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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 0-33377
MCG CAPITAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 54-7889518
(State of Incorporation) (I.R.S. Employer
Identification Number)
1100 Wilson
Boulevard Suite
800 Arlington, VA 22209
(Address of principal
executive offices) (Zip Code)
Registrant's telephone number, including area code: 703-247-7500
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
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Common Stock, par value
$0.01 per share
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_].
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of common stock held by non-affiliates of the
Registrant as of March 28, 2002 was approximately $314,342,223 based on the
closing price on the Nasdaq National Market. For purposes of this computation,
shares held by certain stockholders and by directors and executive officers of
the Registrant have been excluded. Such exclusion of shares held by such
persons is not intended, nor shall it be deemed, to be an admission that such
persons are affiliates of the Registrant. There were 28,289,884 shares of the
Registrant's common stock outstanding as of March 28, 2002.
Documents Incorporated by Reference
Portions of the Registrant's definitive Proxy Statement relating to the 2002
Annual Meeting of Stockholders, to be filed with the Securities and Exchange
Commission, are incorporated by reference in Part III of this Annual Report on
Form 10-K as indicated herein.
MCG CAPITAL CORPORATION
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business............................................................. 1
Item 2. Properties........................................................... 20
Item 3. Legal Proceedings.................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders.................. 21
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 23
Item 6. Selected Financial Data.............................................. 24
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 25
Item 7a. Quantitative and Qualitative Disclosures about Market Risk........... 42
Item 8. Consolidated Financial Statements and Supplementary Data............. 43
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................... 73
PART III
Item 10. Directors and Executive Officers of the Registrant................... 73
Item 11. Executive Compensation............................................... 73
Item 12. Security Ownership of Certain Beneficial Owners and Management....... 73
Item 13. Certain Relationships and Related Transactions....................... 73
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...... 73
PART I
In this Annual Report, the "Company", "MCG", "we", "us" and "our" refer to
MCG Capital Corporation and its wholly owned subsidiaries and its affiliated
securitization trusts unless the context otherwise requires.
Item 1. Business
GENERAL
We are a solutions-focused financial services firm that primarily provides
capital to support the internal growth and corporate development initiatives of
small- to medium-sized private companies throughout the United States. Since
1990, we and our predecessor have originated an aggregate of over $2 billion in
investments in over 200 transactions, primarily in the form of senior secured
commercial loans and, to a small extent, in the form of subordinated debt and
equity-based investments. We intend to increase gradually our level of
subordinated debt and equity-based investments. However, a substantial majority
of our portfolio will continue to consist of investments in senior secured
commercial loans.
Our investment objective is to achieve current income and capital gains. To
meet this objective, we employ an "expert-activist" investment philosophy to
identify attractive investment opportunities and develop strong customer
relationships. As an expert, we are highly knowledgeable about our target
markets and customers. As an activist, we work with our customers' management
teams and owners to create and execute effective capital deployment strategies.
In addition, we use a "flexible funding" approach that permits adjustments to
transaction terms, including pricing terms, to accommodate the shifting
corporate development needs of our customers. The ongoing consulting services
we provide also support our customers' growth and risk management strategies.
We have built our portfolio through effective origination, disciplined
underwriting and investment approval processes and focused portfolio
management. We typically lend to and invest in companies with $5 million to
$100 million in annual revenues that operate in our target industry sectors. As
of December 31, 2001, our geographically diverse customer base consisted of
approximately 74 companies with headquarters in 26 states and Washington, DC.
Our investment decisions are based on extensive analysis of potential
customers' business operations and asset valuations supported by an in-depth
understanding of the quality of their recurring revenues and cash flow,
variability of costs and the inherent value of their proprietary intangible
assets and intellectual property. We have developed specialized risk management
metrics, pricing tools, due diligence methodologies and data management
processes that are designed to help us maximize our return on investment.
We have a loyal customer base. In 2001, 31 of our closed transactions,
representing approximately 40% of the loans we originated, involved existing
customers. As of December 31, 2001, approximately 52% of the companies that
have been our customers for one year or more had completed two or more
transactions with us and approximately 27% had completed three or more
transactions with us.
As of December 31, 2001, we had outstanding commercial loans of $596.0
million, an increase of $101.9 million or 20.6% from $494.1 million at December
31, 2000 and equity investments of $21.2 million at December 31, 2001 compared
to $6.7 million at December 31, 2000, an increase of $14.5 million or 216.4%.
We acquire our equity investments primarily in connection with our loans,
through a direct purchase or through foreclosure of a borrower's assets or
equity. For the year ended December 31, 2001, we originated approximately
$147.7 million of loans, a decrease of $63.5 million or 30.1% from $211.2
million for the year ended December 31, 2000.
CORPORATE HISTORY AND OFFICES
We were formed by our management and affiliates of Goldman, Sachs & Co. to
purchase a loan portfolio and certain other assets from First Union National
Bank in a management buyout. Our business was originally a
separate division of Signet Bank, whose parent Signet Banking Corporation was
acquired by First Union Corporation in 1997. This separate division was known
as the media communications group. We completed the buyout from First Union
National Bank on June 24, 1998. First Union Corporation changed its name to
Wachovia Corporation on September 1, 2001 following the merger of Wachovia
Corporation with and into First Union Corporation.
Immediately following the completion of our initial public offering in
December 2001, we became an internally managed, non-diversified closed-end
investment company that elected to be regulated as a business development
company under the Investment Company Act of 1940. As a business development
company, we are required to meet regulatory tests, the most significant of
which relate to our investments and borrowings. A business development company
is required to invest at least 70% of its total assets in private or thinly
traded, public U.S.-based companies. A business development company also must
meet a coverage ratio of total assets to total senior securities, which include
all of our borrowings and any preferred stock we may issue in the future, of at
least 200%. In addition, we will elect, effective as of January 1, 2002, to be
taxed for federal income tax purposes as a regulated investment company under
the Internal Revenue Code.
MARKET OPPORTUNITY
Small- and medium-sized businesses are becoming more significant to the U.S.
economy. At the same time, we believe that many such businesses, including our
target customers, have less access to high-quality corporate financial services
than in the past. We also believe this trend is likely to continue given the
broad-based consolidation in the financial services industry. Our focus on
selected markets with strong growth prospects, combined with our customers'
growing demand for capital and the corporate finance and consulting services we
offer enhance our market opportunity.
We target only those sectors deemed attractive by our investment committee.
Before we target a new industry sector or a new industry sub-sector within our
existing industry sectors, our research team performs a market analysis and
identifies specific operational norms and risks of that sector or sub-sector.
Management, working with our credit committee, then develops our lending and
investment criteria for that sector or sub-sector. We analyze new industry
sub-sectors in conjunction with refining and revalidating investment approaches
for our existing industry sectors. Also, on an ongoing basis, our investment
committee and credit committee monitor the level of diversification within the
portfolio for risk associated with sector concentration.
We currently focus on the communications, information services, media, and
technology industry sectors. We believe that traditional financial services
providers typically lack infrastructure and dedicated expertise to focus on
small- and medium-sized companies within these industries. We believe that each
of these sectors has distinct characteristics in terms of risk, capital
requirements, industry and general economic cycles, stage of development and
rates of return. Each such sector also is characterized by ongoing
consolidation and convergence and by substantial new business formation. We
also believe that these sectors have a number of common features, including
favorable regulatory environments, rising projected revenue growth rates,
recurring revenue characteristics and enterprise values that depend
significantly on intangible assets and intellectual property. As a result, we
believe we have a large market opportunity in our target industry sectors. In a
typical year, we estimate that we consider capital transactions with
approximately 650 small- and medium-sized companies in our target industry
sectors, which we believe represents approximately 10% of the companies in our
target industry sectors that we monitor from time to time. We believe that
there are more small- and medium-sized companies in our targeted industry
sectors than the companies we monitor.
. Communications. Our targeted communications businesses consist of voice
and data local and long distance carriers, integrated communications
providers, and wireless services and infrastructure companies, including
companies that operate communications towers and security alarm and
monitoring systems. These businesses generally are non- or
counter-cyclical. Revenues in these businesses are end-user driven and
recurring in nature. We focus specifically on companies that have
achieved a critical mass of customers because we strongly believe that
the primary asset of communications companies is their customer base.
This approach differentiates us from other lenders that focus on the
potential value of equipment and other network assets as their primary
source of collateral.
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. Information Services. Our targeted information services businesses
produce and deliver information-based products and services, which their
customers use to generate insights and make business decisions. The
information these businesses provide may be proprietary or public and is
frequently delivered through paper documents, online services, magnetic
tape or disks and CD-ROM. It also may be bundled with consulting
services or other live events in what is known as continuous information
services. These businesses are generally non-cyclical to
counter-cyclical. Top performing information services companies
typically price their products and services based on the utility
provided to the end-user rather than the cost to produce and distribute
resulting in relatively high margins. We seek companies that define
their market opportunity through proprietary content-based products and
services within specific industries.
. Media. Our targeted media businesses focus on niche, high
affinity-based businesses in consumer special interest publishing, trade
publishing, radio broadcasting, television broadcasting and community
newspaper publishing. Revenue in these businesses is derived largely
from advertising sales and therefore tends to be more cyclical. Our
focus on niche, high-affinity based businesses in this sector is
designed to mitigate the risk of cyclicality because those businesses
tend to have more stable advertising revenues.
. Technology. Our targeted technology businesses provide outsourced
business services in areas such as network security, network operations,
application services and business-to-business transaction enabling, as
well as software applications, including component middleware,
enterprise software and enterprise (intra-corporate) portals. These
businesses are generally moderately cyclical to non-cyclical.
Set forth below is a table showing the composition of our loan portfolio for
the periods ended December 31, 2001 and December 31, 2000, by industry sector.
Loan Portfolio Composition by Industry Sector
(Dollars in thousands)
December 31, 2001 December 31, 2000
-------------------------------------- --------------------------------------
# of Loans % of Average # of Loans % of Average
Loans Outstanding (1) Total Spread (2) Loans Outstanding (1) Total Spread (2)
Industry Sector ----- --------------- ----- ---------- ----- --------------- ----- ----------
Media............... 37 $324,992 54.5% 6.2% 35 $272,529 54.0% 5.6%
Communications...... 19 175,174 29.4 7.6 19 152,235 30.2 8.4
Information Services 8 70,793 11.9 7.0 7 52,509 10.4 4.0
Technology.......... 3 23,750 4.0 3.4 3 25,500 5.1 3.5
Other............... 1 1,293 0.2 6.0 2 1,441 0.3 9.2
-- -------- ----- --- -- -------- ----- ---
Total............... 68 $596,002 100.0% 6.6% 66 $504,214 100.0% 6.2%
== ======== ===== === == ======== ===== ===
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(1) Loans outstanding at December 31, 2000 are reported at cost. Following our
conversion to a business development company, we are required to carry
loans at fair value as determined by our board of directors. Therefore,
loans outstanding at December 31, 2001 are reported at fair value.
(2) Represents the weighted average contractual interest rate minus a benchmark
reference rate (e.g., LIBOR). The average spread is affected by loans
included in the calculation which have fixed interest rates, and therefore
have no spread, or are based on the prime rate and have lower spreads than
loans with LIBOR-based spreads.
STRATEGY
We seek to achieve favorable risk-adjusted rates of return in the form of
current yield and capital appreciation, while maintaining strong credit quality
in our asset portfolio. We believe our strong financial performance is a
product of our industry knowledge and insight, effectiveness in targeting
potential customers and serving them, risk-based pricing techniques and
disciplined portfolio and risk management.
Our investment process is designed to achieve the following strategic
objectives:
. generate favorable risk-adjusted rates of return by delivering capital
and strategic insight to enhance our customers' enterprise value;
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. maintain sound credit and pricing practices regardless of market
conditions;
. avoid adverse investment selection by applying our expert-activist
philosophy and a flexible funding approach; and
. enhance effective risk management by utilizing an integrated team
approach to customer acquisition, research, underwriting, compliance and
loan servicing activities.
Expert-Activist Philosophy
Our "expert-activist" philosophy is one of the foundations of our investment
process. It enables us to make lending and investment decisions quickly and
confidently because we have a firm understanding of the operating
characteristics of our customers' businesses and their associated industry
sectors. We enhance our detailed understanding of our targeted industry sectors
through continuous engagement with existing and prospective customers. We
gather and manage the knowledge and insights gained through this process using
customized databases and work flow methodologies. We use this information to
enhance the quality of our research and the effectiveness of our credit
analysis and to refine and revalidate our investment approaches within
particular sectors and sub-sectors.
We work with our customers to understand the costs and benefits of their
corporate development initiatives, business opportunities, threats to their
businesses and acceptable risks and returns. This understanding, together with
our flexible funding approach, enables us to facilitate customers' corporate
development decisions even in cases where short-term financial performance may
suffer. We believe that this approach differentiates us from most other
commercial lenders and helps to create strong and long-term relationships with
our customers. Our approach to date also has enabled us to originate loans
based on the value we help to create rather than solely on the basis of the
price we charge for capital in order to achieve attractive risk-adjusted
investment returns.
OPERATIONS
To achieve our goal of being the leading provider of solutions-focused
financial services to companies in our target sectors, we foster a credit and
business culture that strives to protect our principal and interest, generate
meaningful capital gains on our equity investments and support gains in our
customers' enterprise values.
Identifying Prospective Customers
We identify and source leads through various data services, customized
Internet searches, industry associations, investment bankers, accountants and
lawyers. Although some customers initiate their first contact with us, we find
that we generally acquire most of our customers through our own initiative.
After our initial contact with a prospect, we then conduct ongoing reviews of
its financial reports and corporate development activity by analyzing the
source data and information regarding the prospects gathered from third-party
databases, industry sector reports, trade and consumer magazines, newspapers
and newsletters. We maintain the data from these sources in an internal
database that not only supports the identification of potential customer
opportunities, but also assists us in understanding our target industry
sectors. We market on a national scale and are well-known in our primary
markets. We also participate in a variety of industry associations and our
employees attend and give presentations at numerous forums, conferences and
meetings annually.
Research
Our unique research capabilities create the foundation for our
"expert-activist" philosophy of investing and give us a competitive advantage.
Our contacts with customers in our targeted industries helps us to continuously
refine and validate our investment philosophy. Our research group's function is
to support and augment the business development process through the
identification of attractive industry sectors and emerging trends, investment
and risk analysis and marketing of our industry expertise.
Through strategic industry analysis, we update our investment perspective in
our target industry sectors and develop investment hypotheses for new industry
sub-sectors. Our research capabilities and findings also are valuable in
attracting customers who are able to draw from our industry expertise to help
refine their strategic plans, identify acquisition opportunities and set
appropriate financial and operating benchmarks.
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Our research department writes and distributes publications to portfolio
companies, prospective customers, investors, and others to facilitate a
dialogue, promote a common strategic outlook and a shared perception of
industry risk and opportunity. This shared perception helps us and our
customers develop mutually agreeable financing structures that mitigate risk to
us and our customers. Our publications also increase our visibility within our
target industry sectors and support our expert-activist investment methodology.
Our research department publishes the following reports:
. regular comprehensive industry research reports that incorporate our
investment perspectives and operational insights, which are supported by
normative data and perceived best practices for our target industries;
. Insights and Outlooks, our periodic publication that reports our views
and interpretation of significant events that impact our customers and
prospective customers; and
. Transactions, our periodic newsletter, which focuses on merger and
acquisition activity within our industry sectors.
In addition, our research department supports our active engagement with
third-party publishers who seek articles from our professionals for their
various publications and reports.
Underwriting
We have always placed primary emphasis on credit and risk analysis and
incorporated the underwriting function directly into the business development
process. Our underwriting team consists of investment professionals who perform
due diligence, credit and corporate financial analyses, deal sponsors who
possess specific industry expertise and are responsible for originating and
managing the transaction, a member of our credit committee and our in-house
counsel. Since we became an independent company in June 1998, our deal sponsors
have led our underwriting teams in originating approximately 140 transactions
with an aggregate value of approximately $747.0 million in loan commitments
resulting in approximately $624.0 million in loans outstanding through December
31, 2001.
To ensure consistent underwriting, we use our sector-specific due diligence
methodologies, developed over the last 10 years, which include standard due
diligence on financial performance and customized analysis of the operations,
systems, accounting policies, human resources and the legal and regulatory
framework of a prospective customer. The members of the underwriting team work
together to conduct due diligence and understand the relationships among the
customer's business plan, operations and financial performance.
As part of our evaluation of a proposed investment, the underwriting team
prepares an investment memorandum for presentation to the credit committee and,
in some instances, the investment committee. In preparing the investment
memorandum, the underwriting team assembles information critical to the
investment decision and regularly seeks information from the research
department on macroeconomic viewpoints, forecasted trends and firm valuation.
The investment memorandum serves as the framework for underwriting the
transaction and generally consists of:
. business description;
. risk evaluation specific to the prospect's business, considering the
anticipated use of proceeds of our loan, and industry sector; and
. description of capital structure and the investment risk and return
characteristics.
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Business Description. The business description of a prospective customer
presents the history, organization and product lines of the customer. In
addition, we analyze the prospective customer's industry sector and sub-sector,
competition and market share, obsolescence and substitution risk, customers and
markets served, legal and regulatory framework and technology issues. The
business description also explicitly discusses unique risks associated with a
proposed transaction. In particular, we analyze the following risks:
. Sector Risk Analysis. Analysis of specific vulnerability to industry
sector risk, such as industry maturity, cyclicality, profitability and
seasonality trends.
. Competitive Risks. Analysis of the strengths and weaknesses of the
prospective customer relative to its primary and secondary competitors.
The factors we consider include relative pricing, product quality,
customer loyalty, substitution and switching costs, brand positioning
and comparative capitalization. We also assess the defensibility of a
prospect's market position and its opportunity for increasing market
share.
. Regulatory Risks. We follow current regulatory developments in each of
our targeted sectors and describe how credit and business risks have
changed with the evolution of regulation and what risks are presented by
existing and currently proposed regulations.
. Customer Concentration and Market Risks. We typically determine the
values of companies in our target sectors largely based upon the
stability of their customer base. We analyze the number and size of
customers and their attrition rates, including the potential impact of
above average customer attrition, low renewals and the risk of loss of
significant customers.
. Technology Risks. Companies in certain sectors rely on the acquisition
or development of proprietary technology for distribution, production,
or administration and others rely on such technology as the products or
services that they offer. We also consider the likely positive or
negative effect of technological advances on the value of their services.
Financial and Customer Risk Assessment. As part of our financial and
customer risk assessment process, we try to determine comparable levels of risk
across industry sectors and customers. Our financial analysis is based on an
integrated financial model that is built upon the historical and projected
financial performance of a prospect. The model also presents the pro forma
post-funding capital structure, along with the sources and uses of funding in
the proposed transaction.
Each model incorporates historical financial results and an underlying set
of assumptions for operating margins, growth rates, capital structure, rates of
return, working capital investment and fixed asset expenditures. A base case is
prepared with assumptions provided by the customer's management. We use
alternative sets of assumptions to evaluate the prospect's ability to support
different capital structures, growth rates, margins, rates of return, and
working capital and fixed asset expenditures. This integrated financial model
goes beyond forecasting financial statements by incorporating cash flow
coverage forecasts, covenant compliance tests, valuation matrices, and an
executive summary, which details investment-specific terms. Financial risk
assessment allows us to evaluate a prospect based on our pre-established risk
acceptance criteria.
We also assess the intangible attributes of a transaction typically embodied
in a prospect's management's track record, business plan, judgments about its
products and other subjective characteristics that may significantly affect the
ultimate risk of a transaction. This assessment entails a subjective
consideration of the quantitative and qualitative attributes of a prospect
considered in the context of its industry sector rather than an assessment
based exclusively on past historical financial performance. Quantitative
attributes we evaluate include sector-specific comparisons such as cash flow
margins, product and cash flow diversification, revenue growth rates, cost
structure and other operating benchmarks that are derived from historical
financial statements.
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Qualitative attributes we evaluate may include management skill and depth,
industry risk, substitution risk, cyclicality, geographic diversification,
facilities infrastructure, administration requirements and product quality and
ranking. Based on this assessment, we assign a low, medium or high volatility
factor to the prospect.
Investment Structure. In underwriting prospective customers, we also focus
on investment structure, payment priority, collateral or asset value, tenor,
and financial support from guarantors and other credit enhancements. We use
loan structure to mitigate the higher risk associated with a higher volatility
factor by requiring better financial and collateral coverage thresholds for
those prospects. In most of our loans, we receive a perfected, first priority
security interest in substantially all of our customers' assets, which entitles
us to a preferred position on payments in the event of liquidation, and a
pledge of the equity by the equity owners. In addition, we structure loan
covenants to assist in the management of risk. Our loan documents ordinarily
include affirmative covenants that require the customers to take specific
actions such as periodic financial reporting, notification of material events
and compliance with laws, restrictive covenants that prevent customers from
taking a range of significant actions such as incurring additional indebtedness
or making acquisitions without our consent, covenants requiring the customer to
maintain or achieve specified financial ratios such as cash flow leverage,
interest coverage and fixed charge coverage, and operating covenants requiring
them to maintain certain operational benchmarks such as minimum revenue or
minimum cash flow. Our loan documents also contain customary events of default
such as non-payment, breach of representation, breach of covenant, insolvency
and change of control. Our direct equity investments at the time they are made
are typically pari passu with or senior to the customers' other equity
securities.
Flexible Funding
We recognize that growth-oriented companies regularly make corporate
development decisions that impact their financial performance, valuation and
risk profile. Often these decisions can favorably impact enterprise value at
the expense of short-term financial performance. Our "flexible funding"
strategy allows us to adjust the return on our capital through risk-based
pricing grids that account for shifts in the customer's financial performance
associated with these decisions. Our loan structures take into account our
customers' potentially varying financial performance so that customers can
retain access to committed capital at different stages in their growth and
development. We calculate rates of return based on a combination of up-front
fees, current and deferred interest rates and residual values in the form of
equity interests, such as warrants, appreciation rights or future contract
payments. Our internal rates of return on invested capital and the customer's
cost of debt capital are generally highest when our customer utilizes high
levels of leverage.
We believe that this method of flexible performance-based pricing allows our
customers to build a long-term relationship with us as a preferred provider. We
also believe our approach presents debt as a viable alternative to raising
additional equity, which permits our customers to avoid the permanently
dilutive effect on existing equity holders associated with equity financing
transactions.
Our loans typically include a variable interest rate component designed to
reflect credit risk, which allows the interest rates our customers pay to
increase or decrease automatically based on changes in their operating and
financial performance. For example, if a customer fails to achieve the
operating or financial performance targets set forth in the loan agreement, the
interest rate payable on our loan typically increases automatically to reflect
the increased credit risk. Conversely, if the customer outperforms, the
interest rate payable would typically decrease to reflect our decreased credit
risk. However, in such a scenario, our decrease in interest income as a result
of the favorable interest rate adjustment is likely to be offset for certain
loans by increases in the value of our upside investments, such as warrants,
stock appreciation rights or direct equity investments.
Investment Approval Process
Our credit committee approves all of our investments, while the investment
committee of our board of directors also must approve some investments. The
four members of our credit committee are Bryan J. Mitchell, our Chairman and
Chief Executive Officer, Steven F. Tunney, our President and Chief Operating
Officer, Robert
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J. Merrick, our Chief Credit Officer and B. Hagen Saville, one of our Executive
Vice Presidents. Credit committee approval requires the approval of Mr. Merrick
and two of the three other members of the credit committee. The investment
committee of our board must approve loans to any customer exceeding $10 million
and all equity investments.
Loan Servicing
After a loan is approved and funded, the underwriting team, along with the
loan administration group and the compliance group, remain involved in the
transaction by reviewing covenant compliance and quarterly financial
performance and by collecting additional industry sector data for inclusion in
our databases.
Loan Administration Group. This group administers the loans on our loan
administration system and is responsible for:
. funding the loans in accordance with the credit committee's and, if
applicable, investment committee's approval;
. recording the loans into our loan administration system;
. ensuring that billing and collections are done in an accurate and timely
fashion;
. collecting on past due accounts; and
. maintaining the collateral that is in our possession.
Compliance Administration Group. This group tracks covenant compliance and
oversees a monthly review of our critical functions to ensure adherence with
our internal policies and procedures. The compliance administration staff is
responsible for:
. reviewing the credit agreement to ensure that the final loan documents
reflect the terms approved by the credit committee and, if applicable,
the investment committee and advising the credit committee of any
deviations;
. ensuring that the customer compliance package is prepared in accordance
with the loan covenant requirements;
. inputting the customer's financial statements into our tracking
schedules and entering the loan covenants into the covenant tracking
system;
. ensuring the mathematical accuracy of all covenant requirements;
. reviewing the customer's financial statements to ensure that the
customer performs in accordance with our expectations;
. reporting all covenant violations, loan amendments and covenant waivers
to the credit committee;
. plotting the customer's actual performance against our risk acceptance
criteria grids each quarter to ensure that the risk rating is still
appropriate; and
. preparing annual reviews and quarterly collateral valuation updates for
each customer.
Loan Monitoring and Restructuring Procedures. We monitor individual
customer's financial trends in order to assess the appropriate course of action
for each customer and to evaluate overall portfolio quality. We closely monitor
the status and performance of each individual investment on a quarterly and, in
some cases, a monthly basis. Because we are a provider of long-term privately
negotiated investment capital to high-growth companies, we do not believe
contract exceptions are necessarily an indication of credit quality or the need
to pursue remedies or an active workout of a portfolio investment.
When principal and interest on a loan is not paid within the applicable
grace period, our loan administration group will contact the customer for
collection. At that time, we will make a determination as to the extent of the
problem, if any. We will then pursue a commitment for immediate payment and
will begin to more actively monitor the investment. We will formulate
strategies to optimize the resolution process and begin the process of
restructuring the investment to better reflect the current financial
performance of the customer. Such a restructuring may involve deferring
payments of principal and interest, adjusting interest rates or warrant
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positions, imposing additional fees, amending financial or operating covenants
or converting debt to equity. In general, in order to compensate us for any
enhanced risk, we receive appropriate compensation from the customer in
connection with a restructuring. During the process of monitoring a loan in
default, we will in appropriate circumstances send a notice of non-compliance
outlining the specific defaults that have occurred and preserving our remedies,
and initiate a review of the collateral. When a restructuring is not the most
appropriate course of action, we may determine to pursue remedies available
under our loan documents or at law to minimize any potential losses, including
initiating foreclosure and/or liquidation proceedings.
When a loan becomes 90 days or more past due, or if we otherwise do not
expect the customer to be able to service its debt and other obligations, we
will, as a general matter, place the loan on non-accrual status and stop
recognizing interest income on that loan until all principal has been paid.
However, we will make exceptions to this policy if the investment is well
secured and in the process of collection. For federal income tax purposes, this
interest income is included in taxable income.
Portfolio Overview
Our investments consist primarily of senior secured commercial loans. We
intend to increase gradually our level of subordinated debt and equity-based
investments. However, a substantial majority of our portfolio will continue to
consist of investments in senior secured commercial loans. Some of our loans
include warrants, options, success fees and other equity-like features. At
December 31, 2001, our largest customer represented approximately 3.9% of the
total fair value of our investments and our 10 largest customers represented
approximately 30.8%. Our customer base includes primarily small- and
medium-sized private companies in the communications, information services,
media, and technology industry sectors. The proceeds of the loans to these
companies are generally used for buyouts, growth, acquisitions, liquidity,
refinancings and restructurings. In addition, we have occasionally made loans
to individuals who are principals in these companies where the proceeds are
used by or in connection with the operations or capitalization of such
companies. Our debt instruments generally provide for a contractual variable
interest rate generally ranging from approximately 400 to 1400 basis points
above LIBOR, in some cases, a portion of which may be deferred. The weighted
average interest coupon yield of our portfolio at December 31, 2001 was 9.2%.
In the future, we also intend to invest in subordinated secured debt
instruments, which we expect will provide for a contractual rate of interest
between 14% and 25%, in some cases, a portion of which may be deferred. Our
loans generally have stated maturities at origination that range from 3 to 7
years. The weighted average maturity of our entire loan portfolio at December
31, 2001 was approximately 5.7 years. The weighted average maturity of our loan
portfolio excluding our investments in the newspaper sub-sector was 4.6 years.
Our customers typically pay us an origination fee based on a percentage of the
commitment amount, and in most instances our customers are permitted to prepay
our loans without penalty. They also often pay us a fee based on any undrawn
commitments.
At December 31, 2001, approximately 50% of our loans had associated warrants
or options to purchase warrants, appreciation rights or other equity interests
or other provisions designed to provide us with an enhanced internal rate of
return. These equity and equity-like instruments generally do not produce a
current return, but are held for potential investment appreciation and capital
gains. The warrants and options to purchase warrants typically are exercisable
immediately and typically remain exercisable for 10 years. The exercise prices
on the warrants vary from nominal exercise prices to exercise prices that are
at or above the current fair market value of the equity for which we are
receiving warrants. In some cases, some or all of the deferred interest may be
exchanged as the exercise price for the option to purchase warrants. The equity
interests and warrants and options to purchase warrants often include
registration rights, which allow us to register the securities after a public
offering. We intend to continue to obtain equity and equity-like instruments
with similar features from our customers.
In most cases, the warrants and options to purchase warrants have a put
right that requires the customer to repurchase our equity position after a
specified period of time at its market value or at a formula price generally
designed to approximate its market value. The warrants and options to purchase
warrants also typically contain
9
customary anti-dilution protection and preemptive rights. Many of the warrants
also give us the right to obtain a seat on the customer's board of directors if
and when we exercise the warrants. The warrants and options to purchase
warrants are generally freely transferable in accordance with applicable law,
although some of the warrants and options to purchase warrants contain rights
of first refusal and restrictions on transfers to competitors. We expect that
we will generally have similar rights with respect to equity and equity-like
investments we make in the future.
Investment Rating System
In addition to various risk management and monitoring tools, we also use an
investment rating system to characterize and monitor our expected level of
returns on each investment in our portfolio. We use the following 1 to 5
investment rating scale. Below is a description of the conditions associated
with each investment rating.
Rating Summary Description
- ------ -------------------
1... Capital gain expected
2... Full return of principal and interest or dividend expected with customer
performing in accordance with plan
3... Full return of principal and interest or dividend expected but customer
requires closer monitoring
4... Some loss of interest or dividend expected but still expecting an overall
positive internal rate of return on the investment
5... Loss of interest or dividend and some loss of principal investment
expected which would result in an overall negative internal rate of
return on the investment
We monitor and, when appropriate, recommend changes to investment ratings.
Our president and chief credit officer review the recommendations and affirm or
change the investment ratings at least quarterly.
The following table shows the distribution of our investments on the 1 to 5
investment rating scale at fair value as of December 31, 2001:
Distribution of Portfolio by
Investment Rating
(in thousands)
---------------------------
Fair Value at December 31,
2001
---------------------------
Investment Rating Amount % of Portfolio
----------------- -------- --------------
1........ $135,230 21.9%
2........ 275,055 44.5
3........ 158,595 25.7
4........ 46,726 7.6
5........ 1,597 0.3
-------- ----
$617,203 100%
======== ====
10
COMPETITION
We compete with a large number of financial services companies, including
specialty and commercial finance companies, commercial banks and private
mezzanine funds, and other sources of financing such as private equity funds,
venture capital companies, investment banks and other equity and non-equity
based investment funds. Although we do not have a direct competitor that
competes in all of our product lines and geographic regions, we compete with
financial services companies who target some of our chosen industry sectors or
geographic areas, or who may only provide corporate finance services to larger
companies. Some of the companies we have competed with in the past include
community banks that are located in our customers' and targeted prospects' home
markets. These community banks typically do not focus on our target industry
sectors. We also compete against regional and national financial institutions.
These include banks such as FleetBoston Financial Corporation, Union Bank of
California, Comerica Bank, Silicon Valley Bank and Wells Fargo & Company;
commercial finance companies such as Coast Business Credit; and finance
subsidiaries of large industrial corporations such as General Electric Capital
Corporation, The CIT Group and Textron Financial Corporation.
We do not seek to compete primarily based on the interest rates we offer,
and we believe that some of our competitors make senior secured commercial
loans with interest rates that are comparable to or lower than the rates we
offer. We believe we compete based on:
. our insight into our customers' business needs that we derive from
information, analytics and effective interaction between our customers'
decision makers and our knowledgeable professionals; and
. our offering of capital coupled with an expanded range of corporate
finance services and information products designed to enhance our
customers' business prospects.
OUR SUBSIDIARIES
We conduct some of our activities through our wholly owned subsidiaries, MCG
Finance I, LLC, MCG Finance II, LLC and MCG Finance III, LLC. From time to
time, MCG Finance I may originate or be the holder of certain loans and
investments we make.
We originate loans and sell them to MCG Finance II, a wholly owned special
purpose finance subsidiary. MCG Finance II in turn sells the loans to MCG
Master Trust, a Delaware business trust we formed in connection with the
securitization facility we established in June 2000. The loans MCG Finance II
sells to MCG Master Trust must satisfy specific criteria, including commitment
amount, sector and sub-sector concentration, credit risk, collateral and
payment performance. These criteria are established in our loan agreements and
credit policy and lending standards. These transactions are structured as
on-balance sheet securitizations for accounting purposes.
We also originate loans and sell them to MCG Finance III, another wholly
owned special purpose finance subsidiary. MCG Finance III in turn sells the
loans to MCG Commercial Loan Trust 2001-1, a Delaware business trust we formed
in connection with the securitization facility we established in December 2001.
These transactions are structured as on-balance sheet securitizations for
accounting purposes.
INVESTMENT POLICIES
The following restrictions are our only "fundamental" policies, which are
policies that may not be changed without the approval of the holders of the
majority of our outstanding voting securities, as defined in the 1940 Act.
We will not:
. act as an underwriter of securities of other issuers, except to the
extent that we may be deemed an "underwriter" of securities (i)
purchased by us that must be registered under the 1933 Act before they
may be offered or sold to the public, or (ii) in connection with
offerings of securities by our portfolio companies;
. purchase or sell real estate or interests in real estate or real estate
investment trusts, except that we may purchase and sell real estate or
interests in real estate in connection with the orderly liquidation of
or pursuit of remedies with respect to investments and we may own the
securities of companies or participate in a partnership or partnerships
that are in the business of buying, selling or developing real estate or
we may own real estate for our own uses;
11
. sell securities short in an uncovered position;
. write or buy uncovered put or call options, except to the extent of
options, warrants or conversion privileges in connection with our loans
or other investments, and rights to require the issuers of such
investments or their affiliates to repurchase them under certain
circumstances;
. engage in the purchase or sale of commodities or commodity contracts,
including futures contracts, except for purposes of hedging in the
ordinary course of business or where necessary in working out distressed
loan or investment situations; or
. acquire more than 3% of the voting stock of, or invest more than 5% of
our total assets in any securities issued by, any other investment
company, except if we acquire them as part of a merger, consolidation or
acquisition of assets or if they result from a sale of a portfolio
company, or otherwise as permitted under the 1940 Act.
Accordingly, all of the other investment and lending guidelines set by our
board of directors or any committees, including our investment objective to
achieve current income and capital gains, are not fundamental. Therefore, our
board may change them without notice to or approval by our stockholders, but
any change may require the consent of our lenders.
Other than the restriction pertaining to the issuance of senior securities
discussed earlier, the percentage restrictions on investments generally apply
at the time a transaction is effected. A subsequent change in a percentage
resulting from market fluctuations or any cause other than an action by us will
not require us to dispose of portfolio securities or to take other action to
satisfy the percentage restriction.
We will at all times conduct our business so as to retain our status as a
business development company. In order to retain that status, we may not
acquire any assets, other than non-investment assets necessary and appropriate
to our operations as a business development company, if after giving effect to
such acquisition the value of our "qualifying assets" is less than 70% of the
value of our total assets.
We propose to concentrate our investments in the communications, information
services, media, and technology industry sectors. From time to time, we may add
new sectors or subsectors.
We may issue senior securities to the extent permitted by the 1940 Act for
the purpose of making investments, as long as we meet a coverage ratio of total
assets to total senior securities of at least 200% after each issuance of
senior securities. Senior securities include all of our borrowings and any
preferred stock we may issue in the future.
In connection with our 2002 Annual Meeting of Stockholders, we are seeking
stockholder approval to eliminate the fundamental nature of the investment
policies, as noted above.
EMPLOYEES
As of December 31, 2001, we employed 57 employees in our three offices,
including investment and portfolio management professionals, operations
professionals, legal counsel, and administrative staff. Of the 57 employees, 44
are based in our Arlington, Virginia office, 6 are based in our Boston,
Massachusetts office and 7 are based in our Richmond, Virginia office. We
believe that our relations with our employees are good.
CERTAIN U.S. FEDERAL TAX MATTERS
Until December 31, 2001, we were subject to tax as an ordinary corporation
under Subchapter C of the Internal Revenue Code. We will elect, effective as of
January 1, 2002, to be taxed for federal income tax purposes as a "regulated
investment company" or "RIC" under Subchapter M of the Internal Revenue Code.
As a RIC, we generally will not have to pay corporate taxes on any income we
distribute to our stockholders as dividends, which will allow us to
substantially reduce or eliminate our corporate-level tax liability.
One requirement to qualify as a RIC is that, by December 31, 2002, we must
eliminate the earnings and profits accumulated while we were taxable under
Subchapter C. We accomplished this by declaring in the fourth quarter of 2001,
and paying to our stockholders in the first quarter of 2002, a cash dividend of
$0.86 per share, representing all of our accumulated earnings and profits for
the period from our inception through December 31, 2001. The dividend is in
addition to the dividends we intend to pay (or be deemed to have distributed)
during 2002 equal to our net income for 2002.
12
Taxation as a Regulated Investment Company
If we:
. qualify as a RIC, and
. distribute each year to stockholders at least 90% of our "investment
company taxable income" (which is defined in the Internal Revenue Code
generally as ordinary income plus net short-term capital gains over net
long-term capital losses), and 90% of any ordinary pre-RIC built-in
gains we recognize between January 1, 2002 and December 31, 2011, less
our taxes on those gains (collectively, the "90% distribution
requirement"),
we will not be subject to U.S. federal income tax on the portion of our income
we distribute to stockholders other than any built-in gain recognized between
January 1, 2002 and December 31, 2011.
We will be subject to a 4% nondeductible U.S. federal excise tax to the
extent we do not distribute (actually or on a deemed basis) 98% of our income
(both ordinary income and net capital gains). The excise tax will apply to the
excess of 98% of our income over the amount of income actually (or deemed)
distributed to our stockholders.
We generally will endeavor in each taxable year to avoid any U.S. federal
excise taxes on our earnings. As discussed below, we can satisfy the
requirement to distribute 98% of our net capital gain by making a deemed
distribution of this amount. (We cannot make deemed distributions of our
ordinary income.) We will, however, be subject to U.S. federal income tax at
the regular corporate rate on any income or capital gain not actually
distributed to our stockholders.
In order to qualify as a RIC for federal income tax purposes, we must, among
other things:
. continue to qualify as a business development company under the 1940 Act;
. derive in each taxable year at least 90% of our gross income from
dividends, interest, payments with respect to securities loans, gains
from the sale of stock or other securities, or other income derived with
respect to our business of investing in such stock or securities; and
. diversify our holdings so that at the end of each quarter of the taxable
year
. at least 50% of the value of our assets consists of cash, cash items,
U.S. government securities, securities of other RICs, and other
securities if such other securities of any one issuer do not
represent more than 5% of the value of our assets or more than 10% of
the outstanding voting securities of the issuer, and
. no more than 25% of the value of our assets is invested in the
securities, other than U.S. government securities or securities of
other RICs, of one issuer or of two or more issuers that are
controlled, as determined under applicable Internal Revenue Code
rules, by us and are engaged in the same or similar or related trades
or businesses.
If we fail to satisfy the 90% Distribution Requirement or otherwise fail to
qualify as a RIC in any taxable year, we will be subject to tax in that year on
all of our taxable income, regardless of whether we make any distributions to
our stockholders. In that case, all of our income will be subject to
corporate-level tax, reducing the amount available to be distributed to our
stockholders, and all of our distributions to our stockholders will be
characterized as ordinary income (to the extent of our current and accumulated
earnings and profits). After January 1, 2002, our corporate-level tax should be
substantially reduced or eliminated, and a portion of our distributions or
deemed distributions may be characterized as long-term capital gain in the
hands of stockholders.
Treatment of Pre-Conversion Built-in Gain
As of January 1, 2002, we held substantial assets (including intangible
assets not reflected on the balance sheet, such as goodwill) with "built in
gain," which are assets whose fair market value on that date exceeded their tax
basis.
We intend to make an election applicable to a corporation that converts from
taxation under Subchapter C to taxation as a RIC to pay corporate level tax on
the amount of net built-in gain we recognize within 10 years after the
effective date of our election to be treated as a RIC. Any such corporate level
tax is payable at the time those gains are recognized (which, generally, will
occur when the built-in gain assets are sold or disposed of in a taxable
transaction).
13
Based on the assets we currently anticipate selling within the ten year
period beginning January 1, 2002 and ending December 31, 2011, we expect we may
have to pay a built-in gain tax of up to $1.1 million at current corporate tax
rates. The amount of this tax will vary depending on the assets that are
actually sold by us in this 10-year period and tax rates. Under newly issued
Treasury Regulations, recognized built-in gains and losses will generally
retain their character as capital gain or ordinary income. Recognized built-in
gains and losses that are ordinary income will be included in our investment
company taxable income and we must distribute to our stockholders at least 90%
of any such built-in gains recognized within the 10 year period, net of the
corporate taxes paid by us on the built-in gains. Any such amount distributed
will be taxable to stockholders as an ordinary dividend. Recognized built-in
gains and losses within the 10 year period, net of taxes, that are capital
gains will be distributed or deemed distributed to our stockholders. Any such
amount distributed or deemed distributed will be taxable to stockholders as a
capital gain.
REGULATION AS A BUSINESS DEVELOPMENT COMPANY
A business development company is regulated by the 1940 Act. It is a unique
kind of investment company that primarily focuses on investing in or lending to
small private companies and making managerial assistance available to them. A
business development company may use capital provided by public stockholders
and from other sources to invest in growing small businesses.
A business development company provides stockholders the ability to retain
the liquidity of a publicly traded stock, while sharing in the possible
benefits of investing in privately owned small- and medium-sized companies.
As a business development company, we may not acquire any asset other than
"qualifying assets" unless, at the time we make the acquisition, the value of
our qualifying assets represent at least 70% of the value of our total assets.
The principal categories of qualifying assets relevant to our business are:
. Securities of an eligible portfolio company that are purchased in
transactions not involving any public offering. An eligible portfolio
company is defined under the 1940 Act to include any issuer that:
. is organized and has its principal place of business in the U.S.,
. is not an investment company or a company operating pursuant to
certain exemptions under the 1940 Act other than a small business
investment company wholly owned by a business development company, and
. does not have any class of publicly traded securities with respect to
which a broker may extend margin credit;
. Securities received in exchange for or distributed with respect to
securities described in the bullet above or pursuant to the exercise of
options, warrants, or rights relating to those securities; and
. Cash, cash items, government securities, or high quality debt securities
(as defined in the 1940 Act), maturing in one year or less from the time
of investment.
To include certain securities described above as qualifying assets for the
purpose of the 70% test, a business development company must offer to make
available to the issuer of those securities significant managerial assistance
such as providing guidance and counsel concerning the management, operations,
or business objectives and policies of a portfolio company. We offer to provide
managerial assistance to each portfolio company.
As a business development company, we are required to meet a coverage ratio
of the value of total assets to total senior securities, which include all of
our borrowings and any preferred stock we may issue in the future, of at least
200%. We may also be prohibited under the 1940 Act from conducting certain
transactions with our affiliates without the prior approval of our directors
who are not interested persons and, in some cases, prior approval by the SEC.
We may not change the nature of our business so as to cease to be, or
withdraw our election as, a business development company unless authorized by
vote of a majority of the outstanding voting securities, as required by the
1940 Act. A majority of the outstanding voting securities of a company is
defined under the 1940 Act as the lesser of: (i) 67% or more of such company's
shares present at a meeting if more than 50% of the outstanding shares of such
company are present or represented by proxy, or (ii) more than 50% of the
outstanding shares of such company. Since we made our business development
company election, we have not made any substantial change in the nature of our
business.
14
PORTFOLIO COMPANIES
The following table sets forth certain information as of December 31, 2001
regarding each portfolio company in which we had a debt or equity investment.
We make available significant managerial assistance to our portfolio companies.
No portfolio company accounts for more than 5% of our assets. The general terms
of our loans and other investments are described in
"Business--Underwriting--Investment Structure," "Business--Flexible Funding"
and "Business--Portfolio Overview." Other than these investments, our only
relationships with our portfolio companies are:
. The consulting services we provide separately to the portfolio companies
indicated by footnote 6 in the table below, which services are typically
ancillary to our investments and which produced aggregate revenues of
approximately $1.1 million for the year ended December 31, 2001; and
. The service by our professionals on the board of directors of the
portfolio companies indicated by footnote 8 in the table below.
Fair
Title of Securities Cost Value(2)
Nature of Its Held by the ------- --------
Portfolio Company Principal Business Company(1) (in thousands)
----------------- ------------------ ------------------------- ----------------
The Adrenaline Group, Inc.(3) Technology Senior Debt $ 750 $ 750
Warrants to purchase
Common Stock -- --
- ------------------------------- ------------------ ------------------------- ------- --------
Alarm Management II LLC(3) Security Alarms Senior Debt 1,800 1,800
- ------------------------------- ------------------ ------------------------- ------- --------
Amalfi Coast Broadcasting Senior Debt 13,000 13,000
- ------------------------------- ------------------ ------------------------- ------- --------
AMI Telecommunications Telecommunications Senior Debt 10,715 10,715
Corporation(3)
Common Stock 200 --
- ------------------------------- ------------------ ------------------------- ------- --------
Badoud Enterprises, Inc.(3) Newspaper Senior Debt 11,320 11,320
- ------------------------------- ------------------ ------------------------- ------- --------
Barcom Inc. and U.S. Alarm Inc. Security Alarms Senior Debt 3,911 3,911
- ------------------------------- ------------------ ------------------------- ------- --------
Biznessonline.com, Inc.(3) (4) Telecommunications Senior Debt 13,529 13,529
Common Stock 18 27
Preferred Stock 2,864 100
Warrants to purchase
Common Stock 253 253
- ------------------------------- ------------------ ------------------------- ------- --------
Boucher Communications, Inc.(3) Publishing Senior Debt 2,450 2,450
Stock Appreciation Rights -- 297
- ------------------------------- ------------------ ------------------------- ------- --------
Bridgecom Holdings, Inc.(3)(5) Telecommunications Senior Debt 17,969 17,969
Warrants to purchase
Common Stock -- --
- ------------------------------- ------------------ ------------------------- ------- --------
15
Fair
Title of Securities Cost Value(2)
Nature of Its Held by the ------- --------
Principal Business Company(1) (in thousands)
Portfolio Company -------------------- ---------------------- ----------------
Brookings Newspapers, L.L.C.(3) Newspaper Senior Debt $ 3,500 $3,500
- --------------------------------- -------------------- ---------------------- ------- --------
BuyMedia Inc.(9) Radio Advertising Warrants to purchase
Selling Service Common Stock -- 42
- --------------------------------- -------------------- ---------------------- ------- --------
Cambridge Information Group, Inc.
(3)(5) Information Services Senior Debt 19,334 19,334
- --------------------------------- -------------------- ---------------------- ------- --------
CCG Consulting, LLC Consulting Senior Debt 1,293 1,293
Warrants to purchase -- 294
membership interest in
LLC
Option to purchase
additional equity -- --
- --------------------------------- -------------------- ---------------------- ------- --------
Community Media Group, Inc. (3) Newspaper Senior Debt 13,505 13,505
- --------------------------------- -------------------- ---------------------- ------- --------
Connective Corp.(4)(9) Publishing Common Stock 57 13
- --------------------------------- -------------------- ---------------------- ------- --------
Corporate Legal Times L.L.C. Publishing Senior Debt 4,813 4,813
Warrants to purchase
membership interest in
LLC 153 86
- --------------------------------- -------------------- ---------------------- ------- --------
Costa De Oro Television, Inc. Broadcasting Senior Debt 5,011 5,011
- --------------------------------- -------------------- ---------------------- ------- --------
Country Media, Inc. Newspaper Senior Debt 8,448 8,448
Common Stock 100 205
- --------------------------------- -------------------- ---------------------- ------- --------
Creatas, L.L.C.(3) Information Services Senior Debt 13,664 13,664
LLC Interest 100 465
- --------------------------------- -------------------- ---------------------- ------- --------
Creative Loafing, Inc.(3) Newspaper Senior Debt 16,795 16,795
- --------------------------------- -------------------- ---------------------- ------- --------
Crescent Publishing Company LLC Publishing Senior Debt 13,700 13,700
- --------------------------------- -------------------- ---------------------- ------- --------
Dowden Health Media, Inc. Publishing Senior Debt 1,500 1,500
- --------------------------------- -------------------- ---------------------- ------- --------
Edgell Communications, Inc.(3) Publishing Senior Debt 520 520
- --------------------------------- -------------------- ---------------------- ------- --------
Media Investment
The e-Media Club, LLC Group LLC Interest 908 90
- --------------------------------- -------------------- ---------------------- ------- --------
Executive Enterprise Institute,
LLC(3)(8) Business Conference LLC Interest 301 167
- --------------------------------- -------------------- ---------------------- ------- --------
Fawcette Technical Publications Publishing Senior Debt 14,787 14,787
Holdings(3)
Warrants to purchase
Common Stock 519 519
- --------------------------------- -------------------- ---------------------- ------- --------
Financial Technologies Holdings, Technology Senior Debt 20,500 20,500
Inc.(3)
Warrants to purchase
Common Stock -- --
- --------------------------------- -------------------- ---------------------- ------- --------
16
Fair
Title of Securities Cost Value(2)
Nature of Its Held by the -------- --------
Portfolio Company Principal Business Company(1) (in thousands)
----------------- -------------------- ---------------------- -----------------
Halcyon Business Publications, Inc. Publishing Senior Debt $ 275 $ 275
- ----------------------------------- -------------------- ---------------------- -------- --------
I-55 Internet Services, Inc. Telecommunications Senior Debt 3,623 3,623
Warrants to purchase
Common Stock -- --
- ----------------------------------- -------------------- ---------------------- -------- --------
IDS Telecom LLC Telecommunications Senior Debt 17,039 17,039
Warrants to purchase
membership interest in
LLC 376 637
- ----------------------------------- -------------------- ---------------------- -------- --------
Images.com, Inc. Information Services Senior Debt 2,775 2,775
- ----------------------------------- -------------------- ---------------------- -------- --------
Information Today, Incorporated Information Services Senior Debt 7,500 7,500
- ----------------------------------- -------------------- ---------------------- -------- --------
Intellisec Holdings, Inc(3) Security Alarms Senior Debt 14,265 14,265
Warrants to purchase
Common Stock -- --
- ----------------------------------- -------------------- ---------------------- -------- --------
Intellisec Holdings, Inc(3) Security Alarms Senior Debt 14,265 14,265
- ----------------------------------- -------------------- ---------------------- -------- --------
Jeffrey A. Stern Publishing Senior Debt 157 157
- ----------------------------------- -------------------- ---------------------- -------- --------
JMP Media, L.L.C. Broadcasting Senior Debt 15,781 15,781
- ----------------------------------- -------------------- ---------------------- -------- --------
Joseph C. Millstone Telecommunications Senior Debt 500 500
- ----------------------------------- -------------------- ---------------------- -------- --------
The Joseph F. Biddle Publishing
Company(3) Newspaper Senior Debt 14,207 14,207
- ----------------------------------- -------------------- ---------------------- -------- --------
Kings III of America, Inc., North
America Security Alarms Senior Debt 4,997 4,997
- ----------------------------------- -------------------- ---------------------- -------- --------
The Korea Times Los Angeles, Inc. Newspaper Senior Debt 11,927 11,927
- ----------------------------------- -------------------- ---------------------- -------- --------
Manhattan Telecommunications Telecommunications Senior Debt 22,975 22,975
Corporation
Warrants to purchase 754 644
Common Stock
- ----------------------------------- -------------------- ---------------------- -------- --------
McGinnis-Johnson Consulting, LLC Newspaper Subordinated Debt 7,828 7,828
- ----------------------------------- -------------------- ---------------------- -------- --------
Media Central LLP/Primedia Publishing Senior Debt 10,000 10,000
- ----------------------------------- -------------------- ---------------------- -------- --------
Telecommunications
Midwest Towers Partners, LLC(3) Towers Senior Debt 16,307 16,307
- ----------------------------------- -------------------- ---------------------- -------- --------
Miles Media Group, Inc.(3) Publishing Senior Debt 7,850 7,850
Warrants to purchase
Common Stock 20 490
- ----------------------------------- -------------------- ---------------------- -------- --------
Minnesota Publishers, Inc.(3) Newspaper Senior Debt 14,250 14,250
- ----------------------------------- -------------------- ---------------------- -------- --------
Murphy McGinnis Media, Inc.(3) Newspaper Senior Debt 14,000 14,000
- ----------------------------------- -------------------- ---------------------- -------- --------
NBG Radio Networks, Inc.(4) Broadcasting Senior Debt 6,298 6,298
Warrants to purchase
Common Stock -- --
- ----------------------------------- -------------------- ---------------------- -------- --------
17
Fair
Title of Securities Cost Value(2)
Nature of Its Held by the ------- --------
Portfolio Company Principal Business Company(1) (in thousands)
----------------- -------------------- ---------------------- ----------------
Netplexus Corporation Technology Senior Debt $ 3,500 $ 2,500
Preferred Stock 766 --
Warrants to purchase
Common Stock -- --
- --------------------------------- -------------------- ---------------------- ------- --------
New Century Companies, Inc.(4)(9) Other Common Stock 157 294
Preferred Stock -- 42
Warrants to purchase
Common Stock -- 33
- --------------------------------- -------------------- ---------------------- ------- --------
nii communications, Inc.(3) Telecommunications Senior Debt 5,565 5,565
Common Stock 400 162
Warrants to purchase
Common Stock 747 991
- --------------------------------- -------------------- ---------------------- ------- --------
New Northwest Broadcasters,
Inc.(3) Broadcasting Senior Debt 10,853 10,853
- --------------------------------- -------------------- ---------------------- ------- --------
Newsletter Holdings, LLC(3) Publishing Senior Debt 1,340 1,340
- --------------------------------- -------------------- ---------------------- ------- --------
NOW Communications, Inc.(3) Telecommunications Senior Debt 4,367 4,367
Warrants to purchase
Common Stock -- --
- --------------------------------- -------------------- ---------------------- ------- --------
Pacific-Sierra Publishing, Inc. Newspaper Senior Debt 24,160 24,160
- --------------------------------- -------------------- ---------------------- ------- --------
Pfingsten Publishing, LLC(3) Publishing Senior Debt 10,250 10,250
- --------------------------------- -------------------- ---------------------- ------- --------
Powercom Corporation(3) Telecommunications Senior Debt 3,917 3,917
Warrants to purchase
Common Stock 139 105
- --------------------------------- -------------------- ---------------------- ------- --------
R.R. Bowker LLC Information Services Senior Debt 15,000 15,000
Warrants to purchase
Common Stock 882 882
- --------------------------------- -------------------- ---------------------- ------- --------
Rising Tide Holdings LLC(3) Publishing Senior Debt 3,097 1,597
Warrants to purchase
membership interest in
LLC -- --
- --------------------------------- -------------------- ---------------------- ------- --------
Robert N. Snyder Information Services Senior Debt 1,300 1,300
- --------------------------------- -------------------- ---------------------- ------- --------
Sabot Publishing, Inc.(3) Publishing Senior Debt 9,800 9,800
- --------------------------------- -------------------- ---------------------- ------- --------
18
Fair
Title of Securities Cost Value(2)
Nature of Its Held by the ------- --------
Portfolio Company Principal Business Company(1) (in thousands)
----------------- -------------------- ---------------------- ----------------
Stonebridge Press, Inc.(3) Newspaper Senior Debt $ 5,473 $ 5,473
- --------------------------------- -------------------- ---------------------- ------- --------
Sunshine Media Corp.(3) Publishing Senior Debt 13,094 13,094
LLC Interest Class A 500 553
Warrants to purchase
membership interest in
LLC Class B -- --
- --------------------------------- -------------------- ---------------------- ------- --------
Talk America Holdings, Inc.(3)(4) Telecommunications Senior Debt 17,500 17,500
(5)
Common Stock 1,050 482
Warrants to purchase
Common Stock 25 --
- --------------------------------- -------------------- ---------------------- ------- --------
TGI Group, LLC Information Services Senior Debt 7,920 7,920
Warrants to purchase
membership interest in
LLC 126 23
- --------------------------------- -------------------- ---------------------- ------- --------
THE Journal, LLC Publishing Senior Debt 3,196 2,100
- --------------------------------- -------------------- ---------------------- ------- --------
Tower Resource Management, Telecommunications Senior Debt 1,573 1,573
Inc.(3) Towers
Warrants to purchase
Common Stock -- --
- --------------------------------- -------------------- ---------------------- ------- --------
Unifocus, Inc.(3) Information Services Senior Debt 3,300 3,300
Warrants to purchase
Equity 139 369
- --------------------------------- -------------------- ---------------------- ------- --------
UMAC, Inc.(8)(9)(10) Publishing Common Stock 8,360 8,360
- --------------------------------- -------------------- ---------------------- ------- --------
ValuePage Holdings, Inc.(3) Telecommunications Senior Debt 13,105 8,472
- --------------------------------- -------------------- ---------------------- ------- --------
VS&A-PBI Holding LLC(3) Publishing Senior Debt 12,375 12,375
LLC Interest 500 --
- --------------------------------- -------------------- ---------------------- ------- --------
WirelessLines, Inc.(3) Telecommunications Senior Debt 6,150 6,150
Warrants to purchase
Common Stock -- --
- --------------------------------- -------------------- ---------------------- ------- --------
Witter Publishing Corporation Publishing Senior Debt 2,747 2,747
Warrants to purchase
Common Stock 78 76
- --------------------------------- -------------------- ---------------------- ------- --------
Working Mother Media, Inc.(7)(8) Publishing Senior Debt 6,718 6,718
Preferred Stock 4,499 4,499
Common Stock 1 1
- --------------------------------- -------------------- ---------------------- ------- --------
Wyoming Newspapers, Inc.(3) Newspaper Senior Debt 12,563 12,563
- --------------------------------- -------------------- ---------------------- ------- --------
19
(1) Some of the warrants listed are structured as options to purchase warrants. Such options are freely exercisable by us at
any time.
(2) Fair value refers to market value or fair value, as appropriate.
(3) Some of the listed securities are issued by affiliates of the listed portfolio company.
(4) This is a public company.
(5) We provide consulting services to this portfolio company.
(6) Intentionally omitted.
(7) In August 2001, we foreclosed on the assets of MacDonald Communication Corporation and transferred them to
Working Mother Media, Inc. (formerly WMAC, Inc.), a majority owned subsidiary of MCG Finance I, LLC
(formerly MCG Finance Corporation).
(8) We hold a board position(s) in this portfolio company.
(9) Non-income producing.
(10) In September 2001, we foreclosed on the assets of Upside Media, Inc. and transferred them to UMAC, Inc., a wholly
owned subsidiary of MCG Finance I, LLC (formerly MCG Finance Corporation).
DETERMINATION OF NET ASSET VALUE
We intend to determine the net asset value per share of our common stock
quarterly. The net asset value per share is equal to the value of our total
assets minus liabilities and any preferred stock outstanding divided by the
total number of shares of common stock outstanding. At the time of this filing,
we do not have any preferred stock outstanding.
Portfolio assets for which market prices are available are valued at those
prices. However, most of our assets were acquired in privately negotiated
transactions and have no readily determinable market values. They are carried
at fair value as determined by our board of directors. The valuation committee
of our board of directors will review our loans and investments and will make
recommendations to our board of directors.
As a general rule, we do not value our loans above cost, but loans will be
subject to depreciation events when the asset is considered impaired. Also, our
valuation of our equity securities may increase if circumstances warrant. With
respect to private equity securities, each investment is valued using industry
valuation benchmarks, and then the value is assigned a discount reflecting the
illiquid nature of the investment, as well as our minority, non-control
position. When an external event such as a purchase transaction, public
offering, or subsequent equity sale occurs, the pricing indicated by the
external event will be used to corroborate our private equity valuation.
Securities that are traded in the over-the-counter market or on a stock
exchange generally are valued at the prevailing bid price on the valuation
date. However, restricted and unrestricted publicly traded securities may be
valued at discounts from the public market value due to restrictions on sale,
the size of our investment or market liquidity concerns. A substantial portion
of our assets consist of securities carried at fair value determined by our
board of directors. Determination of fair value involves subjective judgments
and the resultant values may not represent amounts at which investments could
be bought or sold in an independent third party transaction and the difference
could be material.
Item 2. Properties
Neither we nor any of our subsidiaries own any real estate or other physical
properties materially important to our operation or any of our subsidiaries. We
lease approximately 23,480 square feet of office space in Arlington, Virginia
for our corporate headquarters under a lease expiring July 31, 2002. We also
lease office space in Boston, Massachusetts and Richmond, Virginia.
20
Item 3. Legal Proceedings
Although we may, from time to time, be involved in litigation and claims
arising out of our operations in the normal course of our business, as of
December 31, 2001, we were not a party to any material pending legal
proceedings.
Item 4. Submission of Matters to a Vote of Security Holders
On October 12, 2001, we held an Annual Meeting of Stockholders to elect our
directors. The following individuals were elected by the following vote as
directors to serve on our Board of Directors until their successor is duly
elected and qualified:
Percentage Total Vote
Total Vote of Class Withheld
For Each Entitled to From Each
Name Director Vote Director
---- ---------- ----------- ----------
Bryan J. Mitchell...... 11,894,953 99.17% --
Robert J. Merrick...... 11,894,953 99.17 --
Wallace B. Millner, III 11,894,953 99.17 --
Steven F. Tunney....... 11,894,953 99.17 --
Joseph P. DiSabato..... 6,816,066 99.78 --
Joseph Gleberman....... 6,816,066 99.78 --
Norman W. Alpert....... 4,700,000 100 --
Todd N. Khoury......... 4,700,000 100 --
Michael A. Pruzan...... 4,700,000 100 --
In connection with our initial public offering and pursuant to our
certificate of incorporation in effect prior to our initial public offering,
Messrs. Mitchell, Merrick, Millner and Tunney were elected by our Class A,
Class B and Class E common stockholders; Messrs. DiSabato and Gleberman were
elected by our Class A stockholders and Messrs. Alpert, Khoury and Pruzan were
elected by our Class E stockholders.
During the fourth quarter of 2001, prior to the completion of our initial
public offering, our stockholders executed written consents approving the
following transactions:
On October 31, 2001, our common stockholders acted by majority written
consent for the purpose of approving (i) our Restated Certificate of
Incorporation to be effective immediately prior to the consummation of our
initial public offering; (ii) our Restated Certificate of Incorporation to be
effective upon the consummation of our initial public offering; (iii) the
Recapitalization and Transaction Agreement between us and certain stockholders
in connection with our initial public offering; and (iv) our Amended and
Restated Bylaws. The holders of 11,575,387 shares of common stock or 91.35% of
our outstanding shares of common stock approved these actions.
On October 31, 2001, our Class A and Class E stockholders acted by majority
written consent for the purpose of approving (i) the initial public offering of
our common stock; (ii) our Restated Certificate of Incorporation to be
effective immediately prior to the consummation of our initial public offering
(iii) our Restated Certificate of Incorporation to be effective upon
consummation of our initial public offering; (iv) the Recapitalization and
Transaction Agreement between us and certain stockholders in connection with
our initial public offering; (v) our election to be a closed-end investment
company and business development company; (vi) our election to withdraw as a
closed-end investment company; (vii) the issuance of 1,539,851 shares of our
common stock in connection with the termination of our stock option plan;
(viii) our election to be regulated as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended; and (ix) the
incorporation of two wholly-owned subsidiaries of MCG Finance I, LLC (formerly
MCG Finance Corporation), one of our subsidiaries, for the purpose of working
out, restructuring and/or foreclosing upon our loans to two entities. The
holders of 6,496,500 Class A shares, or 95.10% of our outstanding Class A
shares approved these actions and the holders of 4,666,667 Class E shares or
99.29% of our outstanding Class E shares approved these actions.
21
On October 31, 2001, our Class B and Class D stockholders acted by majority
written consent for the purpose of approving (i) our Restated Certificate of
Incorporation to be effective immediately prior to the consummation of our
initial public offering and (ii) our Restated Certificate of Incorporation to
be effective upon consummation of our initial public offering. The holders of
378,887 Class B shares or 81.85% of our outstanding Class B shares approved the
above referenced transactions and the holders of 677,934 Class D shares or 100%
of our outstanding Class D shares approved these actions.
On November 19, 2001, our common stockholders acted by majority written
consent for the purpose of approving the classification of our Board of
Directors into the following three classes: (i) directors whose terms expire at
the annual meeting of the stockholders in 2002, Robert J. Merrick, Wallace B.
Millner, III and Bryan J. Mitchell; (ii) directors whose terms expire at the
annual meeting of the stockholders in 2003, Jeffrey M. Bucher, Kenneth J.
O'Keefe and Michael A. Pruzan; and (iii) directors whose terms expire at the
annual meeting of the stockholders in 2004, Norman W. Alpert, Joseph H.
Gleberman and Steven F. Tunney. The holders of 11,575,387 shares of common
stock or 91.35% of our outstanding shares of common stock approved these
actions.
22
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the Nasdaq National Market under the symbol
"MCGC." We completed our initial public offering of common stock in December
2001 at the price of $17 per share. Prior to such date there was no public
market for our common stock.
The following table sets forth the range of high and low closing prices of
our common stock as reported on the Nasdaq National Market and the dividends
declared by the Company for the fourth quarter of 2001. We declared a dividend
consisting of a fourth quarter dividend and an earnings and profit dividend
that was paid on January 31, 2002 to stockholders of record on January 22, 2002.
Price Range Cash
------------- Dividend
High Low Per Share
------ ------ ---------
Fiscal 2001
Fiscal 2001 Fourth quarter ended December 31
(beginning November 29, 2001).................. $17.80 $14.95 $0.86
As of March 28, 2002, we had approximately 104 shareholders of record.
RECENT SALES OF UNREGISTERED SECURITIES
During our last fiscal year, we issued 2,239,781 shares of our common stock
pursuant to an exemption from the registration requirements of the Securities
Act of 1933, as amended, under Section 4(2) of the Securities Act as
transactions by an issuer not involving any public offering, or under Rule 701
thereunder. Of the total 2,239,781 shares, 1,539,851 shares of our common stock
were issued prior to the completion of our initial public offering in
connection with the termination of all options outstanding under our stock
option plan; 6,000 shares of our common stock were issued prior to the
completion of our initial public offering to three directors in connection with
their service on our board of directors; 68,930 shares of our common stock were
issued prior to the completion of our initial public offering to one of our
investors for the termination of all of its outstanding warrants to purchase
shares of our common stock; and 625,000 shares of our common stock were issued
in a private offering concurrent with our initial public offering.
DIVIDEND POLICY
We intend to make quarterly distributions to holders of our common stock.
The amount of our quarterly distributions will be determined by our board of
directors. We intend to distribute to our stockholders all of our income,
except for certain net capital gains. We intend to make deemed distributions to
our stockholders of any retained net capital gains. We declared an aggregate
dividend of $0.86 per share in December 2001 consisting of a dividend of $0.25
per share for the fourth quarter of 2001 and an additional dividend of $0.61
per share representing the distribution of substantially all of our earnings
and profits since inception.
Our ability to make distributions will be limited by asset coverage
requirements under the 1940 Act. Covenants and provisions in our credit
facilities currently limit the ability of MCG Finance II, LLC, MCG Finance III,
LLC and our securitization trusts to make distributions to MCG Capital, which
could affect our ability to make distributions to our stockholders and to
maintain our status as a regulated investment company.
23
Item 6. Selected Financial Data
The selected financial data should be read in conjunction with our
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and notes thereto. As
discussed in Note A to the Consolidated Financial Statements we completed an
initial public offering and concurrent private offering of our common stock on
December 4, 2001. The results of operations for 2001 are divided into two
periods, the "Post-IPO as a Business Development Company" period and "Pre-IPO
prior to becoming a Business Development Company" period. Different accounting
principles are used in the preparation of financial statements of a business
development company under the Investment Company Act of 1940 and, as a result,
the financial results for periods prior to December 1, 2001 are not comparable
to the period commencing on December 1, 2001 and are not expected to be
representative of our financial results in the future. On January 1, 2001, we
adopted the provisions of Financial Accounting Standards Board Statements
("SFAS") No. 133 and 138, "Accounting for Derivative Instruments and Hedging
Activities". As a result of the changes, the financial results for periods
prior to January 1, 2001 are not comparable to the period commencing on January
1, 2001 and are not expected to be representative of the financial results of
the Company in the future.
Post-IPO as a
Business Predecessor as
Development Pre-IPO prior to becoming a a division of
Company Business Development Company Signet Bank
------------- ----------------------------------------------------- --------------
One Month Eleven Months June 25, 1998 January 1,
Ended Ended Year Ended Year Ended through 1998 Year Ended
December 31, November 30, December 31, December 31, December 31, through December 31,
(Dollars in thousands except 2001 2001 2000 1999 1998 June 24, 1998 1997
per share data) ------------- ------------- ------------ ------------ ------------- -------------- ------------
Income Statement Data:
Operating income............... $ 6,012 $65,789 $ 63,750 $ 28,429 $ 10,256 $9,975 $ 22,276
Income (loss) before cumulative
effect of accounting changes.. (2,270) 8,779 14,071 5,783 800 1,966 2,744
Net (decrease) increase in
stockholders' equity resulting
from earnings (loss)/net
income (loss)................. (6,742) 10,556 14,071 5,783 800 1,974 3,077
Per Common Share Data:
Income (loss) before cumulative
effect of accounting changes
per common share--basic
and diluted................... $ (0.08) $ 0.69 $ 1.35 $ 0.87 $ 0.13 (a) (a)
Net income (loss) per common
share--basic and diluted...... (0.25) 0.83 1.35 0.87 0.13 (a) (a)
Net asset value per common
share......................... 12.46 13.31 12.54 10.01 9.10 (a) (a)
Dividends per common share..... 0.86 -- -- -- -- (a) (a)
Selected Period-End Balances:
Total investment portfolio..... $605,069 (a) $490,892 $301,963 $180,865 (a) $232,868
Total assets................... 673,066 (a) 526,493 326,314 199,432 (a) 237,267
Borrowings..................... 287,808 (a) 356,833 248,217 138,785 (a) 183,537
Other data:
Number of portfolio companies.. 74 (a) 70 52 37 (a) 43
Number of employees 57 57 46 33 27 (a) (a)
- --------
(a) Certain information in the "Pre-IPO prior to becoming a Business
Development Company" and "Predecessor as a division of Signet Bank" periods
are not meaningful for comparative purposes.
24
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information contained in this section should be read in conjunction with
the Selected Consolidated Financial and Other Data and our Consolidated
Financial Statements and notes thereto appearing elsewhere in this Annual
Report. The Annual Report, including the Management's Discussion and Analysis
of Financial Condition and Results of Operations, contains forward-looking
statements that involve substantial risks and uncertainties. These
forward-looking statements are not historical facts, but rather are based on
current expectations, estimates and projections about our industry, our
beliefs, and our assumptions. Words such as "anticipates", "expects",
"intends", "plans", "believes", "seeks", and "estimates" and variations of
these words and similar expressions are intended to identify forward-looking
statements. These statements are not guarantees of future performance and are
subject to risks, uncertainties, and other factors, some of which are beyond
our control and difficult to predict and could cause actual results to differ
materially from those expressed or forecasted in the forward-looking statements
including without limitation (1) an economic downturn could impair our
customers' ability to repay our loans and increase our non-performing assets,
(2) an economic downturn could disproportionately impact the communications,
information services, media and technology industries in which we concentrate
causing us to suffer losses in our portfolio and experience diminished demand
for capital in these industry sectors, (3) a contraction of available credit
and/or an inability to access the equity markets could impair our lending and
investment activities, (4) interest rate volatility could adversely affect our
results and (5) the risks, uncertainties and other factors we identify from
time to time in our filings with the Securities and Exchange Commission,
including our Form 10-K's, Form 10-Q's and Form 8-K's. Although we believe that
the assumptions on which these forward-looking statements are based are
reasonable, any of those assumptions could prove to be inaccurate, and as a
result, the forward-looking statements based on those assumptions also could be
incorrect. In light of these and other uncertainties, the inclusion of a
projection or forward-looking statement in this Annual Report should not be
regarded as a representation by us that our plans and objectives will be
achieved. You should not place undue reliance on these forward-looking
statements, which apply only as of the date of this Annual Report.
Overview
MCG Capital Corporation is a solutions-focused financial services company
providing financing and advisory services to companies throughout the United
States in the communications, information services, media and technology
industry sectors. On December 4, 2001, we completed an initial public offering
of 13,375,000 shares of our common stock and concurrent private offering of
625,000 shares of our common stock with gross proceeds totaling $237.3 million.
Upon completion of these offerings, we became an internally managed,
non-diversified, closed-end investment company that elected to be treated as a
business development company under the Investment Company Act of 1940. We will
elect, effective as of January 1, 2002, to be taxed as a regulated investment
company for U.S. federal income tax purposes. Pursuant to this election, we
generally will not have to pay corporate-level taxes on any income we
distribute to our stockholders as dividends, allowing us to substantially
reduce or eliminate our corporate-level tax liability.
The results of operations for 2001 are divided into two periods. The
eleven-month period from January 1, 2001 through November 30, 2001 reflects our
results prior to operating as a business development company under the
Investment Company Act of 1940. The one-month period from December 1, 2001
through December 31, 2001 reflects our results as a business development
company under the Investment Company Act of 1940, including a one-time
conversion adjustment. The principal differences between these two periods
relate to accounting for investments and income taxes. See Note A to our
Consolidated Financial Statements. In addition, certain prior year items have
been reclassified to conform to the current year presentation as a business
development company.
25
We were formed by our management and affiliates of Goldman, Sachs & Co. to
purchase a loan portfolio and certain other assets from First Union National
Bank in a management buyout that was completed on June 24, 1998. Prior to this
purchase, we conducted our business as a division of Signet Bank. This separate
division was known as the media communications group. Signet Banking
Corporation, the parent of Signet Bank, was acquired by First Union Corporation
(now Wachovia Corporation) on November 28, 1997.
Portfolio Composition and Asset Quality
Our primary business is lending to and investing in businesses, primarily in
the communications, information services, media, and technology industry
sectors, through investments in senior debt, subordinated debt and equity-based
investments, including warrants and equity appreciation rights. We intend to
increase gradually our level of subordinated debt and equity-based investments.
However, a substantial majority of our portfolio will continue to consist of
investments in senior secured commercial loans. The total portfolio value of
investments in publicly traded and non-publicly traded securities was $617.2
million, $510.9 million, and $313.4 million at December 31, 2001, 2000, and
1999, respectively. The increase in the value of investments during each period
was primarily attributable to originated senior debt securities. See Note A to
our consolidated financial statements for further discussion of investment
valuations.
Total portfolio investment activity as of and for the years ended December
31, 2001, 2000, and 1999 was as follows: (Dollars in millions)
December 31, December 31, December 31,
2001 (a) 2000(a) 1999(a)
(Dollars in millions) ------------ ------------ ------------
Beginning Portfolio......... $510.9 $313.4 $184.2
Originations/Draws/Purchases 167.6 258.1 164.5
Pay-offs/Sales of Securities (33.0) (62.8) (39.1)
Charge-offs/Write-downs..... (14.8)(b) (0.5) --
Realized Gains (Losses)..... (1.7) 2.1 3.8
Unrealized Gains (Losses)... (11.8) 0.6 --
------ ------ ------
Ending Portfolio............ $617.2 $510.9 $313.4
====== ====== ======
- --------
(a) Balances prior to our election to be regulated as a business development
company primarily include amounts at cost.
(b) Represents $14.8 million of loan charge-offs against the allowance for loan
losses previously provided for prior to our election to be regulated as a
business development company. We had provided for loan losses of $20.3
million from inception through November 30, 2001 including $2.0 million of
allowance recorded in the asset acquisition on June 24, 1998.
The majority of our commercial loans are senior secured loans. The majority
of our non-loan investments are either warrants to acquire equity interests or
direct equity investments. The receipt of warrants allows us to participate in
positive changes in the value of the portfolio company, while minimizing the
amount of upfront cost to us. The following table shows the fair value of our
portfolio of investments by asset class as of December 31, 2001, 2000 and 1999:
December 31, December 31, December 31,
2001 2000 1999
------------ ------------ ------------
Senior Debt...... 95.3% 96.8% 93.7%
Subordinated Debt 1.2 1.4 2.0
Equity........... 3.5 1.8 4.3
----- ----- -----