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EX-31.2 - SECTION 302 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-31293013.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-32193013.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER - MCG CAPITAL CORPex-32293013.htm
EX-15.1 - LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION FROM ERNST & YOUNG - MCG CAPITAL CORPex-15193013.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CHIEF EXECUTIVE OFFICER - MCG CAPITAL CORPex-31193013.htm


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 September 30, 2013
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.)
1001 19th Street North, 10th Floor
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 October 25, 2013, there were 71,212,013 shares of the registrant’s $0.01 par value Common Stock outstanding.




MCG CAPITAL CORPORATION
FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2013
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)
REVIEW 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)
September 30,
2013
December 31,
2012
 
(unaudited)
 
Assets
 
 
Cash and cash equivalents
$
96,384

$
73,588

Cash, securitization accounts
7,793

16,980

Cash, restricted
38,408

54,838

Investments at fair value
 
 
Non-affiliate investments (cost of $480,467 and $534,389, respectively)
301,343

365,639

Affiliate investments (cost of $46,139 and $69,500, respectively)
47,224

62,079

Control investments (cost of $62,664 and $64,898, respectively)
46,965

50,006

Total investments (cost of $589,270 and $668,787, respectively)
395,532

477,724

Interest receivable
4,356

2,700

Other assets
3,545

4,946

Total assets
$
546,018

$
630,776

Liabilities
 
 
Borrowings (maturing within one year of $4,001 and $15,038, respectively)
$
179,173

$
248,053

Interest payable
725

2,496

Other liabilities
2,619

8,499

Total liabilities
182,517

259,048

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 September 30, 2013 and December 31, 2012, 71,212 issued and outstanding on September 30, 2013 and 71,721 issued and outstanding on December 31, 2012
712

717

Paid-in capital
983,337

984,468

Distributions in excess of earnings
(426,810
)
(422,395
)
Net unrealized depreciation on investments
(193,738
)
(191,062
)
Total stockholders’ equity
363,501

371,728

Total liabilities and stockholders’ equity
$
546,018

$
630,776

Net asset value per common share at end of period
$
5.10

$
5.18



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
Nine months ended
 
September 30
September 30
(in thousands, except per share amounts)
2013
2012
2013
2012
Revenue
 
 
 
 
Interest and dividend income
 
 
 
 
Non-affiliate investments (less than 5% owned)
$
10,060

$
9,174

$
28,915

$
35,401

Affiliate investments (5% to 25% owned)
1,238

1,418

4,560

4,856

Control investments (more than 25% owned)
1,289

1,243

4,462

4,696

Total interest and dividend income
12,587

11,835

37,937

44,953

Advisory fees and other income
 
 




Non-affiliate investments (less than 5% owned)
570

210

1,344

1,357

Control investments (more than 25% owned)
13

24

25

1,262

Total advisory fees and other income
583

234

1,369

2,619

Total revenue
13,170

12,069

39,306

47,572

Operating expense
 
 




Interest expense
2,316

2,974

7,003

12,728

Employee compensation








Salaries and benefits
644

2,018

3,610

8,684

Amortization of employee restricted stock awards
420

505

1,174

1,694

Total employee compensation
1,064

2,523

4,784

10,378

General and administrative expense
1,824

2,504

3,942

10,714

Restructuring expense
2

12

14

59

Total operating expense
5,206

8,013

15,743

33,879

Net operating income before net investment gain (loss), loss on extinguishment of debt and income tax provision
7,964

4,056

23,563

13,693

Net realized gain (loss) on investments
 
 




Non-affiliate investments (less than 5% owned)
109


(658
)
12,550

Affiliate investments (5% to 25% owned)
(7
)

(554
)
16,370

Control investments (more than 25% owned)

(5,394
)
51

(102,288
)
Total net realized gain (loss) on investments
102

(5,394
)
(1,161
)
(73,368
)
Net unrealized (depreciation) appreciation on investments
 
 




Non-affiliate investments (less than 5% owned)
(5,005
)
2,463

(10,374
)
(13,892
)
Affiliate investments (5% to 25% owned)
71

(3,662
)
8,506

(19,407
)
Control investments (more than 25% owned)
217

6,838

(807
)
92,109

Other fair value adjustments
(1
)
(17
)
(1
)
(46
)
Total net unrealized (depreciation) appreciation on investments
(4,718
)
5,622

(2,676
)
58,764

Net investment gain (loss) before income tax provision
(4,616
)
228

(3,837
)
(14,604
)
Loss on extinguishment of debt before income tax (benefit) provision



(174
)
Income tax provision
59

18

111

329

Net income (loss)
$
3,289

$
4,266

$
19,615

$
(1,414
)
Income per basic and diluted common share
$
0.05

$
0.06

$
0.28

$
(0.02
)
Cash distributions declared per common share
$
0.125

$
0.14

$
0.38

$
0.45

Weighted-average common shares outstanding—basic and diluted
71,218

73,431

71,313

74,588


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)
 
Nine months ended
 
September 30
(in thousands, except per share amounts)
2013
2012
Increase in net assets from operations
 
 
Net operating income before net investment loss, loss on extinguishment of debt and income tax provision
$
23,563

$
13,693

Net realized loss on investments
(1,161
)
(73,368
)
Net unrealized appreciation on investments
(2,676
)
58,764

Loss on extinguishment of debt before income tax provision

(174
)
Income tax provision
(111
)
(329
)
Net income (loss)
19,615

(1,414
)
Distributions to stockholders
 
 
Distributions declared
(26,706
)
(33,793
)
Net decrease in net assets resulting from stockholder distributions
(26,706
)
(33,793
)
Capital share transactions
 
 
Repurchase of common stock
(2,272
)
(22,416
)
Amortization of restricted stock awards
 
 
Employee awards accounted for as employee compensation
1,174

1,694

Non-employee director awards accounted for as general and administrative expense
43

53

Common stock withheld to pay taxes applicable to the vesting of restricted stock
(81
)
(336
)
Net decrease in net assets resulting from capital share transactions
(1,136
)
(21,005
)
Total decrease in net assets
(8,227
)
(56,212
)
Net assets
 
 
Beginning of period
371,728

434,952

End of period
$
363,501

$
378,740

Net asset value per common share at end of period
$
5.10

$
5.20

Common shares outstanding at end of period
71,212

72,788



The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
3


MCG Capital Corporation
Consolidated Statements of Cash Flows
(unaudited)
 
Nine months ended
 
September 30
(in thousands)
2013
2012
Cash flows from operating activities
 
 
Net income (loss)
$
19,615

$
(1,414
)
Adjustments to reconcile net income to net cash provided by operating activities
 
 
Investments in portfolio companies
(85,029
)
(42,619
)
Principal collections related to investment repayments or sales
167,724

314,598

Decrease (increase) in interest receivable, accrued payment-in-kind interest and dividends
(5,948
)
9,717

Amortization of restricted stock awards
 
 
Employee
1,174

1,694

Non-employee director
43

53

Decrease in cash—securitization accounts from interest collections
2,431

5,475

Decrease in restricted cash—escrow accounts
5,881

327

Depreciation and amortization
1,019

6,120

Decrease in other assets
500

1,039

Decrease in other liabilities
(7,702
)
(1,676
)
Realized loss on investments
1,161

73,368

Net unrealized appreciation on investments
2,676

(58,764
)
Loss on extinguishment of debt

174

Net cash provided by operating activities
103,545

308,092

Cash flows from financing activities
 
 
Repurchase of common stock
(2,272
)
(22,416
)
Payments on borrowings
(68,879
)
(202,740
)
Proceeds from borrowings

21,400

Decrease (increase) in cash in restricted and securitization accounts
 


Securitization accounts for repayment of principal on debt
6,756

31,156

Restricted cash
10,549

(79,906
)
Payment of financing costs
(116
)
(1,030
)
Distributions paid
(26,706
)
(46,885
)
Common stock withheld to pay taxes applicable to the vesting of restricted stock
(81
)
(336
)
Net cash used in financing activities
(80,749
)
(300,757
)
Net increase in cash and cash equivalents
22,796

7,335

Cash and cash equivalents
 
 
Beginning balance
73,588

58,563

Ending balance
$
96,384

$
65,898

Supplemental disclosure of cash flow information
 
 
Interest paid
$
7,802

$
9,261

Income taxes paid
158

61

Paid-in-kind interest collected
2,161

8,510

Dividend income collected
680

8,149


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
4


MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2013 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Control Investments(4):
 
 
 
 
 
 
 
GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)(1)
4.3
%

4.3
%
$
13,331

$
10,959

$
11,557

 
Subordinated Debt (Due 12/16)(6)
2.5
%

2.5
%
11,519

6,975


 
 
Class B Voting Units (8.0%, 86,700 units)(5)
 
 
 
 
9,071


Jet Plastica
Investors, LLC
(2)(9)
Plastic Products
Senior Debt A (Due 3/15)(1)(6)
2.4
%
7.5
%
9.9
%
5,232

3,897


RadioPharmacy
Investors, LLC
(2)
Healthcare
Senior Debt (Due 12/16)(1)
7.5
%

7.5
%
7,640

7,640

7,640

 
Subordinated Debt (Due 12/16)(1)
12.0
%
3.0
%
15.0
%
10,762

10,758

10,758

 
 
Preferred LLC Interest (19.7%, 70,000 units)
 
 
 
 
13,364

17,010

Total control investments (represents 11.9% of total investments at fair value)
 
 
 
 
62,664

46,965

Affiliate Investments(3):
 
 
 
 
 
 
 
C7 Data Centers, Inc.
Business Services
Senior Debt (Due 9/17)(1)
9.5
%

9.5
%
16,850

16,569

16,743

Series B Preferred Units (10.0%, 7,142,857 units)
 
 
 
 
2,203

2,819

Contract Datascan Holdings, Inc.
Business Services

Subordinated Debt (Due 3/16)(1)
12.0
%
2.0
%
14.0
%
8,706

8,296

8,296

Series A Preferred Stock (10.0%, 2,313 shares)(1)(5)
 
 
 
 
2,387

2,657

Series B Preferred Stock (10.0%, 358 shares)(1)(5)
 
 
 
 
307

412

 
 
Common Stock (8,519 shares)(1)(5)
 
 
 
 
538


IDOC, LLC
Healthcare
Senior Debt (Due 8/17)(1)
9.8
%

9.8
%
15,000

14,746

14,746

 
 
Limited Partner Interests (8.0%)(1)(2)
 
 
 
 
1,093

1,551

Total affiliate investments (represents 11.9% of total investments at fair value)
 
 
 
 
46,139

47,224



The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
5


MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2013 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
Accurate Group Holdings, Inc.(2)
Business Services
Subordinated Unsecured Debt (Due 8/18)(1)
12.5
%

12.5
%
$
10,000

$
9,822

$
9,822

Series A Preferred Stock (974,805 shares)(5)
 
 
 
 
2,000

1,955

Advanced Sleep
Concepts, Inc.
(2)
Home Furnishings
Senior Debt (Due 8/14 to 1/14)(1)
10.3
%

10.3
%
7,559

7,552

6,764

Subordinated Debt (Due 1/14)(1)(6)
%
10.0
%
10.0
%
3,677

3,352


Broadview Networks Holdings, Inc.
Communications
Common Stock (132,779 shares)(5)
 
 
 
 
159,579

875

 
Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 


 
 
Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 


Color Star Growers of Colorado, Inc.
Agriculture
Subordinated Debt (Due 11/16)(1)(6)
12.0
%
3.0
%
15.0
%
13,864

13,522

13,195

Community Investors, Inc.
Business Services
Senior Debt (Due 5/18)(1)
9.8
%

9.8
%
12,300

12,067

12,067

Preferred Stock (10.0%, 297,436 shares)(1)
 
 
 
 
309

309

 
 
Common Stock (2,564 shares)(1)(5)
 
 
 
 
3

45

Cruz Bay Publishing, Inc.
Publishing
Subordinated Debt (Due 3/15)(1)
5.0
%
7.3
%
12.3
%
21,130

21,086

21,086

Dorsey School of Business Holdings, Inc.
Education
Senior Debt (Due 6/18)(1)
9.5
%

9.5
%
10,000

9,857

9,857

Education Management, Inc.(11)
Education
Senior Debt (Due 6/15)(1)
10.5
%

10.5
%
23,300

23,176

22,248

G&L Investment Holdings, LLC(2)
Insurance
Subordinated Debt (Due 5/14)(1)
10.7
%
4.3
%
15.0
%
19,275

19,178

19,178

 
Series A Preferred Shares (14.0%,
5,000,000 shares)
(5)
 
 
 
 
8,191

4,934

 
 
Class C Shares (621,907 shares)(5)
 
 
 
 
529


Golden Knight II CLO, Ltd.(10)
Diversified Financial Services
Income Notes (Due 4/19)
 
 
 
 
2,594

3,256

Hammond's Candies Since 1920 II, LLC
Manufacturing
Subordinated Debt (Due 9/18)(1)
10.0
%
4.0
%
14.0
%
9,284

9,121

9,121

Huron Inc.
Manufacturing
Subordinated Unsecured Debt (Due 8/18)(1)
10.0
%
4.0
%
14.0
%
13,187

12,949

12,949

Intrafusion Holding Corp.
Healthcare
Senior Debt (Due 6/18)(1)
12.0
%

12.0
%
11,500

11,281

11,281

Legacy Cabinets Holdings II, Inc.
Home Furnishings
Class B-1 Common Stock (2,000 shares)(5)
 
 
 
 
2,185

62

Mailsouth, Inc.
Publishing
Senior Debt (Due 12/16)(1)
6.8
%

6.8
%
4,080

4,043

3,982

Maverick Healthcare
Equity, LLC
Healthcare
Preferred Units (10.0%, 1,250,000 units)(5)
 
 
 
 
2,021

2,013

 
Class A Common Units (1,250,000 units)(5)
 
 
 
 


Midwest Technical Institute, Inc.
Education
Senior Debt (Due 10/17)(1)
9.5
%

9.5
%
14,250

13,971

14,098

Miles Media Group, LLC(2)
Business Services
Senior Debt (Due 6/16)(1)
12.5
%

12.5
%
19,363

19,197

19,197

Oceans Acquisition, Inc.
Healthcare
Senior Debt (Due 12/17)(1)
10.8
%

10.8
%
12,710

12,443

12,443


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
6


MCG Capital Corporation
Consolidated Schedule of Investments
September 30, 2013 (unaudited)
(dollars in thousands)
 
 
 
Interest Rate(8)
Principal
Cost
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Rita’s Water Ice Franchise Company, LLC
Restaurants
Senior Debt (Due 11/16)(1)
14.0
%

14.0
%
$
9,375

$
9,315

$
9,315

Sagamore Hill Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 8/14)(1)
10.5
%

10.5
%
8,900

8,868

8,868

SC Academy Holdings, Inc.
Education
Subordinated Debt (Due 7/16)(1)
%
14.0
%
14.0
%
14,129

14,060

14,060

South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt (Due 10/17)(1)
12.0
%
2.5
%
14.5
%
18,683

18,379

18,478

Summit Business Media Parent Holding Company LLC
Information Services
Class E Series I Units (636 units)(1)(5)
 
 
 
 
4,120

547

Class E Series II Units (276 units)(1)(5)
 
 
 
 
1,788

60

Ted's Café Escondido Holdings, Inc.
Restaurants
Senior Debt (Due 12/18)(1)
9.5
%

9.5
%
14,000

13,676

13,676

The e-Media Club I, LLC
Investment Fund
LLC Interest (74 units)(5)
 
 
 
 
88

11

Virtual Radiologic Corporation
Healthcare
Senior Debt (Due 12/16)(1)
7.3
%

7.3
%
13,635

13,516

8,675

Visant Corporation
Consumer Products
Senior Debt (Due 12/16)(1)
5.3
%

5.3
%
4,711

4,711

4,581

West World Media, LLC
Information Services
Senior Debt (Due 9/15)(1)
11.0
%
3.0
%
14.0
%
11,507

11,093

11,199

Class A Membership Units (25,000 units)(1)(5)
 
 
 
 
1

390

 
 
Warrant to purchase Class A Membership Units (expire 9/15)(1)(5)
 
 
 
 
324

378

Xpressdocs Holdings, Inc.
Business Services
Series A Preferred Stock (161,870 shares)(5)
 
 
 
 
500

368

Total non-affiliate investments (represents 76.2% of total investments at fair value)
 
 
 
 
480,467

301,343

Total Investments
 
 
 
 
 
 
$
589,270

$
395,532



The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
7


MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2012
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Control Investments(4):
 
 
 
 
 
 
 
GMC Television Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 12/16)(1)
4.3
%

4.3
%
$
17,570

$
15,150

$
15,736

 
Subordinated Debt (Due 12/16)(6)
2.5
%

2.5
%
11,303

6,976


 
 
Class B Voting Units (8.0%, 86,700 units)(5)
 
 
 
 
9,071


Jet Plastica
Investors, LLC
(2)(9)
Plastic Products
Senior Debt A (Due 3/15)(1)(6)
2.3
%
7.0
%
9.3
%
4,963

3,897


RadioPharmacy
Investors, LLC
(2)
Healthcare
Senior Debt (Due 12/16)(1)
7.5
%

7.5
%
7,640

7,640

7,640

 
Subordinated Debt (Due 12/16)(1)
12.0
%
3.0
%
15.0
%
10,521

10,518

10,518

 
 
Preferred LLC Interest (19.7%, 70,000 units)
 
 
 
 
11,646

16,112

Total control investments (represents 10.5% of total investments at fair value)
64,898

50,006

Affiliate Investments(3):
 
 
 
 
 
 
 
Advanced Sleep
Concepts, Inc.
(2)
Home Furnishings
Senior Debt (Due 1/14)(1)
12.9
%

12.9
%
$
7,559

$
7,539

$
7,199

Subordinated Debt (Due 1/14)(1)(6)
12.0
%
4.0
%
16.0
%
5,873

5,385

10

 
 
Series A Preferred Stock (20.0%, 49 shares)(5)
 
 
 
 
344


 
 
Series B Preferred Stock (1,000 shares)(5)
 
 
 
 


 
 
Common Stock (423 shares)(5)
 
 
 
 
524


 
 
Warrants to purchase Common Stock
(expire 10/16)
(5)
 
 
 
 
348


C7 Data Centers, Inc.
Business Services
Senior Debt (Due 9/17)(1)
9.5
%

9.5
%
10,000

9,659

9,659

Series B Preferred Units (10.0%, 7,142,857 units)
 
 
 
 
2,053

2,421

Contract Datascan Holdings, Inc.
Business Services

Subordinated Debt (Due 3/16)(1)
12.0
%
2.0
%
14.0
%
8,575

8,059

7,870

Series A Preferred Stock (10.0%, 2,313 shares)(1)(5)
 
 
 
 
2,387

2,203

Series B Preferred Stock (10.0%, 358 shares)(1)(5)
 
 
 
 
307

341

 
 
Common Stock (8,519 shares)(1)(5)
 
 
 
 
538


IDOC, LLC
Healthcare
Senior Debt (Due 8/17)(1)
9.8
%

9.8
%
15,000

14,707

14,707

 
 
Limited Partner Interests (8.0%)(1)(2)
 
 
 
 
1,032

1,073

Miles Media Group, LLC(2)
Business Services
Senior Debt (Due 6/16)(1)
12.5
%

12.5
%
16,738

16,495

16,495

Warrants to purchase Class A Units (expire 3/21)(1)(5)
 
 
 
 
123

101

Total affiliate investments (represents 13.0% of total investments at fair value)
 
 
 
 
69,500

62,079



The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
8


MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2012
(dollars in thousands)
 
 
 
Interest Rate(8)
 
 
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Principal
Cost
Non-Affiliate Investments (less than 5% owned):
 
 
 
 
 
 
Accurate Group Holdings, Inc.(2)
Business Services
Subordinated Unsecured Debt (Due 6/18)(1)
12.5
%

12.5
%
$
10,000

$
9,802

$
9,802

Series A Preferred Stock (974,805 shares)(5)
 
 
 
 
2,000

2,000

BarBri, Inc.
Publishing
Senior Debt (Due 6/17)(1)
6.0
%

6.0
%
6,099

6,046

6,110

Broadview Networks Holdings, Inc.
Communications
Common Stock (132,779 shares)(5)
 
 
 
 
159,579

1,087

 
Series A-1 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 


 
 
Series A-2 Warrant to purchase Common Stock (expire 11/20)(5)
 
 
 
 


Capstone Logistics, LLC
Logistics
Senior Debt (Due 9/16)(1)
10.5
%

10.5
%
27,347

27,237

27,237

Chase Industries, Inc.
Manufacturing
Subordinated Unsecured Debt (Due 5/18)(1)
11.5
%

11.5
%
16,800

16,472

16,472

Color Star Growers of Colorado, Inc.
Agriculture
Subordinated Debt (Due 11/16)(1)
12.0
%
3.0
%
15.0
%
13,553

13,292

13,292

Construction Trailer Specialists, Inc.(2)
Auto Parts
Senior Debt (Due 6/13)(1)
8.6
%
6.3
%
14.9
%
6,445

6,434

6,434

Cruz Bay Publishing, Inc.
Publishing
Subordinated Debt (Due 3/15)(1)(7)
5.0
%
7.3
%
12.3
%
20,000

19,942

19,942

CWP/RMK Acquisition Corp.(2)
Home Furnishings
Senior Debt (Due 12/16)(6)
6.8
%

6.8
%
600

519

597

Education Management, Inc.
Education
Senior Debt (Due 6/15)(1)
9.3
%

9.3
%
26,654

26,459

25,260

Gans Communications,
L.P.(2)
Cable
Senior Debt (Due 10/17)(1)
5.0
%

5.0
%
5,015

4,996

5,061

G&L Investment Holdings, LLC(2)
Insurance
Subordinated Debt (Due 5/14)(1)
10.7
%
4.3
%
15.0
%
18,667

18,462

18,462

 
Series A Preferred Shares (14.0%,
5,000,000 shares)
(5)
 
 
 
 
8,191

8,067

 
 
Class C Shares (621,907 shares)(5)
 
 
 
 
529


Golden Knight II CLO, Ltd.(10)
Diversified Financial Services
Income Notes (Due 4/19)
 
 
 
 
2,989

2,847

Hammond's Candies Since 1920 II, LLC
Manufacturing
Senior Debt (Due 12/17)(1)
8.5
%

8.5
%
3,500

3,427

3,427

 
Subordinated Debt (Due 6/18)(1)
10.0
%
4.0
%
14.0
%
9,008

8,829

8,829

Jenzabar, Inc.
Technology
Subordinated Preferred Stock (109,800 shares)
 
 
 
 
1,098

988

Legacy Cabinets Holdings II, Inc.
Home Furnishings
Class B-1 Common Stock (2,000 shares)(5)
 
 
 
 
2,185


Mailsouth, Inc.
Publishing
Senior Debt (Due 12/16)(1)
6.8
%

6.8
%
4,640

4,590

4,594

Maverick Healthcare
Equity, LLC
Healthcare
Preferred Units (10.0%, 1,250,000 units)
 
 
 
 
1,925

2,078

 
Class A Common Units (1,250,000 units)(5)
 
 
 
 

444

Midwest Technical Institute, Inc.
Education
Senior Debt (Due 10/17)(1)
9.5
%

9.5
%
17,063

16,682

16,682

NDSSI Holdings,
LLC(2)
Electronics
Senior Debt (Due 12/12)(1)
12.8
%
1.0
%
13.8
%
30,175

30,174

30,174

 
Series D Preferred Units (30.0%, 2,000,000 units)(5)
 
 
 
 
2,000

3,000

 
 
Series A Preferred Units (516,691 units)(5)
 
 
 
 
718


 
 
Series B Convertible Preferred Units
(165,003 units)
(5)
 
 
 
 
142

187

 
 
Class A Common Units (1,000,000 units)(5)
 
 
 
 
333


Oceans Acquisition, Inc.
Healthcare
Senior Debt (Due 12/17)(1)
10.8
%

10.8
%
23,710

23,237

23,237


The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
9


MCG Capital Corporation
Consolidated Schedule of Investments
December 31, 2012
(dollars in thousands)
 
 
 
Interest Rate(8)
Principal
Cost
Fair
Value
Portfolio Company
Industry
Investment
Current
PIK
Total
Orbitz Worldwide, Inc.(10)
Personal Transportation
Senior Debt (Due 7/14)(1)
3.2
%

3.2
%
$
2,808

$
2,728

$
2,702

Rita’s Water Ice Franchise Company, LLC
Restaurants
Senior Debt (Due 11/16)(1)
14.0
%

14.0
%
9,375

9,301

9,301

Sagamore Hill Broadcasting, LLC(2)
Broadcasting
Senior Debt (Due 8/14)(1)
10.5
%

10.5
%
9,700

9,636

9,636

SC Academy Holdings, Inc.
Education
Subordinated Debt (Due 7/16)(1)
12.0
%

12.0
%
18,000

17,841

17,841

Softlayer Technologies, Inc.
Business Services
Senior Debt (Due 11/16)(1)
7.3
%

7.3
%
13,720

13,606

13,814

South Bay Mental Health Center, Inc.
Healthcare
Subordinated Debt (Due 10/17)(1)
12.0
%
2.5
%
14.5
%
18,333

17,984

18,219

Summit Business Media Parent Holding Company LLC
Information Services
Class E Series I Units (636 units)(1)(5)
 
 
 
 
4,120

439

Class E Series II Units (276 units)(1)(5)
 
 
 
 
1,788

13

Sunshine Media
Group, Inc.
(2)
Publishing
Warrants to purchase Common Stock
(expire 1/21)
(5)
 
 
 
 


The e-Media Club I, LLC
Investment Fund
LLC Interest (74 units)(5)
 
 
 
 
88

11

The Gavilon Group, LLC
Agriculture
Senior Debt (Due 12/16)(1)
6.0
%

6.0
%
8,500

8,409

8,489

Virtual Radiologic Corporation
Healthcare
Senior Debt (Due 12/16)(1)
7.8
%

7.8
%
13,740

13,591

12,091

Visant Corporation
Consumer Products
Senior Debt (Due 12/16)(1)
5.3
%

5.3
%
4,760

4,772

4,338

VS&A-PBI Holding LLC
Publishing
LLC Interest(5)
 
 
 
 
500


West World Media, LLC
Information Services
Senior Debt (Due 9/15)(1)
11.0
%
3.0
%
14.0
%
11,462

10,911

11,140

Class A Membership Units (25,000 units)(1)(5)
 
 
 
 
1

335

 
 
Warrant to purchase Class A Membership Units
(expire 9/15)
(1)(5)
 
 
 
 
324

719

Xpressdocs Holdings, Inc.
Business Services
Series A Preferred Stock (161,870 shares)(5)
 
 
 
 
500

241

Total non-affiliate investments (represents 76.5% of total investments at fair value)
 
 
 
 
534,389

365,639

Total Investments
 
 
 
 
 
 
$
668,787

$
477,724



The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
10


MCG Capital Corporation
Consolidated Schedule of Investments

(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) 
Equity security is non-income producing at period-end.
(6) 
Loan or debt security is on non-accrual status.
(7) 
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.
(8) 
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. Rates on preferred stock and preferred LLC interests, where applicable, represent the contractual rate.
(9) 
During the three months ended June 30, 2012, Jet Plastica Investors, LLC liquidated substantially all of its assets.  Including the proceeds from the liquidation, we have received $11.0 million of payments on our senior debt.
(10) 
Investment is not a qualifying asset under section 55(a) of the Investment Company Act of 1940, as amended. Qualifying assets must represent at least 70% of total assets at the time of acquisition of any additional non-qualifying assets.
(11) 
In October 2013, we signed a letter of intent to exchange $5.0 million of our senior debt to Education Management, Inc. for $5.0 million of a new class of preferred stock of Education Management, Inc.  If the transaction is consummated as contemplated, Education Management, Inc. will become an affiliate.



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 Subsidiary—This subsidiary is a bankruptcy remote, special-purpose entity to which we transfer certain loans. The financing subsidiary, in turn, transfers the loans to a Delaware statutory trust. For accounting purposes, the transfers of the loans to the Delaware statutory trust is structured as an on-balance sheet securitization.
Small Business Investment Subsidiaries—We own Solutions Capital I, L.P., or Solutions Capital, 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. in order to apply for a second SBIC license. In September 2012, we submitted documentation to the SBA in support of a potential SBIC license for Solutions Capital II, L.P. In February 2013, we received a letter from the SBA inviting us to file a formal license application, which we submitted to the SBA in March 2013 and was accepted by the SBA in May 2013. Neither receipt of such an invitation nor acceptance of the application from the SBA assures an applicant that the SBA will grant the additional license in any specified time period or at all. MCG is also the sole member of Solutions Capital G.P., LLC, which acts as the general partner of Solutions Capital and Solutions Capital II, L.P.
Taxable SubsidiariesWe 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; Solutions Capital II, L.P.; Solutions Capital G.P., LLC; and MCG’s special-purpose financing subsidiary, 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

12


Consolidated Financial Statements, we have evaluated subsequent events that occurred after the balance sheet date as of September 30, 2013 through the date these financial statements were issued.
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, 2012.
NOTE 2—INVESTMENT PORTFOLIO
The following table summarizes the composition of our investment portfolio at cost and fair value:
 
COST BASIS
FAIR VALUE BASIS
 
September 30, 2013
December 31, 2012
September 30, 2013
December 31, 2012
(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
$
228,577

38.8
%
$
297,842

44.6
%
$
218,937

55.4
%
$
291,760

61.1
%
Subordinated debt




 
 




 
 
Secured
124,727

21.2

127,288

19.0

114,173

28.8

114,983

24.1

Unsecured
22,771

3.8

26,274

3.9

22,771

5.8

26,274

5.4

Total debt investments
376,075

63.8

451,404

67.5

355,881

90.0

433,017

90.6

Equity investments




 
 




 
 
Preferred
44,041

7.5

46,403

6.9

37,284

9.4

41,558

8.7

Common/common equivalents
169,154

28.7

170,980

25.6

2,367

0.6

3,149

0.7

Total equity investments
213,195

36.2

217,383

32.5

39,651

10.0

44,707

9.4

Total investments
$
589,270

100.0
%
$
668,787

100.0
%
$
395,532

100.0
%
$
477,724

100.0
%
Our debt instruments bear contractual interest rates ranging from 2.5% to 15.0%, a portion of which may be in the form of paid-in-kind interest, or PIK. As of September 30, 2013, approximately 72.8% of the fair value of our loan portfolio had variable interest rates, based on a London Interbank Offer Rate, or LIBOR, benchmark or the prime rate, and 27.2% of the fair value of our loan portfolio had fixed interest rates. As of September 30, 2013, approximately 63.6% 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 2.5% and 6.0%. At origination, our loans generally have four- to six-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 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.

13


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
 
September 30, 2013
December 31, 2012
September 30, 2013
December 31, 2012
(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
$
3,897

1.04
%
$
3,897

0.86
%
$

%
$

%
Not on non-accrual status








Total loans greater than 90 days past due
$
3,897

1.04
%
$
3,897

0.86
%
$

%
$

%
Loans on non-accrual status
 
 
 
 
 
 
 
 
0 to 90 days past due
$
23,849

6.34
%
$
12,880

2.85
%
$
13,195

3.71
%
$
607

0.14
%
Greater than 90 days past due
3,897

1.04

3,897

0.86





Total loans on non-accrual status
$
27,746

7.38
%
$
16,777

3.71
%
$
13,195

3.71
%
$
607

0.14
%
The following table summarizes our investment portfolio by industry at fair value:
 
September 30, 2013
December 31, 2012
(dollars in thousands)
Investments
at Fair Value
Percent of
Total Portfolio
Investments at
Fair Value
Percent of
Total Portfolio
Healthcare
$
104,598

26.4
%
$
106,119

22.2
%
Business services
74,689

18.9

64,947

13.6

Education
60,262

15.2

59,783

12.5

Publishing
25,069

6.4

30,646

6.4

Insurance
24,112

6.1

26,529

5.6

Restaurants
22,991

5.8

9,301

1.9

Manufacturing
22,070

5.6

28,728

6.0

Broadcasting
20,424

5.2

25,372

5.3

Agriculture
13,195

3.3

21,781

4.6

Information services
12,573

3.2

12,646

2.7

Home furnishings
6,826

1.7

7,806

1.6

Consumer products
4,581

1.2

4,338

0.9

Auto parts


6,434

1.3

Cable


5,061

1.1

Electronics


33,361

7.0

Logistics


27,237

5.7

Other(a)
4,142

1.0

7,635

1.6

Total
$
395,532

100.0
%
$
477,724

100.0
%
______________________
(a)    No individual industry within this category exceeds 1%.
 
 
 
 

14


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.

15


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:
 
September 30, 2013
(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
$
17,239

$
151,012

$
168,251

Subordinated secured debt

95,118

95,118

Unsecured subordinated debt

22,771

22,771

Preferred equity
3,256

9,580

12,836

Common/common equivalents

2,367

2,367

Total non-affiliate investments
20,495

280,848

301,343

Affiliate investments
 
 


Senior secured debt

31,489

31,489

Subordinated secured debt

8,297

8,297

Preferred equity

7,438

7,438

Total affiliate investments

47,224

47,224

Control investments
 
 


Senior secured debt

19,197

19,197

Subordinated secured debt

10,758

10,758

Preferred equity

17,010

17,010

Total control investments

46,965

46,965

Total assets at fair value
$
20,495

$
375,037

$
395,532

As of September 30, 2013, 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. As of each of September 30, 2013 and December 31, 2012, our portfolio contained zero non-majority control investments. 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 comprised 11.9% of our investment portfolio as of September 30, 2013. 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 in question. Also, in a limited number of cases, we use income approaches to determine fair value, 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 upon a hypothetical sale or exit and then allocate such value to the investment's securities in order of their relative liquidation preference. In addition, we assume that any outstanding debt or other securities that are senior to our securities are required to be repaid at par. 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-Control Investments—Non-control investments comprised 88.1% of our investment portfolio as of September 30, 2013. Quoted prices were not available for 94.1% of our non-control investments as of

16


September 30, 2013. 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. In the event the fair value of a non-control debt investment, as determined by the same market or income approach used to value our control investments, is below our cost, we estimate the fair value using the market or income approach.
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 September 30, 2013, these securities represented 5.2% of our investment portfolio. We utilize independent pricing services to arrive at 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, as of September 30, 2013, 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 99.0% of our investment portfolio, 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 executive 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 the three and nine months ended September 30, 2013 and 2012, there were no transfers in or out of Level 1, 2 or 3.

17


The following table provides a reconciliation of fair value changes during the three months ended September 30, 2013 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 as of June 30, 2013
 
 
 
 
Senior secured debt
$
166,355

$
31,489

$
19,191

$
217,035

Subordinated secured debt
94,127

8,217

10,676

113,020

Unsecured subordinated debt
39,244



39,244

Preferred equity
12,706

7,261

16,220

36,187

Common/common equivalents equity
2,475



2,475

Total fair value as of June 30, 2013
314,907

46,967

46,087

407,961

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(1,267
)
(41
)
5

(1,303
)
Subordinated secured debt
(372
)


(372
)
Preferred equity
(3,134
)
105

211

(2,818
)
Common/common equivalents equity
(108
)


(108
)
Total realized/unrealized gain (loss)
(4,881
)
64

216

(4,601
)
Issuances
 
 
 
 
Senior secured debt
2,152

35

6

2,193

Subordinated secured debt
1,363

80

82

1,525

Unsecured subordinated debt
462



462

Preferred equity
8

72

579

659

Total issuances
3,985

187

667

4,839

Settlements
 
 
 
 
Senior secured debt
(6,348
)
6

(5
)
(6,347
)
Unsecured subordinated debt
(16,935
)


(16,935
)
Total settlements
(23,283
)
6

(5
)
(23,282
)
Sales








Senior secured debt
(9,880
)


(9,880
)
Total sales
(9,880
)


(9,880
)
Fair value as of September 30, 2013
 
 
 
 
Senior secured debt
151,012

31,489

19,197

201,698

Subordinated secured debt
95,118

8,297

10,758

114,173

Unsecured subordinated debt
22,771



22,771

Preferred equity
9,580

7,438

17,010

34,028

Common/common equivalents equity
2,367



2,367

Total fair value as of September 30, 2013
$
280,848

$
47,224

$
46,965

$
375,037

There were no purchases of level 3 investments during the three months ended September 30, 2013.

18


The following table provides a reconciliation of fair value changes during the three-month period ended September 30, 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 as of June 30, 2012
 
 
 
 
Senior secured debt
$
197,716

$
21,718

$
34,817

$
254,251

Subordinated secured debt
64,655

13,412

10,436

88,503

Preferred equity
14,140

2,662

15,754

32,556

Common/common equivalents equity
1,883



1,883

Total fair value as of June 30, 2012
278,394

37,792

61,007

377,193

Realized/unrealized gain (loss)
 
 
 
 
Senior secured debt
(10
)
(848
)
857

(1
)
Subordinated secured debt
1,848

(2,239
)

(391
)
Preferred equity
310

(517
)
588

381

Common/common equivalents equity
(33
)
(61
)

(94
)
Total realized/unrealized gain (loss)
2,115

(3,665
)
1,445

(105
)
Issuances
 
 
 
 
Senior secured debt
945

24,338

12

25,295

Subordinated secured debt
567

70

81