Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
OR
o 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 | 54-1889518 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
1100 Wilson Boulevard, Suite 3000 Arlington, VA (Address of principal executive offices) | 22209 (Zip Code) |
(703) 247-7500
(Registrant's telephone number, including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
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 o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer x |
Non-accelerated filer o | Smaller reporting company o |
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act). Yes o No x
As of April 27, 2012, there were 76,762,220 shares of the registrant’s $0.01 par value Common Stock outstanding.
MCG CAPITAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2012
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION | |
ITEM 1. FINANCIAL STATEMENTS | |
CONSOLIDATED BALANCE SHEETS | |
CONSOLIDATED STATEMENTS OF OPERATIONS | |
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS | |
CONSOLIDATED STATEMENTS OF CASH FLOWS | |
CONSOLIDATED SCHEDULE OF INVESTMENTS | |
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) | |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM | |
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | |
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | |
ITEM 4. CONTROLS AND PROCEDURES | |
PART II. OTHER INFORMATION | |
ITEM 1. LEGAL PROCEEDINGS | |
ITEM 1A. RISK FACTORS | |
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES | |
ITEM 4. MINE SAFETY DISCLOSURES | |
ITEM 5. OTHER INFORMATION | |
ITEM 6. EXHIBITS | |
SIGNATURES |
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MCG Capital Corporation
Consolidated Balance Sheets
(in thousands, except per share amounts) | March 31, 2012 | December 31, 2011 | ||||
(unaudited) | ||||||
Assets | ||||||
Cash and cash equivalents | $ | 59,941 | $ | 58,563 | ||
Cash, securitization accounts | 35,380 | 40,306 | ||||
Cash, restricted | 69,279 | 34,964 | ||||
Investments at fair value | ||||||
Non-affiliate investments (cost of $512,777 and $570,209, respectively) | 494,532 | 570,133 | ||||
Affiliate investments (cost of $42,695 and $40,858, respectively) | 53,756 | 51,770 | ||||
Control investments (cost of $405,586 and $406,151, respectively) | 117,852 | 119,263 | ||||
Total investments (cost of $961,058 and $1,017,218, respectively) | 666,140 | 741,166 | ||||
Interest receivable | 4,122 | 4,049 | ||||
Other assets | 9,362 | 11,490 | ||||
Total assets | $ | 844,224 | $ | 890,538 | ||
Liabilities | ||||||
Borrowings (maturing within one year of $28,734 and $32,983, respectively) | $ | 402,783 | $ | 430,219 | ||
Interest payable | 1,110 | 2,710 | ||||
Dividends payable | 13,050 | 13,092 | ||||
Other liabilities | 8,796 | 9,565 | ||||
Total liabilities | 425,739 | 455,586 | ||||
Stockholders’ equity | ||||||
Preferred stock, par value $0.01, authorized 1 share, none issued and outstanding | — | — | ||||
Common stock, par value $0.01, authorized 200,000 shares on March 31, 2012 and December 31, 2011, 76,762 issued and outstanding on March 31, 2012 and 76,997 issued and outstanding on December 31, 2011 | 768 | 770 | ||||
Paid-in capital | 1,004,976 | 1,009,748 | ||||
Distributions in excess of earnings | ||||||
Paid-in capital | (195,310 | ) | (195,310 | ) | ||
Other | (96,734 | ) | (103,912 | ) | ||
Net unrealized depreciation on investments | (295,215 | ) | (276,344 | ) | ||
Total stockholders’ equity | 418,485 | 434,952 | ||||
Total liabilities and stockholders’ equity | $ | 844,224 | $ | 890,538 | ||
Net asset value per common share at end of period | $ | 5.45 | $ | 5.65 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
1
MCG Capital Corporation
Consolidated Statements of Operations
(unaudited)
Three months ended March 31, | ||||||
(in thousands, except per share amounts) | 2012 | 2011 | ||||
Revenue | ||||||
Interest and dividend income | ||||||
Non-affiliate investments (less than 5% owned) | $ | 14,357 | $ | 17,558 | ||
Affiliate investments (5% to 25% owned) | 1,184 | 1,143 | ||||
Control investments (more than 25% owned) | 1,755 | 4,735 | ||||
Total interest and dividend income | 17,296 | 23,436 | ||||
Advisory fees and other income | ||||||
Non-affiliate investments (less than 5% owned) | 236 | 507 | ||||
Control investments (more than 25% owned) | 27 | 360 | ||||
Total advisory fees and other income | 263 | 867 | ||||
Total revenue | 17,559 | 24,303 | ||||
Operating expense | ||||||
Interest expense | 5,202 | 3,873 | ||||
Employee compensation | ||||||
Salaries and benefits | 3,875 | 3,976 | ||||
Amortization of employee restricted stock awards | 478 | 624 | ||||
Total employee compensation | 4,353 | 4,600 | ||||
General and administrative expense | 3,936 | 2,827 | ||||
Restructuring expense | 26 | — | ||||
Total operating expense | 13,517 | 11,300 | ||||
Net operating income before net investment loss, loss on extinguishment of debt and income tax provision | 4,042 | 13,003 | ||||
Net realized gain (loss) on investments | ||||||
Non-affiliate investments (less than 5% owned) | 16,370 | (27,917 | ) | |||
Affiliate investments (5% to 25% owned) | — | (917 | ) | |||
Control investments (more than 25% owned) | 8 | 1,207 | ||||
Total net realized gain (loss) on investments | 16,378 | (27,627 | ) | |||
Net unrealized (depreciation) appreciation on investments | ||||||
Non-affiliate investments (less than 5% owned) | (18,169 | ) | 31,533 | |||
Affiliate investments (5% to 25% owned) | 149 | 1,447 | ||||
Control investments (more than 25% owned) | (846 | ) | (26,279 | ) | ||
Derivative and other fair value adjustments | (5 | ) | (18 | ) | ||
Total net unrealized (depreciation) appreciation on investments | (18,871 | ) | 6,683 | |||
Net investment loss before income tax provision | (2,493 | ) | (20,944 | ) | ||
Loss on extinguishment of debt before income tax provision | (174 | ) | (863 | ) | ||
Income tax provision | 18 | 11 | ||||
Net income (loss) | $ | 1,357 | $ | (8,815 | ) | |
Income (loss) per basic and diluted common share | $ | 0.02 | $ | (0.12 | ) | |
Cash distributions declared per common share | $ | 0.17 | $ | 0.15 | ||
Weighted-average common shares outstanding—basic and diluted | 77,050 | 75,765 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
2
MCG Capital Corporation
Consolidated Statements of Changes in Net Assets
(unaudited)
Three months ended March 31, | ||||||
(in thousands, except per share amounts) | 2012 | 2011 | ||||
Decrease in net assets from operations | ||||||
Net operating income before net investment loss, loss on extinguishment of debt and income tax provision | $ | 4,042 | $ | 13,003 | ||
Net realized gain (loss) on investments | 16,378 | (27,627 | ) | |||
Net unrealized (depreciation) appreciation on investments | (18,871 | ) | 6,683 | |||
Loss on extinguishment of debt before income tax provision | (174 | ) | (863 | ) | ||
Income tax provision | (18 | ) | (11 | ) | ||
Net income (loss) | 1,357 | (8,815 | ) | |||
Distributions to stockholders | ||||||
Distributions declared | (13,050 | ) | (11,582 | ) | ||
Net decrease in net assets resulting from stockholder distributions | (13,050 | ) | (11,582 | ) | ||
Capital share transactions | ||||||
Repurchase of common stock | (5,085 | ) | — | |||
Amortization of restricted stock awards | ||||||
Employee | 478 | 624 | ||||
Non-employee director | 17 | 17 | ||||
Common stock withheld to pay taxes applicable to the vesting of restricted stock | (184 | ) | (1,167 | ) | ||
Net decrease in net assets resulting from capital share transactions | (4,774 | ) | (526 | ) | ||
Total decrease in net assets | (16,467 | ) | (20,923 | ) | ||
Net assets | ||||||
Beginning of period | 434,952 | 578,016 | ||||
End of period | $ | 418,485 | $ | 557,093 | ||
Net asset value per common share at end of period | $ | 5.45 | $ | 7.23 | ||
Common shares outstanding at end of period | 76,762 | 77,065 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
3
MCG Capital Corporation
Consolidated Statements of Cash Flows
(unaudited)
Three months ended March 31, | ||||||
(in thousands) | 2012 | 2011 | ||||
Cash flows from operating activities | ||||||
Net income (loss) | $ | 1,357 | $ | (8,815 | ) | |
Adjustments to reconcile net loss to net cash provided by operating activities | ||||||
Investments in portfolio companies | (4,367 | ) | (89,483 | ) | ||
Principal collections related to investment repayments or sales | 75,520 | 119,260 | ||||
Decrease in interest receivable, accrued payment-in-kind interest and dividends | 1,280 | 6,503 | ||||
Amortization of restricted stock awards | ||||||
Employee | 478 | 624 | ||||
Non-employee director | 17 | 17 | ||||
Decrease (increase) in cash—securitization accounts from interest collections | 292 | (7,891 | ) | |||
Increase in restricted cash—escrow accounts | 1,122 | (1,224 | ) | |||
Depreciation and amortization | 2,757 | 902 | ||||
Decrease in other assets | 401 | 85 | ||||
Decrease in other liabilities | (2,342 | ) | (419 | ) | ||
Realized (gain) loss on investments | (16,378 | ) | 27,627 | |||
Net change in unrealized depreciation (appreciation) on investments | 18,871 | (6,683 | ) | |||
Loss on extinguishment of debt | 174 | 863 | ||||
Net cash provided by operating activities | 79,182 | 41,366 | ||||
Cash flows from financing activities | ||||||
Repurchase of common stock | (5,085 | ) | — | |||
Payments on borrowings | (49,010 | ) | (25,402 | ) | ||
Proceeds from borrowings | 21,400 | 5,000 | ||||
Decrease (increase) in cash in restricted and securitization accounts | ||||||
Securitization accounts for repayment of principal on debt | 4,634 | (20,426 | ) | |||
Restricted cash | (35,437 | ) | 8,666 | |||
Payment of financing costs | (1,030 | ) | (1,701 | ) | ||
Distributions paid | (13,092 | ) | (10,735 | ) | ||
Common stock withheld to pay taxes applicable to the vesting of restricted stock | (184 | ) | (1,167 | ) | ||
Net cash used in financing activities | (77,804 | ) | (45,765 | ) | ||
Net increase (decrease) in cash and cash equivalents | 1,378 | (4,399 | ) | |||
Cash and cash equivalents | ||||||
Beginning balance | 58,563 | 44,970 | ||||
Ending balance | $ | 59,941 | $ | 40,571 | ||
Supplemental disclosure of cash flow information | ||||||
Interest paid | $ | 4,318 | $ | 3,952 | ||
Income taxes (refunded) paid | 12 | (103 | ) | |||
Paid-in-kind interest collected | 333 | 5,780 | ||||
Dividend income collected | 3,465 | 4,183 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
4
MCG Capital Corporation
Consolidated Schedule of Investments
March 31, 2012 (unaudited)
(dollars in thousands)
Interest Rate(9) | Fair Value | ||||||||||||||||
Portfolio Company | Industry | Investment | Current | PIK | Total | Principal | Cost | ||||||||||
Control Investments(4): | |||||||||||||||||
Broadview Networks Holdings, Inc.(6) | Communications | Series A Preferred Stock (12.0%, 87,254 shares) | $ | 81,984 | $ | 4,663 | |||||||||||
Series A-1 Preferred Stock (12.0%, 100,702 shares) | 77,496 | 5,382 | |||||||||||||||
Series B Preferred Stock (12.0%, 1,282 shares) | 100 | 69 | |||||||||||||||
Class A Common Stock (4,731,031 shares) | — | — | |||||||||||||||
GMC Television Broadcasting, LLC(2) | Broadcasting | Senior Debt (Due 12/16)(1) | 4.5 | % | — | 4.5 | % | $ | 19,103 | 16,658 | 17,037 | ||||||
Subordinated Debt (Due 12/16)(1)(7) | 2.5 | % | — | 2.5 | % | 11,089 | 6,976 | — | |||||||||
Class B Voting Units (8.0%, 86,700 units) | 9,071 | — | |||||||||||||||
Intran Media, LLC(6) | Other Media | Series A Preferred Units (10.0%, 36,300 units) | 9,095 | 400 | |||||||||||||
Series B Preferred Units (10.0%, 12,700 units) | 3,000 | — | |||||||||||||||
Series C Preferred Units (10.0%,15,000 units) | 1,250 | — | |||||||||||||||
Jet Plastica Investors, LLC(2)(12) | Plastic Products | Senior Debt A (Due 3/15)(1)(7) | 2.5 | % | 7.0 | % | 9.5 | % | 15,421 | 14,645 | 12,048 | ||||||
Senior Debt B (Due 6/15)(1)(7) | 2.5 | % | 5.0 | % | 7.5 | % | 24,518 | 18,974 | — | ||||||||
Senior Debt C (Due 6/16)(7) | — | 2.5 | % | 2.5 | % | 6,380 | 6,250 | — | |||||||||
Senior Debt D (Due 3/13-9/16)(7) | — | 2.5 | % | 2.5 | % | 29,388 | 21,560 | — | |||||||||
Series B Preferred Stock (8.0%, 10,000 shares) | 10,000 | — | |||||||||||||||
Preferred LLC Interest (8.0%, 301,595 units) | 34,014 | — | |||||||||||||||
NPS Holding Group, LLC(2)(5)(6) | Business Services | Senior Debt Revolver (Due 6/13)(1)(7) | 6.3 | % | 2.5 | % | 8.7 | % | 3,959 | 2,360 | 4,203 | ||||||
Senior Debt A1 (Due 6/13)(1)(7) | 6.3 | % | — | 6.3 | % | 9,157 | 3,470 | 6,048 | |||||||||
Senior Debt A2 (Due 6/13)(1)(7) | 6.3 | % | — | 6.3 | % | 2,069 | 1,905 | 32 | |||||||||
Senior Debt A3 (Due 6/13)(1)(7) | 6.3 | % | — | 6.3 | % | 15,324 | 6,228 | 230 | |||||||||
Series A Preferred Units (504 units) | 50 | — | |||||||||||||||
Series B Preferred Units (5.0%, 10,731 units) | 10,731 | — | |||||||||||||||
Common Units (36,500 units) | — | — | |||||||||||||||
Orbitel Holdings, LLC(2) | Cable | Senior Debt (Due 2/13)(1) | 10.0 | % | — | 10.0 | % | 17,775 | 17,733 | 17,733 | |||||||
Preferred LLC Interest (10.0%, 150,000 units)(1) | 17,929 | 17,124 | |||||||||||||||
PremierGarage Holdings, LLC(2)(6) | Home Furnishings | Preferred LLC Units (400 units) | 400 | — | |||||||||||||
Common LLC Units (79,935 units) | 4,971 | — | |||||||||||||||
RadioPharmacy Investors, LLC(2) | Healthcare | Senior Debt (Due 12/16)(1) | 7.5 | % | — | 7.5 | % | 8,176 | 8,176 | 8,176 | |||||||
Subordinated Debt (Due 12/16)(1) | 12.0 | % | 3.0 | % | 15.0 | % | 10,362 | 10,357 | 10,357 | ||||||||
Preferred LLC Interest (19.7%, 70,000 units) | 10,203 | 14,350 | |||||||||||||||
Total Control Investments (represents 17.7% of total investments at fair value) | 405,586 | 117,852 | |||||||||||||||
Affiliate Investments(3): | |||||||||||||||||
Advanced Sleep Concepts, Inc.(2) | Home Furnishings | Senior Debt (Due 1/14)(1) | 13.4 | % | — | 13.4 | % | $ | 7,559 | $ | 7,523 | $ | 7,523 | ||||
Subordinated Debt (Due 1/14)(1) | 12.0 | % | 4.0 | % | 16.0 | % | 5,697 | 5,674 | 5,674 | ||||||||
Series A Preferred Stock (20.0%, 49 shares) | 344 | 43 | |||||||||||||||
Series B Preferred Stock (1,000 shares) | — | 190 | |||||||||||||||
Common Stock (423 shares) | 524 | — | |||||||||||||||
Warrants to purchase Common Stock (expire 10/16) | 348 | — | |||||||||||||||
Contract Datascan Holdings, Inc. | Business Services | Subordinated Debt (Due 3/16)(1) | 12.0 | % | 2.0 | % | 14.0 | % | 8,445 | 7,847 | 7,468 | ||||||
Series A Preferred Stock (10.0%, 2,313 shares)(1) | 2,387 | 2,231 | |||||||||||||||
Common Stock (4,806 shares)(1) | 477 | — | |||||||||||||||
Stratford School Holdings, Inc.(2) | Education | Senior Debt (Due 12/15)(1) | 7.5 | % | — | 7.5 | % | 17,500 | 17,418 | 17,418 | |||||||
Series A Convertible Preferred Stock (12.0%, 10,000 shares) | 153 | 10,207 | |||||||||||||||
Warrants to purchase Common Stock (expire 5/15)(1) | — | 3,002 | |||||||||||||||
Total Affiliate Investments (represents 8.1% of total investments at fair value) | 42,695 | 53,756 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
5
MCG Capital Corporation
Consolidated Schedule of Investments
March 31, 2012 (unaudited)
(dollars in thousands)
Interest Rate(9) | Fair Value | ||||||||||||||||
Portfolio Company | Industry | Investment | Current | PIK | Total | Principal | Cost | ||||||||||
Non-Affiliate Investments (less than 5% owned): | |||||||||||||||||
BarBri, Inc. | Publishing | Senior Debt (Due 6/17)(1) | 6.0 | % | — | 6.0 | % | $ | 6,974 | $ | 6,912 | $ | 6,938 | ||||
Capstone Logistics, LLC(12) | Logistics | Senior Debt (Due 9/16)(1) | 10.5 | % | — | 10.5 | % | 29,920 | 29,786 | 29,786 | |||||||
Chase Doors Holdings, Inc. | Manufacturing | Senior Debt (Due 12/15)(1) | 9.5 | % | — | 9.5 | % | 23,444 | 23,234 | 23,411 | |||||||
Coastal Sunbelt Holding, Inc.(2) | Food Services | Senior Debt (Due 8/14-12/15)(1) | 9.1 | % | — | 9.1 | % | 19,661 | 19,530 | 19,530 | |||||||
Subordinated Debt (Due 8/15)(1) | 16.0 | % | — | 16.0 | % | 9,038 | 8,970 | 9,004 | |||||||||
Coastal Sunbelt Real Estate, Inc. | Real Estate Investments | Series A-2 Preferred Stock (12.0%, 20,000 shares) | — | 441 | |||||||||||||
Construction Trailer Specialists, Inc.(2) | Auto Parts | Senior Debt (Due 6/13)(1) | 8.6 | % | 6.3 | % | 14.9 | % | 8,020 | 7,880 | 7,781 | ||||||
Cruz Bay Publishing, Inc. | Publishing | Subordinated Debt (Due 12/13)(1)(8) | 5.2 | % | 8.0 | % | 13.2 | % | 27,188 | 22,905 | 19,450 | ||||||
CWP/RMK Acquisition Corp.(2)(6) | Home Furnishings | Senior Debt (Due 12/16)(7) | 7.0 | % | — | 7.0 | % | 600 | 560 | 597 | |||||||
Data Based Systems International, Inc. | Business Services | Subordinated Debt (Due 8/16)(1) | 10.0 | % | 4.0 | % | 14.0 | % | 9,095 | 8,927 | 9,050 | ||||||
Education Management, Inc. | Education | Senior Debt (Due 6/15)(1) | 9.3 | % | — | 9.3 | % | 25,000 | 24,791 | 24,791 | |||||||
Gans Communications, L.P.(2) | Cable | Senior Debt (Due 10/17)(1) | 5.3 | % | — | 5.3 | % | 5,565 | 5,549 | 5,578 | |||||||
G&L Investment Holdings, LLC(2) | Insurance | Subordinated Debt (Due 5/14)(1) | 10.7 | % | 4.3 | % | 15.0 | % | 18,074 | 17,782 | 17,782 | ||||||
Series A Preferred Shares (14.0%, 5,000,000 shares) | 8,192 | 7,355 | |||||||||||||||
Class C Shares (621,907 shares) | 529 | — | |||||||||||||||
Golden Knight II CLO, Ltd. | Diversified Financial Services | Income Notes (Due 4/19) | 8.0 | % | — | 8.0 | % | 3,043 | 2,533 | ||||||||
Goodman Global, Inc. | Manufacturing | Senior Debt (Due 10/16)(1) | 5.8 | % | — | 5.8 | % | 5,599 | 5,628 | 5,643 | |||||||
GSDM Holdings Corp.(2)(13) | Healthcare | Senior Debt (Due 1/16)(1) | 11.5 | % | 6.0 | % | 17.5 | % | 27,183 | 26,947 | 26,947 | ||||||
Series B Preferred Stock (12.5%, 852,950 shares) | 5,457 | 7,433 | |||||||||||||||
Industrial Safety Technologies, LLC | Manufacturing | Senior Debt (Due 9/16)(1) | 9.5 | % | — | 9.5 | % | 22,000 | 21,784 | 21,784 | |||||||
Jenzabar, Inc.(10) | Technology | Subordinated Preferred Stock (109,800 shares) | 1,098 | 988 | |||||||||||||
Legacy Cabinets Holdings II, Inc.(6) | Home Furnishings | Class B-1 Common Stock (2,000 shares) | 2,185 | 25 | |||||||||||||
Mailsouth, Inc. | Publishing | Senior Debt (Due 12/16)(1) | 6.8 | % | — | 6.8 | % | 4,950 | 4,891 | 4,887 | |||||||
Maverick Healthcare Equity, LLC | Healthcare | Preferred Units (10.0%, 1,250,000 units) | 1,787 | 1,930 | |||||||||||||
Class A Common Units (1,250,000 units) | — | 400 | |||||||||||||||
Metropolitan Telecommunications Holding Company(2) | Communications | Senior Debt (Due 3/14-12/16)(1) | 8.1 | % | — | 8.1 | % | 22,770 | 22,646 | 22,646 | |||||||
Miles Media Group, LLC(2) | Business Services | Senior Debt (Due 6/16)(1) | 12.5 | % | — | 12.5 | % | 17,488 | 17,211 | 15,993 | |||||||
Warrants to purchase Class A Units (expire 3/21) (1) | 123 | 31 | |||||||||||||||
NDSSI Holdings, LLC(2) | Electronics | Senior Debt (Due 12/12)(1) | 12.8 | % | 1.0 | % | 13.8 | % | 29,941 | 29,806 | 29,305 | ||||||
Series D Preferred Units (30.0%, 2,000,000 units) | 2,000 | 2,429 | |||||||||||||||
Series A Preferred Units (516,691 units) | 718 | — | |||||||||||||||
Series B Convertible Preferred Units (165,003 units) | 142 | — | |||||||||||||||
Class A Common Units (1,000,000 units) | 333 | — |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
6
MCG Capital Corporation
Consolidated Schedule of Investments
March 31, 2012 (unaudited)
(dollars in thousands)
Interest Rate(9) | Principal | Cost | Fair Value | ||||||||||||||
Portfolio Company | Industry | Investment | Current | PIK | Total | ||||||||||||
Orbitz Worldwide, Inc. | Personal Transportation | Senior Debt (Due 7/14)(1) | 3.4 | % | — | 3.4 | % | $ | 2,808 | $ | 2,690 | $ | 2,672 | ||||
Ozburn-Hessey Holding Company LLC | Logistics | Senior Debt (Due 4/16)(1) | 8.3 | % | — | 8.3 | % | 4,378 | 4,424 | 3,866 | |||||||
Philadelphia Media Network, Inc.(6) | Newspaper | Class A Common Stock (1,000 shares) | 5,070 | 6 | |||||||||||||
Qualawash Holdings, LLC | Repair Services | Subordinated Debt (Due 1/16)(1) | 11.0 | % | — | 11.0 | % | 20,000 | 19,845 | 19,845 | |||||||
Rita’s Water Ice Franchise Company, LLC | Restaurants | Senior Debt (Due 11/16)(1) | 14.0 | % | — | 14.0 | % | 9,375 | 9,287 | 9,287 | |||||||
Sagamore Hill Broadcasting, LLC(2) | Broadcasting | Senior Debt (Due 8/14)(1) | 12.0 | % | 1.0 | % | 13.0 | % | 11,028 | 10,938 | 10,938 | ||||||
Sally Holdings LLC | Cosmetics | Senior Debt (Due 11/13)(1) | 2.5 | % | — | 2.5 | % | 7,307 | 7,315 | 7,311 | |||||||
SC Academy Holdings, Inc. | Education | Subordinated Debt (Due 7/16)(1) | 12.0 | % | — | 12.0 | % | 13,500 | 13,401 | 13,440 | |||||||
Scotsman Industries, Inc. | Manufacturing | Senior Debt (Due 4/16)(1) | 5.8 | % | — | 5.8 | % | 5,309 | 5,308 | 5,302 | |||||||
Service Champ, Inc.(11) | Auto Parts | Subordinated Unsecured Debt ( Due 2/17)(1) | 12.0 | % | 2.3 | % | 14.3 | % | 12,180 | 12,078 | 12,353 | ||||||
ShowPlex Cinemas, Inc. | Entertainment | Senior Debt (Due 5/15)(1) | 11.0 | % | — | 11.0 | % | 7,820 | 7,682 | 7,682 | |||||||
Softlayer Technologies, Inc. | Business Services | Senior Debt (Due 11/16)(1) | 7.3 | % | — | 7.3 | % | 13,825 | 13,689 | 13,882 | |||||||
Summit Business Media Parent Holding Company LLC(6) | Information Services | Class E Series I Units (636 units)(1) | 4,120 | 398 | |||||||||||||
Class E Series II Units (276 units) (1) | 1,788 | — | |||||||||||||||
Sunshine Media Group, Inc.(2)(6) | Publishing | Warrants to purchase Common Stock (expire 1/21) | — | — | |||||||||||||
Tank Intermediate Holding Corp. | Manufacturing | Senior Debt (Due 4/16)(1) | 4.8 | % | — | 4.8 | % | 5,434 | 5,422 | 5,431 | |||||||
The e-Media Club I, LLC(6) | Investment Fund | LLC Interest (74 units) | 88 | 11 | |||||||||||||
The Gavilon Group, LLC | Agriculture | Senior Debt (Due 12/16)(1) | 6.0 | % | — | 6.0 | % | 9,250 | 9,152 | 9,264 | |||||||
Virtual Radiologic Corporation | Healthcare | Senior Debt (Due 12/16)(1) | 7.8 | % | — | 7.8 | % | 13,880 | 13,703 | 13,047 | |||||||
Visant Corporation | Consumer Products | Senior Debt (Due 12/16)(1) | 5.3 | % | — | 5.3 | % | 4,851 | 4,866 | 4,746 | |||||||
VS&A-PBI Holding LLC(6) | Publishing | LLC Interest | 500 | — | |||||||||||||
West World Media, LLC | Information Services | Senior Debt (Due 9/15)(1) | 11.0 | % | 3.0 | % | 14.0 | % | 11,342 | 10,658 | 10,658 | ||||||
Class A Membership Units (25,000 units) (1) | 1 | 296 | |||||||||||||||
Warrant to purchase Class A Membership Units (expire 9/15) (1) | 324 | 719 | |||||||||||||||
Xpressdocs Holdings, Inc.(2) | Business Services | Senior Debt (Due 4/12-4/13)(1) | 10.9 | % | 0.9 | % | 11.8 | % | 18,776 | 18,582 | 18,777 | ||||||
Series A Preferred Stock (161,870 shares) | 500 | 133 | |||||||||||||||
Total Non-Affiliate Investments (represents 74.2% of total investments at fair value) | 512,777 | 494,532 | |||||||||||||||
Total Investments | $ | 961,058 | $ | 666,140 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
7
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
Interest Rate(9) | Fair Value | ||||||||||||||||
Portfolio Company | Industry | Investment | Current | PIK | Total | Principal | Cost | ||||||||||
Control Investments(4): | |||||||||||||||||
Broadview Networks Holdings, Inc.(6) | Communications | Series A Preferred Stock (12.0%, 87,254 shares) | $ | 81,984 | $ | 5,015 | |||||||||||
Series A-1 Preferred Stock (12.0%, 100,702 shares) | 77,496 | 5,788 | |||||||||||||||
Series B Preferred Stock (12.0%, 1,282 shares) | 100 | 74 | |||||||||||||||
Class A Common Stock (4,731,031 shares) | — | — | |||||||||||||||
GMC Television Broadcasting, LLC(2) | Broadcasting | Senior Debt (Due 12/16)(1) | 4.6 | % | — | 4.6 | % | $ | 19,103 | 16,651 | 17,167 | ||||||
Subordinated Debt (Due 12/16)(1)(7) | 2.5 | % | — | 2.5 | % | 10,950 | 6,976 | — | |||||||||
Class B Voting Units (8.0%, 86,700 units) | 9,071 | — | |||||||||||||||
Intran Media, LLC(6) | Other Media | Series A Preferred Units (10.0%, 36,300 units) | 9,095 | 400 | |||||||||||||
Series B Preferred Units (10.0%, 12,700 units) | 3,000 | — | |||||||||||||||
Series C Preferred Units (10.0%,15,000 units) | 1,250 | — | |||||||||||||||
Jet Plastica Investors, LLC(2) | Plastic Products | Senior Debt A (Due 3/15)(1)(7) | 2.6 | % | 7.0 | % | 9.6 | % | 15,288 | 14,914 | 9,145 | ||||||
Senior Debt B (Due 6/15)(1)(7) | 2.6 | % | 5.0 | % | 7.6 | % | 23,836 | 18,977 | — | ||||||||
Senior Debt C (Due 6/16)(7) | — | 2.5 | % | 2.5 | % | 6,299 | 6,250 | — | |||||||||
Senior Debt D (Due 3/13-9/16)(7) | — | 2.5 | % | 2.5 | % | 29,018 | 21,560 | — | |||||||||
Series B Preferred Stock (8.0%, 10,000 shares) | 10,000 | — | |||||||||||||||
Preferred LLC Interest (8.0%, 301,595 units) | 34,014 | — | |||||||||||||||
NPS Holding Group, LLC(2)(5)(6) | Business Services | Senior Debt Revolver (Due 6/13)(1)(7) | 6.3 | % | 2.5 | % | 8.7 | % | 3,909 | 2,360 | 4,116 | ||||||
Senior Debt A1 (Due 6/13)(1)(7) | 6.3 | % | — | 6.3 | % | 9,157 | 3,470 | 5,237 | |||||||||
Senior Debt A2 (Due 6/13)(1)(7) | 6.3 | % | — | 6.3 | % | 2,069 | 1,905 | 32 | |||||||||
Senior Debt A3 (Due 6/13)(1)(7) | 6.3 | % | — | 6.3 | % | 15,324 | 6,228 | 230 | |||||||||
Series A Preferred Units (504 units) | 50 | — | |||||||||||||||
Series B Preferred Units (5.0%, 10,731 units) | 10,731 | — | |||||||||||||||
Common Units (36,500 units) | — | — | |||||||||||||||
Orbitel Holdings, LLC(2) | Cable | Senior Debt (Due 2/13)(1) | 10.0 | % | — | 10.0 | % | 18,580 | 18,512 | 18,512 | |||||||
Preferred LLC Interest (10.0%, 150,000 units)(1) | 17,929 | 19,090 | |||||||||||||||
PremierGarage Holdings, LLC(2)(6) | Home Furnishings | Preferred LLC Units (400 units) | 400 | — | |||||||||||||
Common LLC Units (79,935 units) | 4,971 | — | |||||||||||||||
RadioPharmacy Investors, LLC(2) | Healthcare | Senior Debt (Due 12/16)(1) | 7.5 | % | — | 7.5 | % | 8,176 | 8,176 | 8,176 | |||||||
Subordinated Debt (Due 12/16)(1) | 12.0 | % | 3.0 | % | 15.0 | % | 10,362 | 10,355 | 10,355 | ||||||||
Preferred LLC Interest (19.7%, 70,000 units) | 9,726 | 15,926 | |||||||||||||||
Total Control Investments (represents 16.1% of total investments at fair value) | 406,151 | 119,263 | |||||||||||||||
Affiliate Investments(3): | |||||||||||||||||
Advanced Sleep Concepts, Inc.(2) | Home Furnishings | Senior Debt (Due 1/14)(1) | 13.4 | % | — | 13.4 | % | $ | 5,859 | $ | 5,851 | $ | 5,851 | ||||
Subordinated Debt (Due 1/14)(1) | 12.0 | % | 4.0 | % | 16.0 | % | 5,640 | 5,614 | 5,614 | ||||||||
Series A Preferred Stock (20.0%, 49 shares) | 344 | 61 | |||||||||||||||
Series B Preferred Stock (1,000 shares) | — | 270 | |||||||||||||||
Common Stock (423 shares) | 524 | — | |||||||||||||||
Warrants to purchase Common Stock (expire 10/16) | 348 | — | |||||||||||||||
Contract Datascan Holdings, Inc. | Business Services | Subordinated Debt (Due 3/16)(1) | 12.0 | % | 2.0 | % | 14.0 | % | 8,402 | 7,778 | 7,353 | ||||||
Series A Preferred Stock (10.0%, 2,313 shares)(1) | 2,387 | 1,931 | |||||||||||||||
Common Stock (4,806 shares)(1) | 477 | — | |||||||||||||||
Stratford School Holdings, Inc.(2) | Education | Senior Debt (Due 12/15)(1) | 7.5 | % | — | 7.5 | % | 17,500 | 17,412 | 17,412 | |||||||
Series A Convertible Preferred Stock (12.0%, 10,000 shares) | 123 | 10,191 | |||||||||||||||
Warrants to purchase Common Stock (expire 5/15)(1) | — | 3,087 | |||||||||||||||
Total Affiliate Investments (represents 7.0% of total investments at fair value) | 40,858 | 51,770 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
8
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
Interest Rate(9) | Fair Value | ||||||||||||||||
Portfolio Company | Industry | Investment | Current | PIK | Total | Principal | Cost | ||||||||||
Non-Affiliate Investments (less than 5% owned): | |||||||||||||||||
BarBri, Inc. | Publishing | Senior Debt (Due 6/17)(1) | 6.0 | % | — | 6.0 | % | $ | 7,000 | $ | 6,936 | $ | 6,991 | ||||
Bentley Systems, Incorporated | Information Services | Senior Debt (Due 12/16)(1) | 5.8 | % | — | 5.8 | % | 9,900 | 9,810 | 9,810 | |||||||
Capstone Logistics, LLC | Logistics | Senior Debt (Due 9/16)(1) | 10.5 | % | — | 10.5 | % | 29,957 | 29,816 | 29,816 | |||||||
Chase Doors Holdings, Inc. | Manufacturing | Senior Debt (Due 12/15)(1) | 9.5 | % | — | 9.5 | % | 23,660 | 23,442 | 23,442 | |||||||
Coastal Sunbelt Holding, Inc.(2) | Food Services | Senior Debt (Due 8/14-12/15)(1) | 9.1 | % | — | 9.1 | % | 19,961 | 19,818 | 19,818 | |||||||
Subordinated Debt (Due 8/15)(1) | 16.0 | % | — | 16.0 | % | 9,038 | 8,967 | 9,024 | |||||||||
Coastal Sunbelt Real Estate, Inc. | Real Estate Investments | Series A-2 Preferred Stock (12.0%, 20,000 shares) | — | 441 | |||||||||||||
Construction Trailer Specialists, Inc.(2) | Auto Parts | Senior Debt (Due 6/13)(1) | 8.6 | % | 6.3 | % | 14.9 | % | 8,020 | 7,877 | 7,575 | ||||||
Cruz Bay Publishing, Inc. | Publishing | Subordinated Debt (Due 12/13)(1)(8) | 5.3 | % | 8.0 | % | 13.3 | % | 26,154 | 22,895 | 19,440 | ||||||
CWP/RMK Acquisition Corp.(2)(6) | Home Furnishings | Senior Debt (Due 12/16)(7) | 3.0 | % | — | 3.0 | % | 600 | 564 | 559 | |||||||
Data Based Systems International, Inc. | Business Services | Subordinated Debt (Due 8/16)(1) | 10.0 | % | 4.0 | % | 14.0 | % | 9,004 | 8,834 | 8,989 | ||||||
Education Management, Inc. | Education | Senior Debt (Due 6/15)(1) | 9.3 | % | — | 9.3 | % | 25,000 | 24,775 | 24,963 | |||||||
Focus Brands Inc. | Restaurants | Senior Debt (Due 11/16)(1) | 5.3 | % | — | 5.3 | % | 9,354 | 9,355 | 9,296 | |||||||
Gans Communications, L.P.(2) | Cable | Senior Debt (Due 10/17)(1) | 5.3 | % | — | 5.3 | % | 5,565 | 5,548 | 5,520 | |||||||
G&L Investment Holdings, LLC(2) | Insurance | Subordinated Debt (Due 5/14)(1) | 10.7 | % | 4.3 | % | 15.0 | % | 17,882 | 17,565 | 17,565 | ||||||
Series A Preferred Shares (14.0%, 5,000,000 shares) | 8,192 | 7,422 | |||||||||||||||
Class C Shares (621,907 shares) | 529 | — | |||||||||||||||
Golden Knight II CLO, Ltd. | Diversified Financial Services | Income Notes (Due 4/19) | 8.0 | % | — | 8.0 | % | 3,053 | 2,207 | ||||||||
Goodman Global, Inc. | Manufacturing | Senior Debt (Due 10/16)(1) | 5.8 | % | — | 5.8 | % | 5,599 | 5,630 | 5,611 | |||||||
GSDM Holdings Corp.(2) | Healthcare | Senior Debt (Due 1/16)(1) | 11.5 | % | 6.0 | % | 17.5 | % | 26,777 | 26,536 | 26,536 | ||||||
Series B Preferred Stock (12.5%, 852,950 shares) | 5,292 | 8,117 | |||||||||||||||
Haws Corporation | Manufacturing | Senior Debt (Due 12/15)(1) | 10.5 | % | — | 10.5 | % | 16,500 | 16,320 | 16,320 | |||||||
Industrial Safety Technologies, LLC | Manufacturing | Senior Debt (Due 9/16)(1) | 10.0 | % | — | 10.0 | % | 22,000 | 21,772 | 21,772 | |||||||
Jenzabar, Inc.(10) | Technology | Senior Preferred Stock (11.0%, 3,750 shares) | 6,844 | 6,844 | |||||||||||||
Subordinated Preferred Stock (109,800 shares) | 1,098 | 988 | |||||||||||||||
Warrants to purchase Common Stock (expire 4/16) | 422 | 16,858 | |||||||||||||||
Legacy Cabinets Holdings II, Inc.(6) | Home Furnishings | Class B-1 Common Stock (2,000 shares) | 2,185 | — | |||||||||||||
Mailsouth, Inc. | Publishing | Senior Debt (Due 12/16)(1) | 6.8 | % | — | 6.8 | % | 4,963 | 4,901 | 4,888 | |||||||
Maverick Healthcare Equity, LLC | Healthcare | Preferred Units (10.0%, 1,250,000 units) | 1,744 | 1,882 | |||||||||||||
Class A Common Units (1,250,000 units) | — | 484 | |||||||||||||||
Metropolitan Telecommunications Holding Company(2) | Communications | Senior Debt (Due 3/14-12/16)(1) | 8.1 | % | — | 8.1 | % | 23,770 | 23,630 | 23,630 | |||||||
Miles Media Group, LLC(2) | Business Services | Senior Debt (Due 6/16)(1) | 12.5 | % | — | 12.5 | % | 17,738 | 17,444 | 17,309 | |||||||
Warrants to purchase Class A Units (expire 3/21) (1) | 123 | 523 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
9
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
Interest Rate(9) | Principal | Cost | Fair Value | ||||||||||||||
Portfolio Company | Industry | Investment | Current | PIK | Total | ||||||||||||
NDSSI Holdings, LLC(2) | Electronics | Senior Debt (Due 12/12)(1) | 12.8 | % | 1.0 | % | 13.8 | % | $ | 29,859 | $ | 29,718 | $ | 28,791 | |||
Series D Preferred Units (30.0%, 2,000,000 units) | 2,000 | 3,175 | |||||||||||||||
Series A Preferred Units (516,691 units) | 718 | — | |||||||||||||||
Series B Convertible Preferred Units (165,003 units) | 142 | — | |||||||||||||||
Class A Common Units (1,000,000 units) | 333 | — | |||||||||||||||
Orbitz Worldwide, Inc. | Personal Transportation | Senior Debt (Due 7/14)(1) | 3.4 | % | — | 3.4 | % | 3,014 | 2,883 | 2,604 | |||||||
Ozburn-Hessey Holding Company LLC | Logistics | Senior Debt (Due 4/16)(1) | 8.3 | % | — | 8.3 | % | 4,378 | 4,426 | 3,868 | |||||||
Philadelphia Media Network, Inc.(6) | Newspaper | Class A Common Stock (1,000 shares) | 5,070 | 7 | |||||||||||||
Qualawash Holdings, LLC | Repair Services | Subordinated Debt (Due 1/16)(1) | 11.0 | % | — | 11.0 | % | 20,000 | 19,839 | 19,839 | |||||||
Rita’s Water Ice Franchise Company, LLC | Restaurants | Senior Debt (Due 11/16)(1) | 14.0 | % | — | 14.0 | % | 9,375 | 9,282 | 9,282 | |||||||
Sagamore Hill Broadcasting, LLC(2) | Broadcasting | Senior Debt (Due 8/14)(1) | 12.0 | % | 1.0 | % | 13.0 | % | 11,114 | 11,018 | 11,018 | ||||||
Sally Holdings LLC | Cosmetics | Senior Debt (Due 11/13)(1) | 2.6 | % | — | 2.6 | % | 8,531 | 8,541 | 8,521 | |||||||
SC Academy Holdings, Inc. | Education | Subordinated Debt (Due 7/16)(1) | 12.0 | % | — | 12.0 | % | 13,500 | 13,398 | 13,471 | |||||||
Scotsman Industries, Inc. | Manufacturing | Senior Debt (Due 4/16)(1) | 5.8 | % | — | 5.8 | % | 5,309 | 5,309 | 5,256 | |||||||
Service Champ, Inc. | Auto Parts | Subordinated Unsecured Debt (Due 2/17)(1) | 12.0 | % | 2.3 | % | 14.3 | % | 12,111 | 12,009 | 12,203 | ||||||
ShowPlex Cinemas, Inc. | Entertainment | Senior Debt (Due 5/15)(1) | 11.0 | % | — | 11.0 | % | 7,689 | 7,539 | 7,539 | |||||||
Softlayer Technologies, Inc. | Business Services | Senior Debt (Due 11/16)(1) | 7.3 | % | — | 7.3 | % | 13,860 | 13,718 | 13,906 | |||||||
Summit Business Media Parent Holding Company LLC(6) | Information Services | Class E Series I Units (636 units)(1) | 4,120 | 281 | |||||||||||||
Class E Series II Units (276 units) (1) | 1,788 | — | |||||||||||||||
Sunshine Media Group, Inc.(2)(6) | Publishing | Warrants to purchase Common Stock (expire 1/21) | — | — | |||||||||||||
Tank Intermediate Holding Corp. | Manufacturing | Senior Debt (Due 4/16)(1) | 5.0 | % | — | 5.0 | % | 5,506 | 5,421 | 5,448 | |||||||
The e-Media Club I, LLC(6) | Investment Fund | LLC Interest (74 units) | 88 | 11 | |||||||||||||
The Gavilon Group, LLC | Agriculture | Senior Debt (Due 12/16)(1) | 6.0 | % | — | 6.0 | % | 9,500 | 9,395 | 9,464 | |||||||
The Matrixx Group, Incorporated | Plastic Products | Subordinated Debt (Due 6/14)(1) | 10.8 | % | — | 10.8 | % | 12,500 | 12,500 | 12,639 | |||||||
Virtual Radiologic Corporation | Healthcare | Senior Debt (Due 12/16)(1) | 7.8 | % | — | 7.8 | % | 13,915 | 13,730 | 13,184 | |||||||
Visant Corporation | Consumer Products | Senior Debt (Due 12/16)(1) | 5.3 | % | — | 5.3 | % | 4,851 | 4,866 | 4,563 | |||||||
VS&A-PBI Holding LLC(6) | Publishing | LLC Interest | 500 | — | |||||||||||||
West World Media, LLC | Information Services | Senior Debt (Due 9/15)(1) | 11.0 | % | 3.0 | % | 14.0 | % | 11,301 | 10,577 | 10,577 | ||||||
Class A Membership Units (25,000 units) (1) | 1 | 285 | |||||||||||||||
Warrant to purchase Class A Membership Units (expire 9/15) (1) | 324 | 719 | |||||||||||||||
Xpressdocs Holdings, Inc.(2) | Business Services | Senior Debt (Due 4/12-4/13)(1) | 10.9 | % | 0.9 | % | 11.8 | % | 18,734 | 18,539 | 18,733 | ||||||
Series A Preferred Stock (161,870 shares) | 500 | 109 | |||||||||||||||
Total Non-Affiliate Investments (represents 76.9% of total investments at fair value) | 570,209 | 570,133 | |||||||||||||||
Total Investments | $ | 1,017,218 | $ | 741,166 |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
10
MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2011
(dollars in thousands)
(1) | Some or all of this security is held by our SBIC subsidiary or one of our other financing subsidiaries and may have been pledged as collateral in connection therewith. See Note 5—Borrowings to the Condensed Consolidated Financial Statements. |
(2) | Includes securities issued by one or more of the portfolio company’s affiliates. |
(3) | Affiliate investments represent companies in which we own at least 5%, but not more than 25% of the portfolio company’s voting securities. |
(4) | Control investments represent companies in which we own more than 25% of the portfolio company’s voting securities. |
(5) | Represents a non-majority-owned control portfolio company of which we own at least 25%, but not more than 50% of the portfolio company’s voting securities. |
(6) | Portfolio company is non-income producing at period-end. |
(7) | Loan or debt security is on non-accrual status. |
(8) | We did not recognize paid-in-kind, or PIK, interest or accretion income because the fair value of our investment was below its cost basis. However, we continue to accrue interest that is receivable in cash from the portfolio company. |
(9) | Interest rates represent the weighted-average annual stated interest rate on debt securities, presented by nature of indebtedness for a single issuer. PIK interest represents contractually deferred interest that is added to the principal balance of the debt security and compounded if not paid on a current basis. PIK may be prepaid by either contract or the portfolio company's choice, but generally is paid at the end of the loan term. The maturity dates represent the earliest and the latest maturity dates. Rates on preferred stock and preferred LLC interests, where applicable, represent the contractual rate. |
(10) | In February 2012, we accepted $23.7 million for our senior preferred stock and warrant position in Jenzabar. The consideration received also settled any and all direct claims and counterclaims asserted in the litigation by and among the Company, Jenzabar and certain Jenzabar officers and directors. We will receive the balance of the payment for our position in Jenzabar in the amount of $990,000 for our subordinated preferred stock and will exchange those shares upon the final dismissal of the litigation, including the dismissal of the derivative claims. |
(11) | In April 2012, Service Champ, Inc. subordinated unsecured debt was repaid in full. |
(12) | In April 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets. Including the proceeds from the liquidation, we received a $10.2 million payment on our senior debt. We anticipate receiving additional payments on our senior debt upon future collection of certain accounts receivable. |
(13) | In April 2012, GSDM Holdings Corp. repaid our senior debt in full. In addition, the stockholders of GSDM completed a sale of all of the company's outstanding shares of capital stock, in connection with which we sold all of our Series B Preferred Stock for the aggregate amount of $7.1 million. |
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
11
MCG Capital Corporation
Notes to the Condensed Consolidated Financial Statements (Unaudited)
NOTE 1—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
These Condensed Consolidated Financial Statements present the results of operations, financial position and cash flows of MCG Capital Corporation and its consolidated subsidiaries. The terms “we,” “our,” “us” and “MCG” refer to MCG Capital Corporation and its consolidated subsidiaries.
We are a solutions-focused commercial finance company that provides capital and advisory services to middle-market companies throughout the United States. We are an internally managed, non-diversified, closed-end investment company that elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. Our organization includes the following categories of subsidiaries:
Wholly Owned Special-Purpose Financing Subsidiaries—These subsidiaries are bankruptcy remote, special-purpose entities to which we transfer certain loans. Each financing subsidiary, in turn, transfers the loans to a Delaware statutory trust. For accounting purposes, the transfers of the loans to the Delaware statutory trusts are structured as on-balance sheet securitizations.
Small Business Investment Subsidiaries—We own Solutions Capital I, L.P., a wholly owned subsidiary licensed by the United States Small Business Administration, or SBA, which operates as a small business investment company, or SBIC, under the Small Business Investment Act of 1958, as amended, or SBIC Act. In March 2011, we formed another wholly owned subsidiary, Solutions Capital II, L. P., and in May 2011, we submitted a license to the SBA to obtain an SBIC license for Solutions Capital II, L.P. On September 30, 2011, after discussions with the SBA, we elected to withdraw our application for a second license. MCG is also the sole member of Solutions Capital G.P., LLC, which acts as the general partner of Solutions Capital I, L.P.
Taxable Subsidiaries—We currently qualify as a regulated investment company, or RIC, for federal income tax purposes and, therefore, are not required to pay corporate income taxes on any income or gains that we distribute to our stockholders. We have certain wholly owned taxable subsidiaries, or Taxable Subsidiaries, each of which holds one or more portfolio investments listed on our Consolidated Schedules of Investments. The purpose of these Taxable Subsidiaries is to permit us to hold portfolio companies organized as limited liability companies, or LLCs, (or other forms of pass-through entities) and still satisfy the RIC tax requirement that at least 90% of our gross revenue for income tax purposes must consist of investment income. Absent the Taxable Subsidiaries, a portion of the gross income of any LLC (or other pass-through entity) portfolio investment would flow through directly to us, and be included in the calculation of the 90% test. To the extent that such income did not consist of investment income, it could jeopardize our ability to qualify as a RIC and, therefore, cause us to incur significant federal income taxes. The income of the LLCs (or other pass-through entities) owned by Taxable Subsidiaries is taxed to the Taxable Subsidiaries and does not flow through to us, thereby helping us preserve our RIC status and resultant tax advantages. We do not consolidate the Taxable Subsidiaries for income tax purposes and they may generate income tax expense because of the Taxable Subsidiaries’ ownership of the portfolio companies. We reflect any such income tax expense on our Consolidated Statements of Operations.
The accompanying financial statements reflect the consolidated accounts of MCG and the following subsidiaries: Solutions Capital I, L.P.; Solutions Capital II, L.P.; Solutions Capital G.P., LLC; and MCG’s special-purpose financing subsidiaries: MCG Finance V, LLC and MCG Finance VII, LLC.
BASIS OF PRESENTATION AND USE OF ESTIMATES
These unaudited financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America and conform to Regulation S-X under the Securities Exchange Act of 1934, as amended. We believe we have made all necessary adjustments so that the financial statements are presented fairly and that all such adjustments are of a normal recurring nature. We eliminated all significant intercompany balances. In accordance with Article 6 of Regulation S-X of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, we do not consolidate portfolio company investments, including those in which we have a controlling interest. Further, in connection with the preparation of these Condensed Consolidated Financial Statements, we have evaluated subsequent events that occurred after the balance sheet date as of March 31, 2012 through the date these financial statements were issued.
12
Preparing financial statements requires us to make estimates and assumptions that affect the amounts reported on our Condensed Consolidated Financial Statements and accompanying notes. Although we believe the estimates and assumptions used in preparing these Condensed Consolidated Financial Statements and related notes are reasonable, actual results could differ materially.
Interim results are not necessarily indicative of results for a full year. You should read these Condensed Consolidated Financial Statements in conjunction with the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2011.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2011, the FASB issued Accounting Standards Update No. 2011-04—Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, or ASU 2011-04. ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes the application of some requirements for measuring fair value and requires additional disclosure for fair value measurements. The disclosure requirements are expanded to include for fair value measurements categorized in Level 3 of the fair value hierarchy: 1) a quantitative disclosure of the unobservable inputs and assumptions used in the measurement; 2) a description of the valuation processes in place; and 3) a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs. For public entities, ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. We adopted this standard beginning on January 1, 2012. Our implementation of this standard did not have a material impact on our process for measuring fair values, our financial position or our results of operations.
NOTE 2—INVESTMENT PORTFOLIO
The following table summarizes the composition of our investment portfolio at cost and fair value:
COST BASIS | FAIR VALUE BASIS | |||||||||||||||||||
March 31, 2012 | December 31, 2011 | March 31, 2012 | December 31, 2011 | |||||||||||||||||
(dollars in thousands) | Investments at Cost | % of Total Portfolio | Investments at Cost | % of Total Portfolio | Investments at Fair Value | % of Total Portfolio | Investments at Fair Value | % of Total Portfolio | ||||||||||||
Debt Investments | ||||||||||||||||||||
Senior secured debt | $ | 513,771 | 53.5 | % | $ | 551,402 | 54.2 | % | $ | 458,928 | 68.9 | % | $ | 492,488 | 66.4 | % | ||||
Subordinated debt | ||||||||||||||||||||
Secured | 122,684 | 12.8 | 134,721 | 13.2 | 112,070 | 16.8 | 124,289 | 16.8 | ||||||||||||
Unsecured | 12,078 | 1.2 | 12,009 | 1.2 | 12,353 | 1.9 | 12,203 | 1.7 | ||||||||||||
Total debt investments | 648,533 | 67.5 | 698,132 | 68.6 | 583,351 | 87.6 | 628,980 | 84.9 | ||||||||||||
Equity investments | ||||||||||||||||||||
Preferred | 291,144 | 30.3 | 297,283 | 29.3 | 77,901 | 11.7 | 89,931 | 12.1 | ||||||||||||
Common/common equivalents | 21,381 | 2.2 | 21,803 | 2.1 | 4,888 | 0.7 | 22,255 | 3.0 | ||||||||||||
Total equity investments | 312,525 | 32.5 | 319,086 | 31.4 | 82,789 | 12.4 | 112,186 | 15.1 | ||||||||||||
Total investments | $ | 961,058 | 100.0 | % | $ | 1,017,218 | 100.0 | % | $ | 666,140 | 100.0 | % | $ | 741,166 | 100.0 | % |
Our debt instruments bear contractual interest rates ranging from 2.5% to 17.5%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of March 31, 2012, approximately 87.3% of the fair value of our loan portfolio had variable interest rates, based on a LIBOR benchmark or the prime rate, and 12.7% of the fair value of our loan portfolio had fixed interest rates. As of March 31, 2012, approximately 77.2% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR-based index and prime floors between 1.75% and 6.0%. At origination, our loans generally have four- to eight-year stated maturities. Borrowers typically pay an origination fee based on a percent of the total commitment and a fee on undrawn commitments.
When one of our loans becomes more than 90 days 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 generally will cease recognizing interest income on that loan until all principal and interest has been brought current
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through payment or due to a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status:
COST BASIS | FAIR VALUE BASIS | |||||||||||||||||||
March 31, 2012 | December 31, 2011 | March 31, 2012 | December 31, 2011 | |||||||||||||||||
(dollars in thousands) | Investments at Cost | % of Loan Portfolio | Investments at Cost | % of Loan Portfolio | Investments at Fair Value | % of Loan Portfolio | Investments at Fair Value | % of Loan Portfolio | ||||||||||||
Loans greater than 90 days past due | ||||||||||||||||||||
On non-accrual status | $ | 13,963 | 2.15 | % | $ | 13,963 | 2.00 | % | $ | 10,513 | 1.80 | % | $ | 9,615 | 1.53 | % | ||||
Not on non-accrual status | — | — | — | — | — | — | — | — | ||||||||||||
Total loans greater than 90 days past due | $ | 13,963 | 2.15 | % | $ | 13,963 | 2.00 | % | $ | 10,513 | 1.80 | % | $ | 9,615 | 1.53 | % | ||||
Loans on non-accrual status | ||||||||||||||||||||
0 to 90 days past due | $ | 68,965 | 10.64 | % | $ | 69,241 | 9.92 | % | $ | 12,645 | 2.17 | % | $ | 9,704 | 1.54 | % | ||||
Greater than 90 days past due | 13,963 | 2.15 | 13,963 | 2.00 | 10,513 | 1.80 | 9,615 | 1.53 | ||||||||||||
Total loans on non-accrual status | $ | 82,928 | 12.79 | % | $ | 83,204 | 11.92 | % | $ | 23,158 | 3.97 | % | $ | 19,319 | 3.07 | % |
The following table summarizes our investment portfolio by industry at fair value:
Mach 31, 2012 | December 31, 2011 | |||||||||
(dollars in thousands) | Investments at Fair Value | Percent of Total Portfolio | Investments at Fair Value | Percent of Total Portfolio | ||||||
Healthcare | $ | 82,640 | 12.4 | % | $ | 84,660 | 11.4 | % | ||
Business services | 78,078 | 11.7 | 78,468 | 10.6 | ||||||
Education | 68,858 | 10.3 | 69,124 | 9.3 | ||||||
Manufacturing | 61,571 | 9.2 | 77,849 | 10.5 | ||||||
Cable | 40,435 | 6.1 | 43,122 | 5.8 | ||||||
Logistics | 33,652 | 5.1 | 33,684 | 4.5 | ||||||
Communications | 32,760 | 4.9 | 34,507 | 4.7 | ||||||
Electronics | 31,734 | 4.8 | 31,966 | 4.3 | ||||||
Publishing | 31,275 | 4.7 | 31,319 | 4.2 | ||||||
Food services | 28,534 | 4.3 | 28,842 | 3.9 | ||||||
Broadcasting | 27,975 | 4.2 | 28,185 | 3.8 | ||||||
Insurance | 25,137 | 3.8 | 24,987 | 3.4 | ||||||
Auto Parts | 20,134 | 3.0 | 19,778 | 2.7 | ||||||
Repair Services | 19,845 | 3.0 | 19,839 | 2.7 | ||||||
Home Furnishings | 14,052 | 2.1 | 12,355 | 1.7 | ||||||
Information Services | 12,071 | 1.8 | 21,672 | 2.9 | ||||||
Plastic Products | 12,048 | 1.8 | 21,784 | 2.9 | ||||||
Restaurants | 9,287 | 1.4 | 18,578 | 2.5 | ||||||
Agriculture | 9,264 | 1.4 | 9,464 | 1.3 | ||||||
Entertainment | 7,682 | 1.2 | 7,539 | 1.0 | ||||||
Cosmetics | 7,311 | 1.1 | 8,521 | 1.2 | ||||||
Technology | 988 | 0.1 | 24,690 | 3.3 | ||||||
Other(a) | 10,809 | 1.6 | 10,233 | 1.4 | ||||||
Total | $ | 666,140 | 100.0 | % | $ | 741,166 | 100.0 | % | ||
______________________ (a) No individual industry within this category exceeds 1%. |
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NOTE 3—FAIR VALUE MEASUREMENT
We account for our investments in portfolio companies under Accounting Standard Codification Topic 820—Fair Value Measurements and Disclosures, or ASC 820. ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. ASC 820 defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.
Fair Value Hierarchy
ASC 820 establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:
ASC 820 Fair Value Hierarchy | Inputs to Fair Value Methodology |
Level 1 | Quoted prices in active markets for identical assets or liabilities |
Level 2 | Quoted prices for similar assets or liabilities; quoted markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the financial instrument; inputs other than quoted prices that are observable for the asset or liability; or inputs that are derived principally from, or corroborated by, observable market information |
Level 3 | Pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption is unobservable or when the estimation of fair value requires significant management judgment |
We categorize a financial instrument in the fair value hierarchy based on the lowest level of input that is significant to its fair value measurement. In the event that transfers between these levels were to occur in the future, we would recognize those transfers as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.
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Assets Measured at Fair Value on a Recurring Basis
The following table presents the assets that we report at fair value on our Consolidated Balance Sheets by fair value hierarchy:
As of March 31, 2012 | ||||||||||
(in thousands) | Internal Models with Significant | Total Fair Value Reported in Consolidated Balance Sheet | ||||||||
Observable Market Parameters (Level 2) | Unobservable Market Parameters (Level 3) | |||||||||
Non-affiliate investments | ||||||||||
Senior secured debt | $ | 88,567 | $ | 279,913 | $ | 368,480 | ||||
Subordinated secured debt | — | 88,571 | 88,571 | |||||||
Unsecured subordinated debt | — | 12,353 | 12,353 | |||||||
Preferred equity | 2,533 | 20,709 | 23,242 | |||||||
Common/common equivalents | — | 1,886 | 1,886 | |||||||
Total non-affiliate investments | 91,100 | 403,432 | 494,532 | |||||||
Affiliate investments | ||||||||||
Senior secured debt | — | 24,941 | 24,941 | |||||||
Subordinated secured debt | — | 13,142 | 13,142 | |||||||
Preferred equity | — | 12,671 | 12,671 | |||||||
Common/common equivalents | — | 3,002 | 3,002 | |||||||
Total affiliate investments | — | 53,756 | 53,756 | |||||||
Control investments | ||||||||||
Senior secured debt | — | 65,507 | 65,507 | |||||||
Subordinated secured debt | — | 10,357 | 10,357 | |||||||
Preferred equity | — | 41,988 | 41,988 | |||||||
Total control investments | — | 117,852 | 117,852 | |||||||
Total assets at fair value | $ | 91,100 | $ | 575,040 | $ | 666,140 |
As of March 31, 2012, we had no investments that had quoted market prices in active markets, which we would categorize as Level 1 investments under ASC 820. Cash and cash equivalents are carried at cost which approximates fair value and are Level 1 assets.
Valuation Methodologies and Procedures
As required by the 1940 Act, we classify our investments by level of control. Control investments include both majority-owned control investments and non-majority owned control investments. A majority-owned control investment represents a security in which we own more than 50% of the voting interest of the portfolio company and generally control its board of directors. A non-majority owned control investment represents a security in which we own 25% to 50% of the portfolio company’s voting equity. Non-control investments represent both affiliate and non-affiliate securities for which we do not have a controlling interest. Affiliate investments represent securities in which we own 5% to 25% of the portfolio company’s equity. Non-affiliate investments represent securities in which we own less than 5% of the portfolio company’s equity.
• | Majority-Owned Control Investments—Majority-owned control investments comprise 16.1% of our investment portfolio as of March 31, 2012. Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value. Typically, private companies are bought and sold based on multiples of earnings before interest, taxes, depreciation and amortization, or EBITDA, cash flows, net income, revenues or, in limited cases, book value. Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company. Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs. Our valuation approaches for majority-owned investments estimate the value were we to sell or exit the investment. These valuation approaches consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit. |
• | Non-Majority-Owned Control Investments—Non-majority-owned control investments comprise 1.6% of our investment portfolio as of March 31, 2012. For our non-majority-owned control equity investments, we use the same market and income valuation approaches used to value our majority-owned control investments. For non-majority owned control debt investments, we estimate fair value using the market-yield approach based on the |
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expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower.
• | Non-Control Investments—Non-control investments comprise 82.3% of our investment portfolio as of March 31, 2012. Quoted prices are not available for 83.4% of our non-control investments as of March 31, 2012. For our non-control equity investments, we use the same market and income approaches used to value our control investments. For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. |
• | Thinly Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of March 31, 2012, these securities represented 13.7% of our investment portfolio. We utilize independent pricing services with certain of our fair value estimates. The majority of our level 2 investments are senior debt investments that are secured and collateralized. To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence. |
Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales. Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks. We also use independent valuation firms to provide additional data points for our quarterly valuation analyses. Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months. In total, we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve-month period for 97.7% of our investment portfolio as of March 31, 2012, calculated on a fair value basis.
The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs. We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses.
Our board of directors sets our valuation policies and procedures and determines the fair value of our investments. The investment and valuation committee of our board of directors meets at least quarterly with our management to review management’s recommendations of fair value of our investments. Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments.
Due to the uncertainty inherent in the valuation process, such estimates of fair value may differ significantly from the values that would have been used had a ready market for the securities existed, and such differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to differ from the valuations currently assigned.
Changes in Level 3 Fair Value Measurements
We classify securities in the Level 3 valuation hierarchy based on the significance of the unobservable factors to the overall fair value measurement. Our fair value approach for Level 3 securities primarily uses unobservable inputs, but may also include observable, actively quoted components derived from external sources. Accordingly, the gains and losses in the table below include fair value changes due, in part, to observable factors. Additionally, we transfer investments in and out of Level 1, 2 and 3 securities as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period. During each of the three months ended March 31, 2012 and 2011, there were no transfers in or out of Level 1, 2 or 3.
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The following table provides a reconciliation of fair value changes during the three-month period ended March 31, 2012 for all investments for which we determine fair value using unobservable (Level 3) factors.
(in thousands) | Fair value measurements using unobservable inputs (Level 3) | |||||||||||
Non-affiliate Investments | Affiliate Investments | Control Investments | Total | |||||||||
Fair value December 31, 2011 | ||||||||||||
Senior secured debt | $ | 297,680 | $ | 23,263 | $ | 62,615 | $ | 383,558 | ||||
Subordinated secured debt | 100,967 | 12,967 | 10,355 | 124,289 | ||||||||
Unsecured subordinated debt | 12,203 | — | — | 12,203 | ||||||||
Preferred equity | 28,978 | 12,453 | 46,293 | 87,724 | ||||||||
Common/common equivalents equity | 19,168 | 3,087 | — | 22,255 | ||||||||
Total fair value December 31, 2011 | 458,996 | 51,770 | 119,263 | 630,029 | ||||||||
Realized/unrealized gain (loss) | ||||||||||||
Senior secured debt | (424 | ) | — | 3,937 | 3,513 | |||||||
Subordinated secured debt | (228 | ) | 46 | — | (182 | ) | ||||||
Unsecured subordinated debt | 81 | — | 8 | 89 | ||||||||
Preferred equity | (1,633 | ) | 190 | (4,783 | ) | (6,226 | ) | |||||
Common/common equivalents equity | (491 | ) | (85 | ) | — | (576 | ) | |||||
Total realized/unrealized gain (loss) | (2,695 | ) | 151 | (838 | ) | (3,382 | ) | |||||
Issuances | ||||||||||||
Senior secured debt | 1,417 | 3,478 | 35 | 4,930 | ||||||||
Subordinated secured debt | 373 | 129 | 81 | 583 | ||||||||
Unsecured subordinated debt | 69 | — | — | 69 | ||||||||
Preferred equity | 272 | 28 | 478 | 778 | ||||||||
Total issuances | 2,131 | 3,635 | 594 | 6,360 | ||||||||
Settlements | ||||||||||||
Senior secured debt | (18,760 | ) | (1,800 | ) | (1,080 | ) | (21,640 | ) | ||||
Subordinated secured debt | (12,541 | ) | — | (79 | ) | (12,620 | ) | |||||
Unsecured subordinated debt | — | — | (8 | ) | (8 | ) | ||||||
Preferred equity | (6,908 | ) | — | — | (6,908 | ) | ||||||
Common/common equivalents equity | (16,791 | ) | — | — | (16,791 | ) | ||||||
Total settlements | (55,000 | ) | (1,800 | ) | (1,167 | ) | (57,967 | ) | ||||
Fair value as of March 31, 2012 | ||||||||||||
Senior secured debt | 279,913 | 24,941 | 65,507 | 370,361 | ||||||||
Subordinated secured debt | 88,571 | 13,142 | 10,357 | 112,070 | ||||||||
Unsecured subordinated debt | 12,353 | — | — | 12,353 | ||||||||
Preferred equity | 20,709 | 12,671 | 41,988 | 75,368 | ||||||||
Common/common equivalents equity | 1,886 | 3,002 | — | 4,888 | ||||||||
Total fair value as of March 31, 2012 | $ | 403,432 | $ | 53,756 | $ | 117,852 | $ | 575,040 |
There were no purchases or sales of level 3 investments during the three months ended March 31, 2012.
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The following table provides a reconciliation of fair value changes during the three-month period ended March 31, 2011 for all investments for which we determine fair value using unobservable (Level 3) factors.
(in thousands) | Fair value measurements using unobservable inputs (Level 3) | |||||||||||
Non-affiliate Investments | Affiliate Investments | Control Investments | Total | |||||||||
Fair value December 31, 2010 | ||||||||||||
Senior secured debt | $ | 325,874 | $ | 24,207 | $ | 75,714 | $ | 425,795 | ||||
Subordinated secured debt | 121,743 | 12,348 | 56,218 | 190,309 | ||||||||
Unsecured subordinated debt | 12,321 | — | — | 12,321 | ||||||||
Preferred equity | 24,741 | 13,197 | 178,357 | 216,295 | ||||||||
Common/common equivalents equity | 29,170 | 3,548 | — | 32,718 | ||||||||
Total fair value December 31, 2010 | 513,849 | 53,300 | 310,289 | 877,438 | ||||||||
Realized/unrealized gain (loss) | ||||||||||||
Senior secured debt | 717 | — | (28,183 | ) | (27,466 | ) | ||||||
Subordinated secured debt | 2,137 | (77 | ) | 33,783 | 35,843 | |||||||
Unsecured subordinated debt | 205 | — | — | 205 | ||||||||
Preferred equity | 63 | 839 | (30,671 | ) | (29,769 | ) | ||||||
Common/common equivalents equity | 692 | (232 | ) | — | 460 | |||||||
Total realized/unrealized gain (loss) | 3,814 | 530 | (25,071 | ) | (20,727 | ) | ||||||
Purchases | ||||||||||||
Senior secured debt | — | — | 10,000 | 10,000 | ||||||||
Common/common equivalents equity | 123 | — | — | 123 | ||||||||
Total purchases | 123 | — | 10,000 | 10,123 | ||||||||
Issuances | ||||||||||||
Senior secured debt | 2,993 | 469 | 35,168 | 38,630 | ||||||||
Subordinated secured debt | 29,106 | 137 | 887 | 30,130 | ||||||||
Unsecured subordinated debt | 62 | — | — | 62 | ||||||||
Preferred equity | 550 | 366 | 11,584 | 12,500 | ||||||||
Common/common equivalents equity | — | 62 | — | 62 | ||||||||
Total issuances | 32,711 | 1,034 | 47,639 | 81,384 | ||||||||
Settlements | ||||||||||||
Senior secured debt | (14,666 | ) | (473 | ) | (114 | ) | (15,253 | ) | ||||
Subordinated secured debt | (13,515 | ) | — | (65,139 | ) | (78,654 | ) | |||||
Preferred equity | — | — | (5,390 | ) | (5,390 | ) | ||||||
Common/common equivalents equity | (17 | ) | (228 | ) | — | (245 | ) | |||||
Total settlements | (28,198 | ) | (701 | ) | (70,643 | ) | (99,542 | ) | ||||
Sales | ||||||||||||
Senior secured debt | (10,206 | ) | — | — | (10,206 | ) | ||||||
Preferred equity | — | — | (12,540 | ) | (12,540 | ) | ||||||
Total sales | (10,206 | ) | — | (12,540 | ) | (22,746 | ) | |||||
Fair value as of March 31, 2011 | ||||||||||||
Senior secured debt | 304,712 | 24,203 | 92,585 | 421,500 | ||||||||
Subordinated secured debt | 139,471 | 12,408 | 25,749 | 177,628 | ||||||||
Unsecured subordinated debt | 12,588 | — | — | 12,588 | ||||||||
Preferred equity | 25,354 | 14,402 | 141,340 | 181,096 | ||||||||
Common/common equivalents equity | 29,968 | 3,150 | — | 33,118 | ||||||||
Total fair value as of March 31, 2011 | $ | 512,093 | $ | 54,163 | $ | 259,674 | $ | 825,930 |
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Unrealized (Depreciation) Appreciation of Level 3 Investments
The following table summarizes the unrealized (depreciation) appreciation that we recognized on those investments for which we determined fair value using unobservable inputs (Level 3) for the three months ended March 31, 2012 and 2011.
Three months ended March 31, 2012 | Three months ended March 31, 2011 | |||||||||||||||||||||||
(in thousands) | Non-affiliate Investments | Affiliate Investments | Control Investments | Total | Non-affiliate Investments | Affiliate Investments | Control Investments | Total | ||||||||||||||||
Change in unrealized appreciation (depreciation) | ||||||||||||||||||||||||
Senior secured debt | $ | (424 | ) | $ | — | $ | 3,937 | $ | 3,513 | $ | 25,298 | $ | — | $ | (28,183 | ) | $ | (2,885 | ) | |||||
Subordinated secured debt | (90 | ) | 46 | — | (44 | ) | 2,137 | (77 | ) | 33,783 | 35,843 | |||||||||||||
Unsecured subordinated debt | 81 | — | — | 81 | 205 | — | — | 205 | ||||||||||||||||
Preferred equity | (1,633 | ) | 190 | (4,783 | ) | (6,226 | ) | 63 | 1,756 | (31,878 | ) | (30,059 | ) | |||||||||||
Common/common equivalents equity | (424 | ) | (85 | ) | — | (509 | ) | 4,062 | (232 | ) | — | 3,830 | ||||||||||||
Total change in unrealized appreciation (depreciation) on Level 3 investments | $ | (2,490 | ) | $ | 151 | $ | (846 | ) | $ | (3,185 | ) | $ | 31,765 | $ | 1,447 | $ | (26,278 | ) | $ | 6,934 |
Significant Unobservable Inputs
Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with unique contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and complex, often factoring in numerous different inputs, including the historical and forecasted financial and operational performance of the portfolio company, projected cash flows, market multiples, comparable market transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews and other inputs too numerous to list quantitatively herein.
The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of March 31, 2012.
($ in thousands) | Fair Value | Valuation Techniques | Unobservable Inputs | Range | |||||
Minimum | Maximum | ||||||||
Senior debt | $ | 370,361 | Discounted cash flow | Market interest rate | 5.5 | % | 15.2 | % | |
Discounted cash flow | Discount rate | 8.5 | % | 8.5 | % | ||||
Market comparable companies | EBITDA multiple(a) | 5.0x | 8.0x | ||||||
Residual assets | Discount | — | % | 25 | % | ||||
Subordinated debt | 124,423 | Discounted cash flow | Market interest rate | 9.3 | % | 15.5 | % | ||
Market comparable companies | EBITDA multiple(a) | 6.8x | 7.5x | ||||||
Pending transactions/Letters of intent | Discount | — | % | — | % | ||||
Preferred and common equity | 80,256 | Market comparable companies | EBITDA multiple(a) | 5.0x | 9.0x | ||||
Discount for minority interest | — | % | 25.0 | % | |||||
Pending transactions/Letters of intent | Discount | — | % | 5.0 | % | ||||
Residual assets | Discount | — | % | 25.0 | % | ||||
$ | 575,040 |
(a) | EBITDA may include proforma adjustments and/or other addbacks based on specific circumstances related to each investment. |
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NOTE 4—CONCENTRATIONS OF INVESTMENT RISK
During the three months ended March 31, 2012, we had concentrations in certain industries, including the healthcare, business services and education industries. The following table summarizes our fair value and revenue concentrations in each of those industries:
Investments at fair value | Revenue for the three months ended | |||||||||||||||||||
As of March 31, 2012 | As of December 31, 2011 | March 31, 2012 | March 31, 2011 | |||||||||||||||||
(dollars in thousands) | Amount | % of Total Portfolio | Amount | % of Total Portfolio | Amount | % of Total Revenue | Amount | % of Total Revenue | ||||||||||||
Industry | ||||||||||||||||||||
Healthcare | $ | 82,640 | 12.4 | % | $ | 84,660 | 11.4 | % | $ | 2,706 | 15.4 | % | $ | 2,630 | 10.8 | % | ||||
Business services | 78,078 | 11.7 | 78,468 | 10.6 | 2,043 | 11.6 | 2,168 | 8.9 | ||||||||||||
Education | 68,858 | 10.3 | 69,124 | 9.3 | 1,389 | 7.9 | 811 | 3.3 |
NOTE 5—BORROWINGS
As of March 31, 2012, we reported $402.8 million of borrowings on our Consolidated Balance Sheets at cost. The following table summarizes our borrowing facilities and the facility amounts and amounts outstanding and contingent borrowing eligibility of Solutions Capital I, L.P., a wholly owned subsidiary, as an SBIC, under the SBIC Act.
March 31, 2012 | December 31, 2011 | ||||||||||||
(dollars in thousands) | Maturity Date | Total Facility/ Program | Amount Outstanding | Total Facility/ Program | Amount Outstanding | ||||||||
SBIC | |||||||||||||
2008-10B | September 2018 | $ | 2,600 | $ | 2,600 | $ | 2,600 | $ | 2,600 | ||||
2009-10A | March 2019 | 12,000 | 12,000 | 12,000 | 12,000 | ||||||||
2009-10B | September 2019 | 13,000 | 13,000 | 13,000 | 13,000 | ||||||||
2010-10B | September 2020 | 27,500 | 27,500 | 27,500 | 27,500 | ||||||||
2011-10A | March 2021 | 53,500 | 53,500 | 53,500 | 53,500 | ||||||||
2012-10A | March 2022 | 41,400 | 41,400 | 41,400 | 20,000 | ||||||||
Commercial Loan Trust 2006-1 | |||||||||||||
Series 2006-1 Class A-1 Notes | April 2018(a) | 52,831 | 52,831 | 63,389 | 63,389 | ||||||||
Series 2006-1 Class A-2 Notes | April 2018(a) | 2,486 | 2,486 | 2,983 | 2,983 | ||||||||
Series 2006-1 Class A-3 Notes | April 2018(a) | 42,265 | 42,265 | 50,711 | 50,711 | ||||||||
Series 2006-1 Class B Notes | April 2018(a) | 58,750 | 58,750 | 58,750 | 58,750 | ||||||||
Series 2006-1 Class C Notes(b) | April 2018(a) | 45,000 | 32,000 | 45,000 | 32,000 | ||||||||
Series 2006-1 Class D Notes(c) | April 2018(a) | 46,494 | 29,247 | 46,494 | 29,247 | ||||||||
Commercial Loan Funding Trust | |||||||||||||
Variable Funding Note | January 2014(d) | 35,204 | 35,204 | 150,000 | 55,822 | ||||||||
Private Placement Notes | |||||||||||||
Series 2007-A | October 2011 | — | — | 8,717 | 8,717 | ||||||||
Total borrowings | $ | 433,030 | $ | 402,783 | $ | 576,044 | $ | 430,219 | |||||
(a) Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date. The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt. | |||||||||||||
(b) Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased. | |||||||||||||
(c) Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased. | |||||||||||||
(d) In January 2012, this facility entered a 24-month amortization period and the legal final maturity date was extended to January 2014. |
We estimate that the fair value of these borrowings as of March 31, 2012 was approximately $394.6 million, based on market data and current interest rates. This fair value is estimated from market quotes in an inactive market provided
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by an independent pricing service for $194.6 million of our borrowings (level 2) and a market-yield approach for $200.0 million (level 3) of our borrowings.
Each of our credit facilities has certain collateral requirements and/or financial covenants. As of March 31, 2012, the net worth covenant of our Commercial Loan Funding Trust, or SunTrust Warehouse, required that we maintain a consolidated tangible net worth of not less than $375.0 million, plus 50% of any equity raised after February 26, 2009. Under the SunTrust Warehouse agreement, we must also maintain an asset coverage ratio of at least 180%.
As a BDC, we are not permitted to incur indebtedness or issue senior securities, including preferred stock, unless immediately after such borrowing we have an asset coverage for total borrowings (excluding borrowings by our SBIC facility) of at least 200%. In addition, we may not be permitted to declare any cash dividend or other distribution on our outstanding common shares, or purchase any such shares, unless, at the time of such declaration or purchase, we have an asset coverage ratio of at least 200% after deducting the amount of such dividend, distribution or purchase price. If we are unable to meet this asset coverage requirement, we may not be able to incur additional debt. As of March 31, 2012, our ratio of total assets to total borrowings and other senior securities was 265%.
We fund all of our current debt facilities through our bankruptcy remote, special-purpose, wholly owned subsidiaries. Therefore, these subsidiaries’ assets may not be available to our creditors. In some cases, advances under our debt facilities are subject to certain collateral levels, collateral quality, leverage and other restrictive covenants. We continue to service the portfolio investments that we use as collateral in our secured borrowing facilities.
The following table summarizes repayments of our borrowings based on the final legal maturity or the contractual principal collections of the outstanding loans that comprise the collateral, where applicable. Actual repayments could differ significantly due to future prepayments by our borrowers, modifications of our borrowers’ existing loan agreements, and monetizations.
(in thousands) | March 31, 2012 | ||
2012(a) | $ | 28,734 | |
2013 | — | ||
2014 | 34,475 | ||
2015 | — | ||
2016 | — | ||
Thereafter | 339,574 | ||
Total | $ | 402,783 |
(a) | Reflects repayments we are required to make in connection with principal collections from collateral loans in our Commercial Loan Funding Trust and Commercial Loan Trust 2006-1. |
As of March 31, 2012, we were in compliance with all key financial covenants under each of our borrowing facilities, although there can be no assurance regarding compliance in future periods. The following sections provide additional detail about each of our borrowing facilities.
SBIC Debentures
In December 2004, we formed a wholly owned subsidiary, Solutions Capital I, L.P., or Solutions Capital. Solutions Capital has a license from the SBA to operate as an SBIC under the SBIC Act. The license gave Solutions Capital the ability to borrow from the SBA up to $150.0 million, which is the maximum amount of outstanding leverage available to single-license SBIC companies. The maximum amount of outstanding leverage available to SBIC companies with multiple licenses is $225.0 million on an aggregate basis.
To realize the full $150.0 million in borrowings for which we have received approval under this program, we have funded a total of $75.0 million to Solutions Capital. As of March 31, 2012 and December 31, 2011, Solutions Capital had borrowed $150.0 million and $128.6 million, respectively. We may use these funds to provide debt and equity capital to qualifying small businesses. However, we may not use these borrowings to originate debt to certain companies that are currently in our portfolio without SBA approval. In addition, we may not use these funds to provide working capital to MCG, Solutions Capital's parent company.
As of March 31, 2012 and December 31, 2011, we had $172.7 million and $182.4 million, respectively, of investments in our SBIC and we had $63.6 million and $28.8 million, respectively, of restricted cash to be used for additional
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investments in our SBIC.
Once drawn, the SBIC debt bears an interim interest rate of LIBOR plus 30 basis points. The rate then becomes fixed at the time of SBA pooling, which occurs twice each year, and is set to the then-current 10-year treasury rate plus a spread and an annual SBA charge. As of March 31, 2012, the SBIC had borrowings outstanding as summarized in the following table:
Amount Outstanding | |||||||||
(dollars in thousands) | March 31, 2012 | December 31, 2011 | Rate | ||||||
Tranche | |||||||||
2008-10B | $ | 2,600 | $ | 2,600 | 6.44 | % | Fixed | ||
2009-10A | 12,000 | 12,000 | 5.34 | % | Fixed | ||||
2009-10B | 13,000 | 13,000 | 4.95 | % | Fixed | ||||
2010-10B | 27,500 | 27,500 | 3.93 | % | Fixed | ||||
2011-10A | 53,500 | 53,500 | 4.80 | % | Fixed | ||||
2012-10A | 41,400 | 20,000 | 3.38 | % | Fixed | ||||
Total | $ | 150,000 | $ | 128,600 | 3.90 | % |
In October 2008, we received exemptive relief from the SEC which allows us to exclude debt issued by Solutions Capital from the calculation of our consolidated BDC asset coverage ratio.
Commercial Loan Trust 2006-1
In April 2006, we completed a $500.0 million debt securitization through the Commercial Loan Trust 2006-1, or 2006-1 Trust, a wholly owned subsidiary. The 2006-1 Trust issued $106.25 million of Class A-1 Notes, $50.0 million of Class A-2 Notes, $85.0 million of Class A-3 Notes, $58.75 million of Class B Notes, $45.0 million of Class C Notes and $47.5 million of Class D Notes. The respective classes of notes bear interest at LIBOR plus 0.33%, 0.35%, 0.33%, 0.58%, 1.05% and 2.25%.
All of the notes are secured by the assets of the 2006-1 Trust. The following table summarizes the fair value of the assets securitized under this facility as of March 31, 2012 and December 31, 2011:
(dollars in thousands) | March 31, 2012 | December 31, 2011 | ||||||||
Amount | % | Amount | % | |||||||
Securitized assets | ||||||||||
Senior secured debt | $ | 237,074 | 77.0 | % | $ | 258,722 | 78.9 | % | ||
Subordinated secured debt | 38,570 | 12.5 | 43,640 | 13.3 | ||||||
Common Equity | 398 | 0.1 | 282 | 0.1 | ||||||
Total securitized assets | 276,042 | 89.6 | 302,644 | 92.3 | ||||||
Cash, securitization accounts | 31,888 | 10.4 | 25,195 | 7.7 | ||||||
Total collateral | $ | 307,930 | 100.0 | % | $ | 327,839 | 100.0 | % |
We retain all of the equity in the securitization. The securitization included a five-year reinvestment period, which ended in July 2011.
The Class A-1, Class B, Class C and Class D Notes are term notes. The Class A-2 Notes initially provided for a five-year revolving period, which has expired. Therefore, we may not increase the principal amount of the A-2 notes beyond the outstanding balance. The Class A-3 Notes are a delayed draw class of secured notes, which were drawn in full between July 2006 and April 2007. The pool of commercial loans in the trust must meet certain requirements, such as asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements.
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Commercial Loan Funding Trust
Through the MCG Commercial Loan Funding Trust, we had a $35.2 million warehouse financing facility funded through SunTrust Bank. The SunTrust Warehouse is secured primarily by MCG Commercial Loan Funding Trust’s assets, including commercial loans that we sold to the trust. The pool of commercial loans in the trust must meet certain requirements, such as term, average life, investment rating, and agency rating. The pool of commercial loans must also meet certain requirements related to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs.
In January 2012, we entered into an amendment to the SunTrust Warehouse, which, among other things, accelerated the scheduled termination date to January 17, 2012 and set the final legal maturity of this facility to January 17, 2014. The interest rate under the SunTrust Warehouse agreement was the eurodollar or commercial paper rate plus 3.25%. In connection with the execution of the amendment, we used $4.8 million from the principal collections account in the MCG Commercial Loan Funding Trust to reduce the outstanding advances from the SunTrust Warehouse, and we paid an amendment fee of $0.5 million. In addition, due to the reduction of the facility we recognized in interest expense approximately $1.5 million of accelerated deferred financing fees.
As of March 31, 2012, outstanding advances under this facility could be up to 64% of eligible collateral. The SunTrust Warehouse is non-recourse to us; therefore, in the event of a termination event or upon the legal final maturity date, the lenders under the SunTrust Warehouse generally may only look to the collateral to satisfy the outstanding obligations under this facility. The following table summarizes the fair value of the collateral under the MCG Commercial Loan Funding Trust as of March 31, 2012 and December 31, 2011:
(dollars in thousands) | March 31, 2012 | December 31, 2011 | ||||||||
Amount | % | Amount | % | |||||||
Securitized assets | ||||||||||
Senior secured debt | $ | 99,250 | 82.7 | % | $ | 100,527 | 71.5 | % | ||
Subordinated secured debt | 17,283 | 14.4 | 24,870 | 17.7 | ||||||
Total securitized assets | 116,533 | 97.1 | 125,397 | 89.2 | ||||||
Cash, securitization accounts | 3,492 | 2.9 | 15,111 | 10.8 | ||||||
Total collateral | $ | 120,025 | 100.0 | % | $ | 140,508 | 100.0 | % |
PRIVATE PLACEMENT NOTES
In October 2007, we issued $25.0 million of Series 2007-A unsecured notes with a five-year maturity. Initially, the Series 2007-A notes bore interest at a 6.71% per annum, which rate was increased in 2009 to 8.96% per annum. In January 2012, we repaid the Series 2007-A notes in full.
NOTE 6—CAPITAL STOCK
We have one class of common stock and one class of preferred stock authorized. Our board of directors is authorized to: provide for the issuance of shares of preferred stock in one or more series; establish the number of shares to be included in each such series; and establish the designations, voting powers, preferences and rights of the shares of each such series, and any qualifications, limitations or restrictions thereof, subject to the 1940 Act.
STOCK REPURCHASE PROGRAM
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million. Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. During the three months ended March 31, 2012, we repurchased 1,180,000 shares of our common stock at a weighted average purchase price of $4.31 per share, which was a 23.7% discount from our December 31, 2011 net asset value per share.
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DISTRIBUTIONS
The following table summarizes our distributions per share declared since January 1, 2011:
Date Declared | Record Date | Payment Date | Amount | ||
April 27, 2012 | June 13, 2012 | July 13, 2012 | $ | 0.14 | |
February 24, 2012 | April 13, 2012 | May 15, 2012 | $ | 0.17 | |
October 31, 2011 | December 15, 2011 | January 13, 2012 | $ | 0.17 | |
August 1, 2011 | September 14, 2011 | October 14, 2011 | $ | 0.17 | |
May 5, 2011 | June 15, 2011 | July 15, 2011 | $ | 0.17 | |
March 1, 2011 | March 15, 2011 | April 15, 2011 | $ | 0.15 |
NOTE 7—SHARE-BASED COMPENSATION
EMPLOYEE SHARE-BASED COMPENSATION
Third Amended and Restated 2006 Employee Restricted Stock Plan
From time to time, we award shares of restricted common stock to employees under our Third Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, which our stockholders initially approved in June 2006. In May 2010, our stockholders approved an amendment to the 2006 Plan increasing the number of shares we may award from 3,500,000 to 6,050,000 shares. Shares of restricted common stock awarded under the 2006 Plan may be subject to the employees' meeting service or performance conditions specified at the time of award. The award date is the date on which the shares are awarded by the Compensation Committee of our board of directors, while the fair value of the respective stock award is based on the closing price of our common stock on the NASDAQ Global Select Market on the award date. We amortize restricted stock awards on a straight-line basis over the requisite service period and report this expense as amortization of employee restricted stock awards on our Consolidated Statements of Operations.
During the three months ended March 31, 2012 and 2011, we issued 1,000,000 shares and 586,500 shares, respectively, of restricted stock under the 2006 Plan with a weighted-average fair value per share of common stock at the award date of $4.43 and $6.31, respectively.
During the three months ended March 31, 2012 and 2011, we recognized $0.5 million and $0.6 million, respectively, of compensation expense related to share-based compensation awards. As of March 31, 2012, all the restricted share awards for which forfeiture provisions had not lapsed carried non-forfeitable dividend rights to the holder of the restricted shares. As of March 31, 2012, we had $6.1 million of unrecognized compensation cost related to restricted common stock awarded to employees. We expect to recognize these costs over the remaining weighted-average requisite service period of 3.5 years.
Long-Term Incentive Plan
On July 23, 2009, our board of directors approved the Long-Term Incentive Plan, or the LTIP, which is effective for the three-year period ending July 22, 2012. LTIP participants, including our executive officers and key, non-executive employees, were eligible, in the sole discretion of the Compensation Committee of our board of directors, to receive their respective portions of up to an aggregate of 865,000 shares of our restricted common stock to be issued under the 2006 Plan and up to $5.2 million of cash bonuses if the closing price of our common stock achieved specific price thresholds for 20 consecutive trading days.
All of the 865,000 shares of restricted stock under the LTIP were issued during 2009 through 2011, following our achievement of share price thresholds set forth in the following table and authorization of the Compensation Committee of our board of directors. Forfeiture provisions for two-thirds of the respective stock awards lapsed immediately, with the forfeiture provisions for the remaining one-third of the respective stock awards lapsing twelve months later. Similarly, cash awards under the LTIP were subject to the achievement of the share price thresholds set forth in the following table. Upon satisfaction of a price threshold and the authorization of the Compensation Committee, the LTIP provided for the immediate payout of two-thirds of the associated cash with the remainder to be paid twelve months later.
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The following table summarizes the price thresholds, the cumulative percentage, number of shares and cash bonus associated with each stock price threshold set forth in the LTIP. In addition, the following table summarizes the market thresholds that were achieved and the associated stock and cash awards through March 31, 2012.
Market Thresholds, Shares and Cash Bonus Eligible for Award under Long-Term Incentive Plan | Date Market Thresholds Achieved and Shares and Dollar Amounts Awarded | ||||||||||||
Potential Stock Awards | Aggregate Dollar Amount for Each Share Price threshold Achieved | Number of Shares Awarded(a) | |||||||||||
Share Price | % of Award | Number of Shares | Date Share Price Achieved | Dollar Amount Awarded(b) | |||||||||
$3.00 | 25 | % | 216,250 | $ | — | October 2009 | 216,250 | $ | — | ||||
$4.00 | 25 | % | 216,250 | — | October 2009 | 216,250 | — | ||||||
$5.00 | 25 | % | 216,250 | 1,000,000 | April 2010 | 216,250 | 1,000,000 | ||||||
$6.00 | 15 | % | 129,750 | 996,000 | November 2010 | 129,750 | 996,000 | ||||||
$7.00 | 10 | % | 86,500 | 1,006,000 | March 2011 | 86,500 | 1,006,000 | ||||||
$8.00(c) | — | % | — | 2,209,000 | |||||||||
100 | % | 865,000 | $ | 5,211,000 | 865,000 | $ | 3,002,000 |
(a) | As of March 31, 2012, we awarded 865,000 shares under the LTIP program, for which the forfeiture provision have lapsed on 862,917 shares and 2,083 shares were forfeited. |
(b) | As of March 31, 2012, we awarded $3,002,000 of cash awards under the plan, of which $2,001,000 was paid out upon achievement of the market threshold. Cash in the amount of $180,000 was paid to LTIP participants in 2012 after satisfaction of the participants’ service requirement. |
(c) | We are under no obligation to pay the cash award for the $8.00 tranche. The compensation committee of our board of directors has the sole discretion for making such determination, regardless of whether the $8.00 share price has been achieved. Cash awards in the amount of $1,021,000 were forfeited by employees upon resignation/termination from the Company. |
We accounted for the LTIP restricted stock awards as equity awards. As of the July 23, 2009 approval date of the LTIP, we estimated the fair value of these awards was $1.9 million, and we continue to amortize this amount on a straight-line basis over the derived service period. During each of the quarters ended March 31, 2012 and 2011, we recognized less than $0.1 million of compensation expense for these equity awards.
We account for the cash awards under the LTIP as liability awards. As liability awards, we are required to account for the awards based on the fair value of the award at the end of each reporting period and to recognize the expense over the then-current estimated requisite service period. During the three months ended March 31, 2012 and 2011 we reversed less than $0.1 million of previously recognized compensation expense for the cash awards under the LTIP. As of March 31, 2012, the fair value of the $8.00 tranche was less than $0.1 million. However, during the twelve months ending December 31, 2012, we could be required to recognize up to $1.2 million of compensation expense if the associated market condition for the $8.00 tranche were to be achieved before July 22, 2012 and the compensation committee approves the payment.
Non-Employee Director Share-Based Compensation
During June 2006, our stockholders initially approved the 2006 Non-Employee Director Restricted Stock Plan, which was subsequently amended and restated and which we refer to as the 2006 Non-Employee Plan. In May 2010, our stockholders approved an amendment to the 2006 Non-Employee Plan that increased the number of shares we may award from 100,000 to 150,000 shares. During each of the three months ended March 31, 2012 and 2011, we did not award any shares of restricted common stock to non-employee directors. During each of the three months ended March 31, 2012 and 2011, we recognized less than $0.1 million of compensation costs related to share-based awards to non-employee directors. We include this compensation cost in general and administrative expense on our Consolidated Statements of Operations. As of March 31, 2012, we had $0.1 million of unrecognized compensation cost related to restricted common stock awarded to non-employee directors, which we expect to recognize over the remaining weighted-average requisite service period of 1.9 years.
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SUMMARY OF EMPLOYEE AND NON-EMPLOYEE DIRECTOR SHARE-BASED COMPENSATION
The following table summarizes our restricted stock award activity during the three months ended March 31, 2012:
Shares | Weighted-Average Grant Date Fair Value per Share | ||||
Subject to forfeiture provisions as of December 31, 2011 | 430,510 | $ | 6.14 | ||
Awarded | 1,000,000 | $ | 4.43 | ||
Forfeiture provision satisfied | (141,660 | ) | $ | 4.79 | |
Forfeited | (12,750 | ) | $ | 7.09 | |
Subject to forfeiture provisions as of March 31, 2012 | 1,276,100 | $ | 4.89 |
NOTE 8—CORPORATE RESRUCTURING AND 2011 RETENTION PLAN
Corporate Restructuring
On August 1, 2011, our board of directors approved a plan to reduce our workforce by 42%, including 22 current employees and 5 resignations. Affected employees received severance pay, continuation of benefits and, for employees who had been awarded restricted stock, additional lapsing of restrictions associated with restricted stock awards. We have accounted for these costs in accordance with ASC 420-10-Exit or Disposal Cost Obligations.
During the three months ended March 31, 2012, we incurred $26,000 of restructuring expenses related to severance obligations, which we reported as a separate line item on our Consolidated Statements of Operations.
We included liabilities associated with our restructuring in other liabilities on our Consolidated Balance Sheets. The following table summarizes changes in the balance of our restructuring liabilities from January 1, 2012 through March 31, 2012:
(in thousands) | Severance Benefits(a) | Other | Total | ||||||
Balance as of December 31, 2011 | $ | 2,472 | $ | 54 | $ | 2,526 | |||
Additions | — | — | — | ||||||
Accretion | 26 | — | 26 | ||||||
Cash payments | (833 | ) | (8 | ) | (841 | ) | |||
Balance as of March 31, 2012 | $ | 1,665 | $ | 46 | $ | 1,711 |
(a) Includes the cost of severance and continuation of benefits.
2011 Retention Program
On August 1, 2011, our board of directors approved the MCG Capital Corporation 2011 Retention Program, or the Retention Program, for the benefit of our employees, including one of our named executive officers, but excluding our then: i) President and Chief Executive Officer; ii) Executive Vice President and Chief Financial Officer; iii) Executive Vice President of Business Development; and iv) Senior Vice President, General Counsel and Chief Compliance Officer. We designed the Retention Program to provide eligible employees with certain incentives related to their past service and continuing employment with MCG. The Retention Program consists of an aggregate of $1.3 million in cash and up to 121,250 shares of restricted common stock.
Under the Retention Program, we awarded a cash bonus to eligible employees, representing a specified percentage of each eligible employee's respective annual cash bonus target for the fiscal year ending December 31, 2011. We paid half of the incentive bonus to eligible employees on March 31, 2012 and will pay the remaining amount on September 30, 2012, to eligible employees, subject to continued employment with MCG. Certain employees also received shares of restricted common stock under the 2006 Plan. The forfeiture provisions with respect to 50% of the shares of restricted common stock subject to each Retention Program award lapsed on March 31, 2012 and the remaining 50% will lapse on September 30, 2012.
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NOTE 9—INCOME TAXES
As a RIC, we are taxed under Subchapter M of the Internal Revenue Code. As such, our income generally is not taxable to the extent we distribute it to stockholders and we meet certain qualification tests as outlined in the Internal Revenue Code. However, income from certain investments owned by our wholly owned subsidiaries is subject to federal, state and local income taxes. On a continuing basis, we monitor distribution requirements in order to comply with Subchapter M of the Internal Revenue Code.
We use the asset and liability method to account for our Taxable Subsidiaries' income taxes. Using this method, we recognize deferred tax assets and liabilities for the estimated future tax effects attributable to temporary differences between financial reporting and the tax bases of assets and liabilities. In addition, we recognize deferred tax benefits associated with net operating carryforwards that we may use to offset future tax obligations. We measure deferred tax assets and liabilities using the enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences. During each of the three months periods ended March 31, 2012 and 2011, we incurred less than a $0.1 million income tax provision , which was primarily attributable to unrealized depreciation or appreciation and flow-through taxable income on certain investments held by our subsidiaries.
On December 22, 2010, the Regulated Investment Company Modernization Act of 2010, or the Modernization Act, was enacted, which changed various technical rules governing the tax treatment of regulated investment companies. The changes are generally effective for taxable years beginning after the date of enactment. One of the more prominent changes addresses capital loss carryforwards. Under the Modernization Act, each RIC will be permitted to carry forward capital losses incurred in taxable years beginning after the date of enactment for an unlimited period. However, any losses incurred during those future taxable years will be required to be utilized prior to the losses incurred in pre-enactment taxable years, which carry an expiration date. As a result of this ordering rule, pre-enactment capital loss carryforwards may be more likely to expire unused. Additionally, post-enactment capital loss carryforwards will retain their character as either short-term or long-term capital losses rather than being considered all short-term as permitted under previous regulation.
Historically, we have declared dividends that were paid the following quarter. From December 2001 through March 31, 2012, we declared distributions per share of $12.98. Each year, we mail statements on Form 1099-DIV to our stockholders that identify whether we made distributions from ordinary income, net capital gains on the sale of securities, which are each taxable distributions, and/or a return of paid-in-capital surplus, which is a nontaxable distribution. A portion of our distributions may represent a return of capital to our stockholders, to the extent that the total distributions paid in a given year exceed current and accumulated taxable earnings and profits. A portion of the distributions that we paid to stockholders during fiscal years 2011, 2008, 2006, 2005, 2004 and 2003 represented a return of capital.
We determine the tax attributes of our distributions as of the end of our fiscal year based upon our taxable income for the full year and distributions paid during the full year. Therefore, a determination of tax attributes made on a quarterly basis may not be representative of the actual tax attributes of distributions for a full year. If we determined the tax attributes of our distributions as of March 31, 2012, 39% would be from ordinary income and 61% would be a return of capital. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.
Taxable income differs from net income recognized in accordance with accounting principles generally accepted in the United States, or GAAP, because of temporary and permanent differences in income and expense recognition.
Taxable income generally excludes unrealized gains and losses from appreciation or depreciation of our investments, which are included in GAAP net income. Further, amounts recognized for financial reporting purposes may differ from amounts included in taxable income due to the accrued dividends on preferred stock, which increase the book basis but not the tax basis of our investments, and non-accrual interest on loans, which increase the tax basis but not the book basis.
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NOTE 10—EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted income (loss) per common share for the three months ended March 31, 2012 and 2011:
(dollars in thousands, except per share amounts) | Three months ended March 31, | ||||||
2012 | 2011 | ||||||
Numerator for basic and diluted earnings per share | |||||||
Net income (loss) | $ | 1,357 | $ | (8,815 | ) | ||
Less: Dividends declared—common and restricted shares | (13,050 | ) | (11,582 | ) | |||
Undistributed income (loss) | (11,693 | ) | (20,397 | ) | |||
Percentage allocated to common shares(a) | 99.2 | % | 100.0 | % | |||
Undistributed earnings—common shares | (11,599 | ) | (20,397 | ) | |||
Add: Dividends declared—common shares | 12,946 | 11,582 | |||||
Numerator for common shares outstanding excluding participating shares | 1,347 | (8,815 | ) | ||||
Numerator for participating unvested shares only | 10 | — | |||||
Numerator for basic and diluted earnings per share—total | $ | 1,357 | $ | (8,815 | ) | ||
Denominator for basic and diluted weighted-average shares outstanding | |||||||
Common shares outstanding | 76,443 | 75,765 | |||||
Participating unvested shares(b) | 607 | — | |||||
Basic and diluted weighted-average common shares outstanding—total(b) | 77,050 | 75,765 | |||||
Earnings (loss) per share—basic and diluted | |||||||
Excluding participating unvested shares | $ | 0.02 | $ | (0.12 | ) | ||
Including participating unvested shares | $ | 0.02 | $ | (0.12 | ) | ||
(a) Basic and diluted weighted-average common shares: | |||||||
Weighted-average common shares outstanding | 76,443 | 75,765 | |||||
Weighted-average restricted shares | 607 | — | |||||
Total basic and diluted weighted-average common shares | 77,050 | 75,765 | |||||
Percentage allocated to common shares | 99.2 | % | 100.0 | % | |||
(b) For the three months ended March 31, 2011, we excluded 1,087, of weighted-average shares of restricted common stock from the calculation of diluted loss per share because the inclusion of these shares would have had an anti-dilutive impact on the calculation of loss per share. |
Holders of unvested shares of our issued and outstanding restricted common stock are eligible to receive non-forfeitable dividends. As such, these unvested shares are participating securities requiring the two-class method of computing earnings per share in periods with net income. Pursuant to the two-class method, we report basic and diluted loss per share both inclusive and exclusive of the impact of the participating securities.
NOTE 11—CONTINGENCIES AND COMMITMENTS
LEGAL PROCEEDINGS
We are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. While the outcome of these legal proceedings cannot at this time be predicted with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations.
FINANCIAL INSTRUMENTS
During the normal course of business, we are party to certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments. We conduct extensive due diligence and, when appropriate, obtain collateral to limit our credit risk. Generally, these commitments have fixed expiration dates or other termination clauses, which may require payment of a fee by the counterparty. We expect many of these commitments will not be fully used before they expire; therefore, the total commitment amounts do not necessarily represent future cash requirements.
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We do not report the unused portions of these commitments on our Consolidated Balance Sheets. As of March 31, 2012 and December 31, 2011, we had $24.9 million and $22.6 million, respectively, of outstanding unused loan commitments. We estimate that as of each of March 31, 2012 and December 31, 2011, the fair value of these commitments was $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. As of March 31, 2012 and December 31, 2011, we had no outstanding guarantees or standby letters of credit.
LEASE OBLIGATIONS
We lease our headquarters and certain other facilities and equipment under non-cancelable operating and capital leases which expire through 2013. We have sublet certain of our facilities to third parties. Certain facility leases contain provisions for rental options and rent escalations based on scheduled increases, as well as increases resulting from a rise in certain costs incurred by the lessor. As of March 31, 2012, our obligation for the remaining terms of these leases was $2.0 million, substantially all of which will be payable during the twelve months ending March 31, 2013.
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NOTE 12—FINANCIAL HIGHLIGHTS
The following schedule summarizes our financial highlights for the three months ended March 31, 2012 and 2011:
(in thousands, except per share amounts) | Three months ended March 31, | |||||
2012 | 2011 | |||||
Per share data | ||||||
Net asset value at beginning of period(a) | $ | 5.65 | $ | 7.54 | ||
Net income (loss)(b) | ||||||
Net operating income before net investment loss, loss on extinguishment of debt and income tax provision | 0.05 | 0.17 | ||||
Net unrealized (depreciation) appreciation on investments | (0.24 | ) | 0.08 | |||
Net realized gain (loss) on investments | 0.21 | (0.36 | ) | |||
Loss on extinguishment of debt before income tax provision | — | (0.01 | ) | |||
Net income (loss) | 0.02 | (0.12 | ) | |||
Net decrease in net assets resulting from distributions | (0.17 | ) | (0.15 | ) | ||
Net decrease in net assets relating to stock-based transactions | ||||||
Issuance of shares of restricted common stock(c) | (0.07 | ) | (0.05 | ) | ||
Repurchase of common stock | 0.02 | — | ||||
Net increase in stockholders’ equity from restricted stock amortization | — | 0.01 | ||||
Net decrease in net assets relating to share issuances | (0.05 | ) | (0.04 | ) | ||
Net asset value at end of period(a) | 5.45 | 7.23 | ||||
Market price per share | ||||||
Beginning of period | $ | 3.99 | $ | 6.97 | ||
End of period | $ | 4.26 | $ | 6.52 | ||
Total Return(d) | 11.03 | % | -4.45 | % | ||
Shares of Common Stock Outstanding(d) | ||||||
Weighted-average—basic and diluted | 77,050 | 75,765 | ||||
End of period | 76,762 | 77,065 | ||||
Net assets | ||||||
Average (annualized) | $ | 436,919 | $ | 574,024 | ||
End of period | $ | 418,485 | $ | 557,093 | ||
Ratios (annualized) | ||||||
Operating expenses to average net assets | 12.44 | % | 7.98 | % | ||
Net operating income to average net assets | 3.72 | % | 9.19 | % | ||
General and administrative expense to average net assets | 3.62 | % | 2.00 | % | ||
Return on average equity | 1.25 | % | -6.23 | % | ||
(a) Based on total number of shares outstanding. | ||||||
(b) Based on weighted-average number of shares outstanding. | ||||||
(c) Represents the effects of shares issued during the period and the lapsing of forfeiture provisions on restricted stock on earnings per share. | ||||||
(d) Total return = [(ending market price per share – beginning market price per share + dividends paid per share) / beginning market price per share]. |
NOTE 13—SUBSEQUENT EVENTS
DEPARTURE OF OFFICER
On May 3, 2012, the Company accepted the resignation of Stephen J. Bacica from his position as Executive Vice President, Chief Financial Officer and Treasurer. Mr. Bacica will continue to provide transition services to MCG through May 15, 2012, or the Separation Date. Mr. Bacica's resignation allows him to pursue other interests and is not the result of any disagreement with the Company, known to an executive officer of the Company, on any matter relating to the Company's operations, policies or practices.
On May 3, 2012, Mr. Bacica executed a letter agreement, or the Letter Agreement, which sets forth the terms of his
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separation from the Company in accordance with his pre-existing employment agreement with the Company, including the agreement by the Company to treat Mr. Bacica's resignation as a termination other than for cause for purposes of such agreement. Under the terms of the Letter Agreement, Mr. Bacica will receive: (i) his accrued and unpaid base salary and unreimbursed business expenses, in each case through the Separation Date; and (ii) full and immediate lapsing of forfeiture conditions with respect to 23,680 shares of restricted stock that were originally scheduled to lapse through December 31, 2014. Mr. Bacica will also receive a severance payment in the amount of $1,582,000, representing two times his current base salary and two times his target annual bonus, which will be paid in installments over the 24-month period following the Separation Date. Receipt of separation benefits is subject to Mr. Bacica's execution and non-revocation of a release of claims against the Company and his continued compliance with certain non-competition and other obligations.
APPOINTMENT OF OFFICER
Effective May 15, 2012, Keith Kennedy, Executive Vice President and Managing Director, will assume the additional roles of Chief Financial Officer and Treasurer.
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
MCG Capital Corporation
We have reviewed the accompanying consolidated balance sheet of MCG Capital Corporation, including the consolidated schedule of investments, as of March 31, 2012, and the related consolidated statements of operations, changes in net assets, cash flows and financial highlights for the three-month periods ended March 31, 2012 and 2011. These financial statements are the responsibility of MCG Capital Corporation’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of MCG Capital Corporation as of December 31, 2011, including the consolidated schedule of investments, and the related consolidated statements of operations, changes in net assets, cash flows, and financial highlights for the year then ended (not presented herein), and in our report dated March 1, 2012 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2011, including the consolidated schedules of investment, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ ERNST & YOUNG LLP
McLean, Virginia
May 3, 2012
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ITEM 2. 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 Financial Data and our Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
This Quarterly Report on Form 10-Q, including 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, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management including, without limitation: our expectations regarding our results of operations, including revenues, net operating income, net investment losses and general and administrative expenses and the factors that may affect such results; our expectations regarding the full use before expiration of certain financial instruments, including loans, participations in loans, guarantees, letters of credit and other financial commitments; the timing of the anticipated payoff of our SunTrust Warehouse facility and the associated acceleration and recognition of deferred financing fees; the timing and level of staff reductions by year-end 2012; projected future annual base compensation and benefits levels and annual non-compensation cost structure amounts; expected levels of transition plan costs during 2012; forecasted 2012 and 2013 per share net operating income amounts, which may not be realized; the reduction of investments in equity securities to less than 10% of the fair value of our portfolio over the next few years; the limitation of future investing activities principally to debt investments; our level of investments in control companies beyond those that are currently in our portfolio; our decisions to make dividend distributions after taking into account the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our BDC asset coverage ratio; our belief that we will continue to be constrained by the limited access we have to debt and equity capital; our intentions to purchase debt for cash in open market purchases and/or privately-negotiated transactions; the sufficiency of liquidity to meet 2012 operating requirements, as well as new origination opportunities and potential dividend distributions during the upcoming year; our ability to obtain the liquidity for the repayment of our borrowing facilities; general market conditions; the state of the economy and other factors. Forward-looking statements can be identified by terminology such as “anticipate,” “believe,” “could,” “could increase the likelihood,” “hope,” “target,” “project,” “goals,” “potential,” “predict,” “might,” “estimate,” “expect,” “intend,” “is planned,” “may,” “should,” “will,” “will enable,” “would be expected,” “look forward,” “may provide,” “would” or similar terms, variations of such terms or the negative of those terms. 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. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those risk factors discussed in Item IA of Part II of this Quarterly Report on Form 10-Q.
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 Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q. We undertake no obligation to update or revise any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
DESCRIPTION OF BUSINESS
We are a solutions-focused commercial finance company providing capital and advisory services to middle-market companies throughout the United States. For our core portfolio, we make debt and equity investments primarily in companies with annual revenue of $20 million to $200 million and earnings before interest, taxes, depreciation and amortization, or EBITDA, of $3 million to $25 million, which we refer to as “middle-market” companies. Generally, our portfolio companies use our capital investment to finance acquisitions, recapitalizations, buyouts, organic growth and working capital.
We are an internally managed, non-diversified, closed-end investment company that has elected to be regulated as a business development company, or BDC, under the Investment Company Act of 1940, as amended, or the 1940 Act. As a BDC we must meet various regulatory tests, which include investing at least 70% of our total assets in private or thinly traded public U.S.-based companies and meeting a 200% asset coverage ratio of total net assets to total senior securities excluding SBIC debt.
In addition, we have elected to be treated for federal income tax purposes as a regulated investment company, or RIC, under Subchapter M of the Internal Revenue Code. In order to continue to qualify as a RIC for federal income tax purposes and obtain favorable RIC tax treatment, we must meet certain requirements, including certain minimum distribution requirements. If we satisfy these requirements, we generally will not have to pay corporate-level taxes
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on any income we distribute to our stockholders as distributions, allowing us to substantially reduce or eliminate our corporate-level tax liability. From time to time, our wholly owned subsidiaries may execute transactions that trigger corporate-level tax liabilities. In such cases, we recognize a tax provision in the period when it becomes more likely than not that the taxable event will occur.
RECENT DEVELOPMENTS
We continue to execute on our strategic plan to return the Company to its roots as a leading middle-market lender. We continue to simplify our capital structure, redeploy unencumbered cash into yield-oriented investments, repay debt and return equity to our stockholders. We are also re-sizing the business to operate more efficiently. The following significant developments occurred during the first four months of 2012:
• | Equity Monetizations - On February 24, 2012, we successfully exited our equity investment in Jenzabar, Inc. for $23.7 million in proceeds, realizing a $16.4 million gain over the 8-year investment period. On April 30, 2012, we successfully exited our equity investment in GSDM Holdings Corp. for $7.1 million, $5.2 million of which we received at closing and $1.9 million of which will be held in escrow. |
• | Loan Monetizations and Fundings - We received $55.3 million in loan payoffs and amortization payments during the first quarter of 2012. Four borrowers repaid $48.1 million in principal at or above par. We did not fund any new debt investments during the first quarter; however, we funded $3.8 million in loan advances and draws to existing borrowers. In conjunction with the sale of our investment in GSDM Holdings Corp, the Borrower repaid the outstanding contractual loan balances of approximately $27.6 million owed to us. |
• | Open-Market Purchase of Our Stock - In January 2012, our board of directors authorized a stock repurchase program of up to $35.0 million. In the first quarter of 2012, we repurchased and retired 1,180,000 shares at a total cost of $5.1 million, or an average of $4.31 per share. We acquired these shares from sellers in open market transactions. We retire these shares upon settlement, thereby reducing the number of authorized shares otherwise outstanding. |
• | Operational Realignment - Executing on our transition plan, during the first quarter of 2012 we eliminated an additional ten positions, including seven back-office or support positions. In the first quarter, we accrued $1.1 million in severance related expenses and we anticipate accruing an additional $0.4 million in severance related expenses over the remainder of 2012 related to these ten positions. At the end of the required service period for each terminated employee, our full time headcount will be reduced to 28. Furthermore, we would anticipate transitioning our current workforce to a level of 20 to 25 by year end 2012. |
• | Liquidity and De-Leveraging Events - During the first quarter 2012, our asset coverage ratio improved from 244% at December 31, 2011 to 265% at March 31, 2012. We also took the following actions during the quarter: |
◦ | SunTrust Warehouse Modification - In January 2012, we entered into an amendment to our SunTrust Warehouse facility, which among other things, accelerated the scheduled termination date to January 17, 2012 and set the final legal maturity of this facility to January 17, 2014, thereby commencing a 24-month amortization period. We paid down $20.6 million of debt in this facility during the quarter, reducing the outstanding loan balance from $55.8 million at December 31, 2011 to $35.2 million at March 31, 2012. In connection with the execution of the amendment, we paid an amendment fee of $0.5 million. In addition, due to the reduction of the facility we recognized in interest expense approximately $1.5 million of accelerated deferred financing fees. |
◦ | SunTrust Warehouse Pay-off - We anticipate paying off the SunTrust Warehouse facility in the second quarter of 2012. As of March 31, 2012, we had $1.0 million of deferred financing fees on our balance sheet recorded in other assets. Upon the repayment of our obligation to SunTrust, we anticipate accelerating and recognizing the deferred financing fees as an interest expense in our Consolidated Statement of Operations. |
◦ | Private Placement Notes - In January 2012, we repaid in full and terminated the Series 2007-A unsecured notes. We paid the noteholders $8.7 million of principal, $0.2 million in accrued interest and $0.2 million in prepayment fees. The prepayment fees are recorded as a "loss on extinguishment of debt before income tax provision" in our Consolidated Statement of Operations for the three months ended March 31, 2012. |
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OUTLOOK
As previously discussed, based on our continuing success in executing on our strategic plan, we continue to target future annual base compensation and benefits levels of approximately $4.0 million to $5.0 million beginning in 2013, as well as a projected embedded annual non-compensation cost structure of approximately $5.5 million to $6.5 million by no later than the end of the first quarter of 2013, which is when the lease on the Company's current headquarters facility expires.
Consistent with our previous 2012 guidance, we expect to incur costs associated with our transition plan of approximately $0.10 per share to $0.15 per share, primarily attributable to severance costs and the related acceleration of restricted stock for terminated employees, the amendment and anticipated pay-off of our SunTrust Warehouse financing facility, and employee compensation, primarily in the form of retention and inducement payments.
During the three months ended March 31, 2012, we incurred costs associated with our transition plan of $3.7 million or $0.05 per share, consisting of $1.5 million in accelerated deferred financing fees associated with the amendment of our SunTrust Warehouse financing facility that we recorded as interest expense, $1.0 million in retention and inducement payments that we recorded as salaries and benefits, $0.1 million in amortization expenses associated with the elimination of the additional ten positions that we recorded as amortization of employee restricted stock awards, and $1.1 million in severance related expenses that we recorded as general and administrative expense.
Due to increasing debt and equity monetizations within our portfolio, the anticipated effect of debt facility repayment, the timing and impact of slower origination pacing and the resulting additional cash held on our balance sheet, we are revising our net operating income forecast for 2012, excluding transition costs, to approximately $0.35 per share to $0.40 per share from $0.40 per share to $0.50 per share.
As we begin to realize the expected benefits of our transition plan and redeploy capital, taking into consideration the timing of new loans, the yields we expect to earn on our new investments, our ability to use leverage in making these investments, the health and performance of our existing investments, our ability to make quality investments and manage them well, and other risk factors and considerations outlined in our public disclosures, we are forecasting net operating income of approximately $0.50 per share to $0.60 per share for 2013. However, absent a change in current origination levels, we would expect to be at the lower end of this range.
ACCESS TO CAPITAL AND LIQUIDITY
Our access to debt and equity capital continues to be constrained. Because our stock continues to trade below net asset value, or NAV, and we do not have stockholder approval to sell equity below our NAV, we effectively lack access to the equity markets. Lenders, in general, may be reluctant to extend credit to us without such equity capital markets access.
At March 31, 2012, we had $59.9 million of cash and cash equivalents available for general corporate purposes, as well as $63.6 million of cash in restricted accounts related to our SBIC that we could use to fund new investments in the SBIC and $5.7 million of restricted cash held in escrow. In addition, we had $35.4 million of cash in securitization accounts, that may only be used to make interest and principal payments on our securitized borrowings or distributions to MCG in accordance with the indenture agreements.
At March 31, 2012, cash in securitization accounts included $31.9 million in our Commercial Loan Trust 2006-1. In April 2012, we used $28.0 million of securitized cash to repay borrowings of our Commercial Loan Trust 2006-1. The reinvestment period for this facility ended on July 20, 2011 and all subsequent principal collections received have been and will be used to repay the securitized debt.
At March 31, 2012, cash in securitization accounts included $3.5 million in our MCG Commercial Loan Funding Trust that may only be used to make interest and principal payments on our securitized borrowings under the SunTrust Warehouse facility. In April 2012, we used $0.7 million to repay outstanding borrowings of our MCG Commercial Loan Funding Trust. In January 2012, this facility entered a 24-month amortization period with a final legal maturity in January 2014. All future principal collections by the MCG Commercial Loan Funding Trust will be used to reduce the balance of the outstanding advances under this facility. We anticipate paying off the SunTrust Warehouse facility in the second quarter of 2012.
At March 31, 2012, $150.0 million of SBA borrowings were outstanding, the maximum available under our current license.
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OTHER ORGANIZATIONAL CHANGES
On May 3, 2012, we accepted the resignation of Stephen J. Bacica from his position as Executive Vice President, Chief Financial Officer and Treasurer. Mr. Bacica will continue to provide transition services to MCG through May 15, 2012. Mr. Bacica's resignation allows him to pursue other interests and is not the result of any disagreement with the Company, known to an executive officer of the Company, on any matter relating to the Company's operations, policies or practices. In the second quarter of 2012, we will record a liability and recognize a general and administrative expense of approximately $1.6 million for severance obligations payable under the terms of the letter agreement outlining the terms of Mr. Bacica's separation from the Company. In addition, and as a result of the lapsing of the forfeiture provisions on Mr. Bacica's restricted common stock under the terms of his letter agreement, we will recognize approximately $0.2 million of amortization of employee restricted stock.
Effective May 15, 2012, Keith Kennedy, Executive Vice President and Managing Director, will assume the additional roles of Chief Financial Officer and Treasurer.
PORTFOLIO COMPOSITION AND INVESTMENT ACTIVITY
As of March 31, 2012, the fair value of our investment portfolio was $666.1 million, which represents a $75.0 million, or 10.1%, decrease from the $741.2 million fair value as of December 31, 2011. The following sections describe the composition of our investment portfolio as of March 31, 2012 and describe key changes in our portfolio during the three months ended March 31, 2012.
Portfolio Composition
The following table summarizes the composition of our investment portfolio at fair value:
March 31, 2012 | December 31, 2011 | |||||||||
(dollars in thousands) | Investments at Fair Value | Percent of Total Portfolio | Investments at Fair Value | Percent of Total Portfolio | ||||||
Debt investments | ||||||||||
Senior secured debt | $ | 458,928 | 68.9 | % | $ | 492,488 | 66.4 | % | ||
Subordinated debt | ||||||||||
Secured | 112,070 | 16.8 | 124,289 | 16.8 | ||||||
Unsecured | 12,353 | 1.9 | 12,203 | 1.7 | ||||||
Total debt investments | 583,351 | 87.6 | 628,980 | 84.9 | ||||||
Equity investments | ||||||||||
Preferred equity | 77,901 | 11.7 | 89,931 | 12.1 | ||||||
Common/common equivalents equity | 4,888 | 0.7 | 22,255 | 3.0 | ||||||
Total equity investments | 82,789 | 12.4 | 112,186 | 15.1 | ||||||
Total investments | $ | 666,140 | 100.0 | % | $ | 741,166 | 100.0 | % |
Our debt instruments bear contractual interest rates ranging from 2.5% to 17.5%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of March 31, 2012, approximately 87.3% of the fair value of our loan portfolio had variable interest rates, based on a LIBOR benchmark or the prime rate, and 12.7% of the fair value of our loan portfolio had fixed interest rates. As of March 31, 2012, approximately 77.2% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on a LIBOR based index and prime floors between 1.75% and 6.0%. At origination, our loans generally have four- to eight-year stated maturities. Borrowers typically pay an origination fee based on a percentage of the total commitment and a fee on undrawn commitments.
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The following table summarizes our investment portfolio by industry at fair value:
Mach 31, 2012 | December 31, 2011 | |||||||||
(dollars in thousands) | Investments at Fair Value | Percent of Total Portfolio | Investments at Fair Value | Percent of Total Portfolio | ||||||
Healthcare | $ | 82,640 | 12.4 | % | $ | 84,660 | 11.4 | % | ||
Business services | 78,078 | 11.7 | 78,468 | 10.6 | ||||||
Education | 68,858 | 10.3 | 69,124 | 9.3 | ||||||
Manufacturing | 61,571 | 9.2 | 77,849 | 10.5 | ||||||
Cable | 40,435 | 6.1 | 43,122 | 5.8 | ||||||
Logistics | 33,652 | 5.1 | 33,684 | 4.5 | ||||||
Communications | 32,760 | 4.9 | 34,507 | 4.7 | ||||||
Electronics | 31,734 | 4.8 | 31,966 | 4.3 | ||||||
Publishing | 31,275 | 4.7 | 31,319 | 4.2 | ||||||
Food services | 28,534 | 4.3 | 28,842 | 3.9 | ||||||
Broadcasting | 27,975 | 4.2 | 28,185 | 3.8 | ||||||
Insurance | 25,137 | 3.8 | 24,987 | 3.4 | ||||||
Auto Parts | 20,134 | 3.0 | 19,778 | 2.7 | ||||||
Repair Services | 19,845 | 3.0 | 19,839 | 2.7 | ||||||
Home Furnishings | 14,052 | 2.1 | 12,355 | 1.7 | ||||||
Information Services | 12,071 | 1.8 | 21,672 | 2.9 | ||||||
Plastic Products | 12,048 | 1.8 | 21,784 | 2.9 | ||||||
Restaurants | 9,287 | 1.4 | 18,578 | 2.5 | ||||||
Agriculture | 9,264 | 1.4 | 9,464 | 1.3 | ||||||
Entertainment | 7,682 | 1.2 | 7,539 | 1.0 | ||||||
Cosmetics | 7,311 | 1.1 | 8,521 | 1.2 | ||||||
Technology | 988 | 0.1 | 24,690 | 3.3 | ||||||
Other(a) | 10,809 | 1.6 | 10,233 | 1.4 | ||||||
Total | $ | 666,140 | 100.0 | % | $ | 741,166 | 100.0 | % | ||
______________________ (a) No individual industry within this category exceeds 1%. |
As of March 31, 2012, our ten largest portfolio companies represented approximately 44.5% of the total fair value of our investments. These ten companies accounted for 44.8% of our total revenue during the three months ended March 31, 2012.
During the three months ended March 31, 2012, we had concentrations in certain industries, including the healthcare, business services and education industries. The following table summarizes our fair value and revenue concentrations in each of those industries:
Investments at fair value | Revenue for the three months ended | |||||||||||||||||||
As of March 31, 2012 | As of December 31, 2011 | March 31, 2012 | March 31, 2011 | |||||||||||||||||
(dollars in thousands) | Amount | % of Total Portfolio | Amount | % of Total Portfolio | Amount | % of Total Revenue | Amount | % of Total Revenue | ||||||||||||
Industry | ||||||||||||||||||||
Healthcare | $ | 82,640 | 12.4 | % | $ | 84,660 | 11.4 | % | $ | 2,706 | 15.4 | % | $ | 2,630 | 10.8 | % | ||||
Business services | 78,078 | 11.7 | 78,468 | 10.6 | 2,043 | 11.6 | 2,168 | 8.9 | ||||||||||||
Education | 68,858 | 10.3 | 69,124 | 9.3 | 1,389 | 7.9 | 811 | 3.3 |
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Changes in Investment Portfolio
During the three months ended March 31, 2012, we completed $6.2 million of advances including $3.8 million of advances to two existing portfolio companies, compared to $95.1 million of originations and advances during the three months ended March 31, 2011. The following table summarizes our total portfolio investment activity during the three months ended March 31, 2012 and 2011:
Three months ended March 31, | ||||||
(in thousands) | 2012 | 2011 | ||||
Beginning investment portfolio | $ | 741,166 | $ | 1,009,705 | ||
Originations and advances | 6,213 | 95,103 | ||||
Gross payments, reductions and sales of securities | (79,318 | ) | (129,223 | ) | ||
Net gain (loss) | 16,378 | (27,609 | ) | |||
Unrealized (depreciation) | (2,351 | ) | (19,081 | ) | ||
Reversals of unrealized (appreciation) depreciation | (16,515 | ) | 25,782 | |||
Origination fees and amortization of unearned income | 567 | (328 | ) | |||
Ending investment portfolio | $ | 666,140 | $ | 954,349 |
Originations and Advances
The following table shows our originations and advances during the three months ended March 31, 2012 and 2011 by security type:
Three months ended March 31, | ||||||||||
2012 | 2011 | |||||||||
(dollars in thousands) | Amount | % of Total | Amount | % of Total | ||||||
Debt investments | ||||||||||
Senior secured debt | $ | 4,564 | 73.5 | % | $ | 61,918 | 65.1 | % | ||
Subordinated debt | ||||||||||
Secured | 503 | 8.1 | 30,143 | 31.7 | ||||||
Unsecured | 69 | 1.1 | 57 | 0.1 | ||||||
Total debt investments | 5,136 | 82.7 | 92,118 | 96.9 | ||||||
Equity investments | ||||||||||
Preferred equity | 1,077 | 17.3 | 2,801 | 2.9 | ||||||
Common/common equivalents equity | — | — | 184 | 0.2 | ||||||
Total equity investments | 1,077 | 17.3 | 2,985 | 3.1 | ||||||
Total originations and advances | $ | 6,213 | 100.0 | % | $ | 95,103 | 100.0 | % |
The following table shows our significant originations and advances.
(in thousands) | Three months ended March 31, 2012 | |||||||||||
Company | Originations | Draws/ Advances | PIK Advances/ Dividends | Total | ||||||||
Debt | ||||||||||||
Advanced Sleep Concepts, Inc. | $ | — | $ | 3,500 | $ | 57 | $ | 3,557 | ||||
Other (< $1 million) | — | 300 | 1,279 | 1,579 | ||||||||
Total debt | — | 3,800 | 1,336 | 5,136 | ||||||||
Equity (< $1 million) | — | — | 1,077 | 1,077 | ||||||||
Total originations and advances | $ | — | $ | 3,800 | $ | 2,413 | $ | 6,213 |
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Repayments, Sales and Other Reductions of Investment Portfolio
The following table shows our gross payments, reductions and sales of securities during the three months ended March 31, 2012 and 2011 by security type:
Three months ended March 31, | ||||||||||
2012 | 2011 | |||||||||
(dollars in thousands) | Amount | % of Total | Amount | % of Total | ||||||
Debt investments | ||||||||||
Senior secured debt | $ | 42,682 | 53.8 | % | $ | 73,186 | 56.6 | % | ||
Subordinated debt | ||||||||||
Secured | 12,620 | 15.9 | 37,568 | 29.1 | ||||||
Unsecured | 8 | — | — | — | ||||||
Total debt investments | 55,310 | 69.7 | 110,754 | 85.7 | ||||||
Equity investments | ||||||||||
Preferred equity | 7,216 | 9.1 | 18,224 | 14.1 | ||||||
Common/common equivalents equity | 16,792 | 21.2 | 245 | 0.2 | ||||||
Total equity investments | 24,008 | 30.3 | 18,469 | 14.3 | ||||||
Total gross payments, reductions and sales of securities | $ | 79,318 | 100.0 | % | $ | 129,223 | 100.0 | % |
During the three months ended March 31, 2012 and 2011, our gross payments, reductions and sales of securities by transaction type included:
Three months ended March 31, | ||||||
(in thousands) | 2012 | 2011 | ||||
Principal repayments reductions and loan sales | $ | 48,135 | $ | 100,068 | ||
Sale or settlement of equity investments | 20,542 | 14,285 | ||||
Schedule principal amortization | 6,843 | 4,907 | ||||
Collection of accrued paid-in-kind interest and dividends | 3,798 | 9,963 | ||||
Total gross payments, reductions and sales of securities | $ | 79,318 | $ | 129,223 |
As shown in the following table, during the three months ended March 31, 2012, we monetized all, or part of, 5 portfolio investments with proceeds totaling $71.8 million:
Three months ended March 31, 2012 | ||||||||||||
(in thousands) | Principal Repayments and Proceeds from Loan Sales | Sale or Settlement of Equity Investments | PIK Interest and Dividend Prepayments | Total | ||||||||
Monetizations | ||||||||||||
Jenzabar, Inc. | $ | — | $ | 20,542 | $ | 3,158 | $ | 23,700 | ||||
Haws Corporation | 16,500 | — | — | 16,500 | ||||||||
The Matrixx Group, Incorporated | 12,500 | — | — | 12,500 | ||||||||
Bentley Systems, Incorporated | 9,900 | — | — | 9,900 | ||||||||
Focus Brands, Inc. | 9,235 | — | — | 9,235 | ||||||||
Total monetizations | 48,135 | 20,542 | 3,158 | 71,835 | ||||||||
Other scheduled payments | 6,843 | — | 640 | 7,483 | ||||||||
Total gross payments, sales and other reductions of investment portfolio | $ | 54,978 | $ | 20,542 | $ | 3,798 | $ | 79,318 |
The proceeds from these monetizations correlated closely with the most recently reported fair value of the associated investments.
40
ASSET QUALITY
Asset quality is generally a function of portfolio company performance and economic conditions, as well as our underwriting and ongoing management of our investment portfolio. In addition to various risk management and monitoring tools, we use the following investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio:
Investment Rating | Summary Description |
1 | Capital gain expected or realized |
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 expect 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 |
The following table shows the distribution of our investments on our 1 to 5 investment rating scale at fair value as of March 31, 2012 and December 31, 2011:
(dollars in thousands) | March 31, 2012 | December 31, 2011 | ||||||||
Investment Rating | Investments at Fair Value | % of Total Portfolio | Investments at Fair Value | % of Total Portfolio | ||||||
1(a) | $ | 254,282 | 38.2 | % | $ | 283,755 | 38.3 | % | ||
2 | 237,439 | 35.6 | 290,583 | 39.2 | ||||||
3 | 147,659 | 22.2 | 142,639 | 19.2 | ||||||
4 | 2,766 | 0.4 | 11,683 | 1.6 | ||||||
5(b) | 23,994 | 3.6 | 12,506 | 1.7 | ||||||
Total | $ | 666,140 | 100.0 | % | $ | 741,166 | 100.0 | % |
_________________________
(a) | As of March 31, 2012 and December 31, 2011, Investment Rating “1” included $109.1 million, respectively, of loans to companies in which we also hold equity securities. |
(b) | The increase in Investment Rating "5" includes $12.0 million from the reclassification of our investment in Jet Plastica Investors, LLC senior debt from Investment Rating "4". |
When one of our loans becomes more than 90 days 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 generally will cease recognizing interest income on that loan until all principal and interest have been brought current through payment or due to a restructuring such that the interest income is deemed to be collectible. However, we may make exceptions to this policy if the loan has sufficient collateral value and is in the process of collection. If the fair value of a loan is below cost, we may cease recognizing PIK interest and/or the accretion of a discount on the debt investment until such time that the fair value equals or exceeds cost.
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The following table summarizes the cost and fair value of loans more than 90 days past due and loans on non-accrual status:
COST BASIS | FAIR VALUE BASIS | |||||||||||||||||||
March 31, 2012 | December 31, 2011 | March 31, 2012 | December 31, 2011 | |||||||||||||||||
(dollars in thousands) | Investments at Cost | % of Loan Portfolio | Investments at Cost | % of Loan Portfolio | Investments at Fair Value | % of Loan Portfolio | Investments at Fair Value | % of Loan Portfolio | ||||||||||||
Loans greater than 90 days past due | ||||||||||||||||||||
On non-accrual status | $ | 13,963 | 2.15 | % | $ | 13,963 | 2.00 | % | $ | 10,513 | 1.80 | % | $ | 9,615 | 1.53 | % | ||||
Not on non-accrual status | — | — | — | — | — | — | — | — | ||||||||||||
Total loans greater than 90 days past due | $ | 13,963 | 2.15 | % | $ | 13,963 | 2.00 | % | $ | 10,513 | 1.80 | % | $ | 9,615 | 1.53 | % | ||||
Loans on non-accrual status | ||||||||||||||||||||
0 to 90 days past due | $ | 68,965 | 10.64 | % | $ | 69,241 | 9.92 | % | $ | 12,645 | 2.17 | % | $ | 9,704 | 1.54 | % | ||||
Greater than 90 days past due | 13,963 | 2.15 | 13,963 | 2.00 | 10,513 | 1.80 | 9,615 | 1.53 | ||||||||||||
Total loans on non-accrual status | $ | 82,928 | 12.79 | % | $ | 83,204 | 11.92 | % | $ | 23,158 | 3.97 | % | $ | 19,319 | 3.07 | % |
The following table summarizes the changes in the cost and fair value of the loans on non-accrual status from December 31, 2011 through March 31, 2012:
Three months ended March 31, 2012 | ||||||
(In thousands) | Cost | Fair Value | ||||
Non-accrual loan balance as of December 31, 2011 | $ | 83,204 | $ | 19,319 | ||
Payments received on loans on non-accrual status | (276 | ) | (276 | ) | ||
Change in unrealized gain (loss) on non-accrual loans | — | 4,115 | ||||
Total change in non-accrual loans | (276 | ) | 3,839 | |||
Non-accrual loan balance as of March 31, 2012 | $ | 82,928 | $ | 23,158 |
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Results of Operations
The following section compares our results of operations for the three months ended March 31, 2012 to the three months ended March 31, 2011.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2012 AND 2011
The following table summarizes the components of our net income (loss) for the three months ended March 31, 2012 and 2011:
Three months ended March 31, | Variance | ||||||||||
(dollars in thousands) | 2012 | 2011 | $ | Percentage | |||||||
Revenue | |||||||||||
Interest and dividend income | |||||||||||
Interest income | $ | 15,596 | $ | 20,158 | $ | (4,562 | ) | (22.6 | )% | ||
Dividend income | 1,077 | 2,497 | (1,420 | ) | (56.9 | ) | |||||
Loan fees | 623 | 781 | (158 | ) | (20.2 | ) | |||||
Total interest and dividend income | 17,296 | 23,436 | (6,140 | ) | (26.2 | ) | |||||
Advisory fees and other income | 263 | 867 | (604 | ) | (69.7 | ) | |||||
Total revenue | 17,559 | 24,303 | (6,744 | ) | (27.7 | ) | |||||
Operating expenses | |||||||||||
Interest expense | 5,202 | 3,873 | 1,329 | 34.3 | |||||||
Employee compensation | |||||||||||
Salaries and benefits | 3,875 | 3,976 | (101 | ) | (2.5 | ) | |||||
Amortization of employee restricted stock | 478 | 624 | (146 | ) | (23.4 | ) | |||||
Total employee compensation | 4,353 | 4,600 | (247 | ) | (5.4 | ) | |||||
General and administrative expense | 3,936 | 2,827 | 1,109 | 39.2 | |||||||
Restructuring expense | 26 | — | 26 | NM | |||||||
Total operating expense | 13,517 | 11,300 | 2,217 | 19.6 | |||||||
Net operating income before net investment loss, loss on extinguishment of debt and income tax provision | 4,042 | 13,003 | (8,961 | ) | (68.9 | ) | |||||
Net investment loss before income tax provision | (2,493 | ) | (20,944 | ) | 18,451 | (88.1 | ) | ||||
Loss on extinguishment of debt before income tax provision | (174 | ) | (863 | ) | 689 | (79.8 | ) | ||||
Income tax provision | 18 | 11 | 7 | 63.6 | |||||||
Net income (loss) | $ | 1,357 | $ | (8,815 | ) | $ | 10,172 | NM | |||
NM=Not Meaningful |
TOTAL REVENUE
Total revenue includes interest and dividend income and advisory fees and other income. The following sections describe the reasons for the variances in each major component of our revenue during the three months ended March 31, 2012 from the three months ended March 31, 2011.
INTEREST INCOME
The level of interest income that we earn depends upon the level of interest-bearing investments outstanding during the period, as well as the weighted-average yield on these investments. During the three months ended March 31, 2012, the total yield on our average debt portfolio at fair value was 10.9% compared to 11.2% during the three months ended March 31, 2011. The weighted-average yield varies each period because of changes in the composition of our portfolio of debt investments, changes in stated interest rates, fee accelerations of unearned fees on paid/restructured loans and the balance of loans on non-accrual status for which we are not accruing interest.
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The following table shows the various components of the total yield on our average debt portfolio at fair value for the three months ended March 31, 2012 and 2011:
Three months ended March 31, | ||||
2012 | 2011 | |||
Average 90-day LIBOR | 0.5 | % | 0.3 | % |
Spread to average LIBOR on average loan portfolio | 10.6 | 11.0 | ||
Impact of fee accelerations of unearned fees on paid/restructured loans | 0.2 | 0.2 | ||
Impact of non-accrual loans | (0.4 | ) | (0.3 | ) |
Total yield on average loan portfolio | 10.9 | % | 11.2 | % |
During the three months ended March 31, 2012, interest income was $15.6 million, compared to $20.2 million during the three months ended March 31, 2011, which represented a $4.6 million, or 22.6%, decrease. This decrease reflected a $4.1 million decrease resulting from a 20.5% decrease in our average loan balance, a $0.8 million decrease in interest income resulting from a 0.39% decrease in our spread to LIBOR, and a $0.2 million decrease resulting from the net impact of loans that were on non-accrual status during the three months ended March 31, 2012 that were accruing interest during the three months ended March 31, 2011. These decreases were partially offset by a $0.4 million increase in interest income related to the change in LIBOR.
PIK Income
Interest income includes certain amounts that we have not received in cash, such as PIK interest. PIK interest represents contractually deferred interest that is added to the principal balance of the loan and compounded if not paid on a current basis. PIK may be prepaid by either contract or the portfolio company’s choice, but generally is paid at the end of the loan term. The following table shows the PIK-related activity for the three months ended March 31, 2012 and 2011, at cost:
Three months ended March 31, | ||||||
(in thousands) | 2012 | 2011 | ||||
Beginning PIK loan balance | $ | 15,653 | $ | 30,923 | ||
PIK interest earned during the period | 1,336 | 2,435 | ||||
Interest receivable converted to PIK | — | 360 | ||||
Payments received from PIK loans | (333 | ) | (5,780 | ) | ||
PIK converted to other securities | — | (876 | ) | |||
Realized loss | — | (900 | ) | |||
Ending PIK loan balance | $ | 16,656 | $ | 26,162 |
As of March 31, 2012 and 2011, we were not accruing interest on $8.9 million and $6.5 million, respectively, of the PIK loans, at cost, shown in the preceding table. The payments received from PIK loans during the three months ended March 31, 2011, includes $4.7 million of PIK collected in conjunction with the sale of our investment in Superior Industries Investors, LLC.
DIVIDEND INCOME
We accrete dividends on equity investments with stated dividend rates as they are earned, to the extent that we believe the dividends will be paid ultimately and the associated portfolio company has sufficient value to support the accretion. We recognize dividends on our other equity investments when we receive the dividend payment. Our dividend income varies from period to period because of changes in the size and composition of our equity investments, the yield from the investments in our equity portfolio and the ability of the portfolio companies to declare and pay dividends. During the three months ended March 31, 2012 and 2011, we recognized dividend income of $1.1 million and $2.5 million, respectively. In addition, during the three months ended March 31, 2012 and 2011, we received payments on accrued dividends of $3.5 million and $4.2 million, respectively.
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TOTAL OPERATING EXPENSES
Total operating expenses include interest, employee compensation and general and administrative expenses. The reasons for these variances are discussed in more detail below.
INTEREST EXPENSE
During the three months ended March 31, 2012, we incurred $5.2 million of interest expense, which represented a $1.3 million, or 34.3%, increase from the same period in 2011. Interest expense for the three months ended March 31, 2012 increased $1.9 million related to increased amortization of debt issuance costs, including $1.5 million of accelerated deferred financing fees related to the termination of our SunTrust Warehouse financing facility. Interest expense also increased $0.3 million due to an increase in the average LIBOR rate by 0.21% during the first quarter of 2012. These increases were partially offset by a $0.8 million decrease in interest expense due to a lower average borrowing balance in the first quarter of 2012.
EMPLOYEE COMPENSATION
Employee compensation expense includes base salaries and benefits, variable annual incentive compensation and amortization of employee stock awards. During the three months ended March 31, 2012, our employee compensation expense was $4.4 million, which represented a $0.2 million, or 5.4%, decrease from the same period in 2011. Our salaries and benefits decreased by $0.1 million, or 2.5%, due to a $0.9 million decrease in salaries and benefits primarily resulting from a 42% reduction in our workforce that occurred as part of the corporate restructuring that we implemented during 2011 offset by an increase in incentive compensation of $0.8 million primarily resulting from inducement bonuses paid in the first quarter of 2012.
During the three months ended March 31, 2012, we recognized $0.5 million of compensation expense related to restricted stock awards, compared to $0.6 million for the three months ended March 31, 2011, which represented a $0.1 million, or 23.4%, decrease. Included in the amortization of restricted stock for the three months ended March 31, 2012 was $0.1 million of amortization expenses associated with the elimination of ten positions in the first quarter of 2012. The lapsing of forfeiture provisions for previously awarded restricted stock accounted for the reduction in amortization of employee restricted stock.
GENERAL AND ADMINISTRATIVE
During the three months ended March 31, 2012, general and administrative expense was $3.9 million, which represented a $1.1 million, or 39.2%, increase compared to the same period in 2011 primarily due to $1.1 million in severance costs related to positions notified for elimination in the first quarter of 2012. General and administrative expense for the first quarter of 2012 also included $0.3 million of legal expenses related to investment monetizations.
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NET INVESTMENT LOSS BEFORE INCOME TAX PROVISION
During the three months ended March 31, 2012, we incurred $2.5 million of net investment losses before income tax provision, compared to $20.9 million during the same period in 2011. These amounts represent the total of net realized gains and losses, net unrealized (depreciation) appreciation, and reversals of unrealized (appreciation) depreciation. We reverse unrealized (appreciation) depreciation at the time that we realize the gain or loss. The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended March 31, 2012:
Three months ended March 31, 2012 | ||||||||||||||
(in thousands) | Industry | Type | Realized Gain/(Loss) | Unrealized (Depreciation)/ Appreciation | Reversal of Unrealized Depreciation/ (Appreciation) | Net (Loss)/ Gain | ||||||||
Portfolio Company | ||||||||||||||
RadioPharmacy Investors, LLC | Healthcare | Control | $ | — | $ | (2,053 | ) | $ | — | $ | (2,053 | ) | ||
Orbitel Holdings, LLC | Cable | Control | — | (1,966 | ) | — | (1,966 | ) | ||||||
Miles Media Group, LLC | Business Services | Non-Affiliate | — | (1,575 | ) | — | (1,575 | ) | ||||||
Jenzabar, Inc. | Technology | Non-Affiliate | 16,370 | (1 | ) | (16,435 | ) | (66 | ) | |||||
Jet Plastica Investors, LLC | Plastic Products | Control | — | 3,175 | — | 3,175 | ||||||||
Other (< $1 million net gain (loss)) | 8 | 64 | (80 | ) | (8 | ) | ||||||||
Total | $ | 16,378 | $ | (2,356 | ) | $ | (16,515 | ) | $ | (2,493 | ) |
• | During the quarter ended March 31, 2012, we recorded $2.0 million of unrealized depreciation on our investment in Orbitel Holdings, LLC due to a reduction in the multiple used to value that company based on estimated exit value. |
• | We also recorded unrealized depreciation on our investments in Miles Media Group, LLC and RadioPharmacy Investors, LLC, to reflect decreases in the operating performances of those companies. |
• | In April 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets. Including the proceeds from the liquidation, we received a $10.2 million payment on our senior debt and anticipate receiving additional payments on our senior debt upon future collection of certain accounts receivable, resulting in a $3.2 million unrealized appreciation in the first quarter of 2012. |
• | In February 2012, we accepted $23.7 million for our senior preferred stock and warrant position in Jenzabar, Inc., or Jenzabar, which resulted in a $16.4 million reversal of previously unrealized appreciation and the realization of a $16.4 million gain. |
The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from a change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.
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The following table summarizes our realized and unrealized (loss) and gain on investments and changes in our unrealized appreciation and depreciation on investments for the three months ended March 31, 2011:
Three months ended March 31, 2011 | ||||||||||||||
(in thousands) | Industry | Type | Realized Gain/(Loss) | Unrealized (Depreciation)/ Appreciation | Reversal of Unrealized Depreciation/ (Appreciation) | Net (Loss)/ Gain | ||||||||
Portfolio Company | ||||||||||||||
Broadview Networks Holdings, Inc. | Communications | Control | $ | — | $ | (24,289 | ) | $ | — | $ | (24,289 | ) | ||
PremierGarage Holdings, LLC | Home Furnishings | Control | — | (3,281 | ) | — | (3,281 | ) | ||||||
Superior Industries Investors, Inc. | Sporting Goods | Control | 988 | — | (2,788 | ) | (1,800 | ) | ||||||
Provo Craft & Novelty, Inc. | Leisure Activities | Non-Affiliate | — | (1,160 | ) | — | (1,160 | ) | ||||||
Jenzabar, Inc. | Technology | Non-Affiliate | — | (1,121 | ) | — | (1,121 | ) | ||||||
RadioPharmacy Investors, LLC | Healthcare | Control | — | 4,852 | — | 4,852 | ||||||||
Cruz Bay Publishing, Inc. | Publishing | Non-Affiliate | — | 1,524 | — | 1,524 | ||||||||
Restaurant Technologies, Inc. | Food Services | Non-Affiliate | — | 1,429 | — | 1,429 | ||||||||
Active Brands International, Inc. | Consumer Products | Non-Affiliate | (27,654 | ) | — | 27,776 | 122 | |||||||
Other (< $1 million net gain (loss)) | (961 | ) | 2,947 | 794 | 2,780 | |||||||||
Total | $ | (27,627 | ) | $ | (19,099 | ) | $ | 25,782 | $ | (20,944 | ) |
During the quarter ended March 31, 2011, we received payments of $2.1 million on the sale of Active Brands International, Inc. senior debt and wrote off our equity investment in that portfolio company. As a result of this transaction, we reversed $27.8 million of previously unrealized depreciation and realized a $27.7 million loss. During the quarter ended March 31, 2011, we sold our investment in Superior Industries Investors, Inc. As a result of this sale, we reversed $2.8 million of previously unrealized appreciation and realized a $1.0 million gain, including $1.8 million of transaction costs that we recorded at the time of sale.
During the quarter ended March 31, 2011, we recorded unrealized depreciation primarily related to Broadview; PremierGarage Holdings, LLC, or PremierGarage; Provo Craft & Novelty, Inc., or Provo Craft; and Jenzabar. The decreases in the fair values of PremierGarage and Jenzabar were attributable to a decrease in the performance of those companies. The decrease in the fair value of Broadview was primarily attributable to a decrease in the multiples used to value that company. The decrease in the fair value of Provo Craft resulted from a decrease in the company’s performance that resulted in a decrease in the market price of its debt. The remaining unrealized depreciation and appreciation shown in the above table resulted predominantly from a change in the performance of certain of our portfolio companies and the multiples used to value certain of our investments.
LOSS ON EXTINGUISHMENT OF DEBT
We incurred a $0.2 million premium when we repurchased the remaining $8.7 million of our private placement notes during the first quarter of 2012. During the first quarter of 2011, we incurred a $0.9 million premium when we repurchased $17.4 million of our private placement notes.
INCOME TAX PROVISION
During the three months ended March 31, 2012, we incurred an $18,000 income tax provision compared to an $11,000 income tax provision during the three months ended March 31, 2011. The income tax provision for both periods was primarily attributable to unrealized depreciation or appreciation and flow-through taxable income on certain investments held by our subsidiaries.
47
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
CASH AND CASH EQUIVALENTS, CASH, SECURITIZATION ACCOUNTS, AND CASH, RESTRICTED
Our Consolidated Balance Sheets and our Consolidated Statements of Cash Flows reflect three categories of cash: cash and cash equivalents; cash, securitization accounts; and cash, restricted. Each of these categories is described more fully below:
• | Cash and cash equivalents represents unrestricted cash, including checking accounts, interest bearing deposits collateralized by marketable debt securities and highly liquid investments with original maturities of 90 days or less. As of March 31, 2012 and December 31, 2011, we had $59.9 million and $58.6 million, respectively, in cash and cash equivalents. As of March 31, 2012, our cash and cash equivalents included $44.5 million that was held in interest-bearing accounts. |
• | Cash, securitization accounts include principal and interest payments received on securitized loans, which, are held in designated bank accounts until monthly or quarterly disbursements are made from the securitization trusts. We are generally required to use a portion of these amounts to pay interest expense, reduce borrowings or pay other amounts in accordance with the related securitization agreements. Cash in securitization accounts has a negative impact on our earnings since the interest we pay on borrowings typically exceeds the rate of return that we are able to earn on temporary cash investments. Our objective is to maintain sufficient cash-on-hand and availability under our debt facilities to cover current funding requirements. As of March 31, 2012 and December 31, 2011, we had $35.4 million and $40.3 million, respectively, in cash, securitization accounts. |
• | Cash, restricted includes cash held for regulatory purposes and cash held in escrow. The largest component of restricted cash was represented by cash held by Solutions Capital, our SBIC, which generally is restricted to the origination of new loans from our SBIC. As of March 31, 2012 and December 31, 2011, we had $69.3 million and $35.0 million respectively, of restricted cash. |
During the three months ended March 31, 2012, our operating activities provided $79.2 million of cash and cash equivalents, and our financing activities used $77.8 million of cash and cash equivalents.
LIQUIDITY AND CAPITAL RESOURCES
Our access to debt and equity capital continues to be constrained. Because our stock continues to trade below net asset value and we do not have stockholder approval to sell equity below our net asset value, we effectively lack access to the equity markets. Lenders, in general, may be reluctant to extend credit to us without such equity capital markets access.
We expect to continue to monetize our equity investments to reduce them to less than 10% of the fair value of our portfolio over the next few years. We generally expect to limit our future investing activities principally to debt investments and do not intend to make significant investments in control companies beyond those that are currently in our portfolio for the foreseeable future. To help provide sustainable stockholder value, we expect to make future distributions to stockholders based upon an assessment of the minimum statutorily required level of distributions, gains and losses recognized for tax purposes, portfolio transactional events, our liquidity, cash earnings and our BDC asset coverage ratio at the time of such decision. These distributions may be considered a return of capital.
In order to reduce future cash interest payments under our borrowings, as well as future amounts due at maturity or upon redemption under our borrowings, we may, from time to time, purchase debt for cash in open market purchases and/or privately negotiated transactions, if attractive pricing can be identified. We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity and prospects for future access to capital. The amounts involved in any such transactions, individually or in the aggregate, may be material.
As discussed in Liquidity and Capital Resources—Borrowings, the reinvestment periods for both the Commercial Loan Trust 2006-1 facility and the SunTrust Warehouse have ended and all future principal collections from collateral in the facilities will be used to repay the securitized debt. In addition, we anticipate paying off the SunTrust Warehouse facility in the second quarter of 2012.
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Although there can be no assurance, we believe we have sufficient liquidity to meet our operating requirements for the remainder of 2012, as well as liquidity for new origination opportunities and potential dividend distributions.
LIQUIDITY AND CAPITAL RESOURCES—BORROWINGS
As of March 31, 2012, we reported $402.8 million of borrowings on our Consolidated Balance Sheets at cost. The following table summarizes our borrowing facilities and the potential borrowing capacity of those facilities and contingent borrowing eligibility of Solutions Capital I, L.P., a wholly owned subsidiary, as an SBIC, under the SBIC Act.
March 31, 2012 | December 31, 2011 | ||||||||||||
(dollars in thousands) | Maturity Date | Total Facility/ Program | Amount Outstanding | Total Facility/ Program | Amount Outstanding | ||||||||
SBIC | |||||||||||||
2008-10B | September 2018 | $ | 2,600 | $ | 2,600 | $ | 2,600 | $ | 2,600 | ||||
2009-10A | March 2019 | 12,000 | 12,000 | 12,000 | 12,000 | ||||||||
2009-10B | September 2019 | 13,000 | 13,000 | 13,000 | 13,000 | ||||||||
2010-10B | September 2020 | 27,500 | 27,500 | 27,500 | 27,500 | ||||||||
2011-10A | March 2021 | 53,500 | 53,500 | 53,500 | 53,500 | ||||||||
2012-10A | March 2022 | 41,400 | 41,400 | 41,400 | 20,000 | ||||||||
Commercial Loan Trust 2006-1 | |||||||||||||
Series 2006-1 Class A-1 Notes | April 2018(a) | 52,831 | 52,831 | 63,389 | 63,389 | ||||||||
Series 2006-1 Class A-2 Notes | April 2018(a) | 2,486 | 2,486 | 2,983 | 2,983 | ||||||||
Series 2006-1 Class A-3 Notes | April 2018(a) | 42,265 | 42,265 | 50,711 | 50,711 | ||||||||
Series 2006-1 Class B Notes | April 2018(a) | 58,750 | 58,750 | 58,750 | 58,750 | ||||||||
Series 2006-1 Class C Notes(b) | April 2018(a) | 45,000 | 32,000 | 45,000 | 32,000 | ||||||||
Series 2006-1 Class D Notes(c) | April 2018(a) | 46,494 | 29,247 | 46,494 | 29,247 | ||||||||
Commercial Loan Funding Trust | |||||||||||||
Variable Funding Note | January 2014(d) | 35,204 | 35,204 | 150,000 | 55,822 | ||||||||
Private Placement Notes | |||||||||||||
Series 2007-A | October 2011 | — | — | 8,717 | 8,717 | ||||||||
Total borrowings | $ | 433,030 | $ | 402,783 | $ | 576,044 | $ | 430,219 | |||||
(a) Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date. The reinvestment period for this facility ended on July 20, 2011 and we will use all future principal collections from collateral in the facility to repay the securitized debt. | |||||||||||||
(b) Amount outstanding excludes $5.0 million of notes that we repurchased in December 2008 for $1.6 million and $8.0 million of notes that we repurchased in April 2010 for $4.4 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased. | |||||||||||||
(c) Amount outstanding excludes $10.1 million of notes that we repurchased in December 2008 for $2.4 million and $7.5 million of notes that we repurchased in January 2009 for $2.1 million. As part of the consolidation process, we eliminated the notes that MCG, the parent company, purchased. | |||||||||||||
(d) In January 2012, this facility entered a 24-month amortization period and the legal final maturity date was extended to January 2014. |
Each of our credit facilities has certain collateral requirements and/or financial covenants. As of March 31, 2012, the net worth covenant of our SunTrust Warehouse required that we maintain a consolidated tangible net worth of not less than $375.0 million, plus 50% of any equity raised after February 26, 2009. Under the SunTrust Warehouse agreement, we must also maintain an asset coverage ratio of at least 180%.
As of March 31, 2012, our asset coverage ratio was 265% excluding our SBIC debt which is exempt from the asset coverage ratio requirements under the SEC exemptive order.
As of March 31, 2012, we were in compliance with all key financial covenants under each of our borrowing facilities, although there can be no assurance regarding compliance in future periods. On our website, we have provided a list of hyperlinks to each of our borrowing agreements where these covenant requirements can be reviewed. You may view this list at http://www.mcgcapital.com/. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Quarterly Report on Form 10-Q.
Our access to current and future liquidity from our borrowing facilities depends on several factors, including, but not limited to: the credit quality of our investment portfolio, including those investments used to collateralize borrowing facilities; the magnitude of our investments in individual companies and the industries in which they operate; our compliance with specific covenants in each borrowing agreement; and the specific provisions of our borrowing facilities.
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As each of our borrowing facilities matures, it is important that we have sufficient liquidity available to repay our borrowing obligations. We may obtain the liquidity for repayment of our borrowing facilities from a number of sources, including cash on-hand, the maturity or monetization of our investment portfolio, other borrowing facilities and equity issuances, and from other borrowing arrangements.
We have funded all of our current debt facilities through our bankruptcy remote, special-purpose, wholly owned subsidiaries. Therefore, these subsidiaries’ assets may not be available to our creditors. In some cases, advances under our debt facilities are subject to certain collateral levels, collateral quality, leverage and other restrictive covenants. We continue to service those portfolio investments that we use as collateral in our secured borrowing facilities.
SBIC DEBENTURES
In December 2004, we formed a wholly owned subsidiary, Solutions Capital. Solutions Capital has a license from the SBA to operate as an SBIC under the SBIC Act. The license gave Solutions Capital the ability to borrow from the SBA up to $150.0 million, which is the maximum amount of outstanding leverage available to single-license SBIC companies.
To realize the full $150.0 million borrowing for which we have received approval under this program, we have funded a total of $75.0 million to Solutions Capital. As of March 31, 2012 and December 31, 2011, Solutions Capital had borrowed $150.0 million and $128.6 million, respectively. We may use these funds to provide debt and equity capital to qualifying small businesses. However, we may not use these borrowings to originate debt to certain companies that are currently in our portfolio without SBA approval. In addition, we may not use these funds for MCG’s, the parent company’s, working capital.
SBICs are subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of an SBIC license does not assure that an SBIC will receive SBA-guaranteed debenture funding, which is dependent upon continued compliance with SBA regulations and policies. The SBA, as a creditor, will have superior claim to Solutions Capital’s assets over our stockholders in the event we liquidate Solutions Capital or the SBA exercises its remedies under the SBA-guaranteed debentures issued by Solutions Capital upon an event of default.
The following table sets forth the maturity of Solutions Capital debentures, as well as the maturity of the investments and the current balance of restricted cash in Solutions Capital as of March 31, 2012.
Maturities | |||||||||||||||
(in thousands) | Total | Less than 1 year | 1-3 years | 4-5 years | After 5 years | ||||||||||
Borrowings | $ | 150,000 | $ | — | $ | — | $ | — | $ | 150,000 | |||||
Collateral | |||||||||||||||
Fair value of debt investments | 163,521 | 3,733 | 15,676 | 144,112 | — | ||||||||||
Fair value of equity investments(a) | 9,189 | — | — | — | 9,189 | ||||||||||
Cash, restricted account | 64,199 | 64,199 | — | — | — | ||||||||||
Total collateral | $ | 236,909 | $ | 67,932 | $ | 15,676 | $ | 144,112 | $ | 9,189 |
(a) Equity investments do not have a stated maturity date.
COMMERCIAL LOAN TRUST 2006-1
As of March 31, 2012, we had $217.6 million of securitized debt outstanding under the Commercial Loan Trust 2006-1, which matures in April 2018. We retain all of the equity in the securitization. The pool of commercial loans in the trust must meet certain requirements, such as asset mix and concentration, collateral coverage, term, agency rating, minimum coupon, minimum spread and sector diversity requirements. The securitization included a five-year reinvestment period, during which the trust was permitted to use principal collections received on the underlying collateral to purchase new collateral from us.
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The following table sets forth the maturity of this facility, as well as the maturity of the securitized assets and the current balance of securitized cash in this borrowing facility.
Maturities | |||||||||||||||
(in thousands) | Total | Less than 1 year | 1-3 years | 4-5 years | After 5 years | ||||||||||
Borrowings(a) | $ | 217,579 | $ | 28,005 | $ | — | $ | — | $ | 189,574 | |||||
Collateral | |||||||||||||||
Fair value of debt investments | 275,644 | 34,133 | 68,377 | 160,539 | 12,595 | ||||||||||
Fair value of equity investments(b) | 398 | — | — | — | 398 | ||||||||||
Cash, securitization account | 31,888 | 31,888 | — | — | — | ||||||||||
Total collateral | $ | 307,930 | $ | 66,021 | $ | 68,377 | $ | 160,539 | $ | 12,993 |
(a) | Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date. The reinvestment period for this facility ended on July 20, 2011 and all future principal collections from collateral in the facility have been and will be used to repay the securitized debt. |
(b) | Equity investments do not have a stated maturity date. |
We were able to use the cash in the securitized account, as well as proceeds from principal collections of securitized investments, to originate new loans until July 20, 2011. The reinvestment period ended on July 20, 2011 and all subsequent principal collections or monetization proceeds that we receive from collateral used to securitize this Commercial Loan Trust 2006-1 must be applied to the outstanding balance of that facility. Upon maturity of this facility, any remaining balance must be repaid, otherwise all or part of the associated collateral may be forfeited. As shown in the above table, repayments of principal of the collateral held by this facility are expected to permit the repayment of Commercial Loan Trust 2006-1 prior to its April 2018 maturity.
COMMERCIAL LOAN FUNDING TRUST
As of March 31, 2012, we had a $35.2 million balance outstanding under the SunTrust Warehouse, which is funded through SunTrust Bank. The SunTrust Warehouse is secured primarily by MCG Commercial Loan Funding Trust’s assets, including commercial loans that MCG Capital Corporation, the parent, sold to the trust. The pool of commercial loans in the trust must meet certain requirements, such as term, average life, investment rating and agency rating. The pool of commercial loans must also meet certain requirements related to portfolio performance, including required minimum portfolio yield and limitations on delinquencies and charge-offs. In January 2012, we entered into an amendment to the SunTrust Warehouse, which among other things, accelerated the scheduled termination date to January 2012 and set the final legal maturity of this facility to January 17, 2014. We anticipate paying off the SunTrust Warehouse facility in the second quarter of 2012.
Under the SunTrust Warehouse, we are required to comply with various covenants, reporting requirements and other customary requirements for similar revolving credit facilities, including, without limitation, covenants related to: a) limitations on the incurrence of additional indebtedness and liens; b) limitations on certain investments; c) limitations on certain restricted payments; d) maintaining a certain minimum stockholders' equity; e) maintaining a ratio of total assets (less total liabilities and indebtedness not represented by senior securities) to total indebtedness represented by senior securities, of the Company and its subsidiaries, of not less than 1.8:1.0; and f) maintaining minimum liquidity.
In addition, under our SunTrust Warehouse, if Richard W. Neu, B. Hagen Saville or Stephen J. Bacica ceases to be involved actively in the management of MCG and is not replaced by a person reasonably acceptable to SunTrust Bank within 90 consecutive calendar days of such occurrence, we would be in default under such facility. If we lose the services of any of Messrs. Neu, Saville or Bacica and are unable to identify and hire a suitably qualified replacement(s), it could provide SunTrust with the right to accelerate the facility and entitle the administrative agent thereunder to exercise available remedies, including selling the collateral securing this facility and applying the proceeds to reduce outstanding borrowings thereunder.
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The following table sets forth the maturity of the SunTrust Warehouse, as well as the maturity of the securitized assets and the March 31, 2012 balance of securitized cash in this borrowing facility.
Maturities | |||||||||||||||
(in thousands) | Total | Less than 1 year | 1-3 years | 4-5 years | After 5 years | ||||||||||
Borrowings | $ | 35,204 | $ | 729 | $ | 34,475 | $ | — | $ | — | |||||
Collateral | |||||||||||||||
Securitized investments | 116,533 | 18,644 | 40,441 | 57,448 | — | ||||||||||
Cash, securitization accounts | 3,492 | 3,492 | — | — | — | ||||||||||
Total collateral | $ | 120,025 | $ | 22,136 | $ | 40,441 | $ | 57,448 | $ | — |
PRIVATE PLACEMENT NOTES
In October 2007, we issued $25.0 million of Series 2007-A unsecured notes with a five-year maturity. Initially, the Series 2007-A notes bore interest at a 6.71% per annum, which rate was increased in 2009 to 8.96% per annum. In January 2012, we repaid the Series 2007-A notes in full.
WEIGHTED-AVERAGE BORROWINGS AND COST OF FUNDS
The following table shows our weighted-average borrowings, the weighted-average interest rate on all of our borrowings, including amortization of deferred debt issuance costs and commitment fees, the average LIBOR, and the average spread to LIBOR for 2012 and 2011:
For the three months ended | ||||||
(dollars in thousands) | March 31, 2012 | March 31, 2011 | ||||
Weighted-average borrowings | $ | 419,597 | $ | 545,054 | ||
Average LIBOR | 0.52 | % | 0.31 | % | ||
Average spread to LIBOR, excluding amortization of deferred debt issuance costs | 2.08 | 2.08 | ||||
Impact of amortization of deferred debt issuance costs | 2.40 | 0.45 | ||||
Total cost of funds | 5.00 | % | 2.84 | % |
LIQUIDITY AND CAPITAL RESOURCES—COMMON STOCK
We are a closed-end investment company that has elected to be regulated as a BDC under the 1940 Act. The 1940 Act prohibits us from selling shares of our common stock at a price below the current NAV of such stock, except in limited circumstances, including approval by our stockholders of such a sale and certain determinations by our board of directors.
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million. Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases will be made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. During the three months ended March 31, 2012, we repurchased 1,180,000 shares of our common stock at a weighted average purchase price of $4.31 per share, which was a 23.7% discount from our December 31, 2011 net asset value per share.
OFF-BALANCE SHEET ARRANGEMENTS
FINANCIAL INSTRUMENTS
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our customers. These instruments include commitments to extend credit and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. We attempt to limit our credit risk by conducting extensive due diligence and obtaining collateral where appropriate.
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Commitments to extend credit include the unused portions of commitments that obligate us to extend credit in the form of loans, participations in loans, guarantees, letters of credit and other financial commitments. Commitments to extend credit would also include loan proceeds we are obligated to advance, such as loan draws, rotating or revolving credit arrangements, or similar transactions. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the counterparty. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
We do not report the unused portions of these commitments on our Consolidated Balance Sheets. As of March 31, 2012, we had $24.9 million of outstanding unused loan commitments, as shown in the table below. We believe that our operations, monetizations and unrestricted cash will provide sufficient liquidity to fund, as necessary, requests to draw on these unfunded commitments. We estimate that the fair value of these commitments was $0.1 million based on the fees that we currently charge to enter into similar arrangements, taking into account the creditworthiness of the counterparties. From time to time, we provide guarantees or standby letters of credit on behalf of our portfolio companies. As of March 31, 2012, we had no outstanding guarantees or standby letters of credit.
(in thousands) | As of March 31, 2012 | |||||||||||
Unused commitments to portfolio companies | Non-Affiliate Investments | Affiliate Investments | Control Investments | Total | ||||||||
Revolving credit facilities | $ | 10,588 | $ | 8,000 | $ | 3,824 | $ | 22,412 | ||||
Other | 773 | — | 1,750 | 2,523 | ||||||||
Total unused commitments to portfolio companies | $ | 11,361 | $ | 8,000 | $ | 5,574 | $ | 24,935 |
CONTRACTUAL OBLIGATIONS
The following table shows our contractual obligations as of March 31, 2012:
(in thousands) | Payments Due by Period | ||||||||||||||
Contractual Obligations(a) | Total | Less than 1 year | 1-3 years | 4-5 years | After 5 years | ||||||||||
Borrowings | |||||||||||||||
Term securitizations(b) | $ | 217,579 | $ | 28,005 | $ | — | $ | — | $ | 189,574 | |||||
Warehouse facility | 35,204 | 729 | 34,475 | — | — | ||||||||||
SBIC | 150,000 | — | — | — | 150,000 | ||||||||||
Total borrowings | 402,783 | 28,734 | 34,475 | — | 339,574 | ||||||||||
Interest payments on borrowings(c) | 76,864 | 10,948 | 20,068 | 18,762 | 27,086 | ||||||||||
Operating leases | 2,005 | 1,966 | 39 | — | — | ||||||||||
Severance obligations(d) | 4,252 | 3,047 | 1,205 | — | — | ||||||||||
Total contractual obligations | $ | 485,904 | $ | 44,695 | $ | 55,787 | $ | 18,762 | $ | 366,660 |
(a) | Excludes the unused commitments to extend credit to our customers of $24.9 million as discussed above. |
(b) | Borrowings under the Commercial Loan Trust 2006-1 facility are listed based on the contractual maturity date. The reinvestment period for this facility ended on July 20, 2011 and all future principal collections from collateral in the facility have been and will be used to repay the securitized debt. |
(c) | Interest payments are based on contractual maturity and the current outstanding principal balance of our borrowings and assume no changes in interest rate benchmarks. |
(d) | Represents remaining severance payments, benefits, deferred compensation and employer taxes that we are obligated to pay to employees who were terminated as a result of the corporate restructuring that we undertook in August 2011 and for obligations stemming from the resignation of our former chief executive officer. |
DISTRIBUTIONS
We currently qualify as a RIC for federal income tax purposes, which generally allows us to avoid paying corporate income taxes on any income or gains that we distribute to our stockholders. Generally, we intend to distribute sufficient dividends to eliminate taxable income and may distribute more than the taxable income which would be considered a return of capital. As a RIC, we are subject to a 4% excise tax to the extent that we do not distribute on an actual or
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on deemed basis: (i) 98.0% of our current year ordinary income; and (ii) 98.2% of our current year net capital gain income.
We may not be able to achieve operating results that will allow us to make distributions at a specific level or to increase the amount of these distributions. In addition, we may be limited in our ability to make distributions due to the BDC asset coverage test for borrowings applicable to us as a BDC under the 1940 Act and due to provisions in our credit facilities and SBA regulations. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible loss of favorable RIC tax treatment. We cannot assure stockholders that they will receive any distributions or distributions at a particular level. We may make distributions to our stockholders of certain net capital gains. Since December 2001, we have declared distributions of $12.98 per share.
The following table summarizes the distributions that we declared since January 1, 2009:
Date Declared | Record Date | Payable Date | Dividends per Share | ||
April 27, 2012 | June 13, 2012 | July 13, 2012 | $ | 0.14 | |
February 24, 2012 | April 13, 2012 | May 15, 2012 | $ | 0.17 | |
October 31, 2011 | December 15, 2011 | January 13, 2012 | $ | 0.17 | |
August 1, 2011 | September 14, 2011 | October 14, 2011 | $ | 0.17 | |
May 5, 2011 | June 15, 2011 | July 15, 2011 | $ | 0.17 | |
March 1, 2011 | March 15, 2011 | April 15, 2011 | $ | 0.15 | |
November 2, 2010 | December 9, 2010 | January 6, 2011 | $ | 0.14 | |
August 3, 2010 | September 7, 2010 | October 4, 2010 | $ | 0.12 | |
April 29, 2010 | June 2, 2010 | July 2, 2010 | $ | 0.11 |
If we determined the tax attributes of our 2012 distributions as of March 31, 2012, 39% would be from ordinary income and 61% would be a return of capital. A return of capital is a return of stockholder investment, rather than a return of earnings or gains derived from our investment activities. While not immediately taxable to the extent of a stockholder's basis in its shares, a stockholder's basis in the investment will be reduced by the nontaxable amount, which will result in additional gain or a lower loss when the shares are sold. However, actual determinations of the tax attributes of our distributions, including determinations of return of capital, are made annually as of the end of our fiscal year based upon our taxable income and distributions paid for the full year and will be reported to each shareholder on a Form 1099. Future distributions will take into account the requirements for us to distribute the majority of our taxable income to fulfill our distribution requirements as a RIC, together with an assessment of our current and forecasted gains and losses recognized or to be recognized for tax purposes, portfolio transactional events, liquidity, cash earnings and our asset coverage ratio at the time of such decision.
CRITICAL ACCOUNTING POLICIES
These Condensed Consolidated Financial Statements are based on the selection and application of critical accounting policies, which require management to make significant estimates and assumptions. The following section describes our accounting policies associated with the valuation of our portfolio of investments. For a full discussion of our other critical accounting policies and estimates, see Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011.
VALUATION OF INVESTMENTS
FAIR VALUE MEASUREMENTS AND DISCLOSURES
We account for our investments at fair value in accordance with Accounting Standard Codification Topic 820—Fair Value Measurements and Disclosures, or ASC 820. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. ASC 820 defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on exit price in the principal, or most advantageous, market and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs.
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ASC 820 establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:
ASC 820 Fair Value Hierarchy | Inputs to Fair Value Methodology |
Level 1 | Quoted prices in active markets for identical assets or liabilities |
Level 2 | Quoted prices for similar assets or liabilities; quoted markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the financial instrument; inputs other than quoted prices that are observable for the asset or liability; or inputs that are derived principally from, or corroborated by, observable market information |
Level 3 | Pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption is unobservable or when the estimation of fair value requires significant management judgment |
We categorize a financial instrument in the fair value hierarchy based on the lowest level of input that is significant to its fair value measurement. In the event that transfers between these levels were to occur in the future, we would recognize those transfers as of the ending balance sheet date, based on changes in the use of observable and unobservable inputs utilized to perform the valuation for the period.
DETERMINATION OF FAIR VALUE IN GOOD FAITH
As a BDC, we invest primarily in illiquid securities, including debt and equity securities of private companies. To protect our investments and maximize our returns, we negotiate the structure of each equity security and the majority of the debt securities in our investment portfolio. Our contracts with our portfolio companies generally include many terms governing interest rate, repayment terms, prepayment penalties, financial covenants, operating covenants, ownership and corporate governance parameters, dilution parameters, liquidation preferences, voting rights, and put or call rights. In some cases, our loan agreements also allow for increases in the spread to the base index rate, if the portfolio company’s financial or operational performance deteriorates or shows negative variances from its business plan and, in some cases, allow for decreases in the spread if financial or operational performance improves or exceeds the portfolio company’s plan. Generally, our investments are subject to some restrictions on resale and have no established trading market. Because of the type of investments that we make and the nature of our business, our valuation processes require analyses of numerous market, industry and company-specific factors, including: the performance of the underlying investment; the financial condition of the portfolio company; changing market events; market prices, when available; and other factors relevant to the individual security.
There is no single approach for determining fair value in good faith. Unlike banks, we are not permitted to provide a general reserve for anticipated loan losses. As a result, for portfolio investments that do not have an active market, we must apply judgment to the specific facts and circumstances associated with each security to determine fair value.
Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. When such market prices are not available, we use several valuation methodologies to estimate the fair value of our investment portfolio, which generally results in a range of fair values from which we derive a single estimate of the portfolio company’s fair value. To determine a portfolio company’s fair value, we analyze its historical and projected financial results, as well as key market value factors. In determining a security’s fair value, we assume we would exchange it in an orderly transaction at the measurement date. We use the following methods to determine the fair value of investments in our portfolio that are not traded actively:
• | Majority-Owned Control Investments—Majority-owned control investments comprise 16.1% of our investment portfolio. Market quotations are not readily available for these investments; therefore, we use a combination of market and income approaches to determine their fair value. Typically, private companies are bought and sold based on multiples of EBITDA, cash flows, net income, revenues or, in limited cases, book value. Generally, we apply multiples that we observe for other comparable companies to relevant financial data for the portfolio company. Also, in a limited number of cases, we use income approaches to determine the fair value of these securities, based on our projections of the discounted future free cash flows that the portfolio company will likely generate, as well as industry derived capital costs. Our valuation approaches for majority-owned investments estimate the value were we to sell or exit the investment. These valuation approaches consider the value of our ability to control the portfolio company’s capital structure and the timing of a potential exit. |
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• | Non-Majority-Owned Control Investments—Non-majority owned control investments comprise 1.6% of our investment portfolio. For our non-majority owned control equity investments, we use the same market and income valuation approaches used to value our majority-owned control investments. For non-majority-owned control debt investments, we estimate fair value using the market yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. |
• | Non-Control Investments—Non-control investments comprise 82.3% of our investment portfolio. Quoted prices are not available for 83.4% of our non-control investments. For our non-control equity investments, we use the same market and income approaches used to value our control investments. For non-control debt investments for which no quoted prices are available, we estimate fair value using a market-yield approach based on the expected future cash flows discounted at the loans’ effective interest rates, based on our estimate of current market rates. We may adjust discounted cash flow calculations to reflect other market conditions or the perceived credit risk of the borrower. |
• | Thinly Traded and Over-the-Counter Securities—Generally, we value securities that are traded in the over-the-counter market or on a stock exchange at the average of the prevailing bid and ask prices on the date of the relevant period end. However, we may apply a discount to the market value of restricted or thinly traded public securities to reflect the impact that these restrictions have on the value of these securities. We review factors including the trading volume, total securities outstanding and our percentage ownership of securities to determine whether the trading levels are active (Level 1) or inactive (Level 2). As of March 31, 2012, these securities represented 13.7% of our investment portfolio. We utilize independent pricing services with certain of our fair value estimates. The majority of our level 2 investments are senior debt investments that are secured and collateralized. To corroborate “bid/ask” quotes from independent pricing services we perform a market-yield approach to validate prices obtained or obtain other evidence. |
Our valuation analyses incorporate the impact that key events could have on the securities’ values, including public and private mergers and acquisitions, purchase transactions, public offerings, letters of intent and subsequent debt or equity sales. Our valuation analyses also include key external data, such as market changes and industry valuation benchmarks. We also use independent valuation firms to provide additional data points for our quarterly valuation analyses. Our general practice is to obtain an independent valuation or review of valuation at least once per year for each portfolio investment that had a fair value in excess of $5.0 million, unless the fair value has otherwise been derived through a sale of some or all of our investment in the portfolio company or is a new investment made within the last twelve months. In total, we either obtained a valuation or review from an independent firm, considered new investments made or used market quotes in the preceding twelve month period for 97.7% of the fair value of our investment portfolio as of March 31, 2012.
The majority of the valuations performed by the independent valuation firms utilize proprietary models and inputs. We have used, and intend to continue to use, independent valuation firms to provide additional support for our internal analyses.
Our board of directors sets our valuation policies and procedures and determines the fair value of our investments. The investment and valuation committee of our board of directors meets at least quarterly with our management to review management’s recommendations of fair value of our investments. Our board of directors considers our valuations, as well as the independent valuations and reviews, in its determination of the fair value of our investments.
Due to the uncertainty inherent in the valuation process, such fair value estimates may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses that we ultimately realize on these investments to differ from the valuations currently assigned.
Significant Unobservable Inputs
Our investment portfolio is not composed of homogeneous debt and equity securities that can be valued with a small number of inputs. Instead, the majority of our investment portfolio is composed of complex debt and equity securities with unique contract terms and conditions. As such, our valuation of each investment in our portfolio is unique and
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complex, often factoring in numerous different inputs, including the historical and forecasted financial and operational performance of the portfolio company, projected cash flows, market multiples, comparable market transactions, the priority of our securities compared with those of other investors, credit risk, interest rates, independent valuations and reviews and other inputs too numerous to list quantitatively herein.
The following table summarizes the significant unobservable inputs in the fair value measurements of our level 3 investments by category of investment and valuation technique as of March 31, 2012.
($ in thousands) | Fair Value | Valuation Techniques | Unobservable Inputs | Range | |||||
Minimum | Maximum | ||||||||
Senior debt | $ | 370,361 | Discounted cash flow | Market interest rate | 5.5 | % | 15.2 | % | |
Discounted cash flow | Discount rate | 8.5 | % | 8.5 | % | ||||
Market comparable companies | EBITDA multiple(a) | 5.0x | 8.0x | ||||||
Residual assets | Discount | — | % | 25.0 | % | ||||
Subordinated debt | 124,423 | Discounted cash flow | Market interest rate | 9.3 | % | 15.5 | % | ||
Market comparable companies | EBITDA multiple(a) | 6.8x | 7.5x | ||||||
Pending transactions/Letters of intent | Discount | — | % | — | % | ||||
Preferred and common equity | 80,256 | Market comparable companies | EBITDA multiple(a) | 5.0x | 9.0x | ||||
Discount for minority interest | — | % | 25.0 | % | |||||
Pending transactions/Letters of intent | Discount | — | % | 5.0 | % | ||||
Residual assets | Discount | — | % | 25.0 | % | ||||
$ | 575,040 |
(a) | EBITDA may include proforma adjustments and/or other addbacks based on specific circumstances related to each investment. |
RECENT ACCOUNTING PRONOUNCEMENTS
FAIR VALUE
In May 2011, the FASB issued Accounting Standards Update No. 2011-04—Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, or ASU 2011-04. ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes the application of some requirements for measuring fair value and requires additional disclosure for fair value measurements. The disclosure requirements are expanded to include for fair value measurements categorized in Level 3 of the fair value hierarchy: 1) a quantitative disclosure of the unobservable inputs and assumptions used in the measurement; 2) a description of the valuation processes in place; and 3) a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs. For public entities, ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011. We adopted this standard beginning on January 1, 2012. Our implementation of this standard did not have a material impact on our process for measuring fair values, our financial position or our results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There were a number of indicators of modest growth in the United States' economy during the first quarter of 2012. However, certain leading and lagging indicators suggest continuing risk and volatility. In the event of renewed financial turmoil affecting the banking system and financial markets, the financial position and results of operations of certain of the middle-market companies in our portfolio could be affected adversely, which ultimately could lead to difficulty in their meeting debt service requirements and an increase in defaults.
Interest rate sensitivity refers to the change in earnings that may result from changes in the level of interest rates. Our net interest income is affected by changes in various interest rates, including LIBOR, prime rates and commercial paper rates. As of March 31, 2012, approximately 87.3% of our loan portfolio, at fair value, bore interest at a spread
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to LIBOR or prime rate, and 12.7% at a fixed interest rate. As of March 31, 2012, approximately 77.2% of our loan portfolio, at fair value, had LIBOR floors between 1.0% and 3.0% on the LIBOR base index and prime floors between 1.75% and 6.0%. The three-month weighted-average LIBOR interest rate was 0.52% as of March 31, 2012. Thus, the LIBOR floors in these loan investments lessen the impact of such historically low LIBOR rates.
We regularly measure exposure to interest rate risk. We assess interest rate risk and we manage our interest rate exposure on an ongoing basis by comparing our interest rate sensitive assets to our interest rate sensitive liabilities. Based on this review, we determine whether or not any hedging transactions are necessary to mitigate exposure to changes in interest rates.
The following table shows a comparison of the interest rate base for our interest-bearing cash, outstanding commercial loans, at cost, and our outstanding borrowings as of March 31, 2012 and December 31, 2011:
March 31, 2012 | December 31, 2011 | |||||||||||
(in thousands) | Interest Bearing Cash and Commercial Loans | Borrowings | Interest Bearing Cash and Commercial Loans | Borrowings | ||||||||
Money market rate | $ | 50,129 | $ | — | $ | 51,211 | $ | — | ||||
Prime rate | 27,704 | — | 27,867 | — | ||||||||
LIBOR | ||||||||||||
30-day | 24,473 | 35,204 | 71,794 | — | ||||||||
60-day | 539 | — | 12,500 | — | ||||||||
90-day | 472,358 | 217,579 | 462,293 | 237,080 | ||||||||
180-day | 14,043 | — | 14,038 | — | ||||||||
Commercial paper | — | — | — | 55,822 | ||||||||
Fixed rate | 109,416 | 150,000 | 109,640 | 137,317 | ||||||||
Total | $ | 698,662 | $ | 402,783 | $ | 749,343 | $ | 430,219 |
Based on our March 31, 2012 balance sheet, the following table shows the impact to net income of hypothetical base rate increases in interest rates, assuming no changes in our investment and borrowing structure. The impact to net income of hypothetical base rate decreases in interest rates is not shown in the following table because as of March 31, 2012, the quarterly average LIBOR was 0.52% and a 100-basis point decrease could not occur:
(dollars in thousands) Basis Point Change | Interest Income | Interest Expense | Net Income (Loss) | ||||||
100 | $ | 2,211 | $ | 2,528 | $ | (317 | ) | ||
200 | 7,832 | 5,056 | 2,776 | ||||||
300 | 14,991 | 7,583 | 7,408 |
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2012. The term “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
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Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the foregoing evaluation of our disclosure controls and procedures as of March 31, 2012, our Chief Executive Officer and our Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
INTERNAL CONTROL OVER FINANCIAL REPORTING
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act), occurred during the fiscal quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
From time to time, we are a party to certain legal proceedings incidental to the normal course of our business, including the enforcement of our rights under contracts with our portfolio companies. While we cannot predict the outcome of these legal proceedings with certainty, we do not expect that these proceedings will have a material effect on our financial condition or results of operations. During the quarter ended March 31, 2012, there were no new or material developments in legal proceedings.
ITEM 1A. RISK FACTORS.
Investing in our common stock may be speculative and involves a high degree of risk. In addition to the other information contained in this Quarterly Report on Form 10-Q, including our financial statements, the related notes, schedules and exhibits, you should carefully consider the risk factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which could materially affect our business, financial condition and/or operating results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and/or operating results.
There have been no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, which should be read together with the other risk factors and information disclosed elsewhere in this Quarterly Report on Form 10-Q and our other reports filed with the SEC.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
STOCK REPURCHASE PROGRAM
On January 17, 2012, our board of directors authorized a stock repurchase program of up to $35.0 million. Under the program, we are authorized to repurchase shares in open market transactions, including through block purchases, depending on prevailing market conditions and other factors. The repurchase program may be extended, modified or discontinued at any time for any reason. The program does not obligate us to acquire any specific number of shares, and all repurchases are made in accordance with SEC Rule 10b-18, which sets certain restrictions on the method, timing, price and volume of stock repurchases. We retire immediately all such shares of common stock that we purchase in connection with the stock repurchase program.
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NET ISSUANCE OF RESTRICTED STOCK
For certain employees, we may be deemed to have purchased through the net issuance of shares, a portion of the shares of restricted stock previously issued under our Third Amended and Restated 2006 Employee Restricted Stock Plan, or the 2006 Plan, for which the forfeiture provisions have lapsed to satisfy the respective employee’s income tax withholding obligations. We retire immediately all such shares of common stock that we purchase in connection with such net issuance to employees.
DIVIDEND REINVESTMENT PLAN
As part of our dividend reinvestment plan for our common stockholders, we may direct the plan administrator to purchase shares of our common stock on the open market to satisfy dividend reinvestment requests related to dividends that we pay on outstanding shares of our common stock.
The following table summarizes the shares of common stock that we have purchased during the three months ended March 31, 2012.
Period/Purpose | Total number of shares | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs | |||||||
January 1 – 31, 2012 | |||||||||||
Dividend reinvestment requirements(a) | 17,480 | $ | 4.14 | (b) | n/a | n/a | |||||
February 1 – 29, 2012 | |||||||||||
Restricted stock vesting(c) | 5,453 | $ | 4.41 | (d) | n/a | n/a | |||||
March 1 – 31, 2012 | |||||||||||
Stock repurchase program(e) | 1,180,000 | $ | 4.31 | 1,180,000 | $ | 29,914,000 | |||||
Restricted stock vesting(c) | 36,700 | $ | 4.28 | (d) | n/a | n/a | |||||
Total March 1 – 31, 2012 | 1,216,700 | $ | 4.31 | 1,180,000 | $ | 29,914,000 | |||||
Total shares / weighted average price paid | 1,239,633 | $ | 4.31 | 1,180,000 | $ | 29,914,000 |
(a) | Represents stock purchased on the open market to satisfy dividend reinvestment requests. |
(b) | Represents the weighted-average purchase price per share, including commissions, for shares purchased pursuant to the terms of our dividend reinvestment plan. |
(c) | Represents shares repurchased from our employees in connection with the net issuance of shares to satisfy employee tax withholding obligations in connection with the vesting of restricted stock. |
(d) | Based on the weighted-average closing share prices of our common stock on the dates that the forfeiture restrictions lapsed. |
(e) | On January 17, 2012, we announced that our board of directors had authorized a stock repurchase program of up to $35.0 million |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not Applicable.
ITEM 4. MINE SAFETY DISCLOSURES.
Not Applicable.
ITEM 5. OTHER INFORMATION.
DEPARTURE OF OFFICER
On May 3, 2012, the Company accepted the resignation of Stephen J. Bacica from his position as Executive Vice President, Chief Financial Officer and Treasurer. Mr. Bacica will continue to provide transition services to MCG through
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May 15, 2012, or the Separation Date. Mr. Bacica's resignation allows him to pursue other interests and is not the result of any disagreement with the Company, known to an executive officer of the Company, on any matter relating to the Company's operations, policies or practices.
On May 3, 2012, Mr. Bacica executed a letter agreement, or the Letter Agreement, which sets forth the terms of his separation from the Company in accordance with his pre-existing employment agreement with the Company, including the agreement by the Company to treat Mr. Bacica's resignation as a termination by the Company other than for cause for purposes of such agreement. Under the terms of Letter Agreement, Mr. Bacica will receive: (i) his accrued and unpaid base salary and unreimbursed business expenses, in each case accrued through the Separation Date; and (ii) full and immediate lapsing of forfeiture conditions with respect to 23,680 shares of restricted stock that were originally scheduled to lapse through December 31, 2014. Mr. Bacica will also receive a severance amount of $1,582,000, representing two times his current base salary and two times his target annual bonus, which will be paid in installments over the 24-month period following the Separation Date. Receipt of separation benefits is subject to Mr. Bacica's execution and non-revocation of a release of claims against the Company and his continued compliance with certain non-competition and other obligations.
Consistent with Mr. Bacica's employment agreement, the parties must abide by mutual non-disparagement obligations, and Mr. Bacica must cooperate with the Company with respect to ongoing litigation and other transition matters after his termination of employment. Additionally, Mr. Bacica is bound by confidentiality, non-competition, non-solicitation and other restrictive covenants following his termination of employment.
The foregoing description of the Letter Agreement is qualified in its entirety by reference to the full text of the Letter Agreement, which is attached as Exhibit 10.5 and incorporated by reference herein.
APPOINTMENT OF OFFICER
Effective May 15, 2012, Keith Kennedy, Executive Vice President and Managing Director, will assume the additional roles of Chief Financial Officer and Treasurer.
Prior to joining the Company, Mr. Kennedy, age 42, served as an Executive-in-Residence at Arlington Capital Partners from May 2011 to February 2012. From October 2009 until he joined Arlington Capital, Mr. Kennedy pursued principal investing and, during this period, worked exclusively with Jay I. Kislak and J.I. Kislak, Inc. (March to September 2010) to pursue the acquisition of various private companies. From October 2002 to September 2009, Mr. Kennedy worked at GE Capital where he was a Managing Director. Prior to GE, Mr. Kennedy served as a Manager, Transaction Services, at Ernst & Young, LLP. Early in his career, Mr. Kennedy served as an Officer in the U.S. Air Force. Mr. Kennedy received his M.B.A. from The College of William & Mary and Bachelor of Science with High Distinction from Indiana University. Mr. Kennedy is a Chartered Financial Analyst and Certified Public Accountant.
In connection with the commencement of his employment with the Company, in January 2012, the Company executed an offer letter, or the Offer Letter, with Mr. Kennedy.
Term. Under the Offer Letter, Mr. Kennedy is an “at will” employee upon the terms set forth in the Offer Letter, for the period commencing from the date of execution and ending on the date on which such employment is terminated.
Salary, Bonus and Benefits. Mr. Kennedy will receive an annual base salary of $375,000, and is entitled to receive an annual bonus of $375,000 for 2012. Mr. Kennedy is entitled to participate in all benefit plans and programs that the Company establishes and makes available to its employees to the extent that he is eligible under (and subject to the provisions of) the plan documents governing those programs.
Stock-Based Award. On March 15, 2012, the Company's Board of Directors awarded Mr. Kennedy 175,000 shares of restricted common stock, pursuant to the Company's Third Amended and Restated 2006 Employee Restricted Stock Plan and subject to a restricted stock agreement entered into between the Company and Mr. Kennedy. Pursuant to the restricted stock agreement, 100% of the shares of restricted common stock subject to such award shall vest on March 14, 2016.
Payments Upon Termination or Upon a Change of Control. In the event that the Company terminates Mr. Kennedy's employment with the Company during 2012 other than for cause, Mr. Kennedy shall be entitled to receive an amount equal to (i) his unpaid base salary and bonus for 2012 and (ii) $750,000, such amount to be paid (net of all applicable withholdings and deductions) over a twelve-month period following the date of termination in accordance with and at such times as provided under the Company's normal payroll practices during such period. In the event that the Company experiences a change of control during 2012, Mr. Kennedy shall not be entitled to any additional compensation
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other than as set forth above.
During 2013 and thereafter: (i) in the event that the Company terminates Mr. Kennedy's employment other than for cause; or (ii) if 6 months after a change in control, Mr. Kennedy's employment with the Company shall be terminated by Mr. Kennedy for good reason, in each case he shall be entitled to receive an amount equal to $750,000, such amount to be paid (net of all applicable withholdings and deductions) monthly over a twelve-month period following the date of termination in accordance with and at such times as provided under the Company's normal payroll practices during such period.
There is no arrangement or understanding between Mr. Kennedy and any other person pursuant to which he was appointed as Executive Vice President, Managing Director, Chief Financial Officer and Treasurer, nor is there any family relationship between Mr. Kennedy and any of the Company's directors or other executive officers. There are no transactions since the beginning of the Company's last fiscal year, or any currently proposed transaction, in which the Company is a participant, the amount involved exceeds $120,000, and in which Mr. Kennedy had, or will have, a direct or indirect material interest.
The foregoing description of the Offer Letter is qualified in its entirety by reference to the full text of the Offer Letter, which was filed as Exhibit 10.4 to the Company's Current Report on Form 8-K filed with the SEC on March 15, 2012 and incorporated by reference herein.
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ITEM 6. EXHIBITS.
The following table lists exhibits filed as part of this report, according to the number assigned to them in Item 601 of Regulation S-K. All exhibits listed in the following table are incorporated by reference except for those exhibits denoted in the last column.
Incorporated by Reference | |||||
Exhibit No. | Description | Form and SEC File No. | Filing Date with SEC | Exhibit No. | Filed with this 10-Q |
3.1 | Amended and Restated Bylaws of MCG Capital Corporation. | 8-K (0-33377) | April 11, 2012 | 3.1 | |
10.1 | Amendment No. 1 to MCG Capital Corporation 2011 Severance Pay Plan. | 8-K (0-33377) | March 15, 2012 | 10.1 | |
10.2 | MCG Capital Corporation 2012 Annual Incentive Cash Bonus Plan. | 8-K (0-33377) | March 15, 2012 | 10.2 | |
10.3 | Form of Restricted Stock Agreement for MCG Executive Employee (pursuant to the Third Amended and Restated 2006 Employee Restricted Stock Plan). | 8-K (0-33377) | March 15, 2012 | 10.3 | |
10.4 | Offer Letter of Keith Kennedy dated as of January 16, 2012. | 8-K (0-33377) | March 15, 2012 | 10.4 | |
10.5 | Letter agreement between MCG Capital Corporation and Stephen J. Bacica, dated May 3, 2012. | * | |||
14.1 | Amended and Restated Code of Business Conduct and Ethics, effective as of March 15, 2012. | 8-K (0-33377) | March 15, 2012 | 14.1 | |
15.1 | Letter regarding unaudited interim financial information from Ernst & Young LLP, independent registered public accounting firm | * | |||
31.1 | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | * | |||
31.2 | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | * | |||
32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | † | |||
32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | † | |||
* | Filed herewith. | ||||
† | Furnished herewith. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MCG Capital Corporation | |||
Date: | May 3, 2012 | By: | /s/ RICHARD W. NEU |
Richard W. Neu | |||
Chief Executive Officer | |||
Date: | May 3, 2012 | By: | /s/ STEPHEN J BACICA |
Stephen J. Bacica | |||
Chief Financial Officer |
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