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MVC > SEC Filings for MVC > Form 10-Q on 10-Jun-2013All Recent SEC Filings

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Form 10-Q for MVC CAPITAL, INC.


10-Jun-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report contains certain statements of a forward-looking nature relating to future events or the future financial performance of the Company and its investment portfolio companies. Words such as may, will, expect, believe, anticipate, intend, could, estimate, might and continue, and the negative or other variations thereof or comparable terminology, are intended to identify forward-looking statements. Forward-looking statements are included in this report pursuant to the "Safe Harbor" provision of the Private Securities Litigation Reform Act of 1995. Such statements are predictions only, and the actual events or results may differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those relating to adverse conditions in the U.S. and international economies, competition in the markets in which our portfolio companies operate, investment capital demand, pricing, market acceptance, any changes in the regulatory environments in which we operate, changes in our accounting assumptions that regulatory agencies, including the SEC, may require or that result from changes in the accounting rules or their application, competitive forces, adverse conditions in the credit markets impacting the cost, including interest rates and/or availability of financing, the results of financing and investing efforts, the ability to complete transactions, the inability to implement our business strategies and other risks identified below or in the Company's filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. The following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Consolidated Financial Statements, the Notes thereto and the other financial information included elsewhere in this report and the Company's annual report on Form 10-K for the year ended October 31, 2012.

SELECTED CONSOLIDATED FINANCIAL DATA:

Financial information for the fiscal year ended October 31, 2012 is derived from the consolidated financial statements included in the Company's annual report on Form 10-K, which have been audited by Ernst & Young LLP, the Company's independent registered public accounting firm. Quarterly financial information is derived from unaudited financial data, but in the opinion of management, reflects all adjustments (consisting only of normal recurring adjustments), which are necessary to present fairly the results for such interim periods.


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                      Selected Consolidated Financial Data



                                                Six Month Period            Six Month Period
                                                     Ended                       Ended                 Year Ended
                                                   April 30,                   April 30,               October 31,
                                                      2013                        2012                    2012
                                                  (Unaudited)                 (Unaudited)
                                                 (In thousands, except per share data and number of investments)
Operating Data:
Interest and related portfolio income:
Interest and dividend income                $                 10,580    $                 17,313    $          25,205
Fee income                                                     1,412                         967                1,940
Fee income - asset management                                    897                       1,468                2,300
Other income                                                     160                          60                  442

Total operating income                                        13,049                      19,808               29,887

Expenses:
Management fee                                                 3,945                       4,433                8,588
Portfolio fees - asset management                                209                         524                  968
Management fee - asset management                                464                         577                  757
Administrative                                                 1,792                       1,740                3,573
Interest and other borrowing costs                             2,355                       1,627                3,367
Net Incentive compensation (Note 10)                           2,183                      (2,112 )             (5,937 )

Total operating expenses                                      10,948                       6,789               11,316

Total waiver by adviser                                          (75 )                    (2,479 )             (2,554 )

Net operating income before taxes                              2,176                      15,498               21,125

Tax expense, net                                                   2                           1                    4

Net operating income                                           2,174                      15,497               21,121

Net realized and unrealized gain (loss):
Net realized gain (loss) on investments                       43,215                         255              (20,518 )
Net change in unrealized (depreciation)
appreciation on investments                                  (30,621 )                   (23,255 )            (22,257 )

Net realized and unrealized gain (loss)
on investments                                                12,594                     (23,000 )            (42,775 )

Net increase (decrease) in net assets
resulting from operations                   $                 14,768    $                 (7,503 )  $         (21,654 )

Per Share:
Net increase (decrease) in net assets
per share resulting from operations         $                   0.62    $                  (0.31 )  $           (0.90 )
Dividends per share                         $                  0.270    $                  0.240    $           0.495
Balance Sheet Data:
Portfolio at value                          $                368,540    $                434,101    $         404,171
Portfolio at cost                                            327,423                     363,360              332,432
Total assets                                                 491,944                     480,508              456,431
Shareholders' equity                                         388,634                     406,266              386,016
Shareholders' equity per share (net
asset value)                                $                  16.56    $                  16.99    $           16.14
Common shares outstanding at period end                       23,469                      23,917               23,917
Other Data:
Number of Investments funded in period                             6                           6                   11
Investments funded ($) in period            $                 36,469    $                  7,363    $          11,300


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                               2013                       2012                                2011
                           Qtr 2   Qtr 1   Qtr 4     Qtr 3    Qtr 2    Qtr 1    Qtr 4    Qtr 3    Qtr 2   Qtr 1
                                                   (In thousands, except per share data)
Quarterly Data
(Unaudited):

Total operating income     6,663   6,386    6,148     3,931   16,164    3,644    3,421    3,482   4,544    4,524

Management fee             1,865   2,080    2,027     2,127    2,177    2,257    2,155    2,183   2,022    2,485
Portfolio fees - asset
management                   103     106      106       338      462       62        -        -       -        -
Management fee - asset
management                   232     232      140        41      188      388        -        -     227       70
Administrative               902     890      862       971      817      923    1,105    1,049     990    1,176
Interest, fees and other
borrowing costs            1,418     937      886       854      832      795      783      784     745      770
Net Incentive
compensation               1,008   1,175   (1,410 )  (2,415 )   (175 ) (1,937 )  3,483     (463 )   531   (1,603 )
Total waiver by adviser      (37 )   (38 )    (38 )     (37 ) (2,383 )    (96 )    (38 )    (37 )   (38 )   (138 )
Tax expense                    1       1        3         -        -        1        2        -       2       10
Net operating income
(loss) before net
realized and unrealized
gains                      1,171   1,003    3,572     2,052   14,246    1,251   (4,069 )    (34 )    65    1,754
Net increase (decrease)
in net assets resulting
from operations            7,892   6,876   (3,556 ) (10,595 )  1,515   (9,018 ) 13,282   (2,369 ) 2,302   (6,244 )
Net increase (decrease)
in net assets resulting
from operations per
share                       0.33    0.29    (0.14 )   (0.45 )   0.06    (0.37 )   0.56    (0.10 )  0.10    (0.26 )
Net asset value per
share                      16.56   16.29    16.14     16.42    16.99    17.04    17.54     17.1   17.32    17.33

OVERVIEW

The Company is an externally managed, non-diversified, closed-end management investment company that has elected to be regulated as a business development company under the 1940 Act. The Company's investment objective is to seek to maximize total return from capital appreciation and/or income.

On November 6, 2003, Mr. Tokarz assumed his positions as Chairman and Portfolio Manager of the Company. He and the Company's investment professionals (who, effective November 1, 2006, provide their services to the Company through the Company's investment adviser, TTG Advisers) are seeking to implement our investment objective (i.e., to maximize total return from capital appreciation and/or income) through making a broad range of private investments in a variety of industries.

The investments can include senior or subordinated loans, convertible debt and convertible preferred securities, common or preferred stock, equity interests, warrants or rights to acquire equity interests, and other private equity transactions. During the year ended October 31, 2012, the Company made two new investments and made nine follow-on investments in five existing portfolio companies committing a total of $11.3 million of capital to these investments. During the six month period ended April 30, 2013, the Company made two new investments and four follow-on investments in three existing portfolio companies, committing capital totaling $36.5 million.

Prior to the adoption of our current investment objective, the Company's investment objective had been to achieve long-term capital appreciation from venture capital investments in information technology companies. The Company's investments had thus previously focused on investments in equity and debt securities of information technology companies. As of April 30, 2013, 2.19% of the current fair value of our assets consisted of Legacy Investments. We are, however, seeking to manage these Legacy Investments to try and realize maximum returns. We generally seek to capitalize on opportunities to realize cash returns on these investments when presented with a potential "liquidity event,"
i.e., a sale, public offering, merger or other reorganization.

Our new portfolio investments are made pursuant to our current objective and strategy. We are concentrating our investment efforts on small and middle-market companies that, in our view, provide opportunities to maximize total return from capital appreciation and/or income. Under our investment approach, we are permitted to invest, without limit, in any one portfolio company, subject to any diversification limits required in order for us to continue to qualify as a RIC under Subchapter M of the Code. Due to the asset growth and composition of the portfolio, compliance with the RIC requirements currently restricts our ability to make additional investments that represent more than 5% of our total assets or more than 10% of the outstanding voting securities of the issuer ("Non-Diversified Investments").

We participate in the private equity business generally by providing privately negotiated long-term equity and/or debt investment capital to small and middle-market companies. Our financings are generally used to fund growth, buyouts, acquisitions, recapitalizations, note purchases, and/or bridge financings. We generally invest in private companies, though, from time to time, we may invest in public companies that may lack adequate access to public capital.

We may also seek to achieve our investment objective by establishing a subsidiary or subsidiaries that would serve as general partner to a private equity or other investment funds. Furthermore, the Board of Directors authorized the


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establishment of a PE Fund, for which an indirect wholly-owned subsidiary of the Company serves as the GP and which may raise up to $250 million. On October 29, 2010, through MVC Partners and MVCFS, the Company committed to invest approximately $20.1 million in the PE Fund. The PE Fund closed on approximately $104 million of capital commitments. The Company's Board of Directors authorized the establishment of, and investment in, the PE Fund for a variety of reasons, including the Company's ability to make Non-Diversified Investments through the PE Fund. As previously disclosed, the Company is limited in its ability to make Non-Diversified Investments. For services provided to the PE Fund, the GP and MVC Partners are together entitled to receive 25% of all management fees and other fees paid by the PE Fund and its portfolio companies and up to 30% of the carried interest generated by the PE Fund. Further, at the direction of the Board of Directors, the GP retained TTG Advisers to serve as the portfolio manager of the PE Fund. In exchange for providing those services, and pursuant to the Board of Directors' authorization and direction, TTG Advisers is entitled to receive the balance of the fees and any carried interest generated by the PE Fund and its portfolio companies. Given this separate arrangement with the GP and the PE Fund, under the terms of the Company's Advisory Agreement with TTG Advisers, TTG Advisers is not entitled to receive from the Company a management fee or an incentive fee on assets of the Company that are invested in the PE Fund. During the fiscal year ended October 31, 2012, MVC Partners was consolidated with the operations of the Company as MVC Partners' limited partnership interest in the PE Fund is a substantial portion of MVC Partners operations. Previously, MVC Partners was presented as a portfolio company on the Consolidated Schedule of Investments. The consolidation of MVC Partners has not had any material effect on the financial position or net results of operations of the Company. Please see Note 2 of our consolidated financial statements "Consolidation" for more information.

As a result of the closing of the PE Fund, consistent with the Board-approved policy concerning the allocation of investment opportunities, the PE Fund will receive a priority allocation of all private equity investments that would otherwise be Non-Diversified Investments for the Company during the PE Fund's investment period.

Additionally, in pursuit of our objective, we may acquire a portfolio of existing private equity or debt investments held by financial institutions or other investment funds should such opportunities arise.

Furthermore, pending investments in portfolio companies pursuant to the Company's principal investment strategy, the Company may invest in certain securities on a short-term or temporary basis. In addition to cash-equivalents and other money market-type investments, such short-term investments may include exchange-traded funds and private investment funds offering periodic liquidity.

OPERATING INCOME

For the Six Month Period Ended April 30, 2013 and 2012. Total operating income was $13.0 million for the six month period ended April 30, 2013 and $19.8 million for the six month period ended April 30, 2012, a decrease of approximately $6.8 million.

For the Six Month Period Ended April 30, 2013

Total operating income was $13.0 million for the six month period ended April 30, 2013. The decrease in operating income over the same period last year was primarily due to a decrease in dividend income and fee income from asset management. The main components of operating income for the six month period ended April 30, 2013, was dividend income from portfolio companies and the interest earned on loans. The Company earned approximately $10.6 million in interest and dividend income from investments in portfolio companies. Of the $10.6 million recorded in interest/dividend income, approximately $1.3 million was "payment in kind" interest/dividends. The "payment in kind" interest/dividends are computed at the contractual rate specified in each investment agreement and added to the principal balance of each investment. The Company's debt investments yielded rates from 6% to 14%. The Company also received fee income from asset management of the PE Fund and its portfolio companies totaling approximately $897,000 and fee income from portfolio companies of approximately $1.4 million, totaling approximately $2.3 million. Of the $897,000 of fee income from asset management activities, 75% of the income is obligated to be paid to TTG Advisers. However, under the PE Fund's agreements, a significant portion of the portfolio fees that are paid by the PE Fund's portfolio companies to the GP and TTG Advisers is subject to recoupment by the PE Fund in the form of an offset to future management fees paid by the PE Fund.


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For the Six Month Period Ended April 30, 2012

Total operating income was $19.8 million for the six month period ended April 30, 2012. The increase in operating income over the same period last year was primarily due to an increase in dividend income offset by a small decrease in interest income due to repayment of investments that provided the Company with current income and a decrease in other income. The main components of operating income for the six month period ended April 30, 2012, was dividend income from portfolio companies and the interest earned on loans. The Company earned approximately $17.3 million in interest and dividend income from investments in portfolio companies, of which $12.0 million was a non-recurring dividend. Of the $17.3 million recorded in interest/dividend income, approximately $1.5 million was "payment in kind" interest/dividends. The "payment in kind" interest/dividends are computed at the contractual rate specified in each investment agreement and added to the principal balance of each investment. The Company's debt investments yielded rates from 6% to 15%, excluding those investments which interest is being reserved against. The Company also received fee income from asset management of the PE Fund and its portfolio companies totaling approximately $1.5 million and fee income from portfolio companies of approximately $1.0 million, totaling approximately $2.5 million. Of the $1.5 million of fee income from asset management, 75% of the income is obligated to be paid to TTG Advisers.

OPERATING EXPENSES

For the Six Month Period Ended April 30, 2013 and 2012. Operating expenses, net of Voluntary Waivers, were approximately $10.9 million for the six month period ended April 30, 2013 and $4.3 million for the six month period ended April 30, 2012, a decrease of approximately $6.6 million.

For the Six Month Period Ended April 30, 2013

Operating expenses, net of the Voluntary Waivers (as described below), were approximately $10.9 million or 5.65% of the Company's average net assets, when annualized, for the six month period ended April 30, 2013. Significant components of operating expenses for the six month period ended April 30, 2013 were management fee expense related to the Company of approximately $3.9 million, interest and other borrowing costs of approximately $2.4 million, and incentive compensation expense of approximately $2.2 million.

The approximately $6.6 million increase in the Company's net operating expenses for the six month period ended April 30, 2013 compared to the six month period ended April 30, 2012, was primarily due to the approximately $6.6 million increase in the estimated provision for incentive compensation expense, which includes the voluntary incentive fee waiver by TTG Advisers during the six month period ended April 30, 2012, an approximately $728,000 increase in interest and other borrowing costs offset by a decrease of approximately $600,000 in management fee expense, which includes management fees related to the Company and portfolio management fees related to the PE Fund. The portfolio fees are payable to TTG Advisers for monitoring and other customary fees received by the GP from portfolio companies of the PE Fund. To the extent the GP or TTG Advisers receives advisory, monitoring, organization or other customary fees from any portfolio company of the PE Fund or management fees related to the PE Fund, 25% of such fees shall be paid to or retained by the GP and 75% of such fees shall be paid to or retained by TTG Advisers. For the 2011 and 2012 fiscal years, TTG Advisers voluntarily agreed to waive $150,000 of expenses that the Company is obligated to reimburse to TTG Advisers under the Advisory Agreement (the "Voluntary Waiver"). On October 23, 2012, TTG Advisers and the Company entered into an agreement to extend the expense cap of 3.5% and the Voluntary Waiver to the 2013 fiscal year. TTG Advisers had also voluntarily agreed that any assets of the Company that were invested in exchange-traded funds and the Octagon Fund would not be taken into account in the calculation of the base management fee due to TTG Advisers under the Advisory Agreement. For fiscal year 2012 and for the six month period ended April 30, 2013 annualized, the Company's expense ratio was 2.95% and 2.83%, respectively, (taking into account the same carve outs as those applicable to the expense cap).

Pursuant to the terms of the Advisory Agreement, during the six month period ended April 30, 2013, the provision for incentive compensation was increased by a net amount of approximately $2.1 million to approximately $17.8 million. The net increase in the provision for incentive compensation during the six month period ended April 30, 2013 reflects the Valuation Committee's determination to increase the fair values of eleven of the Company's portfolio investments (Custom Alloy, MVC Automotive, Octagon, Security Holdings, SIA Tekers, Turf, Vestal, Pre-Paid Legal, RuMe, Freshii and Centile) by a total of approximately $16.1 million and the difference between the amount received from the sale of Summit and Summit's carrying value at January 31, 2013, which was an increase of approximately $3.2 million. The net


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increase in the provision also reflects the Valuation Committee's determination to decrease the fair values of seven of the Company's portfolio investments (HH&B, Ohio Medical, SGDA Europe, Velocitius, JSC Tekers, Biovation and NPWT) by a total of approximately $8.2 million and the $84,000 realized gain related to NPWT. For the six month period ended April 30, 2013, there was no provision recorded for the net operating income portion of the incentive fee as pre-incentive fee net operating income did not exceed the hurdle rate. Please see Note 10 of our consolidated financial statements "Incentive Compensation" for more information.

For the Six Month Period Ended April 30, 2012

Operating expenses, net of the Voluntary Waivers (as defined below), were approximately $4.3 million or 2.10% of the Company's average net assets, when annualized, for the six month period ended April 30, 2012. Significant components of operating expenses for the six month period ended April 30, 2012 were the management fee expense of totaling approximately $5.0 million, which includes the management fee related to the Company and the PE Fund, and interest and other borrowing costs of approximately $1.6 million.

The $2.9 million decrease in the Company's net operating expenses for the six month period ended April 30, 2012 compared to the six month period ended April 30, 2011, was primarily due to the $1.0 million decrease in the estimated provision for incentive compensation expense and the $2.3 million voluntary waiver of the income incentive fee payment, which were offset by the addition of approximately $524,000 in portfolio fees - asset management expense. The portfolio fees are payable to TTG Advisers for monitoring and other customary fees received by the GP from portfolio companies of the PE Fund. To the extent the GP or TTG Advisers receives advisory, monitoring organization or other customary fees from any portfolio company of the PE Fund, 25% of such fees shall be paid to or retained by the GP and 75% of such fees shall be paid to or retained by TTG Advisers. For the 2010 and 2011 fiscal years, TTG Advisers voluntarily agreed to waive $150,000 of expenses that the Company is obligated to reimburse to TTG Advisers under the Advisory Agreement (the "Voluntary Waiver"). On October 25, 2011, TTG Advisers and the Company entered into an agreement to extend the expense cap of 3.5% and the Voluntary Waiver to the 2012 fiscal year. TTG Advisers had also voluntarily agreed that any assets of the Company that were invested in exchange-traded funds and the Octagon Fund would not be taken into account in the calculation of the base management fee due to TTG Advisers under the Advisory Agreement. For fiscal year 2011 and for the six month period ended April 30, 2012 annualized, the Company's expense ratio was 3.18% and 2.94%, respectively, (taking into account the same carve outs as those applicable to the expense cap).

Pursuant to the terms of the Advisory Agreement, during the six month period ended April 30, 2012, the provision for incentive compensation was decreased by a net amount of approximately $4.4 million to approximately $19.5 million. The net decrease in the provision for incentive compensation during the six month period ended April 30, 2012 reflects the Valuation Committee's determination to decrease the fair values of seven of the Company's portfolio investments (BP, HH&B, MVC Automotive, NPWT, Tekers, Velocitius and Ohio Medical) by a total of $13.2 million. The net decrease in the provision also reflects the Valuation Committee's determination to increase the fair values of five of the Company's portfolio investments (Octagon Fund, SGDA Europe, Security Holdings, Vestal and Turf) by a total of approximately $2.4 million. The Valuation Committee also increased the fair value of the Company's escrow receivable related to Vitality by $130,000. For the six month period ended April 30, 2012, a provision of approximately $2.3 million was recorded for the net operating income portion of the incentive fee as pre-incentive fee net operating income exceeded the hurdle rate for the quarter ended April 30, 2012. TTG Advisers has voluntarily agreed to waive the income-related incentive fee payment of approximately $2.3 million . . .

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