EQS

Business Context and Reporting Period

Company: EQUUS TOTAL RETURN, INC. (EQS)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2015
Business Overview: A Delaware corporation operating as a Business Development Company (BDC) and qualifying as a Regulated Investment Company (RIC). The Fund invests in debt and equity securities of companies with enterprise values between $5.0 million and $75.0 million, focusing on growth, leveraged buyouts, and special situations. As of September 30, 2015, the Fund held 12,673,646 shares of common stock outstanding.

Key Financial Metrics

Results of Operations (Nine Months Ended Sept 30, 2015)

• Total Investment Income: $224,000 (Decreased from $429,000 in prior year).
• Total Expenses: $2,262,000 (Increased from $2,045,000 in prior year, driven by compensation bonuses).
• Net Investment Loss: $(2,038,000) (Worsened from $(1,616,000) in prior year).
• Net Realized Gain (Loss): $(2,483,000) (Prior year: $660,000 gain).
• Net Change in Unrealized Appreciation: $6,655,000 (Offset by $(683,000) related party depreciation).
• Net Increase in Net Assets from Operations: $1,451,000 (Prior year: $36,000).
• Net Increase in Net Assets per Share: $0.11 (Prior year: $0.00).

Material Changes vs. Prior Period

• Portfolio Composition Shifts: The Fund sold its interest in Spectrum Management, LLC (realizing a $2.85 million loss) and Orco Property Group S.A. notes (realizing a $0.37 million gain). The portfolio now consists heavily of Equus Energy, LLC (Control) and PalletOne, Inc. (Affiliate).
• Valuation Changes:
  • Equus Energy, LLC: Fair value decreased by $2.3 million due to declining oil/gas prices and production without reserve increases.
  • PalletOne, Inc.: Fair value increased by $6.5 million due to industry improvements and earnings growth.
  • MVC Capital, Inc.: Fair value decreased by $0.7 million due to share price declines.
• Expense Structure: Expenses increased primarily due to officer and employee bonuses earned during the period, despite a reduction in professional fees in the third quarter.
• Market Price vs. NAV: The common stock traded at a 41.1% discount to NAV as of September 30, 2015, widening from a 26.5% discount at year-end 2014.

Guidance, Outlook, and Risks

• Reorganization Plan: The Fund is pursuing a reorganization under Section 2(a)(33) of the 1940 Act involving a share exchange with MVC Capital, Inc. The intent is to merge or consolidate with MVC or a subsidiary, potentially restructuring as a publicly-traded operating company focused on energy and financial services.
• Liquidity Strategy: Management has shifted strategy from originating new debt/equity investments to preserving liquidity. The Fund maintains a margin loan of approximately $15.0 million to satisfy RIC diversification requirements, collateralized by U.S. Treasury bills.
• Dividend Policy: The Fund pays out net investment income and/or realized capital gains annually as required by the 1940 Act. No dividends were declared in the current period.
• Key Risks:
  • Concentration Risk: The Fund is "non-diversified." Equus Energy and PalletOne each represent 19.9% of Net Assets.
  • Energy Sector Volatility: Significant exposure to Equus Energy makes the Fund sensitive to crude oil and natural gas price fluctuations.
  • RIC Status: Failure to maintain RIC status (e.g., inability to borrow for qualifying investments) would subject the Fund to corporate income taxes.

Investor Verification Checklist

• Reorganization Timeline: Verify the status of the merger/consolidation with MVC Capital, Inc., as the Fund's long-term strategy depends on this transaction.
• Equus Energy Valuation: Review the independent reserve reports and discounted cash flow assumptions used to value the $7.5 million Equus Energy holding amidst low energy prices.
• Margin Loan Sustainability: Confirm the availability of the margin facility used to maintain RIC status and the cost of borrowing relative to investment income.
• Expense Ratio: Monitor the ratio of expenses to average net assets (6.13% for the nine months ended Sept 30, 2015) to ensure it remains sustainable given the low investment income.
• Legal Settlements: Note the $500,000 settlement paid in February 2015 regarding the Champion Window arbitration; verify no further liabilities exist.