EQS

Business Context and Reporting Period

Company: EQUUS TOTAL RETURN, INC. (EQS)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2010
Business Overview: EQS is a non-diversified business development company (BDC) and regulated investment company (RIC) that invests in equity and equity-oriented securities of privately-owned companies. The Fund transitioned to an internally managed structure effective July 1, 2009, terminating its external investment advisory and administrative agreements.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Asset Decline: Net assets decreased by approximately $13.0 million (25.7%) during the six months ended June 30, 2010, compared to a decrease of $5.4 million in the same period in 2009. Net assets per share fell from $5.74 to $4.28.
• Unrealized Depreciation: Net unrealized depreciation increased by $12.3 million in the current period, driven primarily by significant write-downs in portfolio companies including 1848 Capital Partners ($2.4M), Riptide Entertainment ($3.0M), and London Bridge Entertainment ($2.5M).
• Expense Structure: Total expenses increased to $2.36 million from $2.04 million year-over-year. This increase is largely attributed to professional fees ($1.18M vs $0.64M) and mailing/printing expenses ($0.28M vs $0.16M) related to a contested proxy election and shareholder meeting. Conversely, management and administrative fees dropped to zero following the internalization of management in 2009.
• Portfolio Valuation: Total portfolio investments at fair value declined from $42.4 million (Dec 31, 2009) to $27.1 million (June 30, 2010), representing a 36% reduction in portfolio value.

Outlook, Risks, and Management Commentary

• Management Changes: The Fund successfully contested a proxy slate in 2010, resulting in the election of four new independent directors and the appointment of John A. Hardy as Executive Chairman. The Fund is now internally managed.
• Liquidity and Credit Facility: The Fund maintains a $5.0 million revolving line of credit with Amegy Bank. However, as of June 30, 2010, the Fund's net asset value ($37.9M) fell below the $40.0M covenant threshold, rendering the Fund ineligible to draw on the facility. The Fund utilized a margin account ($19.0M) to maintain RIC tax status, which was repaid on July 1, 2010.
• Dividend Policy: The Fund suspended its managed distribution policy in March 2009. No dividends were declared or paid during the six months ended June 30, 2010.
• Legal Proceedings: The Fund received a "Wells" notice from the SEC in June 2009 regarding potential violations related to a 2005 administrative fee and officer compensation. The SEC also subpoenaed records in April 2010 regarding trades by specific entities. The Fund is cooperating with these inquiries.
• Portfolio Risks: Significant concentration risk exists in the "Shipping products and services" sector (19.4% of net assets). Several portfolio companies face liquidity challenges, requiring follow-on investments or resulting in impairment charges.

Investor Verification Checklist

• Covenant Compliance: Verify the status of the $40 million net asset value covenant for the revolving credit facility and the Fund's ability to access liquidity.
• Portfolio Valuations: Review the specific methodologies and assumptions used for the $12.3 million in unrealized depreciation, particularly regarding 1848 Capital Partners, Riptide Entertainment, and London Bridge Entertainment.
• SEC Inquiry Status: Monitor the outcome of the SEC Wells notice and subpoena regarding 2005 activities and recent trading patterns.
• Follow-on Investment Obligations: Assess the Fund's cash reserves against potential follow-on investment commitments required by distressed portfolio companies (e.g., London Bridge).
• Market Discount: Note the widening discount between the market price ($2.68) and net asset value ($4.28), representing a 37.4% discount.