##### Table of Contents

---




UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





|x |  | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- |  | ---------------------------------------------------------------------------------------




For the Quarter Ended June 30, 2002.





| ̈ |  | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- |  | ----------------------------------------------------------------------------------------




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 800 Arlington, VA

22209(Address of principal executive office)

(Zip Code)





(703) 247-7500


(Registrants telephone number, including area code)





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 and (2) has been subject to such filing
requirements for the past 90 days.    Yes  x    No  ̈





Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. The number of shares of the issuers Common Stock, $.01 par value, outstanding as of August 13, 2002 was 31,292,648.





---



1




---

##### Table of Contents

MCG CAPITAL CORPORATION





FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2002





TABLE OF CONTENTS





PART I

FINANCIAL INFORMATIONSelected Consolidated Financial and Other DataSelected Operating DataItem 1.

Financial Statements UnauditedConsolidated Balance Sheets  June 30, 2002 and December 31, 2001Consolidated Statements of Operations for the three and six months ended June 30, 2002 and 2001Consolidated Statement of Stockholders Equity for the six months ended June 30, 2002Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001Consolidated Schedules of Investments as of June 30, 2002 and December 31, 2001Notes to Consolidated Financial StatementsIndependent Accountants Review ReportItem 2.

Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3.

Quantitative and Qualitative Disclosures About Market RiskPART II

OTHER INFORMATIONItem 1.

Legal ProceedingsItem 2.

Changes in Securities and Use of ProceedsItem 3.

Defaults upon Senior SecuritiesItem 4.

Submission of Matters to a Vote of Security HoldersItem 5.

Other InformationItem 6.

Exhibits and Reports on Form 8-KSignatures




2




---

##### Table of Contents




PART I.    FINANCIAL INFORMATION





In this Quarterly Report, the Company, MCG, we, us and our refer to MCG
Capital Corporation and our wholly owned subsidiaries and our affiliated securitization trusts unless the context otherwise requires.





Selected Consolidated Financial and Other Data





The selected consolidated financial and
other data below should be read in conjunction with our Managements Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements (unaudited) and notes thereto. Different
accounting principles are used in the preparation of financial statements of a business development company under the Investment Company Act of 1940 and, as a result, the financial results for the periods ending before December 1, 2001 are not
comparable to the period commencing on December 1, 2001 and are not expected to be representative of our financial results in the future.





Post-IPO as a Business Development Company Three Months Ended June 30, 2002

Pre-IPO prior to becoming a Business Development Company Three Months Ended June 30, 2001

Post-IPO as a Business Development Company Six Months Ended June 30, 2002

Pre-IPO prior to becoming a Business Development Company Six Months Ended June 30, 2001(dollars in thousands except per share data)Income Statement Data:Operating income

$19,433

$17,689

$36,487

$35,601Net operating income (a)

11,450

7,070

21,405

14,145Income before cumulative effect of accounting changes

9,426

2,815

13,147

6,368Net increase in stockholders equity resulting from earnings

9,426

2,815

13,147

8,145Per Common Share Data:Net operating income (a) per common share:basic

$0.42

$0.56

$0.79

$1.12diluted

0.42

0.56

0.79

1.11Income before cumulative effect of accounting changes per common share:basic

0.34

0.22

0.49

0.50diluted

0.34

0.22

0.48

0.50Earnings per common share:basic

0.34

0.22

0.49

0.64diluted

0.34

0.22

0.48

0.64Net asset value per common share

12.62

13.15

12.62

13.15Dividends declared per common share

0.47



0.88

Selected Period-End Balances:Total investment portfolio

$683,020

$546,291Total assets

731,025

603,735Borrowings

316,395

425,402Other data:Number of portfolio companies

78

71Number of employees

59

55


---

|(a) |  | Represents net operating income before provision for loan losses for periods ending prior to December 1, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------



3




---

##### Table of Contents




Selected Operating Data





The following table shows our consolidated results of
operations for the three and six months ended June 30, 2002 and 2001. The three and six months ended June 30, 2002 reflect our financial results as a business development company (BDC), whereas the three and six months ended June 30, 2001 reflect
our financial results prior to operating as a BDC. Different accounting principles are used in the preparation of our financial statements as a BDC under the Investment Company Act of 1940 and, as a result, our financial results as a BDC are not
directly comparable to prior periods. The items in the table below were not affected by the change in accounting principles resulting from our conversion to a BDC.





Post-IPO as a Business Development Company Three Months Ended June 30, 2002

Pre-IPO prior to becoming a Business Development Company Three Months Ended June 30, 2001

Post-IPO as a Business Development Company Six Months Ended June 30, 2002

Pre-IPO prior to becoming a Business Development Company Six MonthsEnded June 30, 2001(dollars in thousands)Operating incomeInterest and fees on commercial loans

$18,255

$17,468

$33,844

$35,064Advisory fees and other income

1,178

221

2,643

537Total operating income

19,433

17,689

36,487

35,601Operating expensesInterest expense

2,844

6,992

5,340

14,522Employee compensation:Salaries and benefits

1,842

2,316

3,863

4,606Long-term incentive compensation

1,731



3,257

Total employee compensation

3,573

2,316

7,120

4,606General and administrative expense

1,566

1,311

2,622

2,328Total operating expenses

7,983

10,619

15,082

21,456Net operating income (a)

11,450

7,070

21,405

14,145Long-term incentive compensation (b)

1,731



3,257

Distributable net operating income (c)

$13,181

$7,070

$24,662

$14,145


---

|(a) |  | Represents net operating income before provision for loan losses for periods ending prior to December 1, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------

|(b) |  | Includes expenses related to termination of the stock option plan and issuance of related restricted stock awards at the time of the IPO.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------

|(c) |  | Distributable net operating income is presented for the three and six months ended June 30, 2001 to facilitate the understanding of the amount of net earnings
we may have potentially distributed if we had operated as a business development company and regulated investment company (without the effect of de-leveraging prior to December 1, 2001) for that period. The amounts of the distributable net operating
income identified in this table are not intended to represent amounts we will distribute in future periods. Distributable net operating income may not be comparable to similarly titled measures reported by other companies. Distributable net
operating income does not represent net increase (decrease) in stockholders equity resulting from earnings or cash generated from operating activities in accordance with GAAP and should not be considered an alternative to such items as an
indication of our performance or to cash flows as a measure of liquidity or ability to make distributions. For additional information on distributions, see the section entitled Financial Condition, Liquidity and Capital
ResourcesDividends.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



4




---

##### Table of Contents




Item 1.Financial Statements (unaudited)





MCG Capital Corporation





Consolidated Balance Sheets





(in thousands, except per share data)





June 30, 2002


December 31, 2001(unaudited)AssetsCash and cash equivalents

$
30,118


$
48,148Investments:Commercial loans, at fair value (cost of $687,252 and $604,232)


672,352



596,002Investments in equity securitiesat fair value (cost of $28,384 and $24,173)


23,824



21,201Unearned income on commercial loans


(13,156
)


(12,134
)Total investments


683,020



605,069Interest receivable


7,710



5,623Other assets


10,177



14,226Total assets

$
731,025


$
673,066LiabilitiesBorrowings

$
316,395


$
287,808Interest payable


1,543



408Dividends payable


13,295



24,327Other liabilities


4,904



8,150Total liabilities


336,137



320,693Stockholders EquityPreferred stock, par value $.01, authorized 1 share, none issued and outstanding






Common stock par value $.01, authorized 100,000 shares, 31,286 issued and outstanding on June 30, 2002 and 28,287 issued
and outstanding on December 31, 2001


313



283Paid-in capital


420,306



370,087Stockholder loans


(5,872
)


(6,510
)Unearned compensationrestricted stock


(11,078
)


(13,077
)Earnings in excess of distributions


10,679



12,792Net unrealized depreciation on investments


(19,460
)


(11,202
)Total stockholders equity


394,888



352,373Total liabilities and stockholders equity

$
731,025


$
673,066





See notes to consolidated financial statements.




5




---

##### Table of Contents




MCG Capital Corporation





Consolidated Statements of Operations (unaudited)





(in thousands, except per share amounts)





Post-IPO as a Business Development Company Three Months Ended June 30, 2002


Pre-IPO prior to becoming a Business Development Company Three Months Ended June 30, 2001


Post-IPO as a Business Development Company Six Months Ended June 30, 2002


Pre-IPO prior to becoming a Business Development Company Six Months Ended June 30, 2001Operating incomeInterest and fees on commercial loans

$18,255


$17,468


$33,844


$35,064Advisory fees and other income

1,178


221


2,643


537Total operating income

19,433


17,689


36,487


35,601Operating expensesInterest expense

2,844


6,992


5,340


14,522Employee compensation:Salaries and benefits

1,842


2,316


3,863


4,606Long-term incentive compensation

1,731





3,257


Total employee compensation

3,573


2,316


7,120


4,606General and administrative expense

1,566


1,311


2,622


2,328Total operating expenses

7,983


10,619


15,082


21,456Net operating income before provision for loan losses

11,450


7,070


21,405


14,145Provision for loan losses




(1,605
)




(2,620
)Realized gains (losses) on investments




(1,250
)




(1,550
)Net change in unrealized appreciation (depreciation) on investments

(2,024
)

415


(8,258
)

653Income from operations before income taxes and cumulative effect of accounting change

9,426


4,630


13,147


10,628Income tax expense




1,815





4,260Income before cumulative effect of accounting change

9,426


2,815


13,147


6,368Cumulative effect of accounting change, net of taxes of $1,223










1,777Net increase in stockholders equity resulting from earnings / net income

$  9,426


$  2,815


$13,147


$  8,145Income per common share before cumulative effect of accounting change:basic

$    0.34


$    0.22


$    0.49


$    0.50diluted

$    0.34


$    0.22


$    0.48


$    0.50Earnings per common share:basic

$    0.34


$    0.22


$    0.49


$    0.64diluted

$    0.34


$    0.22


$    0.48


$    0.64Cash dividends declared

$    0.47





$    0.88


Weighted average common shares outstanding

27,335


12,672


27,077


12,672Weighted average common shares outstanding and dilutive common stock equivalents

27,436


12,691


27,171


12,691





See notes to consolidated financial statements.




6




---

##### Table of Contents




MCG Capital Corporation





Consolidated Statement of Stockholders Equity (unaudited)





(in thousands, except per
share amounts)





Common Stock

Paid-in Capital


Stock-holder Loans


Unearned Compensation Restricted stock

Earnings in excess of Distributions


Net Unrealized Depreciation on Investments


Total Stockholders EquityShares


AmountBalance December 31,     2001

28,287


$283

$
370,087


$
(6,510
)

$(13,077)

$12,792


$(11,202)


$352,373Net increase (decrease)     in stockholders     equity resulting from
    earnings (loss)
















21,405


(8,258
)

13,147Issuance of common     shares in stock     offering, net of costs

3,000


30


50,220














50,250Dividends declared,     $0.88 per share
















(23,518
)




(23,518
)Dividend reinvestment

7





135














135Amortization of     restricted stock     awards














1,882







1,882Reduction in employee     loans

(8
)




(136
)


638


117







619Balance June 30, 2002

31,286


$313

$
420,306


$
(5,872
)

$(11,078)

$10,679


$(19,460)


$394,888








See notes to consolidated financial
statements.




7




---

##### Table of Contents




MCG Capital Corporation





Consolidated Statements of Cash Flows (unaudited)





(in thousands)





Post-IPO as a Business Development Company Six Months Ended June 30, 2002


Pre-IPO prior to becoming a Business Development Company Six Months Ended June 30, 2001Operating activitiesNet increase in stockholders equity resulting from earnings/net income

$13,147


$8,145Adjustments to reconcile net increase in stockholders equity resulting from earnings/net income to net cash
provided (used) by operating activities:Provision for loan losses




2,620Depreciation and amortization

174


265Amortization of restricted stock awards

1,882


Amortization of deferred debt issuance costs

988


1,006Realized losses (gains) on investment




1,550Net change in unrealized depreciation (appreciation) on investments

8,258


(3,653
)Increase in interest receivable

(2,087
)

(231
)Increase in accrued payment-in-kind interest

(4,797
)

(5,165
)Increase (decrease) in unearned income

(488
)

948Decrease (increase) in other assets

3,423


(977
)Increase (decrease) in interest payable

1,135


(384
)Decrease in other liabilities

(1,874
)

(40
)Net cash provided by operating activities

19,761


4,084Investing activitiesNet increase in loans

(78,825
)

(52,857
)Net increase in equity investments

(2,099
)

(2,228
)Proceeds from the sale of foreclosed property




1,752Purchase of premises, equipment and software

(508
)

(151
)Net cash used by investing activities

(81,432
)

(53,484
)Financing activitiesNet proceeds from borrowings

28,587


68,570Payment of financing costs

(28
)

(283
)Issuance of common stock, net of costs

50,385


Dividends paid

(35,922
)

Repayment of loans granted to officers/shareholders

619


Net cash provided by financing activities

43,641


68,287Increase (decrease) in cash and cash equivalents

(18,030
)

18,887Cash and cash equivalents at beginning of period

48,148


16,766Cash and cash equivalents at end of period

$30,118


$35,653Supplemental disclosuresInterest paid

$  3,217


$13,452Income taxes paid (received)

(2,472
)

5,235





See notes to consolidated financial statements.




8




---

##### Table of Contents




MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Portfolio Company

Nature of Its Principal Business

Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (5)

June 30, 2002

December 31, 2001(unaudited)Cost

Fair Value

Cost

Fair ValueThe Adrenaline Group, Inc.(1)

Technology

Senior Debt Warrants to purchase Common Stock

4.6%

$
500 

$
500 

$
750 

$
750 Alarm Management II LLC(1)

Security Alarms

Senior Debt










1,800


1,800Amalfi Coast

Broadcasting

Senior Debt




13,000


13,000


13,000


13,000American Consolidated Media

Newspaper

Senior Debt




20,002


20,002





AMI Telecommunications Corporation (1)

Telecommunications

Senior Debt Common Stock Preferred Stock

5.1% 37.5%


10,485 200 1,100


10,485  1,100


10,715 200 


10,715  Badoud Enterprises, Inc. (1)

Newspaper

Senior Debt




10,118


10,118


11,320


11,320Barcom Electronic Inc.

Security Alarms

Senior Debt




3,865


3,865


3,911


3,911Biznessonline.com, Inc. (1)

Telecommunications

Senior Debt Common Stock Preferred Stock Warrants to purchase Common Stock

7.0% 100.0% 48.3%


14,044 18 2,864 253


13,876 19  147


13,529 18 2,864 253


13,529 27 100 253Boucher Communications,Inc. (1)

Publishing

Senior Debt Stock Appreciation Rights




2,350 


2,350 292


2,450 


2,450 297Bridgecom Holdings, Inc. (1)

Telecommunications

Senior Debt Warrants to purchase Common Stock

12.7%


21,289 


21,289 


17,969 


17,969 Brookings Newspapers,L.L.C. (1)

Newspaper

Senior Debt




3,300


3,300


3,500


3,500BuyMedia Inc. (4)

Other

Warrants to purchase Common Stock

1.5%











42Cambridge Information Group, Inc. (1)

Information Services

Senior Debt




16,484


16,484


19,334


19,334





See notes to consolidated financial statements.




9




---

##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (5)

June 30, 2002

December 31, 2001(unaudited)Portfolio Company

Nature of Its Principal Business



Cost

Fair Value

Cost

Fair ValueCanon Communications, LLC and Chemical Week PublishingL.L.C. (1)

Publishing

Subordinated Debt



15,075

15,075



CCG Consulting, LLC

Consulting

Senior Debt Warrants to purchase membership interest in LLC

14.1%

1,368 

1,368 90

1,293 

1,293 294Option to purchase additional equity

5.6%







Community Media Group, Inc. (1)

Newspaper

Senior Debt



13,281

13,281

13,505

13,505Connective Corp. (4)

Publishing

Common Stock

0.2%

57

5

57

13Corporate Legal Times L.L.C.

Publishing

Senior Debt Warrants to purchase membership interest in LLC

20.0%

4,945 153

4,766 

4,813 153

4,813 86Costa De Oro Television, Inc.

Broadcasting

Senior Debt



5,012

5,012

5,011

5,011Country Media, Inc.

Newspaper

Senior Debt Common Stock

6.3%

7,774 100

7,774 252

8,448 100

8,448 205Creatas, L.L.C. (1)

Information

Senior Debt



13,215

13,215

13,664

13,664Services

LLC Interest

20.0%

100

245

100

465Creative Loafing, Inc. (1)

Newspaper

Senior Debt



16,835

16,835

16,795

16,795Crescent Publishing Company LLC

Newspaper

Senior Debt



13,952

13,952

13,700

13,700Dakota Imaging, Inc.

Technology

Senior Debt Warrants to purchase Common Stock

9.4%

6,500 188

6,500 188

 

 Dowden Health Media, Inc.

Publishing

Senior Debt



1,300

1,300

1,500

1,500Edgell Communications, Inc. (1)

Publishing

Senior Debt



411

411

520

520Eli Research, Inc.

Information Services

Senior Debt Warrants to purchase Common Stock

3.0%

9,801 

9,801 

 

 





See notes to consolidated financial statements.




10




---

##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (5)

June 30, 2002

December 31, 2001(unaudited)Portfolio Company

Nature of Its Principal
Business



Cost

Fair Value

Cost

Fair ValueThe e-Media Club, LLC

Media Investment Group

LLC Interest

0.8%

90

66

90

90Executive Enterprise Institute, LLC (1)

Business Conferences

LLC Interest

15.0%

301

100

301

167Fawcette Technical Publications Holdings (1)

Publishing

Senior Debt Warrants to purchase Common Stock

38.9%

17,659 519

17,659 146

14,787 519

14,787 519Financial Technologies Holdings, Inc. (1)

Technology

Senior Debt Warrants to purchase Common Stock

4.2%

20,500 

20,500 

20,500 

20,500 Halcyon Business Publications, Inc.

Publishing

Senior Debt







275

275I-55 Internet Services, Inc.

Telecommunications

Senior Debt Warrants to purchase Common Stock

7.5%

3,443 

3,443 

3,623 

3,623 IDS Telecom LLC

Telecommunications

Senior Debt Warrants to purchase membership interest in LLC

11.0%

17,879 375

17,879 797

17,039 376

17,039 637Images.com, Inc.

Information Services

Senior Debt



3,000

3,000

2,775

2,775Information Today, Inc.

Information Services

Senior Debt



8,100

8,100

7,500

7,500Intellisec Holdings, Inc. (1) (4)

Security Alarms

Senior Debt Warrants to purchase Common Stock

5.2%

15,020 

11,616 

14,265 

14,265 JMP Media, L.L.C.

Broadcasting

Senior Debt



14,049

14,049

15,781

15,781Jeffrey A. Stern (4)

Publishing

Senior Debt



93

93

157

157Joseph C. Millstone

Telecommunications

Senior Debt



500

500

500

500The Joseph F. Biddle Publishing Company (1)

Newspaper

Senior Debt



12,606

12,606

14,207

14,207Kings III of America, Inc., North America

Security Alarm

Senior Debt



4,998

4,998

4,997

4,997





See notes to consolidated financial statements.




11




---

##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (5)

June 30, 2002

December 31, 2001(unaudited)Portfolio Company

Nature of Its Principal
Business



Cost

Fair Value

Cost

Fair ValueThe Korea Times Los Angeles, Inc.

Newspaper

Senior Debt



11,708

11,708

11,927

11,927Manhattan Telecommunications Corporation

Telecommunications

Senior Debt Warrants to purchase Common Stock

17.5%

24,263 754

24,263 1,664

22,975 754

22,975 644McGinnis-Johnson Consulting, LLC

Newspaper

Subordinated Debt



8,048

8,048

7,828

7,828Media Central LLC

Publishing

Senior Debt



10,000

10,000

10,000

10,000Midwest Towers Partners, LLC (1)

Telecommunications Towers

Senior Debt



16,632

16,632

16,307

16,307Miles Media Group, Inc. (1)

Publishing

Senior Debt Warrants to purchase Common Stock

14.6%

7,800 20

7,800 299

7,850 20

7,850 490Minnesota Publishers, Inc. (1)

Newspaper

Senior Debt



14,250

14,250

14,250

14,250Murphy McGinnis Media, Inc. (1)

Newspaper

Senior Debt



14,000

14,000

14,000

14,000NBG Radio Networks, Inc.

Broadcasting

Senior Debt Warrants to purchase Common Stock

25.0%

6,401 

6,401 

6,298 

6,298 Netplexus Corporation

Technology

Senior Debt  Preferred Stock
Warrants to purchase Common Stock

51.0% 4.8%

1,972  766 

972   

3,500  766 

2,500   New Century Companies, Inc. (1) (4)

Other

Common Stock  Preferred Stock
Warrants to purchase Common Stock

2.8%  26.7% 0.6%

157   

322  46 39

157   

294  42 33nii communications, inc. (1)

Telecommunications

Senior Debt  Common Stock Warrants to purchase Common Stock

3.1% 35.4%

6,598  400 1,095

6,598  86 852

5,565  400 747

5,565  162 991





See notes to consolidated financial statements.




12




---

##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (5)

June 30, 2002

December 31, 2001(unaudited)Portfolio Company

Nature of Its Principal
Business



Cost

Fair Value

Cost

Fair ValueNew Northwest Broadcasters, Inc.(1)

Broadcasting

Senior Debt



11,070

11,070

10,853

10,853Newsletter Holdings, LLC (1)

Publishing

Senior Debt



1,060

1,060

1,340

1,340NOW Communications, Inc. (1)

Telecommunications

Senior Debt Warrants to purchase Common Stock

10.0%

4,450 

4,450 

4,367 

4,367 Pacific-Sierra Publishing, Inc.

Newspaper

Senior Debt



24,276

24,276

24,160

24,160Pfingsten Publishing, LLC (1)

Publishing

Senior Debt



10,200

10,200

10,250

10,250Powercom Corporation (1)

Telecommunications

Senior Debt



3,663

3,663

3,917

3,917Warrants to purchase Common Stock

9.6%

139

39

139

105R.R. Bowker LLC

Information Services

Senior Debt Warrants to purchase membership interest in LLC

14.0%

15,000 882

15,000 569

15,000 882

15,000 882Rising Tide Holdings LLC (1) (4)

Publishing

Senior Debt



3,085

1,016

3,097

1,597Warrants to purchase membership interest in LLC

6.5%







Robert N. Snyder

Information Services

Senior Debt



1,300

1,300

1,300

1,300Sabot Publishing, Inc. (1)

Publishing

Senior Debt



9,888

9,888

9,800

9,800Stonebridge Press, Inc. (1)

Newspaper

Senior Debt



6,141

6,141

5,473

5,473Sunshine Media Corp. (1)

Publishing

Senior Debt



12,805

12,805

13,094

13,094LLC Interest Class A

12.8%

500

579

500

553Warrants to purchase membership interest in LLC Class B

100.0%













See notes to consolidated financial statements.




13




---

##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (5)

June 30, 2002

December 31, 2001(unaudited)Portfolio Company

Nature of Its Principal
Business



Cost

Fair Value

Cost

Fair ValueTalk America Holdings, Inc. (1)

Telecommunications

Senior Debt Common Stock Warrants to purchase Common Stock

1.7% 0.7%

16,250 1,150 25

16,250 5,682 518

17,500 1,050 25

17,500 482 TGI Group, LLC

Information Services

Senior Debt Warrants to purchase membership interest in LLC

5.0%

7,342 126

7,342 

7,920 126

7,920 23THE Journal, LLC

Publishing

Senior Debt



3,266

1,768

3,196

2,100Tower Resource Management, Inc. (1)

Telecommunications Towers

Senior Debt Warrants to purchase Common Stock

8.9%

2,616 

2,616 

1,573 

1,573 21st Century Newspapers, Inc.

Newspaper

Subordinated Debt  Common Stock

1.1%

20,343  452

20,343  452

  

  Unifocus, Inc. (1)

Information Services

Senior Debt Warrants to purchase Equity

20.0%

3,400 247

3,400 431

3,300 139

3,300 369UMAC, Inc. (3) (4)

Publishing

Common Stock

100.0%

9,860

4,171

8,360

8,360ValuePage Holdings, Inc. (1) (4)

Telecommunications

Senior Debt



13,105

6,523

13,105

8,472VS&A-PBI Holding LLC (1)

Publishing

Senior Debt  LLC Interest

0.8%

12,375  500

12,375  

12,375  500

12,375  Wiesner Publishing Company, LLC (1)

Publishing

Senior Debt Subordinated Debt Warrants to Purchase membership interest in LLC

15.0%

6,700 5,500 406

6,700 5,500 406

  

  WirelessLines, Inc. (1)

Telecommunications

Senior Debt Warrants to purchase Common Stock

5.0%

6,150 

6,150 

6,150 

6,150 





See notes to consolidated financial statements.




14




---

##### Table of Contents

MCG Capital Corporation





Consolidated Schedules of Investments





(dollars in thousands)





Title of Securities Held by the Company

Percentage of Class Held on a Fully Diluted Basis (5)

June 30, 2002


December 31, 2001(unaudited)Portfolio Company

Nature of Its Principal Business



Cost


Fair Value


Cost


Fair ValueWitter Publishing Corporation

Publishing

Senior Debt Warrants to purchase Common Stock

10.7%


2,737 87



2,737 71



2,747 78



2,747 76Working Mother Media, Inc. (2)

Publishing

Senior Debt Preferred Stock Class A Preferred Stock Class B Preferred Stock Class C Common Stock

97.8% 100.0% 100.0% 51.0%


7,718 4,499   1



7,718 4,150   1



6,718 4,499   1



6,718 4,499   1Wyoming Newspapers, Inc. (1)

Newspaper

Senior Debt




12,387



12,387



12,563



12,563715,636



696,176



628,405



617,203Unearned income




(13,156
)


(13,156
)


(12,134
)


(12,134
)Total Investments



$
702,480


$
683,020


$
616,271


$
605,069


---

|(1) |  | Some of the securities listed are issued by affiliate(s) of the listed portfolio company.
|--- |  | -----------------------------------------------------------------------------------------

|(2) |  | In August 2001, we foreclosed on the assets of MacDonald Communication Corporation and transferred them to Working Mother Media, Inc. (formerly WMAC, Inc.), a
majority owned subsidiary of MCG Finance I, LLC (formerly MCG Finance Corporation).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | In September 2001, we foreclosed on the assets of Upside Media, Inc. and transferred them to UMAC, Inc., a wholly owned subsidiary of MCG Finance I, LLC
(formerly MCG Finance Corporation).
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) |  | Non-income producing.
|--- |  | ---------------------

|(5) |  | The percentage of class held on a fully diluted basis represents the percentage of the class of security we may own assuming we exercise our
warrants or options (whether or not they are in-the-money) and assuming that warrants, options or convertible securities held by others are not converted. We have not included any security which is subject to significant vesting contingencies.
Common stock, preferred stock, warrants, options and equity interests are generally non-income producing and restricted. The percentage was calculated based on outstanding share information as of June 30, 2002 (i) in the case of private companies,
provided by that company, and (ii) in the case of public companies, provided by that companys most recent public filings with the Commission.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




See notes to consolidated financial statements.




15




---

##### Table of Contents

MCG Capital Corporation





Notes To Consolidated Financial Statements (unaudited)





(in thousands except per share data)





Note 1.    Unaudited Interim Consolidated Financial Statements Basis of Presentation





Interim consolidated financial statements of MCG Capital Corporation (MCG or the Company or
we or us or our) are prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and
Article 10 of Regulation S-X. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments, consisting solely of normal recurring
accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The current periods results of operations are not necessarily indicative of results that ultimately may be achieved
for the year. The interim unaudited consolidated financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Companys Form 10-K, as filed with the United States
Securities and Exchange Commission.





The accompanying financial statements reflect the consolidated accounts of
MCG, including our special purpose financing subsidiaries MCG Finance I, LLC, MCG Finance II, LLC, and MCG Finance III, LLC, with all significant intercompany balances eliminated, and the related consolidated results of operations. In accordance
with Article 6 of Regulation S-X under the Securities Act of 1933 and Securities Exchange Act of 1934, the Company does not consolidate portfolio company investments in which the Company has a controlling interest.





Conversion to Business Development Company





The operating results for the three and six months ended June 30, 2002 reflect the Companys results as a business development company under the Investment Company Act of 1940, as amended, whereas the operating results
for the three and six months ended June 30, 2001 reflect the Companys results prior to operating as a business development company under the Investment Company Act of 1940, as amended. Accounting principles used in the preparation of the
consolidated financial statements for these two periods are different and, therefore, the results of operations are not directly comparable. The primary differences in accounting principles relate to the carrying value of investments and accounting
for income taxessee corresponding sections in the notes to our consolidated financial statements included in the Companys Form 10-K.





Note 2.    Description of Business





MCG is a solutions-focused
financial services company that provides financing and advisory services to companies throughout the United States in the communications, information services, media and technology industry sectors. Prior to its name change effective June 14, 2001,
the Companys legal name was MCG Credit Corporation. On December 4, 2001, MCG completed an initial public offering (IPO) of 13,375,000 shares of common stock and a concurrent private offering of 625,000 shares of common stock. Upon
completion of the offerings, the Company became a non-diversified internally managed, closed-end investment company that elected to be treated as a business development company under the Investment Company Act of 1940, as amended. The Company will
elect to be treated for federal income tax purposes as a regulated investment company under the Internal Revenue Code with the filing of our corporate income tax return for 2002 which election will be effective January 1, 2002.





On June 17, 2002, MCG raised $54 million of gross proceeds in an additional public offering. MCG sold 3,000,000 shares of
common stock at an offering price of $18 per share. The Company expects to use the net proceeds of approximately $50.3 million together with the availability under its existing credit facilities, to originate loans to and investments in small- and
medium-sized private companies and for working capital and general corporate purposes.




16




---

##### Table of Contents




Note 3.    Investments





As of June 30, 2002 and December 31, 2001, investments consisted of the following:





June 30, 2002


December 31, 2001Cost


Value


Cost


ValueCommercial loans

$
687,252


$
672,352


$
604,232


$
596,002Investments in equity securities


28,384



23,824



24,173



21,201Unearned income


(13,156
)


(13,156
)


(12,134
)


(12,134
)Total

$
702,480


$
683,020


$
616,271


$
605,069





The composition of MCGs portfolio of publicly and
non-publicly traded investments as of June 30, 2002 and December 31, 2001 at cost and fair value was as follows:





June 30, 2002


December 31, 2001Investments at Cost

Percentage of Total Portfolio


Investments at Cost

Percentage of Total PortfolioSenior Debt

$
638,286

89.2
%

$
596,403

94.9
%Subordinated Debt


48,966

6.8
%


7,829

1.2
%Equity


22,663

3.2
%


19,962

3.2
%Warrants to Acquire Equity


5,721

0.8
%


4,211

0.7
%Equity Appreciation Rights


0

0.0
%


0

0.0
%$
715,636

100.0
%

$
628,405

100.0
%





June 30, 2002


December 31, 2001Investments at Fair Value

Percentage of Total Portfolio


Investments at Fair Value

Percentage of Total PortfolioSenior Debt

$
623,386

89.6
%

$
588,174

95.3
%Subordinated Debt


48,966

7.0
%


7,828

1.2
%Equity


16,825

2.4
%


15,460

2.5
%Warrants to Acquire Equity


6,707

1.0
%


5,444

0.9
%Equity Appreciation Rights


292

0.0
%


297

0.1
%$
696,176

100.0
%

$
617,203

100.0
%





Set forth below are tables showing the composition of MCGs
portfolio by industry sector at cost and fair value at June 30, 2002 and December 31, 2001:





June 30, 2002


December 31, 2001Investments at Cost

Percentage of Total Portfolio


Investments at Cost

Percentage of Total PortfolioMedia

$
410,707

57.4
%

$
342,408

54.5
%Communications


193,680

27.1
%


186,690

29.7
%Information Services


78,997

11.0
%


72,040

11.5
%Technology


30,426

4.2
%


25,516

4.1
%Other


1,826

0.3
%


1,751

0.2
%$
715,636

100.0
%

$
628,405

100.0
%




17




---

##### Table of Contents




June 30, 2002


December 31, 2001Investments at Fair Value

Percentage of Total Portfolio


Investments at Fair Value

Percentage of Total PortfolioMedia

$
400,659

57.6
%

$
340,210

55.2
%Communications


186,005

26.7
%


178,588

28.9
%Information Services


78,887

11.3
%


72,532

11.8
%Technology


28,660

4.1
%


23,750

3.8
%Other


1,965

0.3
%


2,123

0.3
%$
696,176

100.0
%

$
617,203

100.0
%





Note 4.    Borrowings





As of June 30, 2002, MCG, through MCG Master Trust, an affiliated business trust, had $61,778 in borrowings outstanding under a Revolving
Credit Facility. The maximum outstandings under the notes issued by the Revolving Credit Facility during the three and six months ended June 30, 2002 was $88,897. The average outstanding balance during the three and six months ended June 30, 2002
was $76,228 and $50,342, respectively. The weighted average interest rate, including unused commitment and trustee fees but excluding the amortization of deferred financing costs, for the three and six months ended June 30, 2002 was 3.3% and 3.5%,
respectively, and the interest rate at June 30, 2002 was 3.4%.





As of June 30, 2002, we had no notes outstanding
under a swingline credit facility (the Swingline Notes), which is part of the Revolving Credit Facility, that allows us to borrow up to $25,000, as part of the $200,000 total facility limit, for a period of up to four days. The Swingline
Notes are repaid through the issuance of Series 2000-1 Notes. The Swingline Notes bear interest based on the federal funds rate plus 1.0% and interest is payable monthly. The maximum outstandings under the Swingline Notes during the three and six
months ended June 30, 2002 was $22,900. The average outstanding balance during the three and six months ended June 30, 2002 was $503 and $633, respectively. The weighted average interest rate for the three and six months ended June 30, 2002 was 2.9%
and 2.8%, respectively.





On December 27, 2001, MCG Finance III, LLC (MCG Finance III) sponsored the
creation of MCG Commercial Loan Trust (the Trust), which entered into a term funding securitization agreement by issuing Series 2001-1 Notes (the Trust Notes). The Trust issued $229,860 of Class A Notes rated AAA/Aaa/AAA, and
$35,363 of Class B Notes rated A/A2/A (the Series 2001-1 Class A Asset Backed Bonds and Series 2001-1 Class B Asset Backed Bonds) as rated by Standard & Poors, Moodys and Fitch, respectively. The Series 2001-1 Class
A Asset Backed Bonds bear interest of LIBOR plus 0.60% and Series 2001-1 Class B Asset Backed Bonds bear interest of LIBOR plus 1.75%, and interest on both is payable quarterly. The maximum outstandings under the Notes issued by the Trust during the
three and six months ended June 30, 2002 was $261,417 and $265,223, respectively. The average outstanding balance during the three and six months ended June 30, 2002 was $256,112 and $259,170, respectively. The weighted average interest rate,
excluding fee amortization, for the three and six months ended June 30, 2002 was 2.6%, and the interest rate at June 30, 2002 was 2.7%.





Outstandings under the Revolving Credit Facility and the Trust Notes as of June 30, 2002 and December 31, 2001 by interest rate benchmark were as follows:





June 30, 2002

December 31, 200190-day LIBOR

$
254,617

$
265,223CP Rate


61,778


22,585$
316,395

$
287,808




18




---

##### Table of Contents




Subject to certain minimum equity restrictions and other covenants, total unused
available commitments from the borrowing facilities totaled $138,222 and $177,415 at June 30, 2002 and December 31, 2001, respectively.





Note 5.    Earnings Per Share





The following table sets forth the
computation of basic and diluted earnings per common share for the three and six months ended June 30, 2002 and 2001:





Three Months Ended June 30,

Six Months Ended June 30,2002

2001

2002

2001(in thousands, except per share amounts)BasicNet increase in stockholders equity resulting from earnings/ net income

$
9,426

$
2,815

$
13,147

$
8,145Weighted average common shares outstanding


27,335


12,672


27,077


12,672Earnings per common sharebasic

$
0.34

$
0.22

$
0.49

$
0.64DilutedNet increase in stockholders equity resulting from earnings/net income

$
9,426

$
2,815

$
13,147

$
8,145Weighted average common shares outstanding


27,335


12,672


27,077


12,672Dilutive effect of stock options and restricted stock on which forfeiture provisions have not lapsed


101


19


94


19Weighted average common shares and common stock equivalents


27,436


12,691


27,171


12,691Earnings per common sharediluted

$
0.34

$
0.22

$
0.48

$
0.64




19




---

##### Table of Contents




Note 6.    Financial Highlights





Following is a schedule of financial highlights for the six months ended June 30, 2002:





Six Months Ended June 30, 2002(dollars in thousands, except per share data)Per Share Data(1):Net asset value at beginning of period

$
12.46Net operating income


0.68Increase in unrealized depreciation on investments


(0.26
)Net increase in stockholders equity resulting from earnings


0.42Dividends declared


(0.88
)Effect of distributions from stock offering


0.07Antidilutive effect of distributions recorded as compensation expense


0.04Net decrease in stockholders equity resulting from distributions


(0.77
)Net increase in shareholders equity from restricted stock amortization


0.06Net increase in shareholders equity resulting from reduction in employee loans


0.02Issuance of shares


0.43Net asset value at end of period

$
12.62Per share market value at end of period

$
16.71Total return(2)


1.01
%Shares outstanding at end of period


31,286Ratio/Supplemental Data:Net assets at end of period


394,888Ratio of operating expenses to average net assets


8.36
%Ratio of net operating income to average net assets


11.87
%


---

|(1) |  | Basic and diluted per share data
|--- |  | --------------------------------

|(2) |  | Total return equals the increase of the ending market value at June 30, 2002 over the December 31, 2001 price of $17.80 per share plus dividends paid ($1.27 per
share), divided by the beginning price. Total return is not annualized.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Note 7.    New
Accounting Pronouncement





In July 2001, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets (FAS 142), which requires goodwill and intangible assets with indefinite useful lives to no longer be amortized but to be tested for impairment at least
annually. Intangible assets that have finite lives will continue to be amortized over their estimated useful lives. The amortization and non-amortization provisions of FAS 142 will be applied to all goodwill and intangible assets acquired after June
30, 2001. Effective January 1, 2002, the Company adopted the provisions of FAS 142 and ceased amortization of goodwill and intangible assets with indefinite lives. The adoption of FAS 142 did not have a material impact on the Companys
financial position or results of operations. In accordance with FAS 142, the Company has tested its intangible assets with indefinite lives, $3,850 at January 1, 2002, for impairment as of the date of adoption and determined that there was no
impairment.





Note 8.    Income From Controlled Companies and Other Affiliates





Controlled companies are generally defined under the Investment Company Act of 1940 as companies in which MCG owns more than 25%
of the voting securities of the company. During the three and six months ended June 30, 2002, MCG recognized $600 and $1,393, respectively, of interest and fee income from controlled companies. MCG had no such income




20




---

##### Table of Contents

for the first six months of 2001. During the three and six months ended June 30, 2002, MCG recognized $2,677 and $6,253, respectively, of net unrealized depreciation on investments in controlled
companies. During the three and six months ended June 30, 2001, MCG recognized $91 of net unrealized appreciation on investments in controlled companies. MCG held $32.1 million and $31.0 million of loans at fair value to controlled companies at June
30, 2002 and December 31, 2001, respectively. MCG held $9.6 million and $13.2 million of equity investments at fair value in controlled companies at June 30, 2002 and December 31, 2001, respectively.





Other affiliates are generally defined under the Investment Company Act of 1940 as companies in which MCG owns 5% to 25% of the voting
securities of the company. Interest and fee income from other affiliates amounted to $1,038 and $1,974 for the three and six months ended June 30, 2002, respectively. During the three and six months ended June 30, 2001, MCG recognized $1,798 and
$3,512, respectively, of interest and fee income from other affiliates. During the three and six months ended June 30, 2002, MCG recognized $227 and $214, respectively, of net unrealized depreciation on investments in other affiliates. During the
three and six months ended June 30, 2001, MCG recognized no unrealized appreciation or depreciation on investments in other affiliates. MCG held $34.8 million and $37.7 million of loans at fair value to other affiliates at June 30, 2002 and December
31, 2001, respectively. MCG held $1.2 million and $1.4 million of equity investments at fair value in other affiliates at June 30, 2002 and December 31, 2001, respectively.





Note 9.    Subsequent Events





In July 2002, we completed a transaction to acquire in satisfaction of debt the assets of one of our portfolio companies, ValuePage Holdings, Inc. The assets will be held and operated through a separate portfolio company controlled by us. Our
investment had a fair value of $6.5 million and an unrealized loss of $6.6 million as of June 30, 2002. In conjunction with this transaction, we expect to realize this loss in the third quarter of 2002 and expect this realized loss to be offset by
the reversal of related unrealized depreciation. Accordingly, we expect no material impact to our overall earnings in the third quarter of 2002 as a result of this transaction.





In August 2002, we were awarded, through a bankruptcy proceeding, the right to acquire in satisfaction of debt the Arizona and North Carolina divisions of one of our
portfolio companies, Intellisec Holdings, Inc. We anticipate that upon completion of these sales, the former divisions will be held and operated in two separate portfolio companies controlled by us. We do not expect to realize a material gain or
loss related to these transactions. However, there can be no assurance that a gain or loss will not occur upon the ultimate disposition of these divisions or upon the disposition of the remainder of our investment in Intellisec Holdings, Inc.





In July 2002, we amended certain agreements governing our Revolving Credit Facility. This facility is further
discussed in Note 4. The amendments adjust or add certain provisions to reflect our current size and organizational structure, including a change in the servicer minimum net worth test, the addition of a servicer asset coverage requirement, and an
increase in the allowed portfolio charge-off ratio
.







21




---

##### Table of Contents

Independent Accountants Review Report





Board of Directors and Shareholders


MCG Capital Corporation





We have reviewed the accompanying
consolidated balance sheet of MCG Capital Corporation as of June 30, 2002, including the consolidated schedule of investments, and the related consolidated statements of operations for the three-month and six-month periods ended June 30, 2002 and
2001, the consolidated statement of stockholders equity for the six-month period ended June 30, 2002 and the consolidated statement of cash flows for the six-month periods ended June 30, 2002 and 2001. These financial statements are the
responsibility of the Companys management.





We conducted our reviews in accordance with standards
established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.





Based on our
reviews, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.





We have previously audited, in accordance with auditing standards generally accepted in the United States, the
consolidated balance sheet of MCG Capital Corporation as of December 31, 2001, including the consolidated schedules of investments, and the related consolidated statements of income, stockholders equity, and cash flows for the one-month period
ended December 31, 2001 and the eleven-month period ended November 30, 2001 (not presented herein), and in our report dated January 25, 2002, 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, 2001, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.





/s/ ERNST & YOUNG





Ernst & Young





Richmond, Virginia


August 9,
2002




22




---

##### Table of Contents

Item 2.Managements Discussion and Analysis of Financial Condition and Results of
Operations





Overview





The information contained in this section should be read in conjunction with the Selected Consolidated Financial and Other Data and our Consolidated Financial Statements
and notes thereto appearing herein.





MCG Capital Corporation is a solutions-focused financial services company
providing financing and advisory services to companies throughout the United States in the communications, information services, media and technology industry sectors. On December 4, 2001, we completed an initial public offering of 13,375,000 shares
of our common stock and a concurrent private offering of 625,000 shares of our common stock with gross proceeds totaling $237.3 million. Upon completion of these offerings, we became an internally managed, non-diversified, closed-end investment
company that elected to be treated as a business development company under the Investment Company Act of 1940. MCG Capital Corporation will elect to be treated for federal income tax purposes as a regulated investment company under the Internal
Revenue Code with the filing of our federal corporate income tax return for 2002, which election will be effective as of January 1, 2002. Pursuant to this election, we generally will not have to pay corporate-level taxes on any income we distribute
to our stockholders as dividends, allowing us to substantially reduce or eliminate our corporate-level tax liability.





On June 17, 2002, MCG raised $54 million of gross proceeds in an additional public offering. MCG sold 3,000,000 shares of common stock at an offering price of $18 per share. The Company expects to use the net proceeds of
approximately $50.3 million together with the availability under its existing credit facilities, to originate loans to and investments in small- and medium-sized private companies and for working capital and general corporate purposes.





The results of operations for the three and six months ended June 30, 2002 reflect the Companys results as a business
development company under the Investment Company Act of 1940, as amended, whereas the operating results for the three and six months ended June 30, 2001 reflect the Companys results prior to operating as a business development company under
the Investment Company Act of 1940, as amended. Accounting principles used in the preparation of the consolidated financial statements for these two periods are different and, therefore, the results of operations are not directly comparable.







23




---

##### Table of Contents

The primary differences in accounting principles relate to the carrying value of investments and accounting for income taxessee corresponding sections in the notes to our consolidated
financial statements included in the Companys Form 10-K.





We were formed by our management and affiliates of
Goldman, Sachs & Co. to purchase a loan portfolio and certain other assets from First Union National Bank in a management buyout that was completed on June 24, 1998. Prior to this purchase, we conducted our business as a division of Signet Bank.
This separate division was known as the media communications group. Signet Banking Corporation, the parent of Signet Bank, was acquired by First Union Corporation (now Wachovia Corporation) on November 28, 1997.





Portfolio Composition and Asset Quality





Our primary business is lending to and investing in businesses, primarily in the communications, information services, media, and technology industry sectors, through investments in senior debt,
subordinated debt and equity-based investments, including warrants and equity appreciation rights. The increase in investments during the first six months of 2002 was primarily attributable to originated debt securities, including $40.5 million of
subordinated debt to three companies. We intend to increase our level of subordinated debt and equity-based investments. However, we expect a substantial majority of our portfolio will continue to consist of investments in senior secured commercial
loans. The total portfolio value of publicly traded and non-publicly traded investments was $696.2 million and $617.2 million, at June 30, 2002 and December 31, 2001, respectively (exclusive of unearned income). Total portfolio investment activity
as of and for the six months ended June 30, 2002 and year ended December 31, 2001, was as follows (exclusive of unearned income):





June 30, 2002


December 31, 2001(a)(dollars in millions)Beginning Portfolio

$
617.2


$
510.9Originations/Net Draws/Purchases


89.2



167.6Early Pay-offs/Sales of Securities


(1.9
)


(33.0
)Charge-offs/Write-downs






(14.8
)(b)Realized Gains (Losses)






(1.7
)Unrealized Appreciation on Investments


6.9



2.8Unrealized Depreciation on Investments


(15.2
)


(14.6
)Ending Portfolio

$
696.2


$
617.2


---

|(a) |  | Balances prior to our election to be regulated as a business development company primarily include amounts at cost.
|--- |  | -------------------------------------------------------------------------------------------------------------------

|(b) |  | Represents $14.8 million of loan charge-offs against the allowance for loan losses previously provided for prior to our election to be regulated as a business
development company. We had provided for loan losses of $20.3 million from inception through November 30, 2001 including $2.0 million of allowance recorded in the asset acquisition on June 24, 1998.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




The following table shows the fair value of our portfolio of investments by asset class as of June 30, 2002 and December 31, 2001:





June 30, 2002


December 31, 2001Senior Debt

89.6
%

95.3
%Subordinated Debt

7.0
%

1.2
%Equity

3.4
%

3.5
%100.0
%

100.0
%





Asset quality is generally a function of our underwriting and
ongoing management of our investment portfolio. As a business development company, our loans and equity investments are carried at market value or, in the absence of market value, at fair value as determined by our Board of Directors in good faith
on a quarterly basis. As of June 30, 2002 and December 31, 2001, net unrealized depreciation on investments totaled $19.5 million and $11.2 million, respectively.




24




---

##### Table of Contents




In addition to various risk management and monitoring tools, we also use an
investment rating system to characterize and monitor our expected level of returns on each investment in our portfolio. We use the following 1 to 5 investment rating scale. Below is a description of the conditions associated with each investment
rating:





Investment Rating

Summary Description1

Capital gain expected2

Full return of principal and interest or dividend expected with customer performing in accordance with plan3

Full return of principal and interest or dividend expected but customer requires closer monitoring4

Some loss of interest or dividend expected but still expecting an overall positive internal rate of return on the investment5

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
the 1 to 5 investment rating scale at fair value as of June 30, 2002 and December 31, 2001:





Distribution of Portfolio
by Investment Rating


(dollars in millions)





June 30, 2002


December 31, 2001Investment Rating

Investments at Fair
Value

Percentage of Total Portfolio


Investments at Fair
Value

Percentage of Total Portfolio1

$177.3

25.5
%

$135.2

21.9
%2

318.7

45.8
%

275.1

44.5
%3

143.3

20.6
%

158.6

25.7
%4

40.1

5.7
%

46.7

7.6
%5

16.8

2.4
%

1.6

0.3
%$696.2

100.0
%

$617.2

100.0
%





We manage loan concentrations in our portfolio, both on an
individual loan basis and on a sector or industry basis, to manage overall portfolio performance due to specific customer issues or specific industry issues. At June 30, 2002, of the investments with a 5 rating, $12.6 million are loans, of which
$12.0 million are on non-accrual. Of the investments with a 4 rating, $35.6 million are loans, of which $6.8 million are on non-accrual.







25




---

##### Table of Contents




Set forth below is a table showing the composition of MCGs portfolio by
industry sector at fair value at June 30, 2002, and December 31, 2001:





June 30, 2002


December 31, 2001Media

57.6
%

55.2
%Communications

26.7
%

28.9
%Information Services

11.3
%

11.8
%Technology

4.1
%

3.8
%Other

0.3
%

0.3
%100.0
%

100.0
%





|LOGO | LOGO
|---- | ----




Below is a table showing MCGs originations by
detailed industry for the six months ended June 30, 2002 and the year ended December 31, 2001:





Originations by
Detailed Industry





Six Months EndedJune 30, 2002


Year EndedDecember 31, 2001Newspaper

46
%

27
%Telecom

5
%

14
%Publishing

30
%

18
%Information Services

12
%

22
%Broadcast

0
%

14
%Security

0
%

5
%Technology

7
%

0
%100
%

100
%





We monitor individual customers financial trends in order to
assess the appropriate course of action with respect to each customer and to evaluate overall portfolio quality. We closely monitor the status and performance of each individual investment on a quarterly and, in some cases, a monthly or more
frequent basis. Because we are a provider of long-term privately negotiated investment capital to high-growth companies and we actively manage our investments through tightly-structured contracts, we do not believe contract exceptions are
necessarily an indication of credit quality or the need to pursue remedies or an active workout of a portfolio investment.





At June 30, 2002, there were $18.9 million of loans, or approximately 2.7% of the investment portfolio on non-accrual status, of which $12.1 million were greater than 60 days past due. The nonaccrual loans primarily represented
borrowers in the security alarm and paging businesses. At December 31, 2001, there were $8.6 million of loans greater than 60 days past due representing 1.4% of the investment portfolio, of which $0.2 million were on non-accrual status. When a loan
becomes 90 days or more past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and stop recognizing interest income on that
loan until all principal has been paid. However, we may make exceptions to this policy if the investment is well secured and in the process of collection.




26




---

##### Table of Contents




When principal and interest on a loan is not paid within the applicable grace
period, we will contact the customer for collection. At that time, we will make a determination as to the extent of the problem, if any. We will then pursue a commitment for immediate payment and will begin to more actively monitor the investment.
We will formulate strategies to optimize the resolution process and will begin the process of restructuring the investment to better reflect the current financial performance of the customer. Such a restructuring may involve deferring payments of
principal and interest, adjusting interest rates or warrant positions, imposing additional fees, amending financial or operating covenants or converting debt to equity. In general, in order to compensate us for any enhanced risk, we receive
appropriate compensation from the customer in connection with a restructuring. During the process of monitoring a loan which is out of compliance, we will in appropriate circumstances send a notice of non-compliance outlining the specific defaults
that have occurred and preserving our remedies, and initiate a review of the collateral. When a restructuring is not the most appropriate course of action, we may determine to pursue remedies available under our loan documents or at law to minimize
any potential losses, including initiating foreclosure and/or liquidation proceedings. During 2001, we foreclosed upon two of our portfolio companies, which had an aggregate fair value of $16.0 million as of June 30, 2002 and $19.6 million as of
December 31, 2001. Of the $14.8 million of charge-offs during 2001, $4.5 million related to these foreclosures. There were no foreclosures during the six months ended June 30, 2002. However in July 2002 we acquired in satisfaction of debt the assets
of one of our portfolio companies, ValuePage Holdings Inc. This investment had a fair value of $6.5 million at June 30, 2002.





Prior to our conversion to a business development company, we provided an allowance for loan losses estimated to be sufficient to absorb probable future losses, net of recoveries. From inception through November 30, 2001, we had
provided $20.3 million of allowance for loan losses, including $2.0 million of allowance recorded in the asset acquisition and have charged-off $14.8 million.




27




---

##### Table of Contents




Results of Operations





Comparison of the Three and Six Months Ended June 30, 2002 and 2001





The following table shows our consolidated results of operations for the three and six months ended June 30, 2002 and 2001. The three and six months ended June 30, 2002 reflect our financial results as
a business development company (BDC) whereas the three and six months ended June 30, 2001 reflect our financial results prior to operating as a BDC. Different accounting principles are used in the preparation of our financial statements as a BDC
under the Investment Company Act of 1940 and, as a result, our financial results as a BDC are not directly comparable to prior periods. The items in the table below were not affected by the change in accounting principles resulting from our
conversion to a BDC. See Note 1 to Consolidated Financial Statements under the heading Conversion to Business Development Company.





Post-IPO as a Business Development Company Three Months Ended June 30, 2002

Pre-IPO prior to becoming a Business Development Company Three Months Ended June 30, 2001

Post-IPO as a Business Development Company Six Months Ended June 30, 2002

Pre-IPO prior to becoming a Business Development Company Six MonthsEnded June 30, 2001(dollars in thousands)Operating incomeInterest and fees on commercial loans

$
18,255

$
17,468

$
33,844

$
35,064Advisory fees and other income


1,178


221


2,643


537Total operating income


19,433


17,689


36,487


35,601Operating expensesInterest expense


2,844


6,992


5,340


14,522Employee compensation:Salaries and benefits


1,842


2,316


3,863


4,606Long-term incentive compensation


1,731





3,257


Total employee compensation


3,573


2,316


7,120


4,606General and administrative expense


1,566


1,311


2,622


2,328Total operating expenses


7,983


10,619


15,082


21,456Net operating income(a)


11,450


7,070


21,405


14,145Long-term incentive compensation(b)


1,731





3,257


Distributable net operating income(c)

$
13,181

$
7,070

$
24,662

$
14,145


---

|(a) |  | Represents net operating income before provision for loan losses for periods ending prior to December 1, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------

|(b) |  | Includes expenses related to termination of the stock option plan and issuance of related restricted stock awards at the time of the IPO.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------

|(c) |  | Distributable net operating income is presented for the three and six months ended June 30, 2001 to facilitate the understanding of the amount of net earnings
we may have potentially distributed if we had operated as a business development company and regulated investment company (without the effect of de-leveraging prior to December 1, 2001) for that period. The amounts of the distributable net operating
income identified in this table are not intended to represent amounts we will distribute in future periods. Distributable net operating income may not be comparable to similarly titled measures reported by other companies. Distributable net
operating income does not represent net increase (decrease) in stockholders equity resulting from earnings or cash generated from operating activities in accordance with GAAP and should not be considered an alternative to such items as an
indication of our performance or to cash flows as a measure of liquidity or ability to make distributions. For additional information on distributions, see the section entitled Financial Condition, Liquidity and Capital
ResourcesDividends.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28




---

##### Table of Contents




Operating Income





Operating income includes interest income on commercial loans, advisory fees and other income. Interest income is comprised of commercial loan interest at contractual rates
and upfront fees that are amortized into income over the life of the loan. Most of our loans contain lending features that adjust the rate margin based on the financial and operating performance of the borrower, which generally occurs quarterly.





The change in operating income from the three and six months ended June 30, 2001 compared to the same periods in
2002 is attributable to the following items:





Periods Ended June 30, 2002 vs. June 30, 2001Three Months Ended


Six Months Ended(dollars in millions)Change due to:Asset growth (a)

$
2.8


$
5.3Change in LIBOR (a)


(3.5
)


(8.4
)Change in spread (a)


0.8



1.2Increase in fee income


0.7



0.7Advisory and other income


0.9



2.1Total change in operating income

$
1.7


$
0.9


---

|(a) |  | The change in interest income due to change in LIBOR, change in spread and loan growth has been allocated in proportion to the relationship of the absolute
dollar amount of the changes in each.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Total operating income for the three months ended June
30, 2002 increased $1.7 million, or 9.9%, to $19.4 million from $17.7 million for the three months ended June 30, 2001. The benefit of an increase in loan volume and interest spread was partially offset by a decline in LIBOR rates from the second
quarter of 2001 to the same period in 2002. Loan interest rose $0.1 million from the second quarter of 2001 to the second quarter of 2002. Average three month LIBOR decreased 231 basis points over these periods from 4.23% to 1.92%, decreasing income
by $3.5 million. Average commercial loans increased 19% for the second quarter of 2002 when compared to the second quarter of 2001, contributing a $2.8 million increase in income. The majority of the loans are priced as a variable spread to LIBOR
and this coupon spread increased by 60 basis points resulting in a $0.8 million addition to income. Loan fees increased $0.7 million primarily from origination fees. Due to a number of projects completed this quarter for new and existing customers,
advisory and other income rose $0.9 million. Advisory fees are recognized as earned, which is generally when the investment transaction closes or the services are completed.





Total operating income for the six months ended June 30, 2002 increased $0.9 million, or 2.5%, to $36.5 million from $35.6 million for the six months ended June 30, 2001.
Loan interest declined $1.9 million from the first six months of 2001 compared to the first six months of 2002. Average three month LIBOR decreased 290 basis points over these periods from 4.81% to 1.91%, decreasing income by $8.4 million. Average
commercial loans increased 18% for the first half of 2002 when compared to the first half of 2001, contributing a $5.3 million increase in income. The coupon spread increased 47 basis points in the first six months of 2002, resulting in a $1.2
million increase in income. The loan growth, increase in weighted average spreads and rise in advisory and other income more than offset the affects of the decreases in LIBOR rates from the first half of 2001 to the same period in 2002. Loan fees
increased $0.7 million primarily from origination fees. Due to a number of projects completed during the first half of 2002 for new and existing customers, advisory and other income experienced growth of $2.1 million.




29




---

##### Table of Contents




Operating Expenses





Operating expenses include interest expense on borrowings, including amortization of deferred debt issuance costs, employee compensation, and general and administrative
expenses.





The change in operating expense from the three and six months ended June 30, 2001 compared to the same
periods in 2002 is attributable to the following items:





Periods Ended June 30, 2002 vs. June 30, 2001Three Months Ended


Six Months Ended(dollars in millions)Change due to:Decrease in borrowings(a)

$
(1.0
)

$
(2.4
)Change in LIBOR(a)


(2.2
)


(5.0
)Change in spread(a)


(0.9
)


(1.8
)Salaries and benefits


(0.5
)


(0.8
)Long-term incentive compensation


1.7



3.3General and administrative expense


0.3



0.3Total change in operating expense

$
(2.6
)

$
(6.4
)


---

|(a) |  | The change in interest expense due to decrease in borrowings, change in LIBOR, and change in spread has been allocated in proportion to the relationship of the
absolute dollar amount of the changes in each.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Total operating expenses for the three months
ended June 30, 2002 decreased $2.6 million, or 24.8%, to $8.0 million from $10.6 million for the three months ended June 30, 2001. The decrease was primarily due to a decline in interest expense as average borrowings and rates both declined. Average
three month LIBOR decreased 231 basis points over these periods from 4.23% to 1.92% which caused interest expense to decline by $2.2 million. Average borrowings decreased 19%, decreasing interest expense by $1.0 million. On December 27, 2001, we
issued investment grade asset backed bonds with a blended coupon spread of 75 basis points over LIBOR and, along with a portion of the IPO proceeds, replaced a debt facility priced at LIBOR plus 175 basis points. The decrease in spreads decreased
interest expense by $0.9 million. Salaries and benefits declined $0.5 million. Partially offsetting the decline in interest expense and salaries and benefits was an increase of $1.7 million in long-term incentive compensation from $0 in 2001. The
increase in long-term incentive compensation is related to the amortization of restricted stock awards and the treatment of dividends on certain shares of common stock securing employee loans as compensation. General and administrative expense rose
$0.3 million for the period.





Total operating expenses for the six months ended June 30, 2002 decreased $6.4
million, or 29.7%, to $15.1 million from $21.5 million for the six months ended June 30, 2001. The decrease was primarily due to a decline in interest expense as average borrowings and rates both declined. Average three month LIBOR decreased 290
basis points over these periods from 4.81% to 1.91% which caused interest expense to decline by $5.0 million. Average borrowings decreased 21%, decreasing interest expense by $2.4 million. The decrease in spreads decreased interest expense by $1.8
million. Salaries and benefits declined $0.8 million. Partially offsetting the decline in interest expense and salaries and benefits was a $3.3 million increase in long-term incentive compensation from $0 in 2001. General and administrative expense
rose $0.3 million for the period.





Net operating income before provision for loan losses for the quarter ended
June 30, 2002 totaled $11.5 million compared with $7.1 million for the quarter ended June 30, 2001. Net income totaled $9.4 million for the quarter ended June 30, 2002 and $2.8 million for the quarter ended June 30, 2001.





Net operating income before provision for loan losses for the six months ended June 30, 2002 totaled $21.4 million compared with $14.1
million for the six months ended June 30, 2001. Net income totaled $13.1 million for the six months ended June 30, 2002 and $8.1 million for the six months ended June 30, 2001.





Reconciliation of Net Operating Income to Net (Decrease) Increase in Stockholders Equity from Earnings (Loss)





Provision for Loan Losses





Because we are a business development company and our investments are carried at fair value, we no longer provide a provision for loan losses. The provision for loan losses for the three and six months ended June 30, 2001 totaled
$1.6 million and $2.6 million, respectively.





Realized Gains (Losses) on Investments and Net Unrealized
Appreciation (Depreciation) on Investments





Realized losses for the three and six months ended June 30, 2001
totaled $1.3 million and $1.6 million, respectively, and represented impairment write-offs on equity investments. Net unrealized depreciation on investments for the three and six months ended June 30, 2002 of $2.0 million and $8.3 million,
respectively, reflects the change in fair value primarily for




30




---

##### Table of Contents

assets in the security alarm and publishing sectors. The net unrealized depreciation on investments of $2.0 million for the three months ended June 30, 2002 consisted of $6.0 million of gross
appreciation and $8.0 million of gross depreciation. The appreciation was made up primarily by a $5.6 million appreciation in one of our telecommunications investments, Talk America Holdings, Inc. The unrealized depreciation was primarily related to
a decrease of $2.2 million in the value of one of our publishing investments, UMAC Inc. (which is controlled by MCG) and approximately $3.5 million of adjustments to our loans on non-accrual primarily attributable to Value Page Holdings, Inc. and
Intellisec Holdings, Inc. The net unrealized depreciation on investments of $8.3 million for the six months ended June 30, 2002 consisted of $6.9 million of gross appreciation and $15.2 million of gross depreciation. The appreciation occurred
primarily in two of our telecommunications investments. Talk America Holdings, Inc. appreciated $5.6 million and Manhattan Telecommunications Corporation appreciated $1.0 million. The unrealized depreciation was primarily related to a decrease of
$5.7 million in the value of one of our publishing investments, UMAC Inc. and approximately $5.9 million of adjustments to our loans on non-accrual. Prior to conversion to a business development company, only certain investments were carried at fair
value. Net unrealized appreciation for the three and six months ended June 30, 2001 was $0.4 million and $0.7 million, respectively, and was related to the write up in the fair market value of certain warrants accounted for in accordance with SFAS
No. 133 and 138.





Income Taxes





Through December 31, 2001 we were taxed under Subchapter C of the Internal Revenue Code. We will elect to be a regulated investment company under Subchapter M of the
Internal Revenue Code with the filing of our federal corporate income tax return for 2002, which election will be effective as of January 1, 2002, and will not be subject to taxation of income to the extent such income is distributed to stockholders
and we meet certain minimum dividend distribution and other requirements. Our effective tax rate for the three and six months ended June 30, 2001 was 39.2% and 40.1%, respectively. The effective rate includes both federal and state income tax
components.





Financial Condition, Liquidity and Capital Resources





Cash and Cash Equivalents





At
June 30, 2002 and December 31, 2001, we had $30.1 million and $48.1 million, respectively, in cash and cash equivalents. We invest cash on hand in interest bearing deposit accounts with daily sweep features. On December 4, 2001, we completed an
initial public offering of 13,375,000 shares of our common stock and a concurrent private offering of 625,000 shares of our common stock with gross proceeds totaling $237.3 million (net proceeds totaling $216.9 million). On June 17, 2002, we raised
an additional $54.0 million in gross proceeds (net proceeds of approximately $50.3 million) as the result of an additional public stock offering. The decrease in cash from December 31, 2001 to June 30, 2002 is due to portfolio growth and payment of
dividends partially offset by an increase in borrowings. Our objective is to maintain a low cash balance, while keeping sufficient cash on hand to cover current funding requirements and operations.





Liquidity and Capital Resources





We expect our cash on hand and cash generated from operations to be adequate to meet our cash needs at our current level of operations, including the next twelve months. We generally fund new
originations using cash on hand, advances under our credit facilities and equity financings.





As of June 30, 2002,
we had unused commitments to extend credit to our customers of $17.2 million, which are not reflected on the balance sheet. At the same time, subject to certain minimum equity restrictions and other covenants, total unused available commitments from
our commercial paper facility totaled $138.2 million.







31




---

##### Table of Contents

The following table shows our contractual obligations as of June 30, 2002:





Payments Due by PeriodContractual Obligations(a)

Total

Less than 1
year

1-3 years

4-5 years

After 5 years(dollars in millions)Borrowings(b)

$
316.4

$
61.8

$


$


$
254.6Future minimum rental obligations


1.2


0.7


0.4


0.1


Total contractual obligations

$
317.6

$
62.5

$
0.4

$
0.1

$
254.6


---

|(a) |  | This excludes the unused commitments to extend credit to our customers of $17.2 million as discussed above.
|--- |  | -----------------------------------------------------------------------------------------------------------

|(b) |  | Borrowings are listed based on the contractual maturity of the facility. However, actual payments on borrowings could be earlier since they are based primarily
on when we receive payments from our customers on the commercial loans collateralizing the borrowings.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




As of December 31, 2001 we had unused commitments to extend credit to our customers of $29.4 million, which are not reflected on the balance sheet. At the same time, subject to certain minimum equity restrictions and other covenants,
total unused available commitments from our commercial paper facility totaled $177.4 million. See Borrowings section below for discussion of our borrowing facilities.





The following table shows our contractual obligations as of December 31, 2001:





Payments Due by PeriodContractual Obligations(a)

Total

Less than 1
year

1-3 years

4-5 years

After 5 years(dollars in millions)Borrowings(b)

$
287.8

$


$
22.6

$


$
265.2Future minimum rental obligations


1.5


0.8


0.5


0.2


Total contractual obligations

$
289.3

$
0.8

$
23.1

$
0.2

$
265.2


---

|(a) |  | This excludes the unused commitments to extend credit to our customers of $29.4 million as discussed above.
|--- |  | -----------------------------------------------------------------------------------------------------------

|(b) |  | Borrowings are listed based on the contractual maturity of the facility. However, actual payments on borrowings could be earlier since they are based primarily
on when we receive payments from our customers on the commercial loans collateralizing the borrowings.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




In order to satisfy the requirements applicable to a regulated investment company, we intend to distribute to our stockholders all of our income except for certain net capital gains and adjustments for long-term incentive
compensation. In addition, as a business development company, we generally will be required to meet a coverage ratio of total assets to total senior securities, which include all of our borrowings and any preferred stock we may issue in the future,
of at least 200%. This requirement limits the amount that we may borrow. We anticipate needing to raise additional equity through the capital markets to fund anticipated growth in our loan and investment portfolio.





Borrowings





On
December 27, 2001, we established the MCG Commercial Loan Trust 2001-1 (the Trust), which issued two classes of Series 2001-1 Notes to 15 institutional investors. The facility is secured by all of the Trusts existing assets,
totaling $335.0 million as of June 30, 2002 and $349.5 million as of December 31, 2001. This facility is scheduled to terminate on February 20, 2013 or sooner upon full repayment of the Class A and Class B Notes.







32




---

##### Table of Contents

The Trust issued $229.8 million of Class A Notes rated AAA/Aaa/AAA, and $35.4 million of Class B Notes rated A/A2/A (the
Series 2001-1 Class A Asset Backed Bonds and Series 2001-1 Class B Asset Backed Bonds) as rated by Standard & Poors, Moodys and Fitch, respectively. As of June 30, 2002, $254.6 million of the Series 2001-1 Notes
were outstanding and $265.2 million were outstanding as of December 31, 2001. The Series 2001-1 Class A Asset Backed Bonds bear interest of LIBOR plus 0.60% and Series 2001-1 Class B Asset Backed Bonds bear interest of LIBOR plus 1.75%, and interest
on both is payable quarterly.





As of June 1, 2000, we established a revolving credit facility (the Revolving
Credit Facility), which allows us to issue up to $200.0 million of Series 2000-1 Class A Notes (the Series 2000-1 Notes or Series 2000-1 Class A Asset Backed Securities). As of June 30, 2002, $61.8 million of the Series
2000-1 Notes were outstanding with one investor and as of December 31, 2001 $22.6 million were outstanding with one investor. As of June 30, 2002, we had no notes outstanding under a swingline credit facility (the Swingline Notes), which
is part of the Revolving Credit Facility, that allows us to borrow up to $25.0 million as part of the $200.0 million total facility limit for a period of up to four days. The Swingline Notes are repaid through the issuance of Series 2000-1 Notes.
The Revolving Credit Facility is secured by $198.4 million of commercial loans as of June 30, 2002 and $71.7 million of commercial loans as of December 31, 2001. We are subject to certain limitations on the amount of Series 2000-1 Notes we may issue
at any point in time including the requirement for a minimum amount of unleveraged loans that serve as collateral for the indebtedness. Such amount was a minimum of $30.0 million (subject to increase upon the occurrence of an event of default) prior
to July 8, 2002 and $75.0 million as of July 8, 2002 and thereafter. The Series 2000-1 Notes bear interest based on a commercial paper rate plus 1.0% and interest is payable monthly. This facility is scheduled to terminate on May 31, 2003.





The Trust and the Revolving Credit Facility are both funded through bankruptcy remote, special purpose,
wholly-owned subsidiaries of ours and, therefore, their assets may not be available to our creditors.





On June 24,
1998, one of our subsidiaries entered into a $400.0 million senior secured credit facility (the Facility). The lead bank for this Facility, Heller Financial, Inc. (Heller), held 334,566 Class A shares and 677,934 Class D
shares at December 31, 2000 which it purchased, along with Goldman Sachs, at our inception. On October 25, 2001, Heller was acquired by GE Capital. During 2001, the proceeds from our IPO and the sale of loans to the Trust were used to pay off the
Facilitys outstanding balance of $342.7 million. This Facility has been repaid in full and is no longer in place.





At June 30, 2002, we had aggregate outstanding borrowings of $316.4 million and $287.8 million at December 31, 2001. The following table shows the facility amounts and outstanding borrowings from third-party lenders at June 30, 2002:





Facility amount

Amount outstanding

Interest(a)(dollars in millions)Series 2001-1 Class A Asset Backed Bonds

$
229.8

$
219.2

2.54
%Series 2001-1 Class B Asset Backed Bonds


35.4


35.4

3.69Series 2000-1 Class A Asset Backed Securities


200.0


61.8

2.85Total borrowings

$
465.2

$
316.4

2.73
%


---

|(a) |  | Excludes the cost of commitment fees and other facility fees.
|--- |  | -------------------------------------------------------------






33




---

##### Table of Contents

At December 31, 2001, we had aggregate outstanding borrowings of $287.8 million. The following table shows the facility
amounts and outstanding borrowings from third-party lenders at December 31, 2001:





Facility amount

Amount outstanding

Interest(a)(dollars in millions)Series 2001-1 Class A Asset Backed Bonds

$
229.8

$
229.8

2.50
%Series 2001-1 Class B Asset Backed Bonds


35.4


35.4

3.65Series 2000-1 Class A Asset Backed Securities


200.0


22.6

3.06Total borrowings

$
465.2

$
287.8

2.69
%


---

|(a) |  | Excludes the cost of commitment fees and other facility fees.
|--- |  | -------------------------------------------------------------




See Note 4 to the Consolidated Financial Statements for further discussion of our borrowings.





Dividends





Prior to our conversion, we did not make
distributions to our stockholders, but instead retained all of our income. As a regulated investment company, we are required to distribute at least 90% of our investment company taxable income to avoid corporate level taxes on the amount
distributed and at least 98% of our investment company taxable income to avoid an excise tax. We intend to make distributions on a quarterly basis to our stockholders of all of our income, except for certain net capital gains and adjustments for
long-term incentive compensation expense.





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 from time to time. In addition, we may be limited in our ability to make distributions due to the asset coverage test for borrowings applicable to us as a
business development company under the Investment Company Act of 1940 and due to provisions in our credit facilities. If we do not distribute a certain percentage of our income annually, we will suffer adverse tax consequences, including possible
loss of our status as a regulated investment company. We cannot assure shareholders that they will receive any distributions or distributions at a particular level.





We declared a $0.47 per share dividend on June 3, 2002 to our stockholders of record on June 11, 2002. We declared a $0.41 per share dividend on March 28, 2002 to our
stockholders of record on April 17, 2002. We declared an aggregate dividend of $0.86 per share in December 2001 to our stockholders of record on January 22, 2002 consisting of a dividend of $0.25 per share for the fourth quarter of 2001 and an
additional dividend of $0.61 per share representing the distribution of substantially all of our earnings and profits since inception through December 31, 2001, including the period after we elected to be a business development company through the
effective date of our election to be a regulated investment company for tax purposes. The aggregate dividend declared in December 2001 was required for us to qualify as a regulated investment company.





Related Party Transactions





Prior to our election to be regulated as a business development company, we terminated our stock option plan and adopted a restricted stock program under which we issued 1,539,851 shares of restricted common stock to employees and
directors. The total number of shares issued for the termination of the option plan was based upon the Black-Scholes option-pricing model and assumptions and approved by our Board of Directors. See Notes to Consolidated Financial Statements.





Immediately prior to the initial public offering, we issued 68,930 shares of common stock for the termination of
all warrants held by Wachovia Corporation related to the management buyout in 1998 without regard to exercise price. At that time, Wachovia Corporation was also a shareholder. The total number of shares issued for the termination of the warrants was
based on the Black-Scholes option-pricing model and assumptions




34




---

##### Table of Contents

negotiated with Wachovia Corporation and approved by our Board of Directors. In addition, we have a $200 million variable series securitization facility and a $265.2 million term funding
securitization agreement that were arranged by Wachovia Securities, an affiliate of Wachovia Corporation. Interest paid to an affiliate of Wachovia Corporation holding the Series 2000-1 Notes under the variable series securitization facility totaled
$0.5 million and $1.0 million for the three and six months ended June 30, 2002 and $4.9 million for the year ended December 31, 2001.





We made cash payments totaling $1.7 million to non-executive employees for the taxes imposed on them associated with the issuance of restricted common stock. The cash payments assumed a combined federal and state tax rate of
48% for each employee.





Additionally, in connection with the termination of our stock option plan, certain
executive officers and employees purchased a portion of the 1,539,851 shares of restricted common stock at a per share price of $17.00. Those executive officers and employees issued partially non-recourse notes to us, with an aggregate face value of
$5.8 million secured by approximately 1.4 million shares with a value of $23.8 million at the initial public offering price. The notes are payable at the end of a four and a half-year term, subject to acceleration, bear interest at 4.13% payable
annually and are secured by all of the restricted common stock held by such employee and for some employees, for a specified time-period, additional shares of our common stock the employee owns. The notes are non-recourse as to the principal amount
but recourse as to the interest. Amounts due on these loans are reflected as a reduction of stockholders equity in the consolidated balance sheets.





Heller Financial, Inc., a shareholder, provided our primary lending facility prior to December 28, 2001. Interest paid to Heller Financial, Inc., as agent, totaled $20.2 million for the year ended
December 31, 2001. The Heller lending facility was paid off on December 28, 2001.





Critical Accounting Policies





The consolidated financial statements are based on the selection and application of significant accounting
policies, which require management to make significant estimates and assumptions. We believe that the following are some of the more critical judgment areas in the application of our accounting policies that currently affect our financial condition
and results of operations.





Income Recognition





Interest on commercial loans is computed by methods that generally result in level rates of return on principal amounts outstanding. When a loan becomes 90 days or more
past due, or if we otherwise do not expect the customer to be able to service its debt and other obligations, we will, as a general matter, place the loan on non-accrual status and stop recognizing interest income on that loan until all principal
has been paid. However, we may make exceptions to this policy if the investment is well secured and in the process of collection.





We include in income certain amounts that we have not yet received in cash, such as contracted payment-in-kind (PIK) interest, which represents contractual interest added to the loan balance and is due at the end of the loan term.
PIK loans represented $19.0 million or 2.8% of our portfolio of investments as of June 30, 2002 and $14.2 million or 2.3% of our portfolio of investments as of December 31, 2001. As of June 30, 2002, 92.5% of the $19.0 million of PIK loans have an
investment rating of 3 or better and as of December 31, 2001, 98.8% of the $14.2 million of PIK loans had an investment rating of 3 or better. The increase in loan balances as a result of contracted PIK arrangements are separately identified on our
consolidated statements of cash flows.





Loan origination fees paid up front are deferred and amortized as
adjustments of the related loans yield over the contractual life. In certain loan arrangements, warrants or other equity interests are received from the borrower as additional origination fees. The borrowers granting these interests are
typically non-publicly traded




35




---

##### Table of Contents

companies. We record the financial instruments received at estimated fair value as determined by our Board of Directors. Fair values are estimated using various valuation models which attempt to
estimate the underlying value of the associated entity. These models are then applied to our ownership share considering any discounts for transfer restrictions or other terms which impact the value. Changes in these values are recorded through our
statement of operations. Any resulting discount on the loan from recordation of warrant and other equity instruments are accreted into income over the term of the loan. We had $13.2 million and $12.1 million of unearned fees as of June 30, 2002 and
December 31, 2001, respectively. We recognized $3.0 million of these fees in income during the first half of 2002 and $4.7 million of these fees in income during 2001.





Valuation of Investments





Portfolio assets for which market
prices are available are valued at those prices. However, substantially all of our assets were acquired in privately negotiated transactions and have no readily determinable market values. These securities are carried at fair value as determined by
our Board of Directors under our valuation policy. The valuation committee of our Board of Directors reviews our loans and investments and will make recommendations to our Board of Directors.





As a general rule, we do not value our loans above cost, but loans will be subject to fair value write-downs when the asset is considered impaired. Substantially all
of our commercial loans bear interest at LIBOR-based variable rates, which include a base index rate and a spread that changes with the overall financial and operational performance of the customer. In many cases, our loan agreements allow for
increases in the spread to the base index rate if the financial or operational performance of the customer deteriorates or shows negative variances from the customers business plan and, in some cases, allow for decreases in the spread if
financial or operational performance improves or exceeds the customers plan.





With respect to private equity
securities, each investment is valued using industry valuation benchmarks, and then the value is assigned a discount reflecting the illiquid nature of the investment, as well as our minority, non-control position. When an external event such as a
purchase transaction, public offering, or subsequent equity sale occurs, the pricing indicated by the external event will be used to corroborate our private equity valuation. Securities that are traded in the over-the-counter market or on a stock
exchange generally will be valued at the prevailing bid price on the valuation date. However, restricted and unrestricted publicly traded securities may be valued at discounts from the public market value due to restrictions on sale, the size of our
investment or market liquidity concerns.





Substantially all of our assets consist of securities carried at fair
value as determined by our Board of Directors. Determination of fair value involves subjective judgments and the resultant values may not represent amounts at which investments could be bought or sold in an independent third party transaction and
the differences could be material.





Securitization Transactions





Periodically, the Company transfers pools of loans to special purpose entities (SPEs) for use in securitization transactions. These on-balance sheet securitization
transactions comprise a significant source of our overall funding, with the total face amount of the outstanding loans assumed by third parties equaling $533.3 million at June 30, 2002 and $421.1 million at December 31, 2001. On April 1, 2001, the
Company adopted the requirements of SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which applies prospectively to all securitization transactions occurring after March
31, 2001. Adoption of SFAS No. 140 did not have a material impact on the operations or financial position of the Company. Transfers of loans have not met the requirements of SFAS No. 140 for sales treatment and are, therefore, treated as secured
borrowings, with the transferred loans remaining in investments and the related liability recorded in borrowings.





Subsequent Events





In July 2002, we completed a transaction to acquire in satisfaction of debt the assets of one of our
portfolio companies, ValuePage Holdings, Inc. The assets will be held and operated through a separate portfolio company controlled by us. Our investment had a fair value of $6.5 million and an unrealized loss of $6.6 million as of June 30, 2002. In
conjunction with this transaction, we expect to realize this loss in the third quarter of 2002 and expect this realized loss to be offset by the reversal of related unrealized depreciation. Accordingly, we expect no material impact to our overall
earnings in the third quarter of 2002 as a result of this transaction.





In August 2002, we were awarded, through a
bankruptcy proceeding, the right to acquire in satisfaction of debt the Arizona and North Carolina divisions of one of our portfolio companies, Intellisec Holdings, Inc. We anticipate that upon completion of these sales, the former divisions will be
held and operated in two separate portfolio companies controlled by us. We do not expect to realize a material gain or loss related to these transactions. However, there can be no assurance that a gain or loss will not occur upon the ultimate
disposition of these divisions or upon the disposition of the remainder of our investment in Intellisec Holdings, Inc.





In July 2002, we amended certain agreements governing our Revolving Credit Facility. This facility is further discussed in Note 4. The amendments adjust or add certain provisions to reflect our current size and organizational
structure, including a change in the servicer minimum net worth test, the addition of a servicer asset coverage requirement, and an increase in the allowed portfolio charge-off ratio.




36




---

##### Table of Contents

Item 3.Quantitative and Qualitative Disclosures About Market Risk





Interest rate sensitivity refers to the change in earnings that may result from the 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. Over 90% of our loan portfolio bears interest at a spread to LIBOR, with the remainder bearing interest at a fixed rate or at a spread to a prime rate. Our interest rates on our borrowings are based on LIBOR and
commercial paper rates, with the majority based on LIBOR.





We regularly measure exposure to interest rate risk. We
have interest rate risk exposure mainly from the portion of the commercial loan portfolio funded using stockholders equity. Our Board of Directors assesses interest rate risk and we manage our interest rate exposure on an ongoing basis. The
following table shows a comparison of the interest rate base for our outstanding commercial loans and our outstanding borrowings:





June 30, 2002

December 31, 2001Commercial Loans

Borrowings

Commercial Loans

Borrowings(dollars in millions)Prime Rate

$
20.8

$


$
31.1

$
30-Day LIBOR


46.9





19.2


60-Day LIBOR








2.3


90-Day LIBOR


552.6


254.6


539.6


265.2Commercial Paper Rate





61.8





22.6Fixed Rate


52.1





3.8


$
672.4

$
316.4

$
596.0

$
287.8





Based on our June 30, 2002 balance sheet, for every 100 basis point
increase in interest rates, our annual interest income would increase by $5.6 million and our annual interest expense would increase by $3.2 million resulting in an increase in annual net income of $2.4 million, assuming no changes in our
investments or borrowing structure. For every 100 basis point decrease in interest rates, our annual interest income would decrease by $5.4 million and our annual interest expense would decrease by $3.2 million, resulting in a decrease in annual net
income of $2.2 million, assuming no changes in our investment and borrowing structure.





Based on our December 31,
2001 balance sheet, for every 100 basis point increase in interest rates, our annual interest income would increase by $5.9 million and our annual interest expense would increase by $2.7 million resulting in an increase in annual net income of $3.2
million, assuming no changes in our investments or borrowing structure. For every 100 basis point decrease in interest rates, our annual interest income would decrease by $5.9 million and our annual interest expense would decrease by $2.7 million,
resulting in a decrease in annual net income of $3.2 million, assuming no changes in our investment and borrowing structure.





As a business development company, we will use a greater portion of equity to fund our business than we have in the past. Accordingly, other things being equal, increases in interest rates will result in greater increases in our net
interest income and reductions in interest rates will result in greater decreases in our net interest income compared with the effects of interest rate changes on our results under the more highly leveraged capital structure we have maintained in
the past.





Currently, we do not engage in hedging activities because we have determined that the cost of hedging
the risks associated with interest rate changes outweighs the risk reduction benefit. We monitor this position on an ongoing basis.







37




---

##### Table of Contents

PART II.    OTHER INFORMATION





Item 1.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 upon our financial condition or results of operations.





Item 2.Changes in Securitiesand Use of Proceeds





During the six months ended June 30, 2002, MCG issued a total of 7,665 shares of common stock under its dividend reinvestment plan pursuant to an exemption from the registration requirements of the
Securities Act of 1933. The aggregate offering proceeds for the shares of common stock sold under the dividend reinvestment plan was approximately $0.1 million.




38




---

##### Table of Contents




Item 3.Defaults Upon Senior Securities





Not Applicable.





Item 4.Submission of Matters to a Vote of Security Holders





On May 29, 2002, the Company held its Annual Meeting of Stockholders. The following three matters were submitted to the stockholders for consideration:





| | 1. |  | To elect three directors of the Company who will serve for three years, or until their successors are elected and qualified;
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------




| | 2. |  | To ratify the selection of Ernst & Young LLP to serve as independent auditors for the Company for the fiscal year ending December 31, 2002;
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------




| | 3. |  | To consider and act on a proposal to eliminate the fundamental nature of the Companys investment policies.
| | -- |  | -----------------------------------------------------------------------------------------------------------




The results of the shares voted with regard to each of these matters is as follows:





| | 1. |  | Election of Directors:
| | -- |  | ----------------------




Director

For

WithheldBryan J. Mitchell

23,831,267

2,082,808Robert J. Merrick

25,719,687

194,388Wallace B. Millner, III

25,827,437

86,638





Continuing Directors whose terms did not expire at the annual
meeting were as follows: Steven F. Tunney, Joseph H. Gleberman, Norman W. Alpert, Michael A. Pruzan, Jeffrey M. Bucher and Kenneth J. OKeefe.





| | 2. |  | Ratification of appointment of Ernst & Young LLP as auditors:
| | -- |  | -------------------------------------------------------------




For

Against

Abstain25,723,336

186,569

4,170





| | 3. |  | Approval of the elimination of the fundamental nature of the Companys investment policies:
| | -- |  | -------------------------------------------------------------------------------------------




For

Against

Abstain

Broker Non-Votes24,319,928

119,597

53,275

1,421,275





Item 5.Other Information





Not Applicable.





Item 6.Exhibits and Reports on Form 8-K





(a)    Exhibits





Listed below are the exhibits which are filed as
part of this report (according to the number assigned to them in Item 601 of Regulation S-K):





Exhibit Number

Description of Document10.2

Sale and Servicing Agreement among MCG Master Trust, MCG Finance Corporation II and MCG Capital Corporation (formerly
MCG Credit Corporation), dated as of June 1, 2000, as amended by certain Amendment No. 1, dated as of September 1, 2000, Amendment No. 2, dated as of June 6, 2001, Amendment No. 3, dated as of May 20, 2002, and Amendment No. 4, dated as of July 8,
2002 (filed herewith).10.3

Note Purchase Agreement among MCG Master Trust, MCG Capital Corporation (formerly MCG Credit Corporation), Variable
Funding Capital Corporation, and First Union Securities, Inc. dated as of June 1, 2000, as amended by a certain Amendment No. 1, dated as of June 6, 2001, Amendment No. 2, dated as of May 20, 2002, and Amendment No. 3, dated as of July 8, 2002
(filed herewith).10.10

Series 2000-1 Terms Supplement to the Indenture dated as of June 1, 2000 between MCG Master Trust and Norwest Bank
Minnesota, N.A., as amended by certain Amendment No. 1, dated as of June 6, 2001, Amendment No. 2, dated as of May 20, 2002, and Amendment No. 3, dated as of July 8, 2002 (filed herewith).99.1

Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
1350).99.2

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
1350).





(b)    Form 8-KThe registrant has not
filed any reports on a Current Report on Form 8-K during the quarter for which this report 10-Q is filed. However, on August 6, 2002, the registrant filed a Form 8-K disclosing that its Chairman and CEO, Bryan J. Mitchell, certified certain of the
Companys Exchange Act Filings to the Securities and Exchange Commission (SEC).




39




---

##### Table of Contents




SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) 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 on August 14, 2002.





MCG CAPITAL CORPORATIONBy:

/s/    BRYAN J.
MITCHELLBryan J. Mitchell Chairman of
the Board and Chief Executive Officer





By:

/s/    JANET C.
PERLOWSKIJanet C. Perlowski Chief
Financial Officer




40