
directors, a bank and suppliers .................................... (4,201,393) (4,277,273) (2,343,223)
------------- ------------- -------------
Net cash used by operating activities .............................. (1,043,710) (2,493,597) (402,820)
------------- ------------- -------------
Cash flows from investing activities:
Purchase of portfolio securities ...................................... (32,048,406) (18,889,231) (13,785,810)
Proceeds from sales of portfolio securities ........................... 18,546,690 8,328,182 8,850,646
Principal payments from portfolio securities .......................... 5,206,728 9,281,122 4,698,814
Purchase of temporary cash investments
with original maturities of greater than
three months ....................................................... -- -- --
Maturity of temporary cash investments
with original maturities of greater than
three months ....................................................... -- -- 300,000
------------- ------------- -------------
Net cash provided (used) by investing
activities ...................................................... (8,294,988) (1,279,927) 63,650
------------- ------------- -------------
Cash flows from financing activities:
Advances from bank .................................................... 354,100,000 261,250,000 273,650,000
Repayments to bank .................................................... (337,500,000) (261,700,000) (253,500,000)
Proceeds from rights offering ......................................... -- 13,338,935 --
Rights offering expenses .............................................. -- (225,982) --
Dividends paid ........................................................ (1,209,850) -- (2,753,180)
Repurchase of common stock ............................................ -- -- (1,993,642)
Redemptions of fractional shares ...................................... -- -- (114)
------------- ------------- -------------
Net cash provided by financing
activities ...................................................... 15,390,150 12,662,953 15,403,064
------------- ------------- -------------
Net increase in cash and cash equivalents .................................. 6,051,452 8,889,429 15,063,894
Cash and cash equivalents at
beginning of year ..................................................... 69,129,290 60,239,861 45,175,967
------------- ------------- -------------
Cash and cash equivalents at end
of year ............................................................... $ 75,180,742 $ 69,129,290 $ 60,239,861
============= ============= =============
The accompanying notes are an
integral part of these financial statements.
31
EQUUS II INCORPORATED
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(Continued)
1997 1996 1995
------------- ------------- -------------
Reconciliation of increase in net assets from operations to net cash used by
operating activities:
Increase in net assets from operations ..................................... $ 30,865,471 $ 29,466,916 $ 5,719,861
Adjustments to reconcile increase from
operations to net cash used by operating
activities:
Realized gain on sales of portfolio
securities, net .................................................... (7,565,699) (4,037,326) (7,668,524)
Decrease (increase) in unrealized
appreciation, net .................................................. (24,221,889) (33,696,196) 1,280,549
Increase in accounts receivable ....................................... -- -- (886)
Decrease (increase) in accrued interest receivable .................... 383,442 (371,126) (268,036)
Accrued interest or dividends exchanged
for portfolio securities ........................................... (1,238,434) (435,679) (865,909)
Commitment fees paid .................................................. (75,000) (70,000) (75,000)
Amortization of commitment fee ........................................ 73,750 90,000 65,625
Amortization of deferred
reorganization costs ............................................... 11,730 23,460 23,460
Increase (decrease) in accounts payable ............................... (34,954) (34,055) 105,111
Stock issued to management company
in payment of deferred management
incentive fee ...................................................... 11,210,529 -- --
Increase (decrease) in due to
management company ................................................. (10,452,656) 6,570,409 1,280,929
------------- ------------- -------------
Net cash used by operating activities ...................................... $ (1,043,710) $ (2,493,597) $ (402,820)
============= ============= =============
The accompanying notes are an
integral part of these financial statements.
32
EQUUS II INCORPORATED
SELECTED PER SHARE DATA AND RATIOS
FOR THE FIVE YEARS ENDED DECEMBER 31,1997
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
SELECTED PER SHARE DATA:
Investment income ...................... $ 0.85 $ 0.68 $ 1.04 $ 0.62 $ 0.52
Expenses ............................... 1.04 2.84 1.26 0.45 1.45
--------- --------- --------- --------- ---------
Net investment income (loss) ........... (0.19) (2.16) (0.22) 0.17 (0.93)
Realized gain (loss) on sales of
portfolio securities, net ........... 1.60 1.06 2.58 (0.12) (0.82)
Increase (decrease) in unrealized
appreciation of portfolio
securities , net .................... 5.11 8.82 (0.43) (0.83) 3.71
--------- --------- --------- --------- ---------
Increase (decrease) in net
assets from operations .............. 6.52 7.72 1.93 (0.78) 1.96
--------- --------- --------- --------- ---------
Capital transactions:
Dividends .............................. (0.50) (0.76) (2.00) (0.25) (0.68)
Effect of common stock repurchases ..... -- -- 0.35 0.10 --
Dilutive effect of shares issued
in common stock dividend ............ (0.10) (0.20) (0.51) -- (0.13)
Effect of Rights Offering .............. -- (2.47) -- -- --
--------- --------- --------- --------- ---------
Net decrease in assets from
capital transactions ................ (0.60) (3.43) (2.16) (0.15) (0.81)
--------- --------- --------- --------- ---------
Net increase (decrease) in net assets .. 5.92 4.29 (0.23) (0.93) 1.15
Net assets at beginning of year ........ 24.00 19.71 19.94 20.87 19.72
--------- --------- --------- --------- ---------
Net assets at end of year .............. $ 29.92 $ 24.00 $ 19.71 $ 19.94 $ 20.87
========= ========= ========= ========= =========
Weighted average number of shares
outstanding during year, in thousands 4,733 3,819 2,968 3,083 3,013
SELECTED RATIOS:
Ratio of expenses to average
net assets .......................... 3.98% 13.15% 6.10% 2.23% 7.03%
Ratio of net investment income
(loss) to average net assets ...... (0.74)% (10.02)% (1.09)% 0.83% (4.53)%
Ratio of increase (decrease) in net
assets from operations to average
net assets .......................... 24.92% 35.70% 9.32% (3.81)% 9.52%
The accompanying notes are an
integral part of these financial statements.
33
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1997
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
----------------- ------------------ ---------- ----------
A. C. Liquidating Corporation ...................... February 1985
-10% secured promissory notes .................... $ 188,014 $ --
Allied Waste Industries, Inc. (NASDAQ - AWIN) ...... March 1989
-1,100,000 shares of common stock ................ 4,037,572 24,874,438
-Warrants to buy up to 125,000 shares of common
stock at $5.00 per share through August 1999 .... -- 1,545,977
American Residential Services, Inc. (NYSE - ARS) ... December 1995
-1,125,000 shares of common stock ................ 3,000,272 14,395,793
-Warrants to buy up to 100,000 shares of common
stock at $15 per share through September 2001 ..
Atlas Acquisition, Inc. ............................ May 1997
-32,000 shares of common stock ................... 32,000 32,000
-19,680 shares of preferred stock ................ 1,968,000 1,968,000
Brazos Sportswear, Inc. (NASDAQ - BRZS) ............ February 1989
-2,160,308 shares of common stock ................ 1,331,187 10,531,501
-3,940,779 shares of 8% Series B1 preferred stock 3,940,779 3,940,779
-1,340,210 shares of 8% Series B2 preferred stock 1,340,210 1,340,210
-1,097,410 shares of 8% Series B3 preferred stock 1,097,410 1,097,410
-Warrants to buy up to 30,261 and 140,578 shares
of common stock at $4.62 and $6.59 per share
through August 2006 and March 2007, respectively -- 7,717
-1,000 shares of common stock of GCS RE, Inc. .... 132,910 300,000
Carruth-Doggett Industries, Inc. ................... December 1995
-10% senior subordinated promissory note ......... 2,250,000 2,250,000
-Warrant to buy up to 33,333 shares of common
stock at $0.01 per share through December 2005 .. -- 1,500,000
-Warrant to buy up to 249 shares of common
stock of CDE Corp. at $0.01 per share through
December 2005 ................................... -- --
The accompanying notes are an
integral part of these financial statements.
34
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1997
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
----------------- ------------------ ---------- -----------
Coach USA, Inc. (NYSE - CUI) ................................................... August 1996
-143,112 shares of common stock .............................................. $1,863,357 $ 4,650,424
Container Acquisition, Inc. .................................................... February 1997
-1,370,000 shares of common stock ............................................ 1,370,000 1,370,000
-48,994 shares of preferred stock ............................................ 4,899,400 4,899,400
-Warrant to buy up to 370,588 shares of common
stock at $.01 per share through February 2007 ............................... 1,000 1,000
CRC Holdings, Corp. ............................................................ June 1997
-35,000 shares of common stock ............................................... 3,199,000 3,199,000
-12% subordinated promissory note ............................................ 959,700 959,700
Drypers Corporation (NASDAQ - DYPR) ............................................ July 1991
-1,107,882 shares of common stock ............................................ 6,426,618 4,807,017
-25,000 shares of 7.5% convertible preferred stock ........................... 2,500,000 10,847,314
Equicom, Inc. (formerly Texrock Radio, Inc.) ................................... July 1997
-10% promissory note ......................................................... 2,777,207 2,777,207
Garden Ridge Corporation (NASDAQ - GRDG) ....................................... July 1992
-474,942 shares of common stock .............................................. 685,030 6,458,830
Healthcare Technology Delivery, Inc. ........................................... April 1997
-9,000 shares of common stock ................................................ 50,000 50,000
Hot & Cool Holdings, Inc. ...................................................... March 1996 -- --
-9% increasing rate subordinated
promissory note ............................................................. 1,300,000 1,300,000
-10% subordinated notes ...................................................... 2,200,000 2,200,000
-Warrants to buy up to 14,942 shares of common
stock at $.01 per share through March 2006 ................................. -- 280,000
-Warrants to buy up to 13,155 shares of common
stock at $26 per share through April, 2007 ................................. -- --
NCI Building Systems, Inc. (NASDAQ - BLDG) ..................................... April 1989
-100,000 shares of common stock .............................................. 159,784 3,550,000
The accompanying notes are an
integral part of these financial statements.
35
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1997
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
----------------- -------------- ---------- ----------
One Engineering, Inc. .......................... October 1997
-666.7 shares of common stock ................ $ 667 $ 667
-prime + 1/2% promissory note ................ 66,181 66,181
Paracelsus Healthcare Corporation (NYSE - PLS) . December 1990
-1,263,058 shares of common stock ............ 5,278,748 3,958,090
Raytel Medical Corporation (NASDAQ - RTEL) ..... August 1997
-33,073 shares of common stock ............... 330,730 326,803
Restaurant Development Group, Inc. ............. June 1987
-610,909 shares of Class A common stock ...... 2,891,156 700,000
-Warrants to buy up to 62,500 shares of
common stock at $3 per share through
April 1998 .................................. -- --
Sovereign Business Forms, Inc. ................. August 1996
-11,990 shares of preferred stock ............ 1,199,000 1,199,000
-15% promissory notes ........................ 800,000 800,000
-Warrant to buy 551,894 shares of common
stock at $1 per share through August 2006 .. -- --
Stephen L. LaFrance Holdings, Inc. ............. September 1997
-2,498,452 shares of preferred stock ......... 2,498,452 2,498,452
-Warrant to buy 269 shares of common stock
for $.01 per share through September 2007 .. -- --
Strategic Holdings, Inc. ....................... September 1995
-3,089,751 shares of common stock ............ 3,088,389 3,088,389
-3,822,157 shares of Series B preferred stock 3,820,624 3,820,624
-Warrants to buy 225,000 and 100,000 shares of
common stock at $0.4643 and $1.50 per share,
respectively, through August 2005 .......... -- 100,000
-1,000 shares of SMIP, Inc. common stock ..... 150,000 150,000
-15% promissory note of SMIP, Inc. ........... 175,000 175,000
The accompanying notes are an
integral part of these financial statements.
36
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1997
(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
Travis International, Inc. .................. December 1986
-66,784 shares of common stock ............ 534,589 1,502,640
-104,500 shares of Class A common stock ... 25,701 2,351,250
Triad Medical Inc. .......................... April 1997
-449,213 shares of common stock ........... 300,000 300,000
-Prime + 1/2% promissory note ............. 1,651,965 1,651,965
Tulsa Industries, Inc. ...................... December 1997
-27,500 shares of common stock ............ 33,846 33,846
-546,615 shares of Series A preferred stock 5,466,154 5,466,154
-Warrants to buy 31,731 shares of common
stock at .001 per share .................. -- --
United Rentals, Inc. (NYSE:URI) ............. October 1997
-62,149 shares of common stock ............ 397 928,200
VRPI Spin Off, Inc. ......................... January 1988
-100 shares of common stock ............... 250,000 250,000
-10% secured promissory note .............. 2,672,349 2,672,349
-12% secured promissory note .............. 1,050,000 1,050,000
-10,000 shares of common stock of
Equus Video Corporation .................. 25,000 20,000
WMW Industries, Inc. ........................ October 1989
-602,707 shares of common stock ........... 1,031,576 2,700,000
-12% subordinated promissory note ......... 893,883 893,883
-Junior participation in prime + 1.5% note 1,012,576 1,012,576
----------- ------------
Total .................................. $85,556,433 $151,449,786
=========== ============
The accompanying notes are an
integral part of these financial statements.
37
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1997
(Continued)
Substantially all of the Fund's portfolio securities are restricted from
public sale without prior registration under the Securities Act of 1933. The
Fund negotiates certain aspects of the method and timing of the disposition of
the Fund's investment in each portfolio company, including registration rights
and related costs.
In connection with the investments in Allied Waste Industries, Inc.,
American Residential Services, Inc., Atlas Acquisition, Inc., Brazos Sportswear,
Inc., Coach USA, Inc., CRC Holdings, Corp., Drypers Corporation, Healthcare
Technology Delivery, Inc., Hot & Cool Holdings, Inc., Paracelsus Healthcare
Corporation, Sovereign Business Forms, Inc., Strategic Holdings, Inc. and Triad
Medical Inc., rights have been obtained to demand the registration of such
securities under the Securities Act of 1933, providing certain conditions are
met. The Fund does not expect to incur significant costs, including costs of any
such registration, in connection with the future disposition of its portfolio
securities.
As defined in the Investment Company Act of 1940, the Fund is considered
to have a controlling interest in Atlas Acquisition, Inc., Brazos Sportswear,
Inc., Container Acquisition, Inc., CRC Holdings, Corp., Drypers Corporation, One
Engineering, Inc., Restaurant Development Group, Inc., Strategic Holdings, Inc.,
Triad Medical Inc., Tulsa Industries, Inc., VRPI Spin Off, Inc. and WMW
Industries, Inc. In addition, Healthcare Technology Delivery, Inc. and Travis
International, Inc. are considered to be affiliated entities of the Fund. The
fair values of the Fund's investments in publicly traded securities include
discounts from the closing market prices to reflect the estimated effects of
restrictions on the sale of such securities at December 31, 1997. Such
discounts, shown in the following table, total $17,100,722 or $3.54 per share as
of December 31, 1997.
DISCOUNT FROM
MARKET VALUE
-----------
Allied Waste Industries, Inc. ........... $ 1,512,398
American Residential Services, Inc. ..... 3,244,832
Brazos Sportswear, Inc. ................. 5,878,170
Coach USA, Inc. ......................... 143,828
Drypers Corporation ..................... 5,541,975
Garden Ridge Corporation ................ 309,094
Paracelsus Healthcare Corporation ....... 304,731
Raytel Medical Corporation .............. 57,671
United Rentals, Inc. .................... 108,023
-----------
Total discount .................... $17,100,722
===========
Income was earned in the amount of $2,102,520, $1,577,564 and $1,349,420
for the years December 31, 1997, 1996 and 1995 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 Coach USA, Inc., Paracelsus Healthcare Corporation, Raytel
Medical Corporation, Summit/DPC Partners, L.P. and United Rentals, Inc. The Fund
provides significant managerial assistance to portfolio companies that comprise
90% of the total value of the investments in portfolio companies at December 31,
1997.
The accompanying notes are an
integral part of these financial statements.
38
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1996
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 --
Allied Waste Industries, Inc. (NASDAQ - AWIN) ... March 1989
-1,351,449 shares of common stock ............. 5,109,808 11,749,985
-Warrants to buy up to 125,000 and 15,000
shares of common stock at $5.00 and $13.50 per
share through August 1999 and February 1997,
respectively ................................. -- 126,563
American Residential Services, Inc. (NYSE - ARS) December 1995
-1,221,035 shares of common stock ............. 3,057,100 24,909,505
-Warrants to buy up to 100,000 shares
of common stock at $15 per share through
September 2001 ............................... -- 263,125
BSI Holdings, Inc. .............................. February 1989
-284,909 shares of common stock ............... 1,331,187 8,750,000
-1,200,000 shares of Series A preferred stock . 1,200,000 1,200,000
-3,528,500 shares of 8% Series B preferred stock 3,528,500 3,528,500
-Warrants to buy up to 3,991 shares of common
stock at $35 per share through August 2006 ... -- --
-1,000 shares of common stock of GCS RE, Inc. . 132,910 200,000
Cardiovascular Ventures, Inc. ................... November 1991
-150,000 shares of Series A convertible
preferred stock .............................. 375,000 375,000
-214,286 shares of Series B convertible
preferred stock .............................. 750,001 750,001
-56,717 shares of Series C convertible
preferred stock .............................. 248,137 248,137
The accompanying notes are an
integral part of these financial statements.
39
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1996
(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 2005 ........................ -- --
-Warrant to buy up to 249 shares of
common stock of CDE Corp. at $0.01
per share through December 2005 .............. -- --
Coach USA, Inc. (NASDAQ - TOUR) ................. August 1996
-143,112 shares of common stock ............... 1,863,357 3,422,503
David's Supermarkets, Inc. ...................... February 1990
-735,000 shares of common stock ............... 735,000 450,000
-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 2000 -- --
Drypers Corporation (NASDAQ - DYPR) ............. July 1991
-1,096,892 shares of common stock ............. 6,400,132 3,299,289
-25,000 shares of 7.5% convertible
preferred stock .............................. 2,500,000 6,097,362
-Warrants to buy up to 6,634 shares of common
stock at $4 per share through June 1998 ...... -- --
Garden Ridge Corporation (NASDAQ - GRDG) ........ July 1992
-474,942 shares of common stock ............... 685,030 3,961,380
Hot & Cool Holdings, Inc. ....................... March 1996
-9% increasing rate subordinated
promissory note .............................. 1,300,000 1,300,000
-10% subordinated note ........................ 400,000 400,000
-Warrants to buy up to 14,942 shares of common
stock at $.01 per share through March 2006 .. -- --
The accompanying notes are an
integral part of these financial statements.
40
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1996
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
------------- ---------- ----------
Industrial Equipment Rentals, Inc. ............ June 1993
-182,230 shares of common stock ............. $ 1,822 $1,349,960
-5,371 shares of junior preferred stock ..... 537,100 537,100
-67,500 shares of Series B senior convertible
preferred stock ............................ 250,050 500,040
-12% subordinated debenture ................. 1,077,778 1,077,778
-9% senior subordinated debenture ........... 499,950 499,950
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 --
-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 ............. 159,784 3,450,000
Paracelsus Healthcare Corporation (NYSE - PLS) December 1990
-1,263,058 shares of common stock ............ 5,278,748 4,249,455
Restaurant Development Group, Inc. ............ June 1987
-610,909 shares of Class A common stock ..... 2,891,156 800,000
-Prime +2% promissory note .................. 108,000 108,000
-Warrants to buy up to 62,500 shares of
common stock at $3 per share through
April 1998 ................................. -- --
Sovereign Business Forms, Inc. ................. August 1996
-7,500 shares of preferred stock ............. 750,000 750,000
-15% promissory note ......................... 550,000 550,000
-Warrant to buy 551,894 shares of common
stock at $1 per share through August 2006 .. -- --
The accompanying notes are an
integral part of these financial statements.
41
EQUUS II INCORPORATED
SCHEDULE OF PORTFOLIO SECURITIES
DECEMBER 31, 1996
(Continued)
DATE OF
PORTFOLIO COMPANY INITIAL INVESTMENT COST FAIR VALUE
------------------ ----------- ------------
Strategic Holdings, Inc. ....................... September 1995
-3,089,751 shares of common stock ............ $ 3,088,389 $ 3,088,389
-3,822,157 shares of Series B preferred stock 3,820,624 3,820,624
-Warrants to buy 225,000 and 100,000 shares of
common stock at $0.4643 and $1.50 per share,
respectively, through August 2005 .......... -- --
-1,000 shares of SMIP, Inc. common stock ..... 150,000 150,000
-15% promissory note of SMIP, Inc. ........... 175,000 175,000
Summit/DPC Partners, L.P. ...................... October 1995
-36.11% limited partnership interest ......... 2,600,000 2,600,000
Travis International, Inc. ..................... December 1986
-66,784 shares of common stock ............... 534,589 1,502,640
-104,500 shares of Class A common stock ...... 25,701 2,351,250
VRPI Spin Off, Inc. ............................ January 1988
-100 shares of common stock .................. 250,000 625,000
-10% secured promissory note ................. 2,672,349 2,672,349
-12% secured promissory note ................. 1,050,000 1,050,000
-10,000 shares of common stock
of Equus Video Corporation .................. 25,000 25,000
WMW Industries, Inc. ........................... October 1989
(formerly Williams & Mettle Co.)
-530,035 shares of common stock .............. 1,024,309 463,830
-12% subordinated promissory note ............ 763,747 763,747
-Junior participation in prime + 1.5% note ... 1,012,576 1,012,576
-Warrant to buy 72,672 shares of common
stock at $0.01 per share through
December 1999 ............................... -- --
----------- ------------
Total ..................................... $69,388,024 $111,059,488
=========== ============
The accompanying notes are an
integral part of these financial statements.
42
EQUUS II INCORPORATED
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
(1) ORGANIZATION AND BUSINESS PURPOSE
Equus II Incorporated (the "Fund"), a Delaware corporation with perpetual
existence, was formed by Equus Investments II, L.P. (the "Partnership") on
August 16, 1991. On July 1, 1992, the Partnership was reorganized and all of the
assets and liabilities of the Partnership were transferred to the Fund in
exchange for shares of common stock of the Fund. The shares of the Fund trade on
the American Stock Exchange under the symbol EQS.
The Fund seeks to achieve capital appreciation by making investments in
equity and equity-oriented securities issued by privately-owned companies in
transactions negotiated directly with such companies. The Fund seeks to invest
primarily in companies which intend to acquire other businesses, including
leveraged buyouts. The Fund may also invest in recapitalizations of existing
businesses or special situations from time to time. The Fund's investments in
Portfolio Companies consist principally of equity securities such as common and
preferred stock, but also include other equity-oriented securities such as debt
convertible into common or preferred stock or debt combined with warrants,
options or other rights to acquire common or preferred stock. Current income is
not a significant factor in the selection of investments. The Fund 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 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 is included in the accompanying
Statements of Operations for each of the three years ended December 31, 1997.
Through March 31, 1997, the Management Company also received or reimbursed
a management incentive fee equal to 20% of net realized capital gains less
unrealized capital depreciation, computed on a cumulative basis over the life of
the Fund. The management incentive fee was paid or reimbursed quarterly in
arrears. Pursuant to the vote of the stockholders at a special meeting held on
April 9, 1997 ("Special Meeting"), the Fund entered into a new management
agreement with the Management Company. The only significant change from the
previous management agreement was the elimination of incentive fees based on
capital gains effective as of April 1, 1997.
Included in "Deferred management incentive fees" in the accompanying
Balance Sheets was $10,784,028 at December 31, 1996, which was calculated on the
net unrealized appreciation of investments in portfolio securities. Pursuant to
the vote of the stockholders at the Special Meeting, the deferred incentive fee,
which had increased to $11,210,529 at March 31, 1997, was paid on May 15, 1997,
by the issuance to the Management Company of 459,973 unregistered shares of
common stock of the Fund. The number of shares issued was determined by dividing
the deferred incentive fee by $24.37 per share, the net asset value per share at
March 31, 1997. Deferred management incentive fee expense of $426,501,
$6,488,693 and $1,277,595 resulting from increases in net unrealized
appreciation on portfolio securities have been included in the accompanying
Statements of Operations for the three years ended December 31, 1997. Current
management incentive fees of $55,825 and $1,058,012 were included in the
accompanying Statement of Operations for the years ended December 31, 1997 and
1996, respectively. At December 31, 1996, $125,135 of incentive fees to be
reimbursed by the Management Company to the Fund are netted in "Due to
Management Company", against $516,117 of management
43
fees due to the Management Company.
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. In addition, each director who is not an officer of the Fund will be
granted incentive stock options to purchase shares of the Fund's stock from time
to time. See Note 11. Certain officers and directors of the Fund serve as
directors of Portfolio Companies, and may receive and retain fees, including
non-employee director stock options from such Portfolio Companies 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 estimated effects of restrictions on the sale of such securities
("Valuation Discount"), if applicable. Cost is used to approximate fair value of
other investments until significant developments affecting an investment provide
a basis for use of an appraisal valuation. Thereafter, portfolio investments are
carried at appraised values as determined quarterly by the Management Company,
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, amounting to
$147,899,786 (including $89,710,511 in publicly-traded securities, net of a
$17,100,722 Valuation Discount) and $107,609,488 (including $58,079,167 in
publicly-traded securities, net of a $15,599,614 Valuation Discount) at December
31, 1997 and 1996, respectively, the Fund'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.
On a daily basis, the Fund adjusts its net asset value for changes in the
value of its publicly held securities and material changes in the value of its
private securities and reports those amounts to Lipper Analytical Services, Inc.
("Lipper") and also publishes the daily net asset value on its web site at
www.equuscap.com. On a weekly basis, such net asset values appear in various
publications, including BARRON'S and THE WALL STREET Journal.
Investment Transactions - Investment transactions are recorded on the
accrual method. Realized gains and losses on investments sold are computed on a
specific identification basis.
Cash Flows - For purposes of the Statements of Cash Flows, the Fund
considers all highly liquid temporary cash investments purchased with an
original maturity of three months or less to be cash equivalents.
Income Taxes - No provision for Federal income taxes has been made in the
accompanying financial statements as the Fund has qualified for pass-through
treatment as a "regulated investment company" under Subchapter M of the Internal
Revenue Code of 1986. As such, all net income is allocable to the stockholders
for inclusion in their respective tax returns. Net capital losses are not
allocable to the shareholders but can be carried over to offset future earnings
of the Fund.
(4) BOOK TO TAX RECONCILIATION
The Fund accounts for dividends in accordance with Statement of Position
93-2 which relates to
44
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 undistributed capital gains during
1997 of $35,313. A dividend of such income was declared and will be distributed
in late 1998 or early 1999. The Fund had a net investment loss for tax purposes
for the years ended December 31, 1997 and 1996, and therefore distributed no net
investment income. The Fund, for book purposes, had undistributed net capital
gains of $11,178,936 at December 31, 1997. However, for tax purposes, the Fund
has distributed all but $35,313 of its net realized capital gains. The Fund at
December 31, 1997, reclassified the difference of $11,143,623 from Undistributed
net capital gains to Additional paid-in capital.
The following is a reconciliation of the difference in the Fund's net
realized gain on the sale of portfolio securities for book and tax purposes.
1997 1996 1995
----------- ----------- -----------
Net realized gain on the sales of portfolio
securities, book ........................ $ 7,565,699 $ 4,037,326 $ 7,668,524
Management incentive fee .................. (7,530,386) (1,058,012) --
Reversal of amounts previously written off -- -- 48,838
Utilization of capital loss carryforwards . -- -- (1,892,377)
----------- ----------- -----------
Net realized gain on the sales of
portfolio securities, tax ............... $ 35,313 $ 2,979,314 $ 5,824,985
=========== =========== ===========
(5) DIVIDENDS
The Fund declared dividends of $2,380,327 ($0.50 per share), $3,180,422
($0.76 per share), and $5,814,990 ($2.00 per share) during 1997, 1996 and 1995,
respectively. The Fund has adopted a policy to make dividend distributions of at
least $0.50 per share on an annual basis. In the event that taxable income,
including realized capital gains, exceeds $0.50 per share in any year,
additional dividends may be declared to distribute such excess. The 1997
dividend was paid in additional shares of common stock or in cash by specific
election of the shareholders in January 1998, and represented a return of
capital. The 1996 and 1995 dividends, which represented the Fund's net
investment income and net capital gains for tax purposes, were paid in
additional shares of common stock or in cash by specific election of the
shareholders in January 1997 and December 1995. The Fund paid $828,556,
$1,209,850 and $2,753,180 in cash and issued 67,837, 115,916 and 231,080
additional shares of stock at $22.875, $17.00 and $13.25 per share, in January
1998, January 1997 and December 1995, respectively, in connection with such
dividends. The stock issued in January 1998 and 1997 is reflected as outstanding
as of December 31, 1997 and 1996 in the accompanying financial statements.
(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, 1997. The
following is a list of temporary cash investments at December 31, 1997 and 1996:
1997 1996
----------- -----------
NationsBank of Texas, N.A .......................... $75,164,751 $69,129,279
Great Hall Money Market ............................ -- 11
----------- -----------
Total money market accounts ... $75,164,751 $69,129,290
=========== ===========
45
(7) ACCOUNTS RECEIVABLE
Included in Accounts receivable at December 31, 1997, was $840,000 in
royalties receivable from United Rentals, Inc. related to the sale of the Fund's
investment in J&J Rental Service, Inc. and $90,712 in escrow related to the sale
of the Fund's investment in Industrial Equipment Rentals, Inc.
(8) PORTFOLIO SECURITIES
During the year ended December 31, 1997, the Fund invested $27,644,902 in
eleven new companies and made follow-on investments of $5,952,669 in eight
portfolio companies, including $1,238,434 in accrued interest and dividends
received in the form of additional portfolio securities and $330,730 in
securities received upon the sale of securities of another portfolio company. In
addition, the Fund realized a net capital gain of $7,565,699 during the year
ended December 31, 1997.
During the year ended December 31, 1996, the Fund invested $9,800,000 in
three new companies and made follow-on investments of $10,274,910 in nine
portfolio companies, including $435,679 in dividends and accrued interest
received in the form of additional portfolio securities and $750,000 of common
stock received through the net exercise of common stock warrants. In addition,
the Fund realized net capital gains of $4,037,326 during the year ended December
31, 1996.
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.
(9) DEFERRED REORGANIZATION COSTS
The Fund paid $117,300 in expenses related to the formation of the Fund
and amortized such amount over 5 years. Accumulated amortization of such
expenses totaled $117,300 and $105,570 at December 31, 1997 and 1996,
respectively.
(10) NOTES PAYABLE TO BANK
The Fund has a $150,000,000 line of credit promissory note with
NationsBank of Texas, N.A., with interest payable at 1% over the rate earned in
its money market account. The Fund had $75,000,000 and $65,000,000 outstanding
on such note at December 31, 1997 and 1996, respectively, that was secured by
$75,000,000 and $65,000,000 of the Fund's temporary cash investments. The Fund
paid $75,000 and $50,000 in commitment fees in 1997 and 1996, which were
capitalized and amortized over the commitment period.
The note matures on April 1, 1998.
The Fund has a $30,000,000 revolving line of credit with NationsBank of
Texas, N.A. that expires on April 1, 1998. The Fund had $6,900,000 and $300,000
outstanding under such line of credit at December 31, 1997 and 1996,
respectively, which is secured by the Fund's investments in portfolio
securities. The Fund paid a $20,000 commitment fee in 1996 in connection with
such loan, which was capitalized and amortized over the commitment period which
ended April 4, 1997. The outstanding balance on the loan bears interest at prime
+ 1/4% to 3/4%. The fund also pays 1/4% interest on the unused portion of the
line of credit.
The average daily balances outstanding on the Fund's notes payable during
the years ended December 31, 1997 and 1996, were $4,284,027 and $5,956,570,
respectively.
(11) STOCK OPTION PLAN
At a special meeting of shareholders of the Fund on April 9, 1997,
shareholders approved the Equus II Incorporated 1997 Stock Incentive Plan
("Stock Incentive Plan") which authorizes the Fund to
46
issue options to the directors and officers of the Fund in an aggregate amount
of up to 20% of the outstanding shares of common stock of the Fund.
Implementation of this plan was subject to the receipt of an exemptive order
from the Securities and Exchange Commission ("SEC"), which was received on May
8, 1997. On May 9, 1997, the Compensation committee of the Board of Directors
authorized the Fund to issue options to the officers of the Fund to buy up to
830,136 shares of the Fund's common stock at $17 per share. On July 1, 1997, the
Fund issued options to the officers of the Fund to buy up to 66,995 shares of
the Fund's common stock at $21.3125 per share.
The Stock Incentive Option Plan also provides that each director who is
not an officer of the Fund be granted an incentive stock option to purchase
5,000 shares of the Fund's common stock. In addition, beginning with the 1998
annual meeting of shareholders, each director who is not an officer of the Fund
will, on the first business day following the annual meeting, be granted a
nonqualified stock option to purchase 2,000 shares of the Fund's common stock.
The initial 30,000 options to the directors were issued upon the receipt of an
exemptive order from the SEC on November 4, 1997, at a price of $24 per share.
Under the 1997 Stock Incentive Option Plan, options to purchase 927,131
shares of the Fund's common stock at prices ranging $17 to $24 per share were
outstanding at December 31, 1997. During the year ended December 31, 1997, no
options were exercised. Outstanding options expire in May 2007 through November
2007. If all options granted were exercised as of December 31, 1997, there would
have been dilution of net assets per share of approximately $1.28 per share, or
4.3%, as a result of such exercise.
In accordance with the terms of Accounting Principles Board Opinion No. 25
Accounting for Stock Issued to Employees ("APB 25"), because the exercise price
of the Fund's Incentive Options equals the market price of the underlying stock
on the date of grant, the Fund records no compensation expense for its stock
option awards. As required by the Financial Accounting Standards Board Statement
No. 123, Accounting for Stock-based Compensation ("SFAS 123"), the Fund provides
the following disclosure of hypothetical values for these awards. The weighted
average grant-date fair value of options granted during 1997 was $3.86 per
share. This value was estimated using the Black-Scholes option-pricing model
with the following weighted average assumptions: expected dividend of 5.1%,
expected volatility of 25.3%, risk free interest rates ranging from 6.0% to
6.7%, and expected lives of 10 years. Had compensation expense been recorded
based on these hypothetical values, the Fund's 1997 total increase in net assets
from operations would have been reduced by $3,574,260. Because options vest over
several years and additional grants are expected, the effects of these
hypothetical calculations are not likely to be representative of similar future
calculations.
(12) RIGHTS OFFERING
On March 5, 1996, the Fund filed a registration statement with the
Securities and Exchange Commission for a rights offering. Under the rights
offering, the Fund issued each shareholder of record as of April 10, 1996, one
right for each share owned. One share of common stock could be acquired for
every three rights. The exercise price for shares in the rights offering was
$12.75 per share, a 19.7% discount from the market price on April 10, 1996. On
May 8, 1996, the Fund completed its rights offering, which was over-subscribed.
The Fund issued a total of 1,046,191 shares at $12.75 per share and raised
$13,112,953, net of $225,982 in expenses. The proceeds from the rights offering
were used to repay debt and to fund the commitments the Fund had made for new
and follow-on investments.
(13) COMMITMENTS AND CONTINGENCIES
The Fund has made commitments to invest, under certain circumstances, up
to an additional $850,000 in Atlas Acquisition, Inc., $9,350,000 in Equicom,
Inc., $565,500 in GCS RE, Inc., $500,000 in Hot & Cool Holdings, Inc.,
$2,433,819 in One Engineering, Inc., $2,000,000 in Sovereign Business Forms,
Inc. and $548,034 in Triad Medical 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 $2,500,000 in one new company.
47
On April 1, 1996, two stockholders of the Fund filed an action in federal
district court in Houston, Texas against the directors of the Fund, the
Management Company, and the Fund. Their suit alleged that by approving the
rights offering which was announced in March 1996, the Management Company and
the directors of the Fund violated their fiduciary duties to the Fund's
stockholders under the Investment Company Act of 1940 and Delaware common law.
They also alleged that the Management Company aided and abetted these breaches
of fiduciary duty. The plaintiffs moved the court to certify their suit as a
class action on behalf of all stockholders of the Fund. The court dismissed
their suit in December 1996, but the plaintiffs made substantially similar
claims in an amended shareholder derivative action which they filed in January
1997. The plaintiffs did not specify the amount of any damages in either suit.
The derivative action lawsuit was also dismissed by the court on February 11,
1998; however, the plaintiffs have the right to appeal. During the years ended
December 31, 1997 and 1996, the Fund incurred $45,682 and $92,336, respectively,
in legal expenses related to such action.
The Fund and certain of the portfolio companies are involved in asserted
claims and have the possibility for unasserted claims which may ultimately
affect the fair value of the Fund's portfolio investments. In the opinion of
Management, the financial position or operating results of the Fund will not be
materially affected by these claims.
(14) SUBSEQUENT EVENTS
Subsequent to December 31, 1997, the Fund repaid a net $75,000,000 of
notes payable to the bank.
In January 1998, the Fund advanced an additional $3,595,380 under a 10%
promissory note to Equicom, Inc., in connection with the acquisition of 8
additional radio stations. On January 27, 1998, the Fund converted $6,372,586 in
promissory notes along with $67,919 in accrued interest into 819,680 shares of
common stock and 619,050 shares of preferred stock of Equicom, Inc. In February
1998, the Fund acquired for $145,000 an additional 14,500 shares of Equicom,
Inc. preferred stock.
In January 1998, the Fund made additional investments by advancing
$500,000, $46,246 and $148,035 to Hot & Cool Holdings, Inc., One Engineering,
Inc. and Triad Medical Inc., respectively, under subordinated promissory notes.
In January 1998, the Fund advanced an additional $425,000 in the form of a
junior participation agreement to Atlas Acquisition, Inc.
On January 15, 1998, the Fund sold its investment in WMW Industries, Inc.
The Fund received $1,012,576 in cash to pay off its junior participation note
and 162,428 shares of United States Filter Corp. ("U.S. Filter") common stock.
The Fund could receive up to an additional 41,560 shares of U.S. Filter common
stock, which were placed in an escrow account as security for various
representations made by the Fund. The transaction with U.S. Filter, which is
traded on the New York Stock Exchange, was a tax free exchange, therefore the
Fund did not realize a capital gain on the sale.
In January 1998, initial public offerings of the common stock of Travis
International, Inc. and Triad Medical Inc. were postponed due to the market
conditions.
48
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
1998 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,
1998 (the "1998 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION.
Information regarding Executive Compensation is incorporated by reference
to the Fund's 1998 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 1998 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information regarding Certain Relationships and Related Transactions is
incorporated by reference to the Fund's 1998 Proxy Statement.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) FINANCIAL STATEMENTS PAGE
Report of Independent Public Accountants 27
Balance Sheets
December 31, 1997 and 1996 28
Statements of Operations for the years
ended December 31, 1997, 1996 and 1995 29
Statements of Changes in Net Assets for the
years ended December 31, 1997, 1996 and 1995 30
Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 31
Selected Per Share Data and Ratios for the
five years ended December 31, 1997 33
Schedule of Portfolio Securities
at December 31, 1997 34
Schedule of Portfolio Securities
at December 31, 1996 39
Notes to Financial Statements 43
49
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. [Incorporated by reference to 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 [Incorporated by reference to 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. [Incorporated by reference
to Exhibit 3(c) to Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995]
10. Material Contracts
(a) Form of Management Agreement between the Fund and Equus Capital
Management Corporation. [Incorporated by reference to Exhibit A to
the Definitive Proxy Statement dated February 24, 1997
(b) 1997 Stock Incentive Plan [Incorporated by reference to Exhibit B to
the Registrant's Definitive Proxy Statement dated February 24, 1997]
(c) Amended and Restated Loan Agreement by and between Equus II
Incorporated and NationsBank of Texas, N.A., dated March 29, 1996
[Incorporated by reference to Exhibit 10(g) to Registrant's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1996.]
(b) REPORTS ON FORM 8-K
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 24, 1998 Nolan Lehmann, President
50
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 24, 1998
(Gregory J. Flanagan)
/s/ ROBERT L. KNAUSS Director February 24, 1998
(Robert L. Knauss)
/s/ GARY R. PETERSEN Director February 24, 1998
(Gary R. Petersen)
/s/ JOHN W. STORMS Director February 24, 1998
(John W. Storms)
/s/ FRANCIS D. TUGGLE Director February 24, 1998
(Francis D. Tuggle)
/s/ EDWARD E. WILLIAMS Director February 24, 1998
(Edward E. Williams)
/s/ NOLAN LEHMANN President and Director February 24, 1998
(Nolan Lehmann) (principal financial
and accounting officer)
/s/ SAM P. DOUGLASS Chairman of the Board February 24, 1998
(Sam P. Douglass) and Chief Executive
Officer (principal
executive officer)
51