**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

(Mark One)

For the quarterly period ended June 30,2013

or

For the transition period                     to                      

Commission File Number 814-00098

	 

**EQUUS TOTAL RETURN, INC.**

**(Exact name of registrant as specified inits charter)**

 

**Registrant’s telephone number,including area code: (713) 529-0900**

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 thepreceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subjectto such filing requirements for the past 90 days.    Yes  x    No   ̈

Indicate by check mark whether the registranthas submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submittedand posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorterperiod that the registrant was required to submit and post such files).    Yes   ̈    No   ̈

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrantis a shell company.    Yes   ̈    No  x

There were 10,561,646 shares of the registrant’scommon stock, $.001 par value, outstanding, as of August 14, 2013.

EQUUS TOTAL RETURN, INC.

(A Delaware Corporation)

INDEX

 

EQUUS TOTAL RETURN, INC. 

BALANCE SHEETS 

 

**Part I.Financial Information**

**Item  1.	Financial Statements**

 

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The accompanying notes are an integralpart of these financial statements.

 

 

EQUUS TOTAL RETURN, INC.

STATEMENTS OF OPERATIONS 

(Unaudited)

 

 

 

The accompanying notes are an integralpart of these financial statements.

 

 

 

 

 

 

 

 

 

 

EQUUS TOTAL RETURN, INC. 

STATEMENTS OF CHANGES IN NET ASSETS 

(Unaudited)

 

The accompanying notes are an integralpart of these financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EQUUS TOTAL RETURN, INC. 

STATEMENTS OF CASH FLOWS 

(Unaudited)

 

 

 

 

The accompanying notes are an integralpart of these financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

EQUUS TOTAL RETURN, INC. 

SUPPLEMENTAL INFORMATION—SELECTED PERSHARE DATA AND RATIOS 

(Unaudited)

 

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(1)  Totalreturn = [(ending market price per share - beginning price per share) / beginning market price per share].

 

The accompanying notes are an integralpart of these financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**EQUUS TOTAL RETURN, INC.**

**SCHEDULE OF INVESTMENTS**

**JUNE 30, 2013**

**(Unaudited)**

***(in thousands, except share data)***

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The accompanying notes are an integralpart of these financial statements.

 

**EQUUS TOTAL RETURN, INC.**

**SCHEDULE OF INVESTMENTS – (Continued)**

**JUNE 30, 2013**

**(Unaudited)**

Except for our holding of ordinary sharesof Orco Property Group S.A. (“OPG”), substantially all of our portfolio securities are restricted from public salewithout prior registration under the Securities Act of 1933 or other relevant foreign regulatory authority. We negotiate certainaspects of the method and timing of the disposition of our investment in each portfolio company, including registration rightsand related costs.

We may invest up to 30% of our assetsin non-qualifying portfolio investments, as permitted by the Investment Company Act of 1940 (hereafter, the “1940 Act”).Specifically, we may invest up to 30% of our assets in entities that are not considered “eligible portfolio companies”(as defined in the 1940 Act), including companies located outside of the United States, entities that are operating pursuant tocertain exceptions under the 1940 Act, and publicly-traded entities with a market capitalization exceeding $250 million. As ofJune 30, 2013, except for our holdings in OPG, all of our investments are in enterprises that are considered eligible portfoliocompanies under the 1940 Act, and for which we provide significant managerial assistance.

Our investments in portfolio securitiesconsist of the following types of securities as of June 30, 2013 (in thousands):

 

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Interest payments are being receivedand/or accrued on notes with a fair value of $1.4 million, while accrued interest has been impaired on notes receivable includedin secured and subordinated debt with a fair value of $0.1 million.

 

The following is a summary by industry ofthe Fund’s investments in portfolio securities as of June 30, 2013 (in thousands):

 

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The accompanying notes are an integralpart of these financial statements.

 

 

 

**EQUUS TOTAL RETURN, INC.**

**SCHEDULE OF INVESTMENTS**

**DECEMBER 31, 2012**

***(in thousands, except share data)***

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The accompanying notes are an integral part of these financial statements.

 

**EQUUS TOTAL RETURN,INC.**

**SCHEDULE OF INVESTMENTS– (Continued)**

**DECEMBER 31, 2012**

***(in thousands, exceptshare data)***

 

Substantially all of our portfolio securitiesare restricted from public sale without prior registration under the Securities Act of 1933. We negotiate certain aspects of themethod and timing of the disposition of our investment in each portfolio company, including registration rights and related costs.

 

We may invest up to 30% of our assets in non-qualifyingportfolio investments, as permitted by the 1940 Act. Specifically, we may invest up to 30% of our assets in entities that are notconsidered “eligible portfolio companies” (as defined in the 1940 Act), including companies located outside of theUnited States, entities that are operating pursuant to certain exceptions under the 1940 Act, and publicly-traded entities witha market capitalization exceeding $250 million. As of December 31, 2012, except for our holdings in OPG, all of our investmentsare in enterprises that are considered eligible portfolio companies under the 1940 Act, and for which we provide significant managerialassistance.

 

Our investments in portfolio securities consistof the following types of securities as of December 31, 2012 (in thousands):

 

 

Interest payments are being received and/oraccrued on notes with a fair value of $1.4 million, while accrued interest has been impaired on notes receivable included in securedand subordinated debt with a fair value of $0.4 million.

 

The following is a summary by industry of ourinvestments in portfolio securities as of December 31, 2012 (in thousands):

 

 

The accompanying notes are an integral partof these financial statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EQUUS TOTAL RETURN, INC.

NOTES TO FINANCIAL STATEMENTS 

JUNE 30, 2013 

(Unaudited)

 

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**Description of Business**— EquusTotal Return, Inc. (*“we,” “us,” “our,” “Equus,” the“Company,” and the “Fund*”), a Delaware corporation, 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 andliabilities of the Partnership were transferred to the Fund in exchange for shares of common stock of the Fund. Our shares tradeon the New York Stock Exchange under the symbol ‘EQS’. On August 11, 2006, our shareholders approved a change of theFund’s investment strategy to a total return investment objective. This new strategy seeks to provide the highest total return,consisting of capital appreciation and current income. In connection with this strategic investment change, the shareholders alsoapproved the change of name from Equus II Incorporated to Equus Total Return, Inc.

 

We attempt to maximize the return to stockholdersin the form of current investment income and long-term capital gains by investing in the debt and equity securities of companieswith a total enterprise value of between $5.0 million and $75.0 million, although we may engage in transactions with smaller orlarger investee companies from time to time. We seek to invest primarily in companies pursuing growth either through acquisitionor organically, leveraged buyouts, management buyouts and recapitalizations of existing businesses or special situations. Our income-producinginvestments consist principally of debt securities including subordinate debt, debt convertible into common or preferred stock,or debt combined with warrants and common and preferred stock. Debt and preferred equity financing mayalso be used to create long-term capital appreciation through the exercise and sale of warrants received in connection with thefinancing. We seek to achieve capital appreciation by making investments in equity and equity-oriented securities issuedby privately-owned companies in transactions negotiated directly with such companies. Given market conditionsover the past several years and the performance of our portfolio, our management and Board of Directors believe it is prudent tocontinue to review alternatives to refine and further clarify the current strategies.

 

We elected to be treated as a Business DevelopmentCompany (“BDC”) under the Investment Company Act of 1940 (“1940 Act”). We currently qualify as a regulatedinvestment company (“RIC”) for federal income tax purposes and, therefore, are not required to pay corporate incometaxes on any income or gains that we distribute to our stockholders. We have certain wholly owned taxable subsidiaries (“TaxableSubsidiaries”) each of which holds one or more portfolio investments listed on our Schedules of Investments. The purposeof these Taxable Subsidiaries is to permit us to hold certain income-producing investments or portfolio companies organized aslimited liability companies, or LLCs, (or other forms of pass-through entities) and still satisfy the RIC tax requirement thatat least 90% of our gross revenue for income tax purposes must consist of investment income. Absent the Taxable Subsidiaries, aportion of the gross income of these income-producing investments or of any LLC (or other pass-through entity) portfolio investment,as the case may be, would flow through directly to us for the 90% test. To the extent that such income did not consist of investmentincome, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes.The income of the LLCs (or other pass-through entities) owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries anddoes not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages. We do not consolidate theTaxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries’ownership of the portfolio investments. We reflect any such income tax expense on our Statements of Operations.

 

**Basis of Presentation**—In accordancewith Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, we do not consolidate portfoliocompany investments, including those in which we have a controlling interest. Our interim unaudited financial statements were preparedin accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim financial informationand in accordance with the requirements of reporting on Form 10-Q and Article 10 of Regulation S-X, under the Securities ExchangeAct of 1934, as amended. Accordingly, they are unaudited and exclude some disclosures required for annual financial statements.Management believes it has made all adjustments, consisting solely of normal recurring accruals, necessary for the fair presentationof these interim financial statements.

 

The results of operations for the six monthsended June 30, 2013 are not necessarily indicative of results that ultimately may be achieved for the year. The interim unauditedfinancial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included inthe Fund’s Form 10-K for the fiscal year ended December 31, 2012, as filed with the Securities and Exchange Commission(“SEC”).

 

 

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**Liquidity**—There are several factorsthat may materially affect our liquidity during the reasonably foreseeable future. We view this period as the twelve month periodfrom the date of the financial statements in this Form 10-Q, *i.e*., the period through June 30, 2014.

 

We are evaluating the impact of current marketconditions on our portfolio company valuations and their ability to provide current income. We have followed valuation techniquesin a consistent manner; however, we are cognizant of current market conditions that might affect future valuations of portfoliosecurities. We believe that our operating cash flow and cash on hand will be sufficient to meet operating requirements and to financeroutine capital expenditures through the next twelve months.  

 

**Cash and Cash Equivalents**—As ofJune 30, 2013, we had cash and cash equivalents of $21.3 million. We had $8.8 million of our net assets of $30.2 million investedin portfolio securities.

 

As of December 31, 2012, we had cash and cashequivalents of $23.7 million. We had $9.2 million of our net assets of $32.9 million invested in portfolio securities.

 

**Dividends**—We will pay out netinvestment income and/or realized capital gains, if any, on an annual basis as required under the 1940 Act.

 

**Investment Commitments**—As of June30, 2013, we had no outstanding commitments to our portfolio company investments.

 

Under certain circumstances, we may be calledon to make follow-on investments in certain portfolio companies. If we do not have sufficient funds to make follow-on investments,the portfolio company in need of the investment may be negatively impacted. Also, our equity interest in the estimated fair valueof the portfolio company could be reduced.

 

**RIC Borrowings, Restricted Cash and TemporaryCash Investments**—We may periodically borrow sufficient funds to maintain the Fund’s RIC status by utilizing a marginaccount with a securities brokerage firm. There is no assurance that such arrangement will be available in the future. If we areunable to borrow funds to make qualifying investments, we may no longer qualify as a RIC. We would then be subject to corporateincome tax on the Fund’s net investment income and realized capital gains, and distributions to stockholders would be subjectto income tax as ordinary dividends. Failure to continue to qualify as a RIC could be materially adverse to us and our stockholders.

 

We had no RIC borrowings or restricted cashas of June 30, 2013 and December 31, 2012, respectively.

 

**Certain Risks and Uncertainties**—Economic conditions since 2008 and resulting market dislocations have resulted in a significant decline in the availability ofdebt and equity. Generally, the limited amount of available debt financing has shorter maturities, higher interest rates and fees,and more restrictive terms than debt facilities available in the past. In addition, during these years and continuing into thefirst six months of 2013, the price of our common stock continued to fall well below our net asset value, thereby making it undesirableto issue additional shares of our common stock. Because of these challenges, our near-term strategies shifted solely from originatingdebt and equity investments to also include liquidity preservation efforts necessary to meet our operational needs. Key initiativesthat we have previously undertaken to provide necessary liquidity include monetizations, the suspension of dividends and investmentsin portfolio securities using shares of the Fund. Although we cannot assure you that such initiatives will be sufficient, we believewe have sufficient liquidity to meet our 2013 operating requirements.

 

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The following is a summary of significant accountingpolicies followed by the Fund in the preparation of its financial statements:

 

**Use of Estimates**—The preparationof financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amountsand disclosures in the financial statements. Although we believe the estimates and assumptions used in preparing these financialstatements and related notes are reasonable in light of known facts and circumstances, actual results could differ from those estimates.

 

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**Valuation of Investments**—Portfolioinvestments are carried at fair value with the net change in unrealized appreciation or depreciation included in the determinationof net assets. Valuations of portfolio securities are performed in accordance with accounting principles generally accepted inthe United States of America and the financial reporting policies of the SEC. The applicable methods prescribed by such principlesand policies are described below:

 

*Publicly-traded portfolio securities*—Investmentsin companies whose securities are publicly traded are generally valued at their quoted market price at the close of business onthe valuation date.

 

*Privately-held portfolio securities*—Thefair value of investments for which no market exists is determined on the basis of procedures established in good faith by ourBoard of Directors. As a general principle, the current “fair value” of an investment would be the amount we mightreasonably expect to receive for it upon its current sale, in an orderly manner. Appraisal valuations are necessarily subjectiveand the estimated values arrived at by the Fund may differ materially from amounts actually received upon the disposition of portfoliosecurities.

 

*Thinly Traded and Over-the-Counter Securities*—Generally,we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bidand ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinlytraded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors,including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether thetrading levels are active (Level 1) or inactive (Level 2) or unobservable (Level 3). These types of securities represented 15.9%and 15.4% of our investments in portfolio securities as of June 30, 2013 and December 31, 2012, respectively. We utilized independentpricing services with certain of our fair value estimates. To corroborate “bid/ask” quotes from independent pricingservices, we perform a market-yield approach to validate prices obtained or obtain other evidence.

 

During the first twelve months after an investmentis made, the original investment value is utilized to determine the fair value unless significant developments have occurred duringthis twelve month period which would indicate a material effect on the portfolio company (such as results of operations or changesin general market conditions). After the twelve month period, or if material events have occurred within the twelve month period,we consider a two-step process when appraising investments of privately held companies. The first step involves determining theenterprise value of the portfolio company. During this step, we consider three different valuation approaches: a market approach,an income approach, and an asset approach. The particular facts and circumstances of each portfolio company determine which approach,or combination of approaches, will be utilized. The second step when appraising equity investments of privately held companiesinvolves allocating value to the various debt and equity securities of the company. We allocate value to these securities basedon their relative priorities. For equity securities such as warrants, we may also incorporate alternative methodologies includingthe Black-Scholes Option Pricing Model.

 

**Market approach**—The market approachtypically employed by our management calculates the enterprise value of a company as a multiple of earnings before interest,taxes, depreciation and amortization (“EBITDA”) generated by the company for the trailing twelve month period. Adjustments to the company’s EBITDA, including those for non-recurring items, may be considered. Multiples are estimatedbased on current market conditions and past experience in the private company marketplace and are subjective in nature. We willapply liquidity and other discounts it deems appropriate to equity valuations where applicable. We 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, independentinvestors.

 

**Income approach**—The income approachtypically utilized by our management calculates the enterprise value of a company utilizing a discounted cash flow model incorporatingprojected future cash flows of the company.  Projected future cash flows consider the historical performance of the companyas well as current and projected market participant performance. Discount rates are estimated based on current market conditionsand past experience in the private company marketplace and are subjective in nature. We will apply liquidity and other discountswe deem appropriate to equity valuations where applicable.

 

**Asset approach**—We consider theasset approach to determine the fair value of significantly deteriorated investments demonstrating circumstances indicative ofa liquidation analysis. This situation may arise when a portfolio company: 1) cannot generate adequate cash flow to meet the principaland interest payments on its indebtedness; 2) is not successful in refinancing its debt upon maturity; 3) we believe the creditquality of a loan has deteriorated due to changes in the business and underlying asset or market conditions which may result inthe company’s inability to meet future obligations; or 4) the portfolio company’s reorganization or bankruptcy. Considerationis also given as to whether a liquidation event would be orderly or forced.

 

 

We base adjustments upon such factors as theportfolio company’s earnings, cash flow and net worth, the market prices for similar securities of comparable companies,an assessment of the company’s current and future financial prospects and various other factors and assumptions. In the caseof unsuccessful operations, we may base a portfolio company’s fair value upon the company’s estimated liquidation value.Fair valuations are necessarily subjective, and management’s estimate of fair value may differ materially from amounts actuallyreceived upon the disposition of its portfolio securities. Also, any failure by a portfolio company to achieve its business planor obtain and maintain its financing arrangements could result in increased volatility and result in a significant and rapid changein its value.

 

Our general intent is to hold our loans tomaturity when appraising our privately held debt investments. As such, we believe that the fair value will not exceed the costof the investment. However, in addition to the previously described analysis involving allocation of value to the debt instrument,we perform a yield analysis to determine if a debt security has been impaired.

 

The Audit Committee of the Board of Directorsmay engage independent, third-party valuation firms to conduct independent appraisals and review management’s preliminaryvaluations of each privately-held investment in order to make their own independent assessment. Any third-party valuation datawould be considered as one of many factors in a fair value determination. The Audit Committee then would recommend the fair valuesfor all privately-held securities based on all relevant factors to the Board of Directors for final approval.

 

Because of the inherent uncertainty of thevaluation of portfolio securities which do not have readily ascertainable market values, amounting to $8.6 million and $9.0 millionas of June 30, 2013 and December 31, 2012, respectively, our fair value determinations may materially differ from the values thatwould have been used had a ready market existed for the securities. As of June 30, 2013 and December 31, 2012, one of our portfolioinvestments, consisting of 73,666 ordinary shares of OPG, is publicly listed on the NYSE Euronext Paris Exchange.

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On a daily basis, we adjust our net asset valuefor the changes in the value of our publicly held securities, if applicable, and material changes in the value of private securities,generally determined on a quarterly basis or as announced in a press release, and reports those amounts to Lipper Analytical Services,Inc. Weekly and daily net asset values appear in various publications, including *Barron’s*and *The Wall Street Journal*.

 

**Foreign Exchange**—We record temporarychanges in foreign exchange rates of portfolio securities denominated in foreign currencies as changes in fair value. These changesare therefore reflected as unrealized gains or losses until realized.

 

**Investment Transactions**—Investmenttransactions are recorded on the accrual method. Realized gains and losses on investments sold are computed on a specific identificationbasis.

 

We classify our investments in accordance withthe requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companiesin which we own more than 25% of the voting securities or maintain greater than 50% representation on the portfolio company’sgoverning board. Under the 1940 Act, “Affiliate Investments” are defined as those non-control investments in companiesin which we own between 5% and 25% of the voting securities. Under the 1940 Act, “Non-affiliate Investments” are definedas investments that are neither Control Investments nor Affiliate Investments.

 

**Interest Income Recognition**—Werecord interest income, adjusted for amortization of premium and accretion of discount, on an accrual basis to the extent thatwe expect to collect such amounts. We stop accruing interest on investments when we determine that interest is no longer collectible.We may also impair the accrued interest when we determine that all or a portion of the current accrual is uncollectible. If wereceive any cash after determining that interest is no longer collectible, we treat such cash as payment on the principal balanceuntil the entire principal balance has been repaid, before we recognize any additional interest income. We accrete or amortizediscounts and premiums on securities purchased over the life of the respective security using the effective yield method. The amortizedcost of investments represents the original cost adjusted for the accretion of discount and/or amortization of premium on debtsecurities.

 

**Payment in Kind Interest (PIK)**—Wehave loans in our portfolio that may pay PIK interest. We add PIK interest, if any, computed at the contractual rate specifiedin each loan agreement, to the principal balance of the loan and record it as interest income. To maintain our status as a RIC,we must pay out to stockholders this non-cash source of income in the form of dividends even if we have not yet collected any cashin respect of such investments.

 

**Cash Flows**—For purposes of theStatements of Cash Flows, we consider all highly liquid temporary cash investments purchased with an original maturity of threemonths or less to be cash equivalents. We include our investing activities within cash flows from operations. We exclude “RestrictedCash & Temporary Cash Investments” used for purposes of complying with RIC requirements from cash equivalents. SeeNote 2 for further discussion of the Fund’s RIC borrowings.

 

**Income Taxes**—We intend to complywith the requirements of the Internal Revenue Code necessary for us to qualify as a RIC. So long as we comply with these requirements,we generally will not be subject to corporate-level federal income taxes on otherwise taxable income (including net realized capitalgains) distributed to stockholders. Therefore, we did not record a provision for federal income taxes in our financial statements.We borrow money from time to time to maintain our tax status under the Internal Revenue Code as a RIC. See Note 2 for further discussionof our RIC borrowings.

 

All corporations incorporated in the Stateof Delaware are required to file an Annual Report and to pay a franchise tax. As a result, we paid Delaware Franchise tax in theamount of $0.01 million for the year ended December 31, 2012.

 

Texas margin tax applies to legal entitiesconducting business in Texas. The margin tax is based on our Texas sourced taxable margin. The tax is calculated by applying atax rate to a base that considers both revenue and expenses and therefore has the characteristics of an income tax. As a result,we did not owe state income tax for the year ended December 31, 2012.

 

**Fair Value Measurement**—Fair valueis defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date. We have categorized all investments recorded at fair value based upon the level ofjudgment associated with the inputs used to measure their fair value. Hierarchical levels, directly related to the amount of subjectivityassociated with the inputs to fair valuation of these assets and liabilities, are as follows:

 

Level 1—Inputs are unadjusted, quotedprices in active markets for identical assets at the measurement date. The types of assets carried at Level 1 fair value generallyare equities listed in active markets.

 

Level 2—Inputs (other than quoted pricesincluded in Level 1) are either directly or indirectly observable for the asset in connection with market data at the measurementdate and for the extent of the instrument’s anticipated life. Fair valued assets that are generally included in this categoryare warrants held in a public company.

 

Level 3—Inputs reflect our best estimateof what market participants would use in pricing the asset at the measurement date. It includes prices or valuations that requireinputs that are both significant to the fair value measurement and unobservable. Generally, assets carried at fair value and includedin this category are debt, warrants and/or other equity investments held in a private company. As previously described, we considera two-step process when appraising investments of privately held companies. The first step involves determining the enterprisevalue of the portfolio company. During this step, we consider three different valuation approaches: a market approach, an incomeapproach, and a cost approach. The particular facts and circumstances of each portfolio company determine which approach, or combinationof approaches, will be utilized. The second step when appraising equity investments of privately held companies involves allocatingvalue to the various debt and equity securities of the company. We allocate value to these securities based on their relative priorities.For equity securities such as warrants, we may also incorporate alternative methodologies including the Black-Scholes Option PricingModel. Yield analysis is also employed to determine if a debt security has been impaired.

 

We will record unrealized depreciation on investmentswhen we determine that the fair value of a security is less than its cost basis, and will record unrealized appreciation when wedetermine that the fair value is greater than its cost basis.

 

As of June 30, 2013, investments measured atfair value on a recurring basis are categorized in the tables below based on the lowest level of significant input to the valuations:

 

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As of December 31, 2012, investments measured at fair value on arecurring basis are categorized in the tables below based on the lowest level of significant input to the valuations:

 

 

The following table provides a reconciliationof fair value changes during the six months ended June 30, 2013 for all investments for which we determine fair value using unobservable(Level 3) factors:

 

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The following table provides a reconciliationof fair value changes during the six months ended June 30, 2012 for all investments for which we determine fair value using unobservable(Level 3) factors:

 

 

 

**Significant Unobservable Inputs**— Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a smallnumber of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with distinctcontract terms and conditions. As such, our valuation of each investment in our portfolio is unique and complex, often factoringin numerous different inputs, including historical and forecasted financial and operational performance of the portfolio company,project cash flows, market multiples comparable market transactions, the priority of our securities compared with those of otherinvestors, credit risk, interest rates, independent valuations and reviews and other inputs.

 

The following table summarizes the significantobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation techniqueas of June 30, 2013:

 

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Except as noted below, as compensation forservices to the Fund, each Independent Director receives an annual fee of $20,000 paid quarterly in arrears, a fee of $2,000 foreach meeting of the Board of Directors attended in person, a fee of $1,000 for participation in each telephonic meeting of theBoard and a fee of $1,000 for each committee meeting attended, and reimbursement of all out-of-pocket expenses relating to attendanceat such meetings. A quarterly fee of $15,000 is paid to the Chairman of the Audit Committee and a quarterly fee of $3,750 is paidto the Chairman of the Independent Directors. We have also paid and will likely continue to pay other one-time or recurring feesto members of our Board of Directors in special circumstances. None of our interested directors receive annual fees for their serviceon the Board of Directors.

 

In respect of services provided to the Fundby members of the Board not in connection with their roles and duties as directors, the Fund pays a rate of $250 per hour for servicesrendered.

 

In November, 2011, Equus Energy, LLC, a wholly-ownedsubsidiary of the Fund, entered into a consulting agreement with Global Energy Associates, LLC (“Global Energy”) toprovide consulting services for energy related investments. Henry W. Hankinson, Director, is a managing partner and co-founderof Global Energy. Payments to Global Energy totaled $37,500 for each of the six months ended June 30, 2013 and 2012.

 

On August 12, 2012, Paula Douglass fileda lawsuit against the Fund and members of the Board of Directors in the District Court of Harris County, Texas. Ms.Douglass’ complaint alleged various causes of action, including minority shareholder oppression, dilution, and breachof fiduciary duty, and sought unspecified damages and attorney’s fees. Effective June 13, 2013, the Fund entered into asettlement agreement with Ms. Douglass, Sam Douglass, as well as certain trusts controlled by them. Pursuant to thesettlement agreement and in view of the estimated costs of protracted litigation and the associated disruption to theoperations of the Fund, the Board of Directors approved a payment of $402,254, in complete settlement of the lawsuit, asbeing in the best interests of the Fund and its shareholders. The settlement payment was made on July 30, 2013. Ms. Douglassfiled a motion to dismiss the lawsuit with prejudice on August 8, 2013.

 

Effective June 13, 2013, the Fund entered intoa settlement agreement with Sam Douglass, a former director and executive officer of the Fund, in respect of a claim for indemnificationpursuant to the General Corporation Law of Delaware and an indemnification agreement entered into by the Fund with Mr. Douglasson May 3, 2001. The settlement agreement provides for the reimbursement to Mr. Douglass of actual expenses incurred, excludingany fines or penalties, in connection with an enforcement action initiated by the Securities and Exchange Commission against Mr.Douglass in 2009. The settlement payment of $125,000 was made on June 24, 2013.

 

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We will pay out net investment income and/orrealized capital gains, if any, on an annual basis as required under the 1940 Act.

 

 

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During the six months ended June 30, 2013,we capitalized legal and consulting expenses of $0.2 million relating to Spectrum Management, LLC. We also received a semi-annualinterest payment of $0.03 million and a 5.75% partial principal repayment of $0.01 million in respect of our €1.2 million[$1.5 million] in OPG notes.

 

During the six months ended June 30,2013, we realized capital losses of $1.8 million due to the asset sale of The Bradshaw Group to PartsNow! LLC. The structureand pricing of the transaction was such that only the Class A preferred shareholders received any proceeds. There were noproceeds to the other equity classes, including the Classes B, D, and E preferred stock and warrants owned by the Fund. TheFund invested in Bradshaw in May 2000 and the Fund’s investment has been valued at $0 since 2002.

 

Net unrealized depreciation on investmentsdecreased to $16.0 million during the six months ended June 30, 2013, from a net unrealized depreciation of $17.2 million. Such decrease in unrealized depreciation is largely due to the following changes:

 

 

During the six months ended June 30, 2012,we made no follow-on investments, nor realized any significant gains or losses on sales of portfolio securities. However, the Fundcapitalized $0.3 million in accrued interest relating to the restructuring of 8,890 4% bonds of Orco Germany S.A. that were ultimatelyconverted into shares and notes of OPG.

 

During the six month ended June 30,2012, we realized capital losses of $5.2 million, including the following transactions (in thousands):

 

 

Net unrealized depreciation on investmentsdecreased by $1.7 million during the six months ended June 30, 2012, to a net unrealized depreciation of $15.7 million.  Suchdecrease in unrealized depreciation is largely due to the following changes:

 

 

 

Equus Energy, LLC (“Equus Energy”)was formed in November 2011 as a wholly-owned subsidiary of the Fund to make investments in companies in the energy sector, withparticular emphasis on income-producing oil & gas properties. In December 2011, we contributed $250,000 to the capital of EquusEnergy. On December 27, 2012, we invested an additional $6.8 million in Equus Energy for the purposeof additional working capital and to fund the purchase of $6.6 million in working interests in 150 producing and non-producingoil and gas wells. The working interests include associated development rights of approximately 23,000 acres situated on 15 separateproperties in Texas and Oklahoma. The working interests range from a *de minimus* amount to 50% of the leasehold that includesthese wells.

 

The wells are operated by a number of experiencedoperators, including a major multinational oil and gas conglomerate which has operating responsibility for all of Equus Energy’s40 producing well interests located in the Conger Field, a productive oil and gas field on the edge of the Permian Basin thathas experienced successful gas and hydrocarbon extraction in multiple formations. Equus Energy, which holds a 50% working interestin each of these Conger Field wells, is working with the operator in a recompletion program of existing Conger Field wells tothe Wolfcamp formation, a zone containing oil as well as gas and natural gas liquids. One recompletion in the Conger Field hasbeen effected since the closing date of the acquisition, with additional recompletions scheduled for the remainder of 2013 andbeyond. Part of Equus Energy’s acreage rights described above also includes a 50% working interest in possible new drillingto the base of the Canyon formation (appx. 8,500 feet) on 2,400 acres in the Conger Field. Also included in the interests acquiredby Equus Energy are working interests of 7.5% and 2.5% in the Burnell and North Pettus Units, respectively, which collectivelycomprise approximately 13,000 acres are located in the area known as the “Eagle Ford Shale” play.

 

*Revenue and Income*. Equus Energy generatedrevenue and operating income of $600,760 and $276,894, respectively, in the second quarter of 2013. For the six months ended June30, 2013, revenue and operating income was $1,206,167 and $554,083, respectively. After factoring in depletion, depreciation, andamortization costs, as well as general and administrative costs, Equus Energy generated net income of $102,108 for the three monthsended June 30, 2013 and a net loss of $130,296 for the six months ended June 30, 2013.

 

*Capital Expenditures*. Since the effectivedate of the acquisition of the well interests, Equus Energy has invested $509,036 in respect of three projects, collectively resultingin an estimated 20,000 additional barrel of oil equivalents (“BOE”) to Equus Energy’s proven developed reserves:

 

 

 

** **

We do not consolidate Equus Energy or its whollyowned subsidiaries and accordingly only the value of our investment in Equus Energy is included on our statement of assets andliabilities. Our investment in Equus Energy is valued in accordance with our normal valuation procedures and is based on the valuesof the underlying assets held by EQS Energy Holdings, Inc. a wholly-owned subsidiary of Equus Energy, net of associated liabilities.

 

Belowis summarized consolidated financial information for Equus Energy as of June 30, 2013 and December 31, 2012 and for the three andsix months ended June 30, 2013 (in thousands): 

****

****

 

 

Revenue and direct operating expenses forthe various oil and gas assets included in the accompanying statements represent the net collective working and revenue interestsacquired by Equus Energy. The revenue and direct operating expenses presented herein relate only to the interests in the producingoil and nat8,ural gas properties and do not represent all of the oil and natural gas operations of all of these properties. Directoperating expenses include lease operating expenses and production and other related taxes. General and administrative expenses,depreciation, depletion and amortization (“DD&A”) of oil and gas properties and federal and state taxes have beenexcluded from direct operating expenses in the accompanying statements of revenues and direct operating expenses because the allocationof certain expenses would be arbitrary and would not be indicative of what such costs would have been had Equus Energy been operatedas a stand-alone entity.****The statements of revenues and direct operating expenses presented are not indicative of the financialcondition or results of operations of Equus Energy on a go forward basis due to changes in the business and the omission of variousoperating expenses.

 

 

Minimal general and administrative expenseswere incurred prior to the initial oil and gas investment on December 27, 2012.

** **

****

**Critical Accounting Policies for Equus Energy**– Equus Energy and its wholly-owned subsidiary EQS Energy Holdings, Inc. (collectively “the Company”) followthe *Full Cost Method of Accounting* for oil and gas properties. Under the full cost method, all costs associated with propertyacquisition, exploration, and development activities are capitalized. Capitalized costs include lease acquisitions, geologicaland geophysical work, delay rentals, costs of drilling, completing and equipping successful and unsuccessful oil and gas wellsand directly related costs. Gains or losses are normally not recognized on the sale or other disposition of oil and gas properties.Gains or losses are normally reflected as an adjustment to the full cost pool.

 

The capitalized costs of oil and gas properties,plus estimated future development costs relating to proved reserves and estimated cost of dismantlement and abandonment, net ofsalvage value, are amortized on a unit-of-production method over the estimated productive life of the proved oil and gas reserves.Unevaluated oil and gas properties are excluded from this calculation.  Depletion, depreciation and amortization expense forthe Company’s oil and gas properties totaled $0.5 million for the six months ending June 30, 2013.

 

Capitalized oil and gas property costs arelimited to an amount (the ceiling limitation) equal to the sum of the following:

 

(a)                As of June 30, 2013, the present value of estimated future net revenues from the projectedproduction of proved oil and gas reserves, calculated at the simple arithmetic average, first-day-of-the-month prices during thetwelve-month period before the balance sheet date  (with consideration of price changes only to the extent provided by contractualarrangements) and a discount factor of 10%;

 

(b)                The cost of investments in unproved and unevaluated properties excluded from the costs beingamortized; and

 

(c)                The lower of cost or estimated fair value of unproved properties included in the costs beingamortized.

 

When it is determined that oil and gas propertycosts exceed the ceiling limitation, an impairment charge is recorded to reduce its carrying value to the ceiling limitation. The Company did not recognize an impairment loss on its oil and gas properties during 2012 or during the six months ended June30, 2013.

 

The costs of certain unevaluated leaseholdacreage and certain wells being drilled are not amortized. The Company excludes all costs until proved reserves are found or untilit is determined that the costs are impaired. Costs not amortized are periodically assessed for possible impairments or reductionsin value. If a reduction in value has occurred, costs being amortized are increased. 

 

**Revenue Recognition**—Revenuesare recognized for oil and natural gas sales under the sales method of accounting. Under this method, revenues are recognized onproduction as it is taken and delivered to its purchasers. The volumes sold may be more or less than the volumes entitled to, basedon the owner’s net leasehold interest. These differences result from production imbalances, which are not significant, andare reflected as adjustments to prove reserves and future cash flows in the unaudited supplementary oil and gas information includedherein.

 

**Accounting Policy on Depletion**—TheCompany employs the “Units of Production” method in calculating depletion of its proved oil and gas properties, whereincapitalized costs, as adjusted for future development costs and asset retirement obligations, are amortized over the total estimatedproved reserves.

* *

**Asset Retirement Obligations**– The fair value of asset retirement obligations are recorded in the period in which they are incurred if a reasonable estimateof fair value can be made, and the corresponding cost is capitalized as part of the carrying amount of the related long-lived asset. The fair value of the asset retirement obligation is measured using expected future cash outflows discounted at the Company’scredit-adjusted risk-free interest rate.  Fair value, to the extent possible, should include a market risk premium for unforeseeablecircumstances.  No market risk premium was included in the Company’s asset retirement obligation fair value estimatesince a reasonable estimate could not be made.  The liability is accreted to its then present value each period, and the capitalizedcost is depleted or amortized over the estimated recoverable reserves using the units-of-production method.   

 

** **

Management performed an evaluation of the Fund’sactivity through the date the financial statements were issued, noting the following subsequent events:

 

On July 30, 2013, pursuant tothe settlement agreement with Paula Douglass as described below under *Legal Proceedings*, the Fund made a settlementpayment in the amount of $0.4 million.

 

**Item 2.	Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Overview**

 

Equus Total Return, Inc. (*“we,”“us,” “our,” “Equus,” the “Company,” and the “Fund*”), aDelaware corporation, 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 exchangefor shares of common stock of the Fund. Our shares trade on the New York Stock Exchange under the symbol EQS. On August 11, 2006,our shareholders approved the change of the Fund’s investment strategy to a total return investment objective. This new strategyseeks to provide the highest total return, consisting of capital appreciation and current income. In connection with this strategicinvestment change, the shareholders also approved the change of name from Equus II Incorporated to Equus Total Return, Inc.

 

We attempt to maximize the return to stockholdersin the form of current investment income and long-term capital gains by investing in the debt and equity securities of companieswith a total enterprise value of between $5.0 million and $75.0 million, although we may engage in transactions with smaller orlarger investee companies from time to time. We seek to invest primarily in companies pursuing growth either through acquisitionor organically, leveraged buyouts, management buyouts and recapitalizations of existing businesses or special situations. Our income-producinginvestments consist principally of debt securities including subordinate debt, debt convertible into common or preferred stock,or debt combined with warrants and common and preferred stock. Debt and preferred equity financing mayalso be used to create long-term capital appreciation through the exercise and sale of warrants received in connection with thefinancing. We seek to achieve capital appreciation by making investments in equity and equity-oriented securities issuedby privately-owned companies in transactions negotiated directly with such companies. Given market conditionsover the past several years and the performance of our portfolio, our management and Board of Directors believe it is prudent tocontinue to review alternatives to refine and further clarify the current strategies.

 

We elected to be treated as a BDC under the1940 Act. We currently qualify as a RIC for federal income tax purposes and, therefore, are not required to pay corporate incometaxes on any income or gains that we distribute to our stockholders. We have certain wholly owned Taxable Subsidiaries each ofwhich holds one or more portfolio investments listed on our Schedules of Investments. The purpose of these Taxable Subsidiariesis to permit us to hold certain income-producing investments or portfolio companies organized as limited liability companies, orLLCs, (or other forms of pass-through entities) and still satisfy the RIC tax requirement that at least 90% of our gross revenuefor income tax purposes must consist of investment income. Absent the Taxable Subsidiaries, a portion of the gross income of theseincome-producing investments or of any LLC (or other pass-through entity) portfolio investment, as the case may be, would flowthrough directly to us for the 90% test. To the extent that such income did not consist of investment income, it could jeopardizeour ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes. The income of the LLCs (orother pass-through entities) owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries and does not flow through to us,thereby helping us preserve our RIC status and resultant tax advantages. We do not consolidate the Taxable Subsidiaries for incometax purposes and they may generate income tax expense because of the Taxable Subsidiaries’ ownership of the portfolio investments.We reflect any such income tax expense on our Statements of Operations.

 

**Critical Accounting Policies**

 

Our financial statements are based on the selectionand application of significant accounting policies, which require management to make significant estimates and assumptions. Webelieve that the following are some of the more critical judgment areas in the application of our accounting policies that currentlyaffect our financial condition and results of operations.

 

**Valuation of Investments**— Portfolioinvestments are carried at fair value with the net change in unrealized appreciation or depreciation included in the determinationof net assets. Valuations of portfolio securities are performed in accordance with accounting principles generally accepted inthe United States of America and the financial reporting policies of the SEC. The applicable methods prescribed by such principlesand policies are described below:

 

*Publicly-traded portfolio securities*—Investmentsin companies whose securities are publicly traded are generally valued at their quoted market price at the close of business onthe valuation date.

 

*Privately-held portfolio securities*—Thefair value of investments for which no market exists is determined on the basis of procedures established in good faith by ourBoard of Directors. As a general principle, the current “fair value” of an investment would be the amount we mightreasonably expect to receive for it upon its current sale, in an orderly manner. Appraisal valuations are necessarily subjectiveand the estimated values arrived at by the Fund may differ materially from amounts actually received upon the disposition of portfoliosecurities.

 

*Thinly Traded and Over-the-Counter Securities*—Generally,we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bidand ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinlytraded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors,including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether thetrading levels are active (Level 1) or inactive (Level 2) or unobservable (Level 3). These types of securities represented 16.0%and 15.4% of our investments in portfolio securities as of June 30, 2013 and December 31, 2012, respectively. We utilized independentpricing services with certain of our fair value estimates. To corroborate “bid/ask” quotes from independent pricingservices, we perform a market-yield approach to validate prices obtained or obtain other evidence.

 

During the first twelve months after an investmentis made, the original investment amount is utilized to determine the fair value unless significant developments have occurred duringthis twelve month period which would indicate a material effect on the portfolio company (such as results of operations or changesin general market conditions). After the twelve month period, or if material events have occurred within the twelve month period,Fund management considers a two-step process when appraising investments of privately held companies. The first step involves determiningthe enterprise value of the portfolio company. During this step, our management considers three different valuation approaches:a market approach, an income approach, and an asset approach. The particular facts and circumstances of each portfolio companydetermine which approach, or combination of approaches, will be utilized. The second step when appraising equity investments ofprivately held companies involves allocating value to the various debt and equity securities of the company. Fund management allocatesvalue to these securities based on their relative priorities. For equity securities such as warrants, the Fund may also incorporatealternative methodologies including the Black-Scholes Option Pricing Model.

 

**Market approach**—The market approachtypically employed by our management calculates the enterprise value of a company as a multiple of earnings before interest,taxes, depreciation and amortization (“EBITDA”) generated by the company for the trailing twelve month period. Adjustments to the company’s EBITDA, including those for non-recurring items, may be considered. Multiples are estimatedbased on current market conditions and past experience in the private company marketplace and are subjective in nature. We willapply liquidity and other discounts we deem appropriate to equity valuations where applicable. We 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, independentinvestors.

 

**Income approach**—The income approachtypically utilized by our management calculates the enterprise value of a company utilizing a discounted cash flow model incorporatingprojected future cash flows of the company.  Projected future cash flows consider the historical performance of the companyas well as current and projected market participant performance. Discount rates are estimated based on current market conditionsand past experience in the private company marketplace and are subjective in nature. We will apply liquidity and other discountswe deem appropriate to equity valuations where applicable.

 

**Asset approach**—We consider theasset approach to determine the fair value of significantly deteriorated investments demonstrating circumstances indicative ofa liquidation analysis. This situation may arise when a portfolio company: 1) cannot generate adequate cash flow to meet the principaland interest payments on its indebtedness; 2) is not successful in refinancing its debt upon maturity; 3) we believe thecredit quality of a loan has deteriorated due to changes in the business and underlying asset or market conditions which may resultin the company’s inability to meet future obligations; or 4) the portfolio company’s reorganization or bankruptcy.Consideration is also given as to whether a liquidation event would be orderly or forced.

 

We base adjustments upon such factors as theportfolio company’s earnings, cash flow and net worth, the market prices for similar securities of comparable companies,an assessment of the company’s current and future financial prospects and various other factors and assumptions. In the caseof unsuccessful operations, we may base a portfolio company’s fair value upon the company’s estimated liquidation value.Fair valuations are necessarily subjective, and management’s estimate of fair value may differ materially from amounts actuallyreceived upon the disposition of its portfolio securities. Also, any failure by a portfolio company to achieve its business planor obtain and maintain its financing arrangements could result in increased volatility and result in a significant and rapid changein its value.

 

Our general intent is to hold our loans tomaturity when appraising its privately held debt investments. As such, we believe that the fair value will not exceed the costof the investment. However, in addition to the previously described analysis involving allocation of value to the debt instrument,we perform a yield analysis to determine if a debt security has been impaired.

 

 

The Audit Committee of the Board of Directorsmay engage independent, third-party valuation firms to conduct independent appraisals and review management’s preliminaryvaluations of each privately-held investment in order to make their own independent assessment. Any third-party valuation datawould be considered as one of many factors in a fair value determination. The Audit Committee then would recommend the fair valuesfor all privately-held securities based on all relevant factors to the Board of Directors for final approval.

 

Because of the inherent uncertainty of thevaluation of portfolio securities which do not have readily ascertainable market values, amounting to $8.6 million and $9.0 millionas of June 30, 2013 and December 31, 2012, respectively, our fair value determinations may materially differ from the values thatwould have been used had a ready market existed for the securities. As of June 30, 2013 and December 31, 2012, one of our portfolioinvestments, consisting of 73,666 ordinary shares of OPG, is publicly listed on the NYSE Euronext Paris Exchange.

* *

On a daily basis, we adjust our net asset valuefor the changes in the value of our publicly held securities, if applicable, and material changes in the value of private securities,generally determined on a quarterly basis or as announced in a press release, and reports those amounts to Lipper Analytical Services,Inc. Weekly and daily net asset values appear in various publications, including Barron’s and *The Wall Street Journal*.

*** ***

**Federal Income Taxes**

 

We intend to comply with the requirements ofthe Internal Revenue Code necessary for us to qualify as a RIC. So long as we comply with these requirements, we generally willnot be subject to corporate-level federal income taxes on otherwise taxable income (including net realized capital gains) distributedto stockholders. Therefore, we did not record a provision for federal income taxes in our financial statements. As of December31, 2012, we had a capital loss carry-forward of $29.3 million which may be used to offset future capital gains. We may borrowmoney from time to time to maintain our status as a RIC under the Internal Revenue Code. See Note 2 for further discussion of ourRIC borrowings.

 

**Interest Income Recognition**

 

We record interest income, adjusted for amortizationof premium and accretion of discount, on an accrual basis to the extent that we expect to collect such amounts. We stop accruinginterest on investments when we determine that interest is no longer collectible. We may also impair the accrued interest whenwe determine that all or a portion of the current accrual is uncollectible. If we receive any cash after determining that interestis no longer collectible, we treat such cash as payment on the principal balance until the entire principal balance has been repaid,before we recognize any additional interest income. We accrete or amortize discounts and premiums on securities purchased overthe life of the respective security using the effective yield method. The amortized cost of investments represents the originalcost adjusted for the accretion of discount and/or amortization of premium on debt securities.

** **

**Payment in Kind Interest**

 

We have loans in our portfolio that may payPIK interest. We add PIK interest, if any, computed at the contractual rate specified in each loan agreement, to the principalbalance of the loan and record it as interest income. To maintain the Fund’s status as a RIC, we must pay out to our stockholdersthis non-cash source of income in the form of dividends even if we have not yet collected any cash in respect of such investments.

 

**Current Market Conditions**

 

Overall economic conditions in the United Stateshave improved since 2009, albeit marginally. However, the economic recovery has been hampered by slower growth and persistent highunemployment relative to historical levels. The International Monetary Fund  is forecasting minimal growth of1.75% for the U.S. economy in 2013, with the Congressional Budget Office projecting an unemployment rate exceeding 7.5% at yearend. Additionally, future economic expansion and business investment is threatened by perceptions of higher taxes and healthcarecosts, as well as the high levels of government deficit spending.

 

According to a report issuedThompson Reuters, merger and acquisition activity continued its sharp decline during the first six months of 2013 as comparedto recent years. Nevertheless, market conditions for business transactions including mergers and acquisitions and privateequity investments have improved since 2010, as corporations have been deleveraging and are holding significant amounts ofcash and many have begun to focus on acquisitions as part of future growth plans. Private equity activity declined in thesecond quarter of 2013, but increased overall in the first six months of 2013.

 

 

Consistent with other companies in the financialservices sector, our performance has been adversely affected. Between December 31, 2008 and December 31, 2012 our net asset valuedeclined from $9.16 per share to $3.11 per share. This further impacted the trading price of our common stock, as it declined approximately21.9% and 10.4% during 2010 and 2011, respectively, before increasing 5.36% in 2012. As of June 30, 2013, the closing price ofour common stock was $1.91, which is a discount of 33.1% to our net asset value.

 

Over the past several years, we have executedcertain initiatives to enhance liquidity, achieve a lower operational cost structure, provide more assistance to portfolio companiesand realize certain of our portfolio investments. Specifically, we changed the composition of our Board of Directors and management,terminated certain of our follow-on investments, internalized the management of the Fund, suspended our managed distribution policy,modified our investment strategy to pursue shorter term liquidation opportunities, pursued non-cash investment opportunities, andsold certain of our legacy and underperforming investment holdings. We believe these actions continue to be necessary to protectcapital and liquidity during this turbulent economic period in order to preserve and enhance shareholder value. Because our managementis internalized, certain of our expenses should not increase commensurate with an increase in the size of the Fund and, therefore,we expect to achieve efficiencies in our cost structure if we are able to grow the Fund.

 

**Liquidity and Capital Resources**

 

We generate cash primarily from maturities,sales of securities and borrowings, as well as capital gains realized upon the sale of portfolio investments. We use cash primarilyto make additional investments, either in new companies or as follow-on investments in the existing portfolio companies and topay the dividends to our stockholders.

 

Because of the nature and size of the portfolioinvestments, we may periodically borrow funds to make qualifying investments to maintain our tax status as a RIC. We often borrowsuch funds by utilizing a margin account with a securities brokerage firm. There is no assurance that such arrangement will beavailable in the future. If the Fund is unable to borrow funds to make qualifying investments, it may no longer qualify as a RIC.The Fund would then be subject to corporate income tax on its net investment income and realized capital gains, and distributionsto stockholders would be subject to income tax as ordinary dividends.

 

The Fund has the ability to borrow funds andissue forms of senior securities representing indebtedness or stock, such as preferred stock, subject to certain restrictions.Net taxable investment income and net taxable realized gains from the sales of portfolio investments are intended to be distributedat least annually, to the extent such amounts are not reserved for payment of expenses and contingencies or to make follow-on ornew investments.

 

The Fund reserves the right to retain net long-termcapital 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 shareof the federal income taxes paid on such gains as a credit against their own federal income tax liabilities. Stockholders willalso be entitled to increase the adjusted tax basis of their Fund shares by the difference between their undistributed capitalgains and their tax credit.

 

We are evaluating the impact of current marketconditions on our portfolio company valuations and their ability to provide current income. We have followed valuation techniquesin a consistent manner; however, we are cognizant of current market conditions that might affect future valuations of portfoliosecurities. We believe that our operating cash flow and cash on hand will be sufficient to meet operating requirements and to financeroutine capital expenditures through the next twelve months.  

 

**Results of Operations**

 

**Investment Income and Expense**

 

Net investment loss was $1.4 million and $0.8 millionfor the three months ended June 30, 2013 and 2012, respectively and $2.1 million and $1.3 million for the six months ended June30, 2013 and, 2012, respectively. The increase in net investment loss generated at June 30, 2013 compared to June 30, 2012 is dueprimarily to the decrease in total investment income along with the settlement expense incurred at June 30, 2013.

 

Total income (loss) from portfolio securitieswas $0.01 million and $0.2 million for the three months ended June 30, 2013 and 2012, respectively, and ($0.1) million and $0.4million for the six months ended June 30, 2013 and 2012, respectively. The decrease was primarily due to the decline in incomeproducing investments resulting from the 2012 monetizations of ConGlobal Industries Holding, Inc. and Sovereign Business Forms,Inc., along with the impairment of accrued interest receivable of Spectrum Management, LLC.

 

Total expenses increased from $1.0 millionfor the three months ended June 30, 2012 to $1.4 million for the three months ended June 30, 2013. This increase was largely dueto the increase in settlement expense the three months ended June 30, 2013. Total expenses increased from $1.7 million for thesix months ended June 30, 2012 to $2.1 million for the six months ended June 30, 2013, due primarily to settlement expense.

 

**Realized Gains and Losses on Sales of Portfolio Securities**

 

During the six months ended June30, 2013, we realized capital losses of $1.8 million due to the asset sale of The Bradshaw Group (“Bradshaw”)to PartsNow! LLC. The structure and pricing of the transaction was such that only the Class A preferred shareholdersreceived any proceeds. There were no proceeds to the other equity classes, including the Classes B, D, and E preferred stockand warrants owned by the Fund. The Fund invested in Bradshaw in May 2000 and the Fund’s investment has been valued at$0 since 2002.

 

During the six month ended June 30,2012, we realized capital losses of $5.2 million, including the following transactions (in thousands):

****

 

**Changes in Unrealized Appreciation/Depreciation of PortfolioSecurities**

 

Net unrealized depreciation on investmentsdecreased to $16.0 million during the six months ended June 30, 2013, from a net unrealized depreciation of $17.2 million. Such decrease in unrealized depreciation is largely due to the following changes:

 

 

Net unrealized depreciation on investmentsdecreased by $1.7 million during the six months ended June 30, 2012, to a net unrealized depreciation of $15.7 million.  Suchdecrease in unrealized depreciation is largely due to the following changes:

** **

**Dividends**

 

We will pay out net investment income and/orrealized capital gains, if any, on an annual basis as required under the Investment Company Act of 1940.

 

**Portfolio Investments**

** **

During the six months ended June 30, 2013,we capitalized legal and consulting expenses of $0.2 million relating to Spectrum Management. We also received a semi-annual interestpayment of $0.03 million and a 5.75% partial principal repayment of $9,000 in respect of our €1.2 million [$1.5 million] inOPG notes.

 

During the six months ended June 30, 2012,we made no follow-on investments, nor realized any significant gains or losses on sales of portfolio securities. However, the Fundcapitalized $0.3 million in accrued interest relating to the restructuring of 8,890 4% bonds of Orco Germany S.A. that were ultimatelyconverted into shares and notes of OPG.

 

**Subsequent Events**

** **

Management performed an evaluation of the Fund’sactivity through the date the financial statements were issued, noting the following subsequent event:

 

On July 30, 2013, pursuant tothe settlement agreement with Paula Douglass as described below under *Legal Proceedings*, the Fund made a settlementpayment in the amount of $0.4 million.

 

**Item  3.	Quantitative and Qualitative Disclosureabout Market Risk**

 

We are subject to financial market risks, includingchanges in interest rates with respect to investments in debt securities and outstanding debt payable, as well as changes in marketableequity security prices. In the future, in addition to our investment in OPG shares and the New OPG Notes, we may invest in companiesoutside the United States, including in Europe and Asia, which would give rise to exposure to foreign currency value fluctuations.We do not use derivative financial instruments to mitigate any of these risks. The return on investments is generally not affectedby foreign currency fluctuations.

 

Our investments in portfolio securities consistof some fixed-rate debt securities. Since the debt securities are generally priced at a fixed rate, changes in interest rates donot directly affect interest income. In addition, changes in market interest rates are not typically a significant factor in thedetermination of fair value of these debt securities, since the securities are generally held to maturity. We determine their fairvalues based on the terms of the relevant debt security and the financial condition of the issuer.

 

A major portion of our investment portfolioconsists of debt and equity investments in private companies. Modest changes in public market equity prices generally do not significantlyimpact the estimated fair value of these investments. However, significant changes in market equity prices can have a longer-termeffect on valuations of private companies, which could affect the carrying value and the amount and timing of gains or losses realizedon these investments. A small portion of the investment portfolio also consists of common stock in publicly traded companies. Theseinvestments are directly exposed to equity price risk, in that a hypothetical ten percent change in these equity prices would resultin a similar percentage change in the fair value of these securities.

 

We are classified as a “non-diversified”investment company under the 1940 Act, which means we are not limited in the proportion of our assets that may be invested in thesecurities of a single user. The value of one sector called “Energy” includes one portfolio company and was 22.3% ofthe net asset value and 76.3% of our investments in portfolio company securities (at fair value) as of June 30, 2013. Changes inbusiness or industry trends or in the financial condition, results of operations, or the market’s assessment of any singleportfolio company will affect the net asset value and the market price of our common stock to a greater extent than would be thecase if we were a “diversified” company holding numerous investments.

 

**Item  4.Controlsand Procedures**

 

The Fund maintains disclosure controls andother procedures that are designed to ensure that information required to be disclosed by the Fund in the reports that it filesor submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicated to the Fund’s management, including its ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

The Fund’s management, with the participationof the Fund’s Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of the design and operationsof the Fund’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities ExchangeAct of 1934) as of June 30, 2013. Based on their evaluation, the Fund’s Chief Executive Officer and Chief Financial Officerconcluded that the Fund’s disclosure controls and procedures were effective at a reasonable assurance level. There has beenno change in the Fund’s internal control over financial reporting during the quarter ended June 30, 2013, that has materiallyaffected, or is reasonably likely to materially affect, the Fund’s internal control over financial reporting.

** **

** **

** **

**Part II. Other Information**

 

**Item  1.LegalProceedings**

 

On April 26, 2010, the Securities andExchange Commission (“SEC”) subpoenaed records of the Fund in connection with certain trades in the Fund’s sharesby SPQR Capital LLP, SAE Capital Ltd., Versatile Systems Inc., Mobiquity Investments Limited, and anyone associated with thoseentities. The Fund has fully cooperated with the SEC’s request.

 

In January 2006, we sold our 31.5% ownershipinterest in Champion Window, Inc. (“Champion”), a portfolio company of the Fund, to Atrium Companies Inc. (“Atrium”)pursuant to a Stock Purchase Agreement (“SPA”) dated December 22, 2005. The SPA contained certain limited rights ofindemnification for Atrium in connection with its purchase of such ownership interest.

 

Atrium filed suit in the District Court ofHarris County, Texas against two former officers of Atrium’s subsidiary, Champion, alleging, amongst other matters, thatthe former officers breached their fiduciary duties to Champion by hiring undocumented workers. This action was commenced primarilyas a result of an investigation by the U.S. Immigration and Customs Enforcement agency (“ICE”) into Atrium’shiring practices. On March 12, 2012, to protect its interests, we filed a Petition in Intervention in the State Court Action seekinga declaration from the Court that Equus did not owe any obligation to indemnify Atrium or Champion for any penalties, costs orfees associated with the investigation by ICE.

 

On March 16, 2012, Atrium and Champion fileda claim with the American Arbitration Association in Dallas, Texas, against Equus and a number of the other sellers under the SPA.

 

In the Arbitration Action, Atrium and Championseek damages arising from Equus’ and the other sellers’ indemnity obligations set forth in the SPA. Atrium claims itis entitled to indemnification under the SPA for costs it has incurred in responding to an ongoing investigation by ICE. Atriumentered into a Non-Prosecution Agreement with ICE. It appears that one condition of the Non-Prosecution Agreement required Atriumto pay ICE $2,000,000. Atrium and Champion asserted two counts of breach of contract against Equus, both arising out of the allegedobligation to indemnify Atrium and Champion pursuant to certain provisions of the SPA. Atrium and Champion also asserted claimsfor fraudulent inducement against two former officers and directors of Champion. Through the arbitration, Atrium and Champion seekto recover an unspecified amount in the form of alleged “losses, damages, assessments, penalties, interest, reasonable attorneys’and accountants’ fees, settlement costs, and other costs and expenses arising directly or indirectly out of or incident to,”the alleged breach of the indemnity provisions in the SPA. As a consequence of their fraudulent inducement claim against the twoformer officers and directors, Atrium and Champion alternatively seek equitable rescission of the SPA and exemplary damages fromthe two former officers and directors.

 

Atrium and Champion have yet to specify theamount of damages they seek from Equus or the other sellers pursuant to the alleged indemnity obligations under the SPA. Atriumand Champion have disclosed the payment of $2 million to ICE to resolve the investigation and avoid prosecution for their hiringpractices.

 

We intend to vigorously contest the claimsand deny that we owe any indemnity obligations to Atrium or Champion and further deny that the Fund is in any way liable to Atriumor Champion. To the extent Atrium and Champion are able to establish a right to an indemnity, we will contest the amount of theclaimed indemnity, inasmuch as we believe (among other defenses) that the indemnity obligation can only exist, if at all, withrespect to damages arising as a direct and proximate result of employees who were hired prior to the closing date of the 2006 saleof Champion and remained in continuous employment after the 2006 sale, and not to any employee who may have been hired in the sixyears after the sale.

 

While we believe the Atrium claim is withoutmerit and we intend to vigorously dispute the claim, there is a reasonable possibility of an adverse ruling which may require theFund to indemnify Atrium. If Equus is required to indemnify Atrium and Champion, we estimate that such indemnity obligation couldvary from $2.0 million to $3.0 million. Pursuant to the SPA, the indemnification obligation of Equus and the other sellers is severaland not joint, and any such indemnity, however uncertain, would likely be reduced proportionately to our percentage ownership inChampion at the time of sale, which was 31.5% of Champion’s shares outstanding.

 

Effective June 13, 2013, the Fund entered intoa settlement agreement with Sam Douglass, a former director and executive officer of the Fund, in respect of a claim for indemnificationpursuant to the General Corporation Law of Delaware and an indemnification agreement entered into by the Fund with Mr. Douglasson May 3, 2001. The settlement agreement provides for the reimbursement to Mr. Douglass of actual expenses incurred, excludingany fines or penalties, in connection with an enforcement action initiated by the Securities and Exchange Commission against Mr.Douglass in 2009. The settlement payment of $125,000 was made on June 24, 2013.

 

On August 12, 2012, Paula Douglass fileda lawsuit against the Fund and members of the Board of Directors in the District Court of Harris County, Texas. Ms.Douglass’ complaint alleged various causes of action, including minority shareholder oppression, dilution, and breachof fiduciary duty, and sought unspecified damages and attorney’s fees. Effective June 13, 2013, the Fund entered into asettlement agreement with Ms. Douglass, Sam Douglass, as well as certain trusts controlled by them. Pursuant to thesettlement agreement and in view of the estimated costs of protracted litigation and the associated disruption to theoperations of the Fund, the Board of Directors approved a payment of $402,254, in complete settlement of the lawsuit, asbeing in the best interests of the Fund and its shareholders. The settlement payment was made on July 30, 2013. Ms. Douglassfiled a motion to dismiss the lawsuit with prejudice on August 8, 2013.

 

From time to time, the Fund is also a partyto certain proceedings incidental to the normal course of our business including the enforcement of our rights under contractswith our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, wedo not expect that these proceedings will have a material effect upon the Fund’s financial condition or results of operations.

 

**Item 1A.RiskFactors**

 

There have been no material changes in theFund’s risk factors from the disclosure set forth in the Annual Report on Form 10-K for the year ended December 31,2012.

 

Readers should carefully consider these risksand all other information contained in the annual report on Form 10-K, including the Fund’s financial statements and therelated notes thereto. The risks and uncertainties described below are not the only ones facing the Fund. Additional risks anduncertainties not presently known to the Fund, or not presently deemed material by the Fund, may also impair its operations andperformance.

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**Item  6.	Exhibits**

SIGNATURE

 

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed by the undersigned, thereuntoduly authorized.