EQS

Business Context and Reporting Period

Company: Equus Total Return, Inc. (EQS)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2009
Business Overview: EQS is a closed-end business development company (BDC) and regulated investment company (RIC) investing in debt and equity securities of privately-held middle-market and small-cap companies. The Fund seeks total return through capital appreciation and current income.

Strategic Shift: In June 2009, the Fund terminated its external investment advisory and administration agreements, transitioning to an "internalized" management structure to reduce costs and enhance liquidity. Consequently, management and incentive fees were eliminated for the latter half of the year.

Key Financial Metrics

Material Changes vs. Prior Period

• Significant Decline in Net Assets: Net assets decreased by approximately 35% from $78.4 million in 2008 to $50.9 million in 2009. This was driven by a $15.6 million net realized loss and a $12.2 million increase in net unrealized depreciation.
• Realized Losses: The Fund recorded a net realized loss of $15.6 million in 2009, compared to a gain of $0.9 million in 2008. Major contributors to the loss included write-downs of Nickent Golf, Inc. ($9.7 million), Creekstone Florida Holdings, LLC ($4.0 million), and Metic Group, PLC ($1.0 million).
• Expense Reduction: Total expenses decreased from $3.9 million in 2008 to $3.6 million in 2009. The internalization of management eliminated the 2% management fee and incentive fees, resulting in estimated cost savings of $0.9 million.
• Portfolio Valuation: The fair value of portfolio securities dropped from $68.7 million to $42.4 million. Significant write-downs occurred in Infinia Corporation, Riptide Entertainment, and Spectrum Management due to market conditions and operational performance.

Guidance, Outlook, Risks, and Contingencies

• Management Outlook: Management has shifted focus from originating new investments to protecting capital and preserving liquidity. The Fund suspended its managed distribution policy in March 2009 to conserve cash, though it continues to make distributions to maintain RIC status.
• Liquidity and Debt: The Fund maintains a $7.5 million revolving line of credit with Amegy Bank (extended through July 2011), which was unutilized as of year-end. The Fund utilized a margin account to borrow approximately $30 million at year-end to maintain RIC diversification requirements; this was repaid in January 2010.
• Legal Proceedings: The Fund received a "Wells" notice from the SEC in June 2009 regarding a potential civil action related to a one-time administrative fee paid in 2005 and officer compensation. The Fund is cooperating with the inquiry, and no formal decision has been made.
• Risks: Key risks include the illiquidity of private securities, the potential failure of portfolio companies to meet debt obligations, and the risk of losing RIC tax status if distribution requirements are not met. The Fund's stock continues to trade at a significant discount to NAV.

Investor Verification Checklist

• SEC Inquiry Status: Verify the outcome of the SEC Wells notice regarding 2005 administrative fees and officer compensation.
• Portfolio Write-Downs: Review the specific valuation methodologies used for the significant write-downs in Nickent Golf, Infinia Corporation, and Riptide Entertainment.
• Internalization Costs: Confirm that the projected cost savings from internalizing management are being realized in subsequent periods.
• Dividend Sustainability: Assess the Fund's ability to maintain RIC status and pay required distributions given the suspension of the managed distribution policy and the reliance on non-cash (PIK) income.
• Follow-on Commitments: Monitor the Fund's ability to fund remaining commitments, specifically the $0.2 million commitment to Trulite, Inc.