UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from           to

 

Commission File No. 814-00735

 

KCAP Financial, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   20-5951150

(State or other jurisdiction of

Incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

295 Madison Avenue, 6th Floor

New York, New York 10017

(Address of principal executive offices)

 

(212) 455-8300

(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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨  No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨   Accelerated filer x
         
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

 

The number of outstanding shares of common stock of the registrant as of November 5, 2013 was 33,332,123.

 

 

 

 
 

 

TABLE OF CONTENTS

 

      Page
       
Part I. Financial Information
       
Item 1. Financial Statements   1
       
  Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012   1
       
  Statements of Operations (unaudited) for the three and nine months ended September 30, 2013 and 2012   2
       
  Statements of Changes in Net Assets (unaudited) for the nine months ended September 30, 2013 and 2012   3
       
  Statements of Cash Flows (unaudited) for the nine months ended September 30, 2013 and 2012   4
       
  Schedules of Investments as of September 30, 2013  (unaudited) and December 31, 2012   5
       
  Financial Highlights (unaudited) for the nine months ended September 30, 2013 and 2012   27
       
  Notes to Financial Statements (unaudited)   28
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   55
       
Item 3. Quantitative and Qualitative Disclosures About Market Risk   73
       
Item 4. Controls and Procedures   74
       
Part II. Other Information
       
Item 1. Legal Proceedings   75
       
Item 1A. Risk Factors   75
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   77
       
Item 3. Defaults Upon Senior Securities   77
       
Item 4. Mine Safety Disclosures   77
       
Item 5. Other Information   77
       
Item 6. Exhibits   77
       
Signatures   78

 

 

 
 

 

KCAP FINANCIAL, INC.

BALANCE SHEETS

 

   As of
September 30, 2013
   As of
December 31, 2012
 
   (unaudited)     
ASSETS          
Investments at fair value:          
Time deposits (cost: 2013 -  $0; 2012 - $1,942,834)  $   $1,942,834 
Money market account (cost: 2013 - $9,055,634; 2012 - $30,543,824)   9,055,634    30,543,824 
Debt securities (cost: 2013 - $267,741,058; 2012 - $134,377,151)   257,359,908    111,037,882 
CLO Fund securities managed by non-affiliates (cost: 2013 - $12,634,461; 2012 - $10,487,023)   4,445,290    3,725,924 
CLO Fund securities managed by affiliates (cost: 2013 - $88,711,898; 2012 - $79,659,387)   77,707,198    79,531,583 
Equity securities (cost: 2013 - $18,655,209; 2012 - $18,375,587)   9,385,053    8,020,716 
Asset Manager Affiliates (cost: 2013 - $83,273,236; 2012 - $83,161,529)   82,533,000    77,242,000 
Total investments at fair value (cost: 2013 - $480,071,496; 2012 - $358,547,336)   440,486,083    312,044,763 
Cash   9,721,704    738,756 
Restricted cash   5,999,041     
Interest receivable   2,074,680    697,349 
Accounts receivable   3,325,054    2,210,869 
Other assets   6,406,360    3,568,736 
           
Total assets  $468,012,922   $319,260,473 
           
LIABILITIES          
Convertible Notes  $49,008,000   $60,000,000 
Retail Notes   41,400,000    41,400,000 
Notes issued by KCAP Senior Funding I, LLC (net of discount: $3,139,780)   102,110,220     
Payable for open trades   7,974,944     
Accounts payable and accrued expenses   2,437,029    2,581,432 
Dividend payable       7,403,382 
           
Total liabilities  $202,930,193   $111,384,814 
           
STOCKHOLDERS' EQUITY          
Common stock, par value $0.01 per share, 100,000,000 common shares authorized; 33,314,779 and 26,470,408 common shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively  $331,955   $264,382 
Capital in excess of par value   370,591,623    310,566,503 
Accumulated undistributed net investment income   2,667,111    103,484 
Accumulated net realized losses   (68,401,784)   (56,035,375)
Net unrealized depreciation on investments   (40,106,176)   (47,023,335)
Total stockholders' equity  $265,082,729   $207,875,659 
           
Total liabilities and stockholders' equity  $468,012,922   $319,260,473 
           
NET ASSET VALUE PER COMMON SHARE  $7.96   $7.85 

 

See accompanying notes to financial statements.

 

1
 

 

KCAP FINANCIAL, INC.

STATEMENTS OF OPERATIONS

(unaudited)

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2013   2012   2013   2012 
                 
Investment Income:                    
Interest from investments in debt securities  $3,716,675   $3,570,141   $9,191,940   $8,743,045 
Interest from cash and time deposits   12,183    511    19,920    3,919 
Dividends from investments in CLO Fund securities managed by non-affiliates   281,571    530,420    1,029,236    1,408,124 
Dividends from investments in CLO Fund securities managed by affiliates   5,109,417    5,258,554    15,147,600    13,901,079 
Dividends from Asset Manager Affiliates   3,325,000    925,000    9,625,000    2,950,000 
Capital structuring service fees   200,185    69,305    259,512    230,910 
                     
Total investment income   12,645,031    10,353,931    35,273,208    27,237,077 
                     
Expenses:                    
Interest and amortization of debt issuance costs   2,902,486    1,689,908    7,412,795    4,778,546 
Compensation   1,205,864    385,323    3,225,986    2,407,034 
Professional fees   391,735    713,784    1,686,707    1,876,115 
Insurance   140,647    126,761    395,995    399,040 
Administrative and other   433,594    305,060    1,453,150    1,000,145 
                     
Total expenses   5,074,326    3,220,836    14,174,633    10,460,880 
                     
Net Investment Income   7,570,705    7,133,095    21,098,575    16,776,197 
Realized And Unrealized Gains (Losses) On Investments:                    
Net realized losses from investment transactions   (10,387,242)   (3,767,256)   (12,032,708)   (3,462,835)
Net change in unrealized appreciation (depreciation) on:                    
Debt securities   10,547,127    2,151,333    12,958,119    (2,846,934)
CLO Fund securities managed by non-affiliates   (239,837)   1,520,468    (1,428,072)   1,454,857 
CLO Fund securities managed by affiliates   (2,529,499)   2,281,860    (10,876,896)   4,913,588 
Equity securities   85,773    (1,260,133)   1,084,715    418,214 
Asset Manager Affiliates investments   (4,806,105)   1,309,027    5,179,293    (5,690,582)
Total net change in unrealized appreciation (depreciation)   3,057,459    6,002,555    6,917,159    (1,750,857)
Realized and unrealized appreciation (depreciation) on investments   (7,329,783)   2,235,299    (5,115,549)   (5,213,692)
Realized losses on extinguishments of Convertible Notes   (333,701)       (333,701)    
                     
Net Increase (Decrease) In Net Assets Resulting From Operations  $(92,779)  $9,368,394   $15,649,325   $11,562,505 
Net Increase (Decrease) In Net Assets Resulting from Operations per Common Share:                    
Basic:  $   $0.35   $0.49   $0.45 
Diluted:  $   $0.32   $0.49   $0.44 
Net Investment Income Per Common Share:                    
Basic:  $0.23   $0.27   $0.66   $0.65 
Diluted:  $0.22   $0.25   $0.65   $0.64 
                     
Weighted Average Shares of Common Stock Outstanding—Basic   33,312,328    26,668,701    31,887,711    25,860,510 
Weighted Average Shares of Common Stock Outstanding—Diluted   33,326,934    33,881,913    31,903,230    25,873,247 

 

See accompanying notes to financial statements.

 

2
 

 

KCAP FINANCIAL, INC.

STATEMENTS OF CHANGES IN NET ASSETS

(unaudited)

 

   Nine Months Ended
September 30,
 
   2013   2012 
         
Operations:          
Net investment income  $21,098,575   $16,776,197 
Net realized losses from investment transactions   (12,032,708)   (3,462,835)
Realized losses from extinguishments of Convertible Notes   (333,701)    
Net change in unrealized appreciation (depreciation) on investments   6,917,159    (1,750,857)
Net increase in net assets resulting from operations   15,649,325    11,562,505 
           
Stockholder distributions:          
Tax return of capital distributions to stockholders   (18,534,948)   (11,061,289)
Net decrease in net assets resulting from stockholder distributions   (18,534,948)   (11,061,289)
           
Capital transactions:          
Issuance of common stock for:          
Interest in Asset Manager Affiliate       25,560,000 
Dividend reinvestment plan   564,022    413,482 
Issuance of common stock for public offering   50,404,236     
Vesting of restricted stock   50    925 
Convertible Notes Conversion   8,786,000     
Stock based compensation   338,387    (103,316)
Net increase in net assets resulting from capital transactions   60,092,695    25,871,091 
           
Net assets at beginning of period   207,875,659    180,525,942 
           
Net assets at end of period (including undistributed net investment income of $2,667,111 in 2013 and $6,536,811 in 2012)  $265,082,729   $206,898,249 
           
Net asset value per common share  $7.96   $7.82 
Common shares outstanding at end of period   33,314,779    26,448,313 

 

See accompanying notes to financial statements.

 

3
 

 

KCAP FINANCIAL, INC.

STATEMENTS OF CASH FLOWS

(unaudited)

 

   Nine Months Ended
September 30,
 
   2013   2012 
         
OPERATING ACTIVITIES:          
Net increase in net assets resulting from operations  $15,649,325   $11,562,505 
Adjustments to reconcile net increase in net assets resulting from operations to net cash used in operations:          
Net realized (gains) losses on investment transactions   12,032,708    3,462,835 
Net change in unrealized (appreciation) depreciation on investments   (6,917,159)   1,750,857 
Net accretion of discount on debt securities   (58,083)   (1,171,801)
Amortization of original issue discount   155,695     
Amortization of debt issuance cost   718,473    436,423 
Realized losses on extinguishments of Convertible Notes   333,701     
Payment-in-kind interest income   (3,091)   (580,989)
Stock-based compensation expense   338,387    (103,316)
Changes in operating assets and liabilities:          
Purchases of investments   (206,384,280)   (91,662,374)
Proceeds from sale and redemption of investments   78,920,697    72,020,537 
Increase in interest and dividends receivable   (1,377,331)   (956,993)
Increase in accounts receivable   (1,114,185)   (367,731)
Decrease in time deposits   1,942,834     
Increase in other assets   (3,889,800)   (275,198)
Decrease in due from affiliates       3,517 
Decrease in accounts payable and accrued expenses   (144,403)   (1,440,383)
Net cash used in operating activities   (109,796,512)   (7,322,109)
           
FINANCING ACTIVITIES:          
Proceeds from issuance of common stock   50,404,236     
Dividends paid in cash   (25,374,261)   (14,726,920)
Proceeds from issuance of debt   101,954,525    30,000,000 
Cash paid on repurchase of Convertible Notes   (2,206,000)    
Cash paid on repayment of debt       (2,000,000)
Increase in restricted cash   (5,999,041)   (6,093,126)
Net cash provided by financing activities   118,779,459    7,179,954 
           
CHANGE IN CASH   8,982,947    (142,155)
CASH, BEGINNING OF PERIOD   738,756    2,555,259 
CASH, END OF PERIOD  $9,721,704   $2,413,104 
           
Supplemental Information:          
Interest paid during the period  $7,188,062   $5,624,894 
Dividends paid during the period under the dividend reinvestment plan  $564,008   $414,407 
Issuance of common stock in connection with acquisition of Asset Manager Affiliate  $   $25,560,000 

 

See accompanying notes to financial statements.

 

4
 

 

KCAP FINANCIAL, INC.

SCHEDULE OF INVESTMENTS

As of September 30, 2013

 

(unaudited)

Debt Securities Portfolio

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2 
Advanced Lighting Technologies, Inc.10, 12
Home and Office Furnishings, Housewares, and Durable Consumer Products
  First Lien Bond —  10.5% - 06/2019 - 00753CAE2
10.5% Cash, Due 6/19
  $3,000,000   $2,939,165   $2,556,300 
                   
Advantage Sales & Marketing Inc.10
Diversified/Conglomerate Service
 

Senior Secured Loan — 2013 Term Loan (First Lien)

4.3% Cash, Due 12/17

   1,994,976    2,002,110    2,005,260 
                   
Alaska Communications Systems Holdings, Inc. 10, 12
Telecommunications
 

Senior Secured Loan — Term Loan

6.3% Cash, Due 10/16

   2,370,852    2,377,799    2,359,010 
                   
Allison Transmission, Inc.12
Automobile
 

Senior Secured Loan — New Term B-2 Loan

3.2% Cash, Due 8/17

   1,846,812    1,842,732    1,851,235 
                   
Alpha Topco Limited3
Automobile
 

Senior Secured Loan — New Facility B

4.5% Cash, Due 4/19

   3,980,000    3,983,656    4,009,850 
                   
Apria Healthcare Group Inc.10, 12
Healthcare, Education and Childcare
 

Senior Secured Loan — Initial Term Loan

6.8% Cash, Due 4/20

   2,992,500    3,003,788    3,021,153 
                   
Aramark Corporation10
Diversified/Conglomerate Service
 

Senior Secured Loan — U.S. Term D Loan

4.0% Cash, Due 9/19

   850,000    856,375    852,656 
                   
Aramark Corporation10, 12
Diversified/Conglomerate Service
 

Senior Secured Loan — LC-3 Facility

3.8% Cash, Due 7/16

   61,707    61,830    61,910 
                   
Aramark Corporation10, 12
Diversified/Conglomerate Service
 

Senior Secured Loan — U.S. Term C Loan

3.8% Cash, Due 7/16

   938,293    940,163    941,390 
                   
Aramark Corporation10, 12
Diversified/Conglomerate Service
 

Senior Secured Loan — U.S. Term D Loan

4.0% Cash, Due 9/19

   1,150,000    1,158,625    1,153,594 

 

5
 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2 
ARSloane Acquisition, LLC10, 12
Finance
 

Senior Secured Loan — Tranche B Term Loan (First Lien)

7.5% Cash, Due 10/19

  $1,000,000   $990,000   $990,000 
                   
Asurion, LLC (fka Asurion Corporation)10, 12
Insurance
 

Senior Secured Loan — Incremental Tranche B-1 Term Loan

4.5% Cash, Due 5/19

   1,985,000    2,009,021    1,970,420 
                   
Avis Budget Car Rental, LLC12
Personal Transportation
 

Senior Secured Loan — Tranche B Term Loan

3.0% Cash, Due 3/19

   1,975,082    2,007,591    1,972,208 
                   
Bankruptcy Management Solutions, Inc.10
Diversified/Conglomerate Service
 

Senior Secured Loan — Term B Loan

7.0% Cash, Due 6/18

   722,727    722,727    720,053 
                   
BarBri, Inc. (Gemini Holdings, Inc.)10, 12
Healthcare, Education and Childcare
 

Senior Secured Loan — Term Loan

5.3% Cash, Due 7/19

   3,000,000    2,985,421    3,002,400 
                   
BBB Industries, LLC10, 12
Automobile
 

Senior Secured Loan — Term Loan B

5.5% Cash, Due 3/19

   2,925,000    2,912,631    2,925,293 
                   
Bellisio Foods, Inc. 10, 12
Beverage, Food and Tobacco
 

Senior Secured Loan — Delayed Draw Term Loan

5.3% Cash, Due 8/19

   1,193,220    1,184,422    1,193,220 
                   
Bellisio Foods, Inc. 10, 12
Beverage, Food and Tobacco
 

Senior Secured Loan — U.S. Term B Loans

5.3% Cash, Due 8/19

   2,196,610    2,185,894    2,196,610 
                   
Berry Plastics Corporation12
Containers, Packaging and Glass
 

Senior Secured Loan — Term C Loan

2.2% Cash, Due 4/15

   1,963,255    1,951,366    1,963,912 
                   
Blue Coat Systems, Inc.10, 12
Electronics
 

Senior Secured Loan — New Term Loan

4.5% Cash, Due 5/19

   4,000,000    4,014,653    4,002,000 
                   
Burger King Corporation12
Personal, Food and Miscellaneous Services
 

Senior Secured Loan — Tranche B Term Loan (2012)

3.8% Cash, Due 9/19

   1,633,500    1,634,672    1,637,004 
                   
Caribe Media Inc. (fka Caribe Information Investments Incorporated)10
Printing and Publishing
 

Senior Secured Loan — Loan

10.0% Cash, Due 11/14

   485,322    485,322    475,616 

 

6
 

 

Portfolio Company / Principal Business 

Investment

Interest Rate¹ / Maturity

  Principal   Cost   Value2 
Carolina Beverage Group LLC10
Beverage, Food and Tobacco
 

Senior Secured Bond — 10.625% - 08/2018 - 143818AA0 144A

10.6% Cash, Due 8/18

  $1,500,000   $1,519,751   $1,537,500 
                   
Catalent Pharma Solutions, Inc. (f/k/a Cardinal Health 409, Inc.)10
Healthcare, Education and Childcare
 

Senior Secured Loan — Refinancing Dollar Term-2 (2017)

4.3% Cash, Due 9/17

   3,984,950    3,982,651    3,990,130 
                   
Catalina Marketing Corporation10, 12
Diversified/Conglomerate Service
 

Senior Secured Loan — 2017 Term Loan

5.7% Cash, Due 9/17

   1,704,212    1,684,851    1,719,124 
                   
Clover Technologies Group, LLC (Clover Holdings Inc.)10, 12
Personal and Non Durable Consumer Products (Mfg. Only)
 

Senior Secured Loan — Term Loan

6.8% Cash, Due 5/18

   2,887,309    2,924,887    2,887,309 
                   
CoActive Technologies LLC (fka CoActive Technologies, Inc.)8, 10
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)
 

Junior Secured Loan — Term Loan (Second Lien)

0% Cash, 7.0% PIK, Due 1/15

   2,063,007    1,987,358    1,402,432 
                   
CSM Bakery Supplies LLC10
Beverage, Food and Tobacco
 

Junior Secured Loan — Term Loan (Second Lien)

8.5% Cash, Due 7/21

   3,000,000    3,019,504    2,999,700 
                   
CSM Bakery Supplies LLC10, 12
Beverage, Food and Tobacco
 

Senior Secured Loan — Term Loan

4.8% Cash, Due 7/20

   3,666,667    3,665,093    3,665,200 
                   
Del Monte Foods Company10, 12
Beverage, Food and Tobacco
 

Senior Secured Loan — Initial Term Loan

4.0% Cash, Due 3/18

   2,789,388    2,780,146    2,783,809 
                   
ELO Touch Solutions, Inc.10, 12
Electronics
 

Senior Secured Loan — Term Loan (First Lien)

8.0% Cash, Due 6/18

   1,898,703    1,838,334    1,773,009 
                   
Fender Musical Instruments Corporation10, 12
Hotels, Motels, Inns, and Gaming
 

Senior Secured Loan — Initial Loan

5.8% Cash, Due 4/19

   2,604,650    2,616,804    2,618,767 
                   
FHC Health Systems, Inc.10, 12
Healthcare, Education and Childcare
 

Senior Secured Loan — Term Loan

5.8% Cash, Due 1/18

   3,950,000    3,912,126    3,951,975 
                   
First American Payment Systems, L.P.10
Finance
 

Junior Secured Loan — Term Loan (Second Lien)

10.8% Cash, Due 4/19

   3,000,000    2,948,843    3,000,000 

 

7
 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
First Data Corporation10, 12
Finance
  Senior Secured Loan — 2018 Dollar Term Loan
4.2% Cash, Due 3/18
  $2,000,000   $1,847,540   $1,985,000 
                   
Flexera Software LLC (fka Flexera Software, Inc.)10, 12
Electronics
  Senior Secured Loan — Term Loan
5.0% Cash, Due 3/19
   2,730,455    2,739,671    2,742,960 
                   
Fram Group Holdings Inc./Prestone Holdings Inc.10, 12
Automobile
  Senior Secured Loan — Term Loan (First Lien)
6.5% Cash, Due 7/17
   966,900    973,309    951,493 
                   
Freescale Semiconductor, Inc.
Electronics
  Senior Subordinated Bond — 10.125% - 12/2016 - 35687MAP2
10.1% Cash, Due 12/16
   1,036,000    1,037,666    1,061,900 
                   
Getty Images, Inc.10, 12
Printing and Publishing
  Senior Secured Loan — Initial Term Loan
4.8% Cash, Due 10/19
   3,720,631    3,717,275    3,342,057 
                   
Ginn LA Conduit Lender, Inc.8, 10
Buildings and Real Estate4
  Senior Secured Loan — First Lien Tranche A Credit-Linked Deposit
7.8% Cash, Due 6/11
   1,257,143    1,224,101    51,857 
                   
Ginn LA Conduit Lender, Inc.8, 10
Buildings and Real Estate4
  Senior Secured Loan — First Lien Tranche B Term Loan
7.8% PIK, Due 6/11
   2,694,857    2,624,028    111,163 
                   
Ginn LA Conduit Lender, Inc.8, 10
Buildings and Real Estate4
  Junior Secured Loan — Loan (Second Lien)
11.8% Cash, Due 6/12
   3,000,000    2,715,997    30,015 
                   
Global Tel*Link Corporation10
Telecommunications
  Junior Secured Loan — Term Loan (Second Lien)
9.0% Cash, Due 11/20
   4,000,000    3,922,002    3,991,200 
                   
Grande Communications Networks LLC10, 12
Telecommunications
  Senior Secured Loan — Initial Term Loan
4.5% Cash, Due 5/20
   3,990,000    3,994,994    3,990,000 
                   
Grupo HIMA San Pablo, Inc.10
Healthcare, Education and Childcare
  Senior Secured Loan — Term B Loan (First Lien)
8.5% Cash, Due 1/18
   2,985,000    2,933,216    2,985,000 
                   
Grupo HIMA San Pablo, Inc.10
Healthcare, Education and Childcare
  Junior Secured Loan — Term Loan (Second Lien)
13.8% Cash, Due 7/18
   7,000,000    6,857,954    6,982,500 

 

8
 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
Gymboree Corporation., The10, 12
Retail Stores
  Senior Secured Loan — Term Loan
5.0% Cash, Due 2/18
  $1,421,105   $1,370,319   $1,376,923 
                   
Hargray Communications Group, Inc. (HCP Acquisition LLC)10, 12
Broadcasting and Entertainment
  Senior Secured Loan — Initial Term Loan
4.8% Cash, Due 6/19
   2,992,500    2,963,742    2,994,296 
                   
Harland Clarke Holdings Corp. (fka Clarke American Corp.)10, 12
Printing and Publishing
  Senior Secured Loan — Tranche B-3 Term Loan
7.0% Cash, Due 5/18
   3,478,125    3,445,208    3,474,995 
                   
Hunter Defense Technologies, Inc.10
Aerospace and Defense
  Junior Secured Loan — Term Loan (Second Lien)
7.0% Cash, Due 2/15
   4,074,074    4,044,117    3,853,667 
                   
Iasis Healthcare LLC10
Healthcare, Education and Childcare
  Senior Unsecured Bond — 8.375% - 05/2019 - 45072PAD4
8.4% Cash, Due 5/19
   3,000,000    2,888,709    3,112,500 
                   
International Architectural Products, Inc.8, 10
Mining, Steel, Iron and Non-Precious Metals
  Senior Secured Loan — Term Loan
12.0% Cash, 3.3% PIK, Due 5/15
   247,636    228,563    966 
                   
Jones Stephens Corp.10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Senior Secured Loan — Term Loan
7.0% Cash, Due 9/15
   1,224,485    1,224,485    1,224,485 
                   
Jones Stephens Corp.10, 12
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Senior Secured Loan — Term Loan
7.0% Cash, Due 9/15
   2,950,413    2,950,413    2,950,413 
                   
Key Safety Systems, Inc.10, 12
Automobile
  Senior Secured Loan — Initial Term Loan
4.8% Cash, Due 5/18
   2,692,152    2,679,177    2,694,844 
                   
Kinetic Concepts, Inc.10
Healthcare, Education and Childcare
  Senior Secured Loan — Dollar Term D-1 Loan
4.5% Cash, Due 5/18
   1,994,987    2,009,458    2,008,075 
                   
Kinetic Concepts, Inc.10, 12
Healthcare, Education and Childcare
  Senior Secured Loan — Dollar Term D-1 Loan
4.5% Cash, Due 5/18
   1,994,987    2,012,444    2,008,075 
                   
Landslide Holdings, Inc. (Crimson Acquisition Corp.)10, 12
Electronics
  Senior Secured Loan — Initial Term Loan
5.3% Cash, Due 8/19
   3,491,250    3,501,339    3,492,647 

 

9
 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
LBREP/L-Suncal Master I LLC8, 10
Buildings and Real Estate4
  Senior Secured Loan — Term Loan (First Lien)
7.5% Cash, Due 1/10
  $3,105,832   $3,105,832   $41,618 
                   
LTS Buyer LLC (Sidera Networks, Inc.)10
Telecommunications
  Senior Secured Loan — Term B Loan (First Lien)
4.5% Cash, Due 4/20
   3,990,000    3,983,904    4,011,825 
                   
MB Aerospace ACP Holdings III Corp.10
Aerospace and Defense
  Senior Secured Loan — Term Loan
6.0% Cash, Due 5/19
   3,990,000    3,952,254    3,990,399 
                   
Michael Foods Group, Inc. (f/k/a M-Foods Holdings, Inc.)10, 12
Beverage, Food and Tobacco
  Senior Secured Loan — Term B Facility
4.3% Cash, Due 2/18
   1,801,784    1,809,872    1,813,045 
                   
Neiman Marcus Group Inc., The10, 12
Retail Stores
  Senior Secured Loan — Term Loan
4.0% Cash, Due 5/18
   1,900,856    1,894,346    1,901,788 
                   
Nellson Nutraceutical, LLC10, 12
Beverage, Food and Tobacco
  Senior Secured Loan — Term Loan
6.8% Cash, Due 8/18
   2,000,000    1,985,263    2,000,000 
                   
Ozburn-Hessey Holding Company LLC10, 12
Cargo Transport
  Senior Secured Loan — Term Loan
6.8% Cash, Due 5/19
   3,557,000    3,543,376    3,558,067 
                   
Perseus Holding Corp.10
Leisure, Amusement, Motion Pictures, Entertainment
  Preferred Stock — Preferred Stock
14.0% Cash
   400,000    400,000    160,000 
                   
PetCo Animal Supplies, Inc.10, 12
Retail Stores
  Senior Secured Loan — New Loans
4.0% Cash, Due 11/17
   1,984,694    1,990,479    1,987,482 
                   
Pharmaceutical Product Development, Inc. (Jaguar Holdings, LLC)10
Healthcare, Education and Childcare
  Senior Secured Loan — 2013 Term Loan
4.3% Cash, Due 12/18
   3,526,477    3,539,268    3,538,819 
                   
Pinnacle Foods Finance LLC12
Beverage, Food and Tobacco
  Senior Secured Loan — New Term Loan G
3.3% Cash, Due 4/20
   2,985,000    2,979,214    2,963,359 

 

10
 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
Puerto Rico Cable Acquisition Company Inc.10
Broadcasting and Entertainment
  Senior Secured Loan — Term Loan
5.5% Cash, Due 7/18
  $1,000,000   $1,001,809   $1,000,100 
                   
Puerto Rico Cable Acquisition Company Inc.10, 12
Broadcasting and Entertainment
  Senior Secured Loan — Term Loan
5.5% Cash, Due 7/18
   3,000,000    2,985,381    3,000,300 
                   
SGF Produce Holding Corp.(Frozsun, Inc.)10
Beverage, Food and Tobacco
  Senior Secured Loan — Term Loan
6.3% Cash, Due 3/19
   2,224,569    2,203,964    2,224,569 
                   
SGF Produce Holding Corp.(Frozsun, Inc.)10, 12
Beverage, Food and Tobacco
  Senior Secured Loan — Term Loan
6.3% Cash, Due 3/19
   3,492,781    3,464,126    3,492,781 
                   
Spin Holdco Inc.10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Senior Secured Loan — Initial Term Loan (First Lien)
4.3% Cash, Due 11/19
   1,250,000    1,248,484    1,250,000 
                   
Spin Holdco Inc.10, 12
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Senior Secured Loan — Initial Term Loan (First Lien)
4.3% Cash, Due 11/19
   2,750,000    2,749,091    2,750,000 
                   
Stafford Logistics, Inc.(dba Custom Ecology, Inc.)10, 12
Ecological
  Senior Secured Loan — Term Loan
6.8% Cash, Due 6/19
   2,992,500    2,963,834    2,993,099 
                   
Steinway Musical Instruments, Inc.10
Hotels, Motels, Inns, and Gaming
  Junior Secured Loan — Loan (Second Lien)
9.3% Cash, Due 9/20
   1,000,000    990,043    1,000,300 
                   
Sun Products Corporation, The (fka Huish Detergents Inc.)10, 12
Personal and Non Durable Consumer Products (Mfg. Only)
  Senior Secured Loan — Tranche B Term Loan
5.5% Cash, Due 3/20
   3,980,000    3,950,313    3,885,475 
                   
TPF II LC, LLC (TPF II Rolling Hills, LLC)10, 12
Utilities
  Senior Secured Loan — Term Loan
6.5% Cash, Due 8/19
   2,992,500    2,948,065    2,993,697 
                   
Trico Products Corporation10
Automobile
  Senior Secured Loan — Term Loan
6.3% Cash, Due 7/16
   4,932,422    4,908,972    4,932,422 

 

11
 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
Trico Products Corporation10, 12
Automobile
  Senior Secured Loan — Term Loan
6.3% Cash, Due 7/16
  $3,945,938   $3,927,178   $3,945,938 
                   
Trimaran Advisors, L.L.C.10
Finance
  Senior Unsecured Loan — Revolving Credit Facility
9.0% Cash, Due 11/17
   20,000,000    20,000,000    20,000,000 
                   
TriZetto Group, Inc. (TZ Merger Sub, Inc.)10, 12
Electronics
  Senior Secured Loan — Term Loan
4.8% Cash, Due 5/18
   3,686,032    3,692,221    3,442,754 
                   
TRSO I, Inc.10
Oil and Gas
  Junior Secured Loan — Term Loan (Second Lien)
11.0% Cash, Due 12/17
   10,400,000    10,224,061    10,400,000 
                   
TUI University, LLC10
Healthcare, Education and Childcare
  Senior Secured Loan — Term Loan (First Lien)
7.3% Cash, Due 10/14
   1,647,733    1,634,926    1,614,779 
                   
TWCC Holding Corp.10
Broadcasting and Entertainment
  Junior Secured Loan — Term Loan (Second Lien)
7.0% Cash, Due 6/20
   1,000,000    1,004,919    1,001,400 
                   
TWCC Holding Corp.10, 12
Broadcasting and Entertainment
  Senior Secured Loan — Term Loan
3.5% Cash, Due 2/17
   1,966,350    1,983,283    1,933,905 
                   
Univar Inc.10, 12
Chemicals, Plastics and Rubber
  Senior Secured Loan — Term B Loan
5.0% Cash, Due 6/17
   2,932,200    2,931,153    2,833,429 
                   
US Foods, Inc. (aka U.S. Foodservice, Inc.)10
Personal, Food and Miscellaneous Services
  Senior Secured Loan — Incremental Term Loan
4.5% Cash, Due 3/19
   2,992,500    2,978,166    2,981,278 
                   
Vertafore, Inc.10, 12
Electronics
  Senior Secured Loan — Term Loan (2013)
4.3% Cash, Due 10/19
   1,228,056    1,226,471    1,232,661 
                   
Vestcom International, Inc. (fka Vector Investment Holdings, Inc.)10, 12
Printing and Publishing
  Senior Secured Loan — Term Loan
7.0% Cash, Due 12/18
   2,985,000    2,935,863    2,985,000 

 

12
 

 

Portfolio Company / Principal Business  Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
Wholesome Sweeteners, Inc.10
Beverage, Food and Tobacco
  Junior Secured Loan — Subordinated Note (Second Lien)
14.0% Cash, 2.0% PIK, Due 10/17
  $6,648,597   $6,612,567   $6,648,596 
                   
WideOpenWest Finance, LLC10
Telecommunications
  Senior Secured Loan — Term B Loan
4.8% Cash, Due 4/19
   2,992,481    3,014,127    3,017,543 
                   
WireCo WorldGroup Inc. 10
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)
  Senior Unsecured Bond — 11.75% - 05/2017
11.8% Cash, Due 5/17
   5,000,000    4,963,872    5,141,500 
                   
WireCo WorldGroup Inc. 10, 12
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)
  Senior Unsecured Bond — 11.75% - 05/2017
11.8% Cash, Due 5/17
   3,000,000    2,978,323    3,084,900 
                   
Total Investment in Debt Securities
(97% of net asset value at fair value)
     $269,537,744   $267,741,058   $257,359,908 

 

13
 

 

Equity Securities Portfolio

 

Portfolio Company / Principal Business  Investment  Percentage
Interest/Shares
   Cost   Value2 
Aerostructures Holdings L.P.6, 10
Aerospace and Defense
  Partnership Interests   1.2%  $1,000,000   $1,000 
                   
Aerostructures Holdings L.P.6, 10
Aerospace and Defense
  Series A Preferred Interests   1.2%   250,961    169,567 
                   
Bankruptcy Management Solutions, Inc.6, 10
Diversified/Conglomerate Service
  Class A Warrants   1.7%   -    - 
                   
Bankruptcy Management Solutions, Inc.6, 10
Diversified/Conglomerate Service
  Class B Warrants   1.7%   -    - 
                   
Bankruptcy Management Solutions, Inc.6, 10
Diversified/Conglomerate Service
  Class C Warrants   1.7%   -    - 
                   
Bankruptcy Management Solutions, Inc.6, 10
Diversified/Conglomerate Service
  Common Stock 2013   0.8%   314,325    133,603 
                   
Caribe Media Inc. (fka Caribe Information Investments Incorporated)6, 10
Printing and Publishing
  Common Stock   -    359,765    685,926 
                   
Coastal Concrete Holding II, LLC6, 10
Buildings and Real Estate4
  Class A Units   10.8%   8,625,626    1,000 
                   
eInstruction Acquisition, LLC6, 10
Healthcare, Education and Childcare
  Membership Units   1.1%   1,079,617    1,000 
                   
FP WRCA Coinvestment Fund VII, Ltd.3, 6
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)
  Class A Shares   1,500    1,500,000    1,698,620 
                   
Perseus Holding Corp.6, 10
Leisure, Amusement, Motion Pictures, Entertainment
  Common Stock   0.2%   400,000    1,000 
                   
Plumbing Holdings Corporation6, 10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Common Stock   7.8%  $-   $894,759 
                   
Plumbing Holdings Corporation6, 10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Preferred Stock   15.5%   3,624,915    4,058,119 
                   
TRSO II, Inc.6, 10
Oil and Gas
  Common Stock   5.4%   1,500,000    1,740,459 
                   
Total Investment in Equity Securities
(4% of net asset value at fair value)
          $18,655,209   $9,385,053 

 

14
 

 

CLO Fund Securities

 

CLO Equity Investments

 

Portfolio Company  Investment  Percentage
Interest
   Cost   Value2 
Grant Grove CLO, Ltd.3  Subordinated Securities   22.2%  $4,736,830   $1,086,790 
Katonah III, Ltd.3, 11  Preferred Shares   23.1%   1,620,131    400,000 
Katonah V, Ltd.3, 11  Preferred Shares   16.4%   3,320,000    1,000 
Katonah VII CLO Ltd.3, 7  Subordinated Securities   10.3%   4,505,993    1,656,378 
Katonah VIII CLO Ltd3, 7  Subordinated Securities   6.9%   3,392,605    1,232,090 
Katonah IX CLO Ltd3, 7  Preferred Shares   26.7%   2,038,587    1,041,858 
Katonah X CLO Ltd 3, 7  Subordinated Securities   33.3%   11,781,724    6,407,441 
Katonah 2007-I CLO Ltd.3, 7  Preferred Shares   100.0%   31,207,930    28,903,797 
Trimaran CLO IV, Ltd.3, 7  Preferred Shares   19.0%   3,560,700    2,473,769 
Trimaran CLO V, Ltd.3, 7  Subordinate Notes   20.8%   2,726,500    1,848,975 
Trimaran CLO VI, Ltd.3, 7  Income Notes   16.2%   2,807,800    1,929,246 
Trimaran CLO VII, Ltd.3, 7  Income Notes   10.5%   3,136,900    2,599,644 
Catamaran CLO 2012-1 Ltd.3, 7  Subordinated Notes   24.9%   8,992,300    7,599,000 
Catamaran CLO 2013-1 Ltd.3, 7  Subordinated Notes   23.5%   9,448,400    8,325,000 
Dryden 30 Senior Loan Fund3  Subordinated Notes   7.5%   2,957,500    2,957,500 
                   
Total Investment in CLO Equity Securities          $96,233,900   $68,462,488 

 

CLO Rated-Note Investment

 

Portfolio Company  Investment  Percentage
Interest
   Cost   Value2 
Katonah 2007-I CLO Ltd.3, 7  Floating - 04/2022 - B2L - 48602NAA8
Par Value of $10,500,000
Due 4/22
   100.0%  $1,286,456   $9,520,000 
                   
Catamaran 2012-1 CLO Ltd.3, 7  Float - 12/2023 - F - 14889CAE0
Par Value of $4,500,000
Due 12/23
   42.9%   3,826,003    4,170,000 
                   
Total Investment in CLO Rated-Note          $5,112,459   $13,690,000 
                   
Total Investment in CLO Fund Securities (31% of net asset value at fair value)          $101,346,359   $82,152,488 

 

15
 

 

Asset Manager Affiliates

 

Portfolio Company / Principal Business  Investment  Percentage
Interest
   Cost   Value2 
Asset Manager Affiliates10  Asset Management Company   100.0%  $83,273,236   $82,533,000 
                   
Total Investment in Asset Manager Affiliates (31% of net asset value at fair value)          $83,273,236   $82,533,000 

 

Time Deposits and Money Market Account

 

Time Deposit and Money Market Accounts  Investment  Yield   Par / Cost   Value2 
JP Morgan Business Money Market Account9, 10  Money Market Account   0.10%  $245,944   $245,944 
                   
US Bank Money Market Account10  Money Market Account   0.40%   8,809,690    8,809,690 
                   
Total Investment in Time Deposit and Money Market Accounts (3% of net asset value at fair value)          $9,055,634   $9,055,634 
                   
Total Investments5 (166% of net asset value at fair value)          $480,071,496   $440,486,083 

 

See accompanying notes to financial statements.

 

1A majority of the variable rate loans in the Company’s portfolio companies bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at September 30, 2013.
2Reflects the fair market value of all investments as of September 30, 2013, as determined by the Company’s Board of Directors.
3Non-U.S. company or principal place of business outside the U.S.
4Buildings and real estate relate to real estate ownership, builders, managers and developers.
5The aggregate cost of investments for federal income tax purposes is approximately $480 million. The aggregate gross unrealized appreciation is approximately $12.5 million, the aggregate gross unrealized depreciation is approximately $52.1 million, and the net unrealized depreciation is approximately $39.6 million.

 

16
 

 

6Non-income producing.
7An affiliate CLO Fund is managed by the Asset Manager Affiliates (as such term is defined in the notes to the financial statements).
8Loan or debt security is on non-accrual status and therefore is considered non-income producing.
9Money market account holding restricted cash and security deposits for employee flexible spending and payroll related accounts.
10Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.
11As of September 30, 2013, this CLO Fund Security was not providing a dividend distribution.
12As of September 30, 2013, investment was held in KCAP Senior Funding I, LLC.

 

17
 

  

KCAP FINANCIAL, INC.

SCHEDULE OF INVESTMENTS

As of December 31, 2012

 

Debt Securities Portfolio

 

Portfolio Company / Principal Business   Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
Advanced Lighting Technologies, Inc.10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  First Lien Bond — Bond
10.5% Cash, Due 6/19
  $3,000,000   $2,928,762   $3,000,000 
                   
Alaska Communications Systems Holdings, Inc. 10
Telecommunications
  Senior Secured Loan — Term Loan
5.5% Cash, Due 10/16
   2,940,000    2,952,655    2,783,196 
                   
Allison Transmission, Inc.
Automobile
  Senior Secured Loan — Term B-2 Loan
3.7% Cash, Due 8/17
   1,980,000    1,969,312    1,995,672 
                   
Aramark Corporation10
Diversified/Conglomerate Service
  Senior Secured Loan — LC-3 Facility
3.5% Cash, Due 7/16
   61,707    61,579    61,910 
                   
Aramark Corporation10
Diversified/Conglomerate Service
  Senior Secured Loan — U.S. Term C Loan
3.5% Cash, Due 7/16
   938,293    936,347    941,390 
                   
Asurion, LLC (fka Asurion Corporation)10
Insurance
  Senior Secured Loan — Term Loan (First Lien)
5.5% Cash, Due 5/18
   2,000,000    2,021,506    2,023,130 
                   
Avis Budget Car Rental, LLC
Personal Transportation
  Senior Secured Loan — Tranche C Term Loan
4.3% Cash, Due 3/19
   1,985,007    2,012,685    2,005,353 
                   
Bankruptcy Management Solutions, Inc.10
Diversified/Conglomerate Service
  Junior Secured Loan — Loan (Second Lien)
1.2% Cash, 7.0% PIK, Due 8/15
   1,405,472    1,225,488    47,435 
                   
Bankruptcy Management Solutions, Inc.10
Diversified/Conglomerate Service
  Senior Secured Loan — Term Loan B
6.5% Cash, 1.0% PIK, Due 8/14
   1,439,164    1,405,984    773,551 
                 . 
Berry Plastics Holding Corporation
Containers, Packaging and Glass
  Senior Secured Loan — Term C Loan
2.2% Cash, Due 4/15
   1,979,003    1,949,236    1,971,898 

 

18
 

 

Portfolio Company / Principal Business   Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
Burger King Corporation
     Personal, Food and Miscellaneous Services
  Senior Secured Loan — Tranche B Term Loan (2012)
3.8% Cash, Due 9/19
  $1,645,875   $1,641,896   $1,657,297 
                    
Caribe Media Inc. (fka Caribe Information Investments Incorporated)10
     Printing and Publishing
  Senior Secured Loan — Loan
10.0% Cash, Due 11/14
   621,074    621,074    613,373 
                    
Catalina Marketing Corporation10
     Diversified/Conglomerate Service
  Senior Secured Loan — 2017 Term Loan
5.7% Cash, Due 9/17
   1,704,212    1,672,227    1,711,140 
                    
Chrysler Group LLC10
     Automobile
  Senior Secured Loan — Tranche B Term Loan
6.0% Cash, Due 5/17
   1,979,899    1,979,899    2,024,724 
                    
CoActive Technologies LLC (fka CoActive Technologies, Inc.)8, 10
 Machinery (Non-Agriculture, Non-Construction, Non-Electronic)
  Junior Secured Loan — Term Loan (Second Lien)
2.3% Cash, 4.8% PIK, Due 1/15
   2,063,007    1,987,358    1,299,695 
                    
Del Monte Foods Company10
     Beverage, Food and Tobacco
  Senior Secured Loan — Initial Term Loan
4.5% Cash, Due 3/18
   949,124    950,905    952,237 
                    
Del Monte Foods Company10
     Beverage, Food and Tobacco
  Senior Secured Loan — Initial Term Loan
4.5% Cash, Due 3/18
   1,927,154    1,907,210    1,933,475 
                    
eInstruction Corporation8, 10
     Healthcare, Education and Childcare
  Junior Secured Loan — Term Loan (Second Lien)
11.5% Cash, Due 7/14
   10,000,000    10,000,000    1,000 
                    
ELO Touch Solutions, Inc.10
     Electronics
  Senior Secured Loan — Term Loan (First Lien)
8.0% Cash, Due 6/18
   1,990,000    1,915,453    1,989,603 
                    
First American Payment Systems, L.P.10
     Finance
  Junior Secured Loan — Term Loan (Second Lien 2012)
10.8% Cash, Due 4/19
   3,000,000    2,941,926    2,985,000 
                    
First Data Corporation10
     Finance
  Senior Secured Loan — 2018 Dollar Term Loan
4.2% Cash, Due 3/18
   2,000,000    1,806,842    1,906,710 
                    
Fram Group Holdings Inc./Prestone Holdings Inc.10
     Automobile
  Senior Secured Loan — Term Loan (First Lien)
6.5% Cash, Due 7/17
   989,975    996,484    991,212 

 

19
 

 

Portfolio Company / Principal Business   Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
Freescale Semiconductor, Inc.
Electronics
  Senior Subordinated Bond — Bond
10.1% Cash, Due 12/16
  $1,036,000   $1,038,081   $1,064,490 
                    
Getty Images, Inc.10
Printing and Publishing
  Senior Secured Loan — Initial Term Loan (New)
4.8% Cash, Due 10/19
   2,000,000    1,980,556    2,005,250 
                    
Ginn LA Conduit Lender, Inc.8, 10
Buildings and Real Estate4
  Senior Secured Loan — First Lien Tranche A Credit-Linked Deposit
7.8% Cash, Due 6/11
   1,257,143    1,224,101    38,506 
                    
Ginn LA Conduit Lender, Inc.8, 10
Buildings and Real Estate4
  Senior Secured Loan — First Lien Tranche B Term Loan
7.8% Cash, Due 6/11
   2,694,857    2,624,028    82,543 
                    
Ginn LA Conduit Lender, Inc.8, 10
Buildings and Real Estate4
  Junior Secured Loan — Loan (Second Lien)
11.8% Cash, Due 6/12
   3,000,000    2,715,997    30,015 
                    
Gymboree Corporation., The10
Retail Stores
  Senior Secured Loan — Term Loan
5.0% Cash, Due 2/18
   1,421,105    1,355,901    1,312,746 
                    
HMSC Corporation (aka Swett and Crawford)10
Insurance
  Junior Secured Loan — Loan (Second Lien)
5.7% Cash, Due 10/14
   5,000,000    4,948,801    4,410,000 
                    
Hunter Defense Technologies, Inc.10
Aerospace and Defense
  Junior Secured Loan — Term Loan (Second Lien)
7.0% Cash, Due 2/15
   4,074,074    4,027,935    3,829,630 
                    
Iasis Healthcare LLC10
Healthcare, Education and Childcare
  Senior Unsecured Bond — Bond
8.4% Cash, Due 5/19
   3,000,000    2,877,729    2,865,000 
                    
International Architectural Products, Inc.8, 10
Mining, Steel, Iron and Non-Precious Metals
  Senior Secured Loan — Term Loan
12.0% Cash, Due 5/15
   507,431    480,868    263,864 
                    
Jones Stephens Corp.10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Senior Secured Loan — Term Loan
7.0% Cash, Due 9/15
   4,280,147    4,280,147    4,280,147 
                    
KIK Custom Products Inc.10
Personal and Non Durable Consumer Products (Mfg. Only)
  Junior Secured Loan — Loan (Second Lien)
5.3% Cash, Due 12/14
   5,000,000    5,000,000    3,977,100 

 

20
 

 

Portfolio Company / Principal Business   Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
LBREP/L-Suncal Master I LLC8, 10
Buildings and Real Estate4
  Senior Secured Loan — Term Loan (First Lien)
7.5% Cash, Due 1/10
  $3,345,759   $3,345,759   $303,460 
                   
Legacy Cabinets, Inc.10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Senior Secured Loan — Term Loan
1.0% Cash, 6.3% PIK, Due 5/14
   524,571    463,380    447,040 
                   
Lord & Taylor Holdings LLC (LT Propco LLC)10
Retail Stores
  Senior Secured Loan — Term Loan
5.8% Cash, Due 1/19
   430,951    439,877    436,002 
                   
Merisant Company10
Beverage, Food and Tobacco
  Senior Secured Loan — Loan
7.5% Cash, Due 1/14
   4,547,032    4,538,541    4,547,032 
                   
Michael Foods Group, Inc. (f/k/a M-Foods Holdings, Inc.)10
Beverage, Food and Tobacco
  Senior Secured Loan — Term B Facility
4.3% Cash, Due 2/18
   1,825,626    1,828,589    1,838,934 
                   
Neiman Marcus Group Inc., The10
Retail Stores
  Senior Secured Loan — Term Loan
4.8% Cash, Due 5/18
   2,000,000    1,985,894    2,005,800 
                   
Pegasus Solutions, Inc.10
Leisure, Amusement, Motion Pictures, Entertainment
  Senior Subordinated Bond — Senior Subordinated Second Lien PIK Notes
13.0% PIK, Due 4/14
   1,691,007    1,691,007    1,671,391 
                   
Perseus Holding Corp.10
Leisure, Amusement, Motion Pictures, Entertainment
  Preferred Stock — Preferred Stock
14.0% PIK, Due 4/14
   400,000    400,000    371,160 
                   
PetCo Animal Supplies, Inc.10
Retail Stores
  Senior Secured Loan — New Loan
4.5% Cash, Due 11/17
   2,000,000    2,000,000    2,018,220 
                   
Pinnacle Foods Finance LLC10
Beverage, Food and Tobacco
  Senior Secured Loan — Extended Initial Term Loan
3.7% Cash, Due 10/16
   293,014    293,014    295,025 
                   
Pinnacle Foods Finance LLC10
Beverage, Food and Tobacco
  Senior Secured Loan — Extended Initial Term Loan
3.7% Cash, Due 10/16
   1,989,975    1,988,656    2,003,636 
                   
TPF Generation Holdings, LLC10
Utilities
  Senior Secured Loan — Synthetic LC Deposit (First Lien)
2.3% Cash, Due 12/13
   169,532    169,280    169,956 

 

21
 

 

Portfolio Company / Principal Business   Investment
Interest Rate¹ / Maturity
  Principal   Cost   Value2 
TriZetto Group, Inc. (TZ Merger Sub, Inc.)10
Electronics
  Senior Secured Loan — Term Loan
4.8% Cash, Due 5/18
   1,959,860    1,951,082    1,948,013 
                   
TRSO I, Inc.10
Oil and Gas
  Junior Secured Loan — Term Loan (Second Lien)
11.0% Cash, Due 12/17
   10,400,000    10,192,913    10,192,000 
                   
TUI University, LLC10
Healthcare, Education and Childcare
  Senior Secured Loan — Term Loan (First Lien)
7.3% Cash, , Due 10/14
   2,051,442    2,024,477    1,751,521 
                   
TWCC Holding Corp.10
Broadcasting and Entertainment
  Senior Secured Loan — Term Loan
4.3% Cash, Due 2/17
   1,966,350    1,978,846    1,990,930 
                   
Univar Inc.10
Chemicals, Plastics and Rubber
  Senior Secured Loan — Term B Loan
5.0% Cash, Due 6/17
   2,954,773    2,954,773    2,950,577 
                   
US Foods, Inc. (aka U.S. Foodservice, Inc.)10
Personal, Food and Miscellaneous Services
  Senior Secured Loan — Extended Term Loan
5.8% Cash, Due 3/17
   1,978,284    1,932,524    1,983,536 
                   
Vertafore, Inc.10
Electronics
  Senior Secured Loan — Term Loan (First Lien)
5.3% Cash, Due 7/16
   1,237,381    1,232,977    1,250,275 
                   
Wholesome Sweeteners, Inc.10
Beverage, Food and Tobacco
  Junior Secured Loan — Subordinated Note (Second Lien)
14.0% Cash, Due 10/17
   6,648,596    6,605,857    6,715,082 
                   
WireCo WorldGroup Inc. 10
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)
  Senior Unsecured Bond — Bond
11.8% Cash, Due 5/17
   8,000,000    7,920,733    8,320,000 
                   
Total Investment in Debt Securities
(53% of net asset value at fair value)
     $136,283,876   $134,377,151   $111,037,882 

 

22
 

 

Equity Securities Portfolio

 

Portfolio Company / Principal Business   Investment  Percentage
Interest/Shares
   Cost   Value2 
Aerostructures Holdings L.P.6, 10
Aerospace and Defense
  Partnership Interests   1.2%  $1,000,000   $1,000 
                   
Aerostructures Holdings L.P.6, 10
Aerospace and Defense
  Series A Preferred Interests   1.2%   250,961    44,112 
                   
Bankruptcy Management Solutions, Inc.6, 10
Diversified/Conglomerate Service
  Common Stock   1.2%   218,592    1,000 
                   
Bankruptcy Management Solutions, Inc.6, 10
Diversified/Conglomerate Service
  Warrants   0.1%   -    - 
                   
Coastal Concrete Holding II, LLC6, 10
Buildings and Real Estate4
  Class A Units   10.8%   8,625,626    1,000 
                   
eInstruction Acquisition, LLC6, 10
Healthcare, Education and Childcare
  Membership Units   1.1%   1,079,617    1,000 
                   
FP WRCA Coinvestment Fund VII, Ltd.3, 6,
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)
  Class A Shares   1,500    1,500,000    1,961,550 
                   
International Architectural Products, Inc.6, 10
Mining, Steel, Iron and Non-Precious Metals
  Common Stock   2.5%   292,851    1,000 
                   
Legacy Cabinets, Inc.6, 10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Equity   4.0%   115,580    1,000 
                   
Perseus Holding Corp.6, 10
Leisure, Amusement, Motion Pictures, Entertainment
  Common Stock   0.2%   400,000    10,930 
                   
Plumbing Holdings Corporation6, 10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Common Stock   7.8%   -    644,937 

 

23
 

 

Portfolio Company / Principal Business   Investment  Percentage
Interest/Shares
   Cost   Value2 
Plumbing Holdings Corporation6, 10
Home and Office Furnishings, Housewares, and Durable Consumer Products
  Preferred Stock   9.0%  $3,032,596   $3,240,496 
                   
Caribe Media Inc. (fka Caribe Information Investments Incorporated)6, 10
Printing and Publishing
  Common Stock   1.3%   359,764    612,691 
                   
TRSO II, Inc.6, 10
Oil and Gas
  Common Stock   5.4%   1,500,000    1,500,000 
                    
Total Investment in Equity Securities
(4% of net asset value at fair value)
          $18,375,587   $8,020,716 

 

CLO Fund Securities

 

CLO Equity Investments

 

Portfolio Company   Investment  Percentage
Interest
   Cost   Value2 
Grant Grove CLO, Ltd.3  Subordinated Securities   22.2%  $4,925,009   $3,124,924 
Katonah III, Ltd.3, 11  Preferred Shares   23.1%   2,242,014    600,000 
Katonah V, Ltd.3, 11  Preferred Shares   26.7%   3,320,000    1,000 
Katonah VII CLO Ltd.3, 7  Subordinated Securities   16.4%   4,574,393    2,120,168 
Katonah VIII CLO Ltd3, 7  Subordinated Securities   10.3%   3,450,705    2,171,998 
Katonah IX CLO Ltd3, 7  Preferred Shares   6.9%   2,082,987    1,488,895 
Katonah X CLO Ltd 3, 7  Subordinated Securities   33.3%   11,934,600    9,455,511 
Katonah 2007-I CLO Ltd.3, 7  Preferred Shares   100.0%   31,189,147    30,091,886 
Trimaran CLO IV, Ltd.3, 7  Preferred Shares   19.0%   3,616,600    3,575,571 
Trimaran CLO V, Ltd.3, 7  Subordinate Notes   20.8%   2,757,100    2,930,004 
Trimaran CLO VI, Ltd.3, 7  Income Notes   16.2%   2,894,700    2,936,626 
Trimaran CLO VII, Ltd.3, 7  Income Notes   10.5%   3,146,900    3,357,924 
Catamaran CLO 2012-1 Ltd.3, 7  Subordinated Notes   24.9%   8,982,400    8,493,000 
                    
Total Investment in CLO Equity Securities          $85,116,555   $70,347,507 

 

24
 

 

CLO Rated-Note Investment                
                
Portfolio Company   Investment  Percentage
Interest
   Cost   Value2 
Katonah 2007-I CLO Ltd.3, 7  Class B-2L Notes
Par Value of $10,500,000
5.3%, Due 4/22
   100.0%  $1,252,191   $9,140,000 
Catamaran CLO 2012-1 Ltd.3, 7  Class F Notes
Par Value of $4,500,000
6.8%, Due 12/23
   42.9%   3,777,664    3,770,000 
                    
Total Investment in CLO Rated-Note          $5,029,855   $12,910,000 
                    
Total Investment in CLO Fund Securities (40% of net asset value at fair value)          $90,146,410   $83,257,507 

 

Asset Manager Affiliates

 

Portfolio Company / Principal Business   Investment  Percentage
Interest
   Cost   Value2 
Asset Manager Affiliates10  Asset Management Company   100.0%  $83,161,529   $77,242,000 
                    
Total Investment in Asset Manager Affiliates (37% of net asset value at fair value)          $83,161,529   $77,242,000 

 

Time Deposits and Money Market Account

 

Time Deposit and Money Market Accounts   Investment  Yield   Par / Cost   Value2 
JP Morgan Asset Account10  Time Deposit   0.01%  $1,942,834   $1,942,834 
                    
JP Morgan Business Money Market Account9, 10  Money Market Account   0.15%   195,856    195,856 
                    
US Bank Money Market Account10  Money Market Account   0.40%   30,347,968    30,347,968 
                    
Total Investment in Time Deposit and Money Market Accounts
(16% of net asset value at fair value)
          $32,486,658   $32,486,658 
                    
Total Investments5                  
(150% of net asset value at fair value)          $358,547,336   $312,044,763 

 

See accompanying notes to financial statements.

 

25
 

 

1A majority of the variable rate loans to the Company’s portfolio companies bear interest at a rate that may be determined by reference to either LIBOR or an alternate Base Rate (commonly based on the Federal Funds Rate or the Prime Rate), which typically resets semi-annually, quarterly, or monthly. For each such loan, the Company has provided the weighted average annual stated interest rate in effect at December 31, 2012.
2Reflects the fair market value of all investments as of December 31, 2012, as determined by the Company’s Board of Directors.
3Non-U.S. company or principal place of business outside the U.S.
4Buildings and real estate relate to real estate ownership, builders, managers and developers.
5The aggregate cost of investments for federal income tax purposes is approximately $359 million. The aggregate gross unrealized appreciation is approximately $11 million, the aggregate gross unrealized depreciation is approximately $58 million, and the net unrealized depreciation is approximately $47 million.
6Non-income producing.
7An affiliate CLO Fund managed by an Asset Manager Affiliate (as such term is defined in the notes to the financial statements).
8Loan or debt security is on non-accrual status and therefore is considered non-income producing.
9Money market account holding restricted cash and security deposits for employee flexible spending and payroll related accounts.
10Qualified asset for purposes of section 55(a) of the Investment Company Act of 1940.
11As of December 31, 2012, this CLO Fund Security was not providing a dividend distribution.

 

26
 

 

KCAP FINANCIAL, INC.

FINANCIAL HIGHLIGHTS

(unaudited)

  

   Nine Months Ended
September 30,
 
   2013   2012 
         
Per Share Data: 1          
Net asset value, at beginning of period  $7.85   $7.85 
Net investment income   0.66    0.65 
Net realized losses from investment transactions   (0.38)   (0.13)
Realized losses from extinguishments of Convertible Notes   (0.01)   - 
Net change in unrealized appreciation (depreciation) on investments   0.22    (0.14)
Net increase in net assets resulting from operations   0.49    0.38 
Net decrease in net assets resulting from distributions          
Dividends from net investment income   (0.56)   (0.42)
Net decrease in net assets resulting from distributions   (0.56)   (0.42)
Net increase in net assets relating to stock-based transactions          
Issuance of common stock (not including dividend reinvestment plan)   0.15    - 
Issuance of common stock under dividend reinvestment plan   0.02    0.01 
Stock based compensation expense   0.01    - 
Net increase in net assets from distributions   0.18    0.01 
           
Net asset value, end of period  $7.96   $7.82 
Total net asset value return2   8.4%   4.9%
           
Ratio/Supplemental Data:          
Per share market value at beginning of period  $9.19   $6.31 
Per share market value at end of period  $8.95   $9.26 
Total market return3   3.5%   53.4%
Shares outstanding at end of period   33,314,779    26,448,313 
Net assets at end of period  $265,082,729   $206,898,249 
Portfolio turnover rate4   40.5%   16.8%
Average debt outstanding  $135,721,238   $73,655,109 
Weighted average debt outstanding   6.4%   7.8%
Asset coverage ratio   234%   335%
Ratio of net investment income to average net assets5   11.0%   11.1%
Ratio of total expenses to average net assets5   7.5%   6.9%
Ratio of interest expense to average net assets5   3.9%   3.2%
Ratio of non-interest expenses to average net assets5   3.6%   3.8%

 

1    Based on average number of common shares outstanding for the period.

2    Total net asset value return (not annualized) equals the change in the net asset value per share over the beginning of period net asset value per share plus dividends, divided by the beginning net asset value per share less proceeds from issuance of common shares.

3    Total market return (not annualized) equals the change in the ending market price over the beginning of period price per share plus dividends, divided by the beginning price.

4    Not annualized. Portfolio turnover rate equals the year-to-date sales and paydowns over the average of the invested assets at fair value.

5    Annualized

 

See accompanying notes to financial statements.

 

27
 

 

KCAP FINANCIAL, INC.

 

NOTES TO FINANCIAL STATEMENTS

(unaudited)

 

1. ORGANIZATION

 

KCAP Financial, Inc. (“KCAP” or the “Company”) is an internally managed, non-diversified closed-end investment company that is regulated as a business development company (“BDC”) under the Investment Company Act of 1940. The Company invests in senior secured loans and mezzanine debt and, to a lesser extent, equity capital of middle market companies in a variety of industries. The Company generally targets companies that generate positive cash flows because the Company looks to cash flows as the primary source for servicing debt. However, the Company may invest in other companies if it is presented with attractive opportunities. The Company defines the middle market as comprising of companies with earnings before interest, taxes, depreciation and amortization (“EBITDA”), of $10 million to $50 million and/or total debt of $25 million to $150 million. The Company was formed as a Delaware limited liability company on August 8, 2006 and, prior to the issuance of shares of the Company’s common stock in its initial public offering (“IPO”), converted to a corporation incorporated in Delaware on December 11, 2006. Prior to its IPO, the Company did not have material operations. The Company’s IPO of 14,462,000 shares of common stock raised net proceeds of approximately $200 million. Prior to the IPO, the Company issued 3,484,333 shares to affiliates of Kohlberg & Co., L.L.C., a leading middle market private equity firm, in exchange for the contribution to the Company of their ownership interests in Katonah Debt Advisors, L.L.C., and related affiliates controlled by the company (collectively, “Katonah Debt Advisors”) and in securities issued by collateralized loan obligation funds (“CLO Funds”) managed by Katonah Debt Advisors and two other asset managers.

 

On February 29, 2012, the Company purchased Trimaran Advisors, L.L.C. (“Trimaran Advisors”), a CLO manager similar to Katonah Debt Advisors with assets under management of approximately $1.5 billion, for total consideration of $13.0 million in cash and 3,600,000 shares of the Company’s common stock. Contemporaneously with the acquisition of Trimaran Advisors, the Company acquired from Trimaran Advisors equity interests in certain CLO Funds managed by Trimaran Advisors for an aggregate purchase price of $12.0 million in cash. As of September 30, 2013, Katonah Debt Advisors and Trimaran Advisors are the Company’s only wholly-owned portfolio companies (collectively, “Asset Manager Affiliates”) and have approximately $3.4 billion of par value assets under management. The Asset Manager Affiliates are registered under the Investment Advisers Act of 1940 and are managed independently from the Company by separate management teams and investment approval processes.

 

The Company’s investment objective is to generate current income and capital appreciation from investments made in senior secured term loans, mezzanine debt and selected equity investments in privately-held middle market companies. The Company also expects to continue to receive distributions of recurring fee income and to generate capital appreciation from its investment in the asset management business of the Asset Manager Affiliates. The Asset Manager Affiliates manage CLO Funds which invest in broadly syndicated loans, high-yield bonds and other credit instruments.

 

While the Company’s primary investment focus is on making loans to, and selected equity investments in, privately-held middle market companies, the Company may also invest in other investments such as loans to larger, publicly-traded companies, high-yield bonds and distressed debt securities. The Company may also receive warrants or options to purchase common stock in connection with its debt investments. In addition, the Company may also invest in debt and equity securities issued by the CLO Funds managed by our Asset Manager Affiliates or by other asset managers.

 

The Company has elected to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a RIC, the Company must, among other things, meet certain source-of-income, and asset diversification and annual distribution requirements. As a RIC, the Company generally will not have to pay corporate-level taxes on any income that it distributes in a timely manner to its stockholders.

 

The Company consolidates the results of KCAP Senior Funding I, LLC and KCAP Senior Funding I Holdings, LLC in its consolidated financial statements as KCAP Senior Funding I, LLC and KCAP Senior Funding I Holdings, LLC are operated solely for investment activities of the Company. The creditors of KCAP Senior Funding I, LLC have received security interests in the assets owned by KCAP Senior Funding I, LLC and such assets are not intended to be available to the creditors of KCAP Financial, Inc., or any other affiliate.

 

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2. SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited financial statements have been prepared on the accrual basis of accounting in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required for annual financial statements. The unaudited interim financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto in the Company’s Form 10-K for the year ended December 31, 2012, as filed with the U.S. Securities and Exchange Commission (the “Commission” or the “SEC”).

 

The financial statements reflect all adjustments, both normal and recurring which, in the opinion of management, are necessary for the fair presentation of the Company’s results of operations and financial condition for the periods presented. Furthermore, the preparation of the financial statements requires management to make significant estimates and assumptions including with respect to the fair value of investments that do not have a readily available market value. Actual results could differ from those estimates, and the differences could be material. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for the full year.

 

The accompanying financial statements reflect the consolidated accounts of the Company and its special purpose financing subsidiaries, KCAP Funding, KCAP Senior Funding I, LLC and KCAP Senior Funding I Holdings, LLC, (see Note 4) with all significant intercompany balances eliminated. In accordance with Article 6 of Regulation S-X under the Securities Act of 1933, as amended (the “Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company does not consolidate portfolio company investments, including those in which it has a controlling interest (e.g., the Asset Manager Affiliates). The Asset Manager Affiliates are subject to Accounting Standards Codification Topic 810, “Consolidation” and although the Company cannot consolidate portfolio company investments, this guidance impacted the required disclosures relating to the Asset Manager Affiliates, as it requires the Asset Manager Affiliates to consolidate their managed CLO Funds. As a result of the consolidation of these CLOs into the Asset Manager Affiliates, the Asset Manager Affiliates qualify as a “significant subsidiary” and, as a result, the Company is required to include additional disclosures regarding the Asset Manager Affiliates in its filings with the SEC. The additional financial information regarding the Asset Manager Affiliates do not directly impact the financial position or results of operations of the Company.

 

In addition, Katonah 2007-I Ltd. qualifies as a “significant subsidiary” and the Company is also required to provide additional disclosures relating to it. Katonah 2007-I CLO Ltd is an exempted company incorporated in November 15, 2006 with limited liability under the laws of the Cayman Islands for the sole purpose of investing in broadly syndicated loans, high-yield bonds and other credit instruments. The fund is what is commonly known as a collateralized loan obligation fund (“CLO Fund”). The additional disclosures regarding Katonah 2007-I Ltd. do not directly impact the financial position or results of operations of the Company.

 

The additional financial information regarding the Asset Manager Affiliates and Katonah 2007-I CLO Ltd. (“Katonah 2007-I CLO”) can be found in Note 5 – Asset Manager Affiliates, below.

 

New Accounting Pronouncements

 

In June 2013, the FASB issued ASU No. 2013-08, Financial Services-Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements (“ASU 2013-08”). ASU 2013-08 changes the approach to the assessment of whether a company is an investment company, clarifies the characteristics of an investment company, provides comprehensive guidance for the investment company assessment and contains certain disclosure requirements. ASU 2013-08 is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013. Earlier application is prohibited. We do not believe the adoption of ASU 2013-08 will have a material impact on our financial statements.

 

Investments

 

Investment transactions are recorded on the applicable trade date. Realized gains or losses are determined using the specific identification method.

 

Valuation of Portfolio Investments. The Company’s Board of Directors is ultimately and solely responsible for making a good faith determination of the fair value of portfolio investments on a quarterly basis. Debt and equity securities for which market quotations are readily available are generally valued at such market quotations. Debt and equity securities that are not publicly traded or whose market price is not readily available are valued by the Board of Directors based on detailed analyses prepared by management, the Valuation Committee of the Board of Directors, and, in certain circumstances, third parties with valuation expertise. Valuations are conducted by management on 100% of the investment portfolio at the end of each quarter. The Company follows the provisions of ASC Fair Value Measurements and Disclosures (“Fair Value Measurements and Disclosures ”). This standard defines fair value, establishes a framework for measuring fair value, and expands disclosures about assets and liabilities measured at fair value. Fair Value Measurements and Disclosures defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Subsequent to the adoption of Fair Value Measurements and Disclosures, the FASB has issued various staff positions clarifying the initial standard as noted below.

 

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The FASB issued guidance that clarified and required disclosures about fair value measurements. These include requirements to disclose the amounts and reasons for significant transfers between Level I and Level II, as well as significant transfers in and out of Level III of the fair value hierarchy. Note 4 - Investments below reflects the amended disclosure requirements. The guidance also required that purchases, sales, issuances and settlements be presented gross in the Level III reconciliation.

 

Fair Value Measurements and Disclosures requires the disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period.

 

Since 2010, the Company engaged an independent valuation firm to provide an annual third-party review of the CLO fair value model relative to its functionality, model inputs and calculations as a reasonable method to determine CLO fair values, in the absence of Level I or Level II trading activity or observable market inputs. The independent valuation firm concluded that the Company’s CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow model for fair value purposes and that the inputs were being employed correctly.

 

The Company has engaged an independent valuation firm to provide third party valuation consulting services to the Company’s Board of Directors. Each quarter the independent valuation firm will perform third party valuations of the Company’s investments on illiquid securities such that they are reviewed at least once during a trailing 12 month period. These third party valuation estimates were considered as one of the relevant data inputs in the Company’s determination of fair value. The Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.

 

The Board of Directors may consider other methods of valuation than those set forth below to determine the fair value of Level III investments as appropriate in conformity with GAAP. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may differ materially from the values that would have been used had a readily available market existed for such investments. Further, such investments may be generally subject to legal and other restrictions on resale or otherwise be less liquid than publicly traded securities. In addition, changes in the market environment and other events may occur over the life of the investments that may cause the value realized on such investments to be different from the currently assigned valuations.

 

The Company’s valuation methodology and procedures are as follows:

 

1)Each portfolio company or investment is cross-referenced to an independent pricing service to determine if a current market quote is available. The nature and quality of such quote is reviewed to determine reliability and relevance of the quote. Factors considered in this determination include whether the quote is from a transaction or is a broker quote, the date and aging of such quote, whether the transaction is arms-length, whether it is of a liquidation or distressed nature and certain other factors judged to be relevant by management within the framework of Fair Value Measurements and Disclosures.

 

2)If an investment does not have a market quotation on either a broad market exchange or from an independent pricing service, the investment is initially valued by the Company’s investment professionals responsible for the portfolio investment in conjunction with the portfolio management team.

 

3)Preliminary valuation conclusions are discussed and documented by management.

 

4)Debt securities, equity securities, CLO Fund securities and the Asset Manager Affiliates will be selected for review by an independent valuation firm, which is engaged by the Company’s Board of Directors. Such independent valuation firm reviews management’s preliminary valuations and makes their own independent valuation assessment.

 

5)The Valuation Committee of the Board of Directors reviews the portfolio valuations, as well as the input and report of such independent valuation firm, as applicable.

 

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6)Upon approval of the investment valuations by the Valuation Committee of the Board of Directors, the Audit Committee of the Board of Directors reviews the results for inclusion in the Company’s quarterly and annual financial statements, as applicable.

 

7)The Board of Directors discusses the valuations and determines in good faith that the fair values of each investment in the portfolio is reasonable based upon any applicable independent pricing service, input of management, estimates from independent valuation firms (if any) and the recommendations of the Valuation Committee of the Board of Directors.

 

The majority of the Company’s investment portfolio is composed of debt and equity securities with unique contract terms and conditions and/or complexity that requires a valuation of each individual investment that considers multiple levels of market and asset specific inputs, including historical and forecasted financial and operational performance of the individual investment, projected cash flows, market multiples, comparable market transactions, the priority of the security compared with those of other securities for such issuers, credit risk, interest rates, and independent valuations and reviews.

 

Debt Securities. To the extent that the Company’s investments are exchange traded and are priced or have sufficient price indications from normal course trading at or around the valuation date (financial reporting date), such pricing will determine fair value. Pricing service marks from third party pricing services may be used as an indication of fair value, depending on the volume and reliability of the marks, sufficient and reasonable correlation of bid and ask quotes, and, most importantly, the level of actual trading activity. However, the Company has been unable to identify directly comparable market indices or other market guidance that correlate directly to the types of investments the Company owns. As a result, for most of its assets, the Company determines fair value using alternative methodologies using available market data, as adjusted, to reflect the types of assets the Company owns, their structure, qualitative and credit attributes and other asset specific characteristics.

 

The Company derives fair value for its illiquid investments that do not have indicative fair values based upon active trades primarily by using a present value technique that discounts the estimated contractual cash flows for the underlying assets with discount rates imputed by broad market indices, bond spreads and yields for comparable issuers relative to the subject assets (the “Income Approach”) and also considers recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad market information related to its loan and debt securities. Because the Company has not identified any market index that directly correlates to the loan and debt securities held by the Company and therefore uses the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Income Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. Other significant assumptions, such as coupon and maturity, are asset-specific and are noted for each investment in the Schedules of Investments.

 

Equity Securities. The Company’s equity securities in portfolio companies for which there is no liquid public market are carried at fair value based on the enterprise value of the portfolio company, which is determined using various factors, including EBITDA (earnings before interest, taxes, depreciation and amortization) and cash flows from operations less capital expenditures and other pertinent factors, such as recent offers to purchase a portfolio company’s securities or other liquidation events. The determined fair values are generally discounted to account for restrictions on resale and minority ownership positions. The values of the Company’s equity securities in public companies for which market quotations are readily available are based upon the closing public market prices on the balance sheet date. Securities that carry certain restrictions on sale are typically valued at a discount from the public market value of the security.

 

The significant inputs used to determine the fair value of equity securities include prices, earnings, EBITDA and cash flows after capital expenditures for similar peer comparables and the investment entity itself. Equity securities are classified as Level III, as described in Note 4 below, when there is limited activity or less transparency around inputs to the valuation given the lack of information related to such equity investments held in nonpublic companies. Significant assumptions observed for comparable companies are applied to relevant financial data for the specific investment. Such assumptions, such as model discount rates or price/earnings multiples, vary by the specific investment, equity position and industry and incorporate adjustments for risk premiums, liquidity and company specific attributes. Such adjustments require judgment and may be material to the calculation of fair value.

 

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Asset Manager Affiliates. The Company’s investments in its wholly-owned asset management companies, the Asset Manager Affiliates, are carried at fair value, which is primarily determined utilizing a discounted cash flow model which incorporates different levels of discount rates depending on the hierarchy of fees earned (including the likelihood of realization of senior, subordinate and incentive fees) and prospective modeled performance. Such valuation takes into consideration an analysis of comparable asset management companies and a percentage of assets under management. The Asset Manager Affiliates are classified as a Level III investment (as described below). Any change in value from period to period is recognized as net change in unrealized appreciation or depreciation.

 

CLO Fund Securities.  The Company typically makes a minority investment in the most junior class of securities of CLO Funds raised and managed by the Asset Manager Affiliates and may selectively invest in securities issued by funds managed by other asset management companies (collectively, “CLO Fund securities”). The securities held by CLO Funds generally relate to credit instruments issued by corporations.

 

The Company’s investments in CLO Fund securities are carried at fair value, which is based either on (i) the present value of the net expected cash inflows for interest income and principal repayments from underlying assets and cash outflows for interest expense, debt paydown and other fund costs for the CLO Funds that are approaching or past the end of their reinvestment period and therefore are selling assets and/or using principal repayments to pay down CLO Fund debt (or will begin to do so shortly), and for which there continue to be net cash distributions to the class of securities owned by the Company, or (ii) a discounted cash flow model for more recent CLO Funds that utilizes prepayment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow and comparable yields for similar securities or preferred shares to those in which the Company has invested or (iii) indicative prices provided by the underwriters or brokers who arrange CLO Funds. The Company recognizes unrealized appreciation or depreciation on the Company’s investments in CLO Fund securities as comparable yields in the market change and/or based on changes in net asset values or estimated cash flows resulting from changes in prepayment or loss assumptions in the underlying collateral pool. As each investment in CLO Fund securities ages, the expected amount of losses and the expected timing of recognition of such losses in the underlying collateral pool are updated and the revised cash flows are used in determining the fair value of the CLO Fund investment. The Company determines the fair value of its investments in CLO Fund securities on a security-by-security basis.

 

Due to the individual attributes of each CLO Fund security, they are classified as a Level III investment unless specific trading activity can be identified at or near the valuation date. When available, observable market information will be identified, evaluated and weighted accordingly in the application of such data to the present value models and fair value determination. Significant assumptions to the present value calculations include default rates, recovery rates, prepayment rates, investment/reinvestment rates and spreads and the discount rate by which to value the resulting underlying cash flows. Such assumptions can vary significantly, depending on market data sources which often vary in depth and level of analysis, understanding of the CLO market, detailed or broad characterization of the CLO market and the application of such data to an appropriate framework for analysis. The application of data points are based on the specific attributes of each individual CLO Fund security’s underlying assets, historic, current and prospective performance, vintage, and other quantitative and qualitative factors that would be evaluated by market participants. The Company evaluates the source of market data for reliability as an indicative market input, consistency amongst other inputs and results and also the context in which such data is presented.

 

For bond rated note tranches of CLO Fund securities (those above the junior class) without transactions to support a fair value for the specific CLO Fund and tranche, fair value is based on discounting estimated bond payments at current market yields, which may reflect the adjusted yield on the leveraged loan index for similarly rated tranches, as well as prices for similar tranches for other CLO Funds and also other factors such as indicative prices provided by underwriters or brokers who arrange CLO Funds, and the default and recovery rates of underlying assets in the CLO Fund, as may be applicable. Such model assumptions may vary and incorporate adjustments for risk premiums and CLO Fund specific attributes. Such adjustments require judgment and may be material to the calculation of fair value.

 

Cash. The Company defines cash as demand deposits. The Company places its cash with financial institutions and, at times, cash held in checking accounts may exceed the Federal Deposit Insurance Corporation insured limit.

 

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Restricted Cash. Restricted cash consists of cash held for reinvestment, quarterly interest and principal distribution (if any) to holders of CLO Fund Liabilities, and payment of CLO Fund expenses. As of September 30, 2013, the Company had approximately $6 million of restricted cash, all of which related to the KCAP Senior Funding I Notes.

 

Time Deposits and Money Market Accounts.  Time deposits primarily represent investments of cash held in a demand deposit accounts.  Money market accounts primarily represent short term interest-bearing deposit accounts.

 

Interest Income.  Interest income, including the amortization of premium and accretion of discount, is recorded on the accrual basis to the extent that such amounts are expected to be collected. The Company generally places a loan or security on non-accrual status and ceases recognizing cash interest income on such loan or security when a loan or security becomes 90 days or more past due or if the Company otherwise does not expect the debtor to be able to service its debt obligations. Non-accrual loans remain in such status until the borrower has demonstrated the ability and intent to pay contractual amounts due or such loans become current. As of September 30, 2013, four issuers representing less than 1% of the Company’s total investments at fair value were on a non-accrual status.

 

Dividends from Asset Manager Affiliates. The Company records dividend income from its Asset Manager Affiliates on the declaration date, which represents the ex-dividend date.

 

Dividend Income from CLO Fund Securities.  The Company generates dividend income from its investments in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by the Asset Manager Affiliates and selective investments in securities issued by funds managed by other asset management companies. The Company’s CLO Fund junior class securities are subordinated to senior note holders who typically receive a stated interest rate of return based on a floating rate London Interbank Offered Rate (“LIBOR”) on their investment. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior note holders and less fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares. The Company makes estimated interim accruals of such dividend income based on recent historical distributions and CLO Fund performance and adjusts such accruals on a quarterly basis to reflect actual distributions.

 

For non-junior class CLO Fund securities, such as the Company’s investment in the Class B-2L Notes of the Katonah 2007-I CLO and Class F Notes of the Catamaran 2012-1 CLO, interest is earned at a fixed spread relative to the LIBOR index.

 

Capital Structuring Service Fees. The Company may earn ancillary structuring and other fees related to the origination, investment, disposition or liquidation of debt and investment securities. Generally, the Company will capitalize loan origination fees, then amortize these fees into interest income over the term of the loan using the effective interest rate method, recognizes prepayment and liquidation fees upon receipt and equity structuring fees as earned, which generally occurs when an investment transaction closes.

 

Debt Issuance Costs.  Debt issuance costs represent fees and other direct costs incurred in connection with the Company’s borrowings. These amounts are capitalized and amortized ratably over the contractual term of the borrowing.

 

During March 2011, the Company issued $60 million of Convertible Notes (the “Convertible Notes”) and incurred debt issuance costs of approximately $2.4 million which are being amortized over a five-year period. During October 2012, the Company issued $41.4 million of 7.375% Notes due 2019 (the “Retail Notes”) and incurred debt issuance costs of approximately $1.5 million, which are being amortized over a seven year period. At September 30, 2013, there was an unamortized debt issuance cost of approximately $2.3 million included in other assets in the accompanying balance sheet. Amortization expense related to the Convertible Notes and Retail Notes for the nine months ended September 30, 2013 and 2012 was approximately $422,000 and $354,000, respectively, and is included in interest and amortization of debt issuance costs on the statement of operations.

 

On June 18, 2013, the Company completed the sale of notes in a $140,000,000 debt securitization financing transaction. The notes offered in this transaction (the “Notes”) were issued by KCAP Senior Funding I, LLC, a newly formed special purpose vehicle (the “Issuer”), in which KCAP Senior Funding I Holdings, LLC, a wholly-owned subsidiary of the Company (the “Depositor”), owns all of the equity, and are backed by a diversified portfolio of bank loans. The secured Notes (the “Secured Notes”) were issued as Class A-1 senior secured floating rate notes which have an initial face amount of $77,250,000; and bear interest at the three-month LIBOR plus 1.50%, Class B-1 senior secured floating rate notes which have an initial face amount of $9,000,000, bear interest at three-month LIBOR plus 3.25%, Class C-1 secured deferrable floating rate notes which have an initial face amount of $10,000,000, bear interest at three-month LIBOR plus 4.25%, and Class D-1 secured deferrable floating rate notes which have an initial face amount of $9,000,000 bear interest at three-month LIBOR plus 5.25%. The Depositor retained all of the subordinated notes of the Issuer (the “Subordinated Notes”), which have an initial face amount of $34,750,000, which was eliminated in connection with the preparation of the consolidated financial statements. The Subordinated Notes do not bear interest. Both the Secured Notes and the Subordinated Notes have a stated maturity on the payment date occurring in July, 2024 and are subject to a two year non-call period. The Issuer has a four year reinvestment period. At September 30, 2013, there were unamortized issuance costs of approximately $3.7 million and unamortized original issue discount, (“OID”) costs of approximately $3.1 million included in assets and liabilities in the accompanying balance sheet, respectively. Amortization expense for the nine months ended September 30, 2013 was approximately $185,000 and $156,000, for issuance costs and OID respectively, and is included in interest and amortization of debt issuance costs on the statement of operations.

 

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Extinguishment of Debt. An issuer must derecognize a liability if and only if it has been extinguished through delivery of cash, delivery of other financial assets, delivery of goods or services, or reacquisition by the issuer of its outstanding debt securities whether the securities are cancelled or held. If the debt contains a cash conversion option, the issuer must allocate the consideration transferred and transaction costs incurred to the extinguishment of the liability component and the reacquisition of the equity component and recognize a gain or loss in the statement of operations.

 

On April 4, 2013, approximately $9 million of the Company’s 8.75% Convertible Notes were converted at a price basis per share of $8.159 into 1,102,093 shares of KCAP common stock. On September 4, 2013, the Company purchased $2.0 million face value of its own Convertible Notes at $114.50 plus accrued interest. KCAP subsequently surrendered these notes to the Trustee for cancellation effective September 13, 2013. For the nine months ended September 30, 2013 total realized losses on extinguishment of debt were approximately $330,000.

 

Expenses. The Company is internally managed and expenses costs, as incurred, with regard to the running of its operations. Primary operating expenses include employee salaries and benefits, the costs of identifying, evaluating, negotiating, closing, monitoring and servicing the Company’s investments and related overhead charges and expenses, including rental expense, and any interest expense incurred in connection with borrowings. The Company and the Asset Manager Affiliates share office space and certain other operating expenses. The Company has entered into an Overhead Allocation Agreement with the Asset Manager Affiliates which provides for the sharing of such expenses based on an allocation of office lease costs and the ratable usage of other shared resources.

 

Dividends. Dividends and distributions to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is determined by the Board of Directors each quarter and is generally based upon the distributable taxable income estimated by management for the period and year.

 

The Company has adopted a dividend reinvestment plan that provides for reinvestment of its distributions on behalf of its stockholders, unless a stockholder “opts out” of the plan to receive cash in lieu of having their cash dividends automatically reinvested in additional shares of the Company’s common stock.

 

3. EARNINGS PER SHARE

 

The following information sets forth the computation of basic and diluted net increase in net assets available to common stockholders per share for the three and nine months ended September 30, 2013 and 2012 (unaudited):

 

   (unaudited)   (unaudited)  
   Three Months Ended September 30,   Nine Months Ended September 30,  
   2013   2012   2013   2012  
                 
Net increase (decrease) in net assets resulting from operations   $(92,779)  $9,368,395   $15,649,325   $11,562,505 
Net decrease (increase) in net assets allocated to unvested share awards    754        (79,480)   (136,546)
Add: Interest on Convertible Notes    1,102,675    1,312,500    3,537,532     
Add: Amortization of Capitalized Costs on Convertible Notes    92,401    118,020    290,876     
                      
Net increase in net assets available to common stockholders    1,103,051    10,798,915    19,398,253    11,425,959 
Weighted average number of common shares outstanding for basic shares computation    33,312,328    26,668,700    31,887,711    25,860,510 
Effect of dilutive securities - stock options    14,606        15,519    12,737 
Effect of dilutive Convertible Notes        7,213,212         
                      
Weighted average number of common and common stock equivalent shares outstanding for diluted shares computation    33,326,934    33,881,912    31,903,230    25,873,247 
                      
Net increase in net assets per basic common shares:                     
Net increase in net assets from operations   $   $0.35   $0.49   $0.45 
Net increase in net assets per diluted shares:                     
Net increase in net assets from operations   $   $0.32   $0.49   $0.44 

 

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Share-based awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and included in the computation of both basic and diluted earnings per share. Grants of restricted stock awards to the Company’s employees and directors are considered participating securities when there are earnings in the period and the earnings per share calculations include outstanding unvested restricted stock awards in the basic weighted average shares outstanding calculation. Subsequent to September 30, 2013, 17,344 shares were issued under the Company’s Dividend Reinvestment Plan. Had these shares been issued during the quarter, their impact would have been immaterial to earning per share.

 

The Company’s Convertible Notes are included in the computation of the diluted net increase or decrease in net assets resulting from operations per share in accordance with ASC 261-10-45-40-b by application of the “if-converted method.” Under the if-converted method, interest charges applicable to the convertible notes for the period are added to the reported net increase or decrease in net assets resulting from operations and the full amount of shares (pro-rata if not outstanding for the full period) that would be issued are added to weighted average basic shares. Convertible notes are considered anti-dilutive only when its interest per share upon conversion exceeds the basic net increase or decrease in net assets resulting from operations per share. For the three and nine months ended September 30, 2013, the effect of the convertible notes were anti-dilutive. For the three and nine months ended September 30, 2012, the effect of the convertible notes were dilutive.

 

The if-converted method of computing the dilutive effects on convertible notes assume a conversion even if the contracted conversion price exceeds the market value of the shares. As of September 30, 2013 the conversion rate of the Convertible Notes is approximately 125.0814 shares of our common stock per $1,000 principal amount of the conversion rate, equivalent to a conversion price of approximately $7.99 per share of the Company’s common stock. Subsequent to the reporting period, the conversion rate of the Convertible Notes is approximately 126.2342 shares of the Company’s common stock per $1,000 principal amount of the Convertible Notes, equivalent to a conversion price of approximately $7.92 per share of our common stock. Upon conversion, the Company may issue the full amount of common stock and retire the full amount of debt outstanding.

 

4. INVESTMENTS

 

The Company invests in senior secured loans and mezzanine debt and, to a lesser extent, equity capital of middle market companies in a variety of industries. The Company generally targets companies that generate positive cash flows because the Company looks to cash flows as the primary source for servicing debt. However, the Company may invest in other companies if it is presented with attractive opportunities.

 

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The following table shows the Company’s portfolio by security type at September 30, 2013 and December 31, 2012:

 

   September 30, 2013 (unaudited)   December 31, 2012 
Security Type  Cost   Fair Value      Cost   Fair Value    
Time Deposits  $-   $-    -%  $1,942,834   $1,942,834    1%
Money Market Account   9,055,634    9,055,634    3    30,543,824    30,543,824    15 
Senior Secured Loan   186,686,207    179,395,497    68    67,874,565    60,258,885    29 
Junior Secured Loan   44,327,364    41,309,810    16    49,646,273    33,486,956    17 
Senior Unsecured Loan   20,000,000    20,000,000    8    -    -    - 
First Lien Bond   2,939,165    2,556,300    1    2,928,762    3,000,000    1 
Senior Subordinated Bond   1,037,667    1,061,901    -    2,729,088    2,735,881    1 
Senior Secured Bond   1,519,751    1,537,500    1    -    -    - 
Senior Unsecured Bond   10,830,904    11,338,900    4    10,798,463    11,185,000    5 
CLO Fund Securities   101,346,359    82,152,488    31    90,146,410    83,257,507    40 
Equity Securities   18,655,209    9,385,053    4    18,375,588    8,020,716    4 
Preferred Stock   400,000    160,000    -    400,000    371,160    - 
Asset Manager Affiliates   83,273,236    82,533,000    30    83,161,529    77,242,000    37 
                               
Total  $480,071,496   $440,486,083    166%  $358,547,336   $312,044,763    150%

 

 

¹ Calculated as a percentage of net asset value.

 

36
 

 

 

 

 

 

The industry concentrations based on the fair value of the Company’s investment portfolio as of September 30, 2013 and December 31, 2012, were as follows:

 

   September 30, 2013 (unaudited)    December 31, 2012  
Industry Classification  Cost   Fair Value   %1   Cost   Fair Value   %1 
Aerospace and Defense  $9,247,332   $8,014,633    3%  $5,278,896   $3,874,742    2%
Asset Management Companies2   83,273,236    82,533,000    30    83,161,529    77,242,000    37 
Automobile   21,227,656    21,311,075    8    4,945,695    5,011,608    2 
Beverage, Food and Tobacco   33,409,815    33,518,389    12    18,112,772    18,285,421    9 
Broadcasting and Entertainment   9,939,134    9,930,001    4    1,978,846    1,990,930    1 
Buildings and Real Estate   18,295,585    235,653    -    18,535,511    455,524    - 
Cargo Transport   3,543,376    3,558,067    1    -    -    - 
Chemicals, Plastics and Rubber   2,931,153    2,833,429    1    2,954,773    2,950,577    1 
CLO Fund Securities   101,346,358    82,152,488    31    90,146,410    83,257,507    40 
Containers, Packaging and Glass   1,951,367    1,963,912    1    1,949,236    1,971,898    1 
Diversified/Conglomerate Service   7,741,005    7,587,590    3    5,520,217    3,536,426    2 
Ecological   2,963,834    2,993,099    1    -    -    - 
Electronics   18,050,353    17,747,931    7    6,137,592    6,252,380    3 
Finance   25,786,383    25,975,000    10    4,748,767    4,891,710    2 
Healthcare, Education and Childcare   36,839,576    36,216,406    14    15,981,824    4,618,521    2 
Home and Office Furnishings, Housewares, and Durable Consumer Products   14,736,555    15,684,076    6    10,820,467    11,613,621    5 
Hotels, Motels, Inns, and Gaming   3,606,847    3,619,067    1    -    -    - 
Insurance   2,009,021    1,970,420    1    6,970,307    6,433,130    3 
Leisure, Amusement, Motion Pictures, Entertainment   800,000    161,000    -    2,491,007    2,053,481    1 
Machinery (Non-Agriculture, Non-Construction, Non-Electronic)   11,429,553    11,327,452    4    11,408,091    11,581,245    6 
Mining, Steel, Iron and Non-Precious Metals   228,563    966    -    773,718    264,864    - 
Oil and Gas   11,724,061    12,140,459    4    11,692,913    11,692,000    6 
Personal and Non Durable Consumer Products (Mfg. Only)   6,875,201    6,772,784    3    5,000,000    3,977,100    2 
Personal, Food and Miscellaneous Services   4,612,838    4,618,282    2    3,574,421    3,640,835    2 
Personal Transportation   2,007,591    1,972,208    1    2,012,685    2,005,353    1 
Printing and Publishing   10,943,433    10,963,594    4    2,961,395    3,231,314    2 
Retail Stores   5,255,144    5,266,193    2    5,781,672    5,772,767    3 
Telecommunications   17,292,827    17,369,578    7    2,952,654    2,783,195    1 
Time Deposit and Money Market Accounts   9,055,634    9,055,634    4    32,486,658    32,486,658    16 
Utilities   2,948,065    2,993,697    1    169,280    169,956    - 
Total  $480,071,496   $440,486,083    166%  $358,547,336   $312,044,763    150%

 

 
1Calculated as a percentage of net asset value.

 

2Represents the Asset Manager Affiliates.

 

37
 

 

The Company may invest up to 30% of the investment portfolio in opportunistic investments in debt and equity securities of CLO Funds, distressed debt or equity securities of public companies. The Company expects that these public companies generally will have debt that is non-investment grade. The Company also may invest in debt of middle market companies located outside of the United States.

 

At September 30, 2013 and December 31, 2012 the total amount of non-qualified assets were approximately, 21% and 29% of total assets, respectively. The majority of non-qualified assets were foreign investment which were approximately 20% and 27% of the Company’s investments (including the Company’s investments in CLO Funds, which are typically domiciled outside the U.S. and represented approximately 19% and 27% of its portfolio on such dates), as of September 30, 2013 and December 31, 2012, respectively.

 

At September 30, 2013 and December 31, 2012, the Company’s ten largest portfolio companies represented approximately 43% and 62%, respectively, of the total fair value of its investments. The Company’s largest investment, the Asset Manager Affiliates which are its wholly owned asset manager affiliates represented 19% and 25% of the total fair value of the Company’s investments at September 30, 2013 and December 31, 2012, respectively. Excluding the Asset Manager Affiliates and CLO Fund securities, the Company’s ten largest portfolio companies represented approximately 16% and 17% of the total fair value of the Company’s investments at September 30, 2013 and December 31, 2012, respectively.

 

Investment in CLO Fund Securities

 

The Company typically makes a minority investment in the most junior class of securities of CLO Funds (typically preferred shares or subordinated securities) managed by the Asset Manager Affiliates and may selectively invest in securities issued by funds managed by other asset management companies. Preferred shares or subordinated securities issued by CLO Funds are entitled to recurring dividend distributions which generally equal the net remaining cash flow of the payments made by the underlying CLO Fund’s securities less contractual payments to senior bond holders, management fees and CLO Fund expenses. CLO Funds managed by the Asset Manager Affiliates (“CLO Fund securities managed by affiliates”) invest primarily in broadly syndicated non-investment grade loans, high-yield bonds and other credit instruments of corporate issuers. The underlying assets in each of the CLO Funds in which the Company has an investment are generally diversified secured or unsecured corporate debt. The CLO Funds are leveraged funds and any excess cash flow or “excess spread” (interest earned by the underlying securities in the fund less payments made to senior bond holders, fund expenses and management fees) is paid to the holders of the CLO Fund’s subordinated securities or preferred shares.

 

The subordinated securities and preferred share securities are considered equity positions in the CLO Funds and, as of September 30, 2013 and December 31, 2012, the Company had approximately $82 million and $83 million, respectively, of CLO Fund securities at fair value. The cost basis of the Company’s investment in CLO Fund securities as of September 30, 2013 was approximately $101 million and aggregate unrealized depreciation on the CLO Fund securities totaled approximately $19 million. The cost basis of the Company’s investment in CLO Fund equity securities as of December 31, 2012, was approximately $90 million and aggregate unrealized depreciation on the CLO Fund securities totaled approximately $7 million.

 

In December 2012, the Company purchased $4.5 million par value of the class F Notes and $8.9 million par value of the Subordinated Notes of Catamaran 2012-1 CLO (“Catamaran 2012-1”) managed by Trimaran Advisors. The Company purchased the class F and Subordinated Notes for 84% and 100% of the par value, respectively.

 

In June 2013, the Company purchased $9 million of 100% par value of the Subordinated Notes of Catamaran 2013-1 CLO (“Catamaran 2013-1”) managed by Trimaran Advisors.

 

All CLO Funds managed by the Asset Manager Affiliates are currently making quarterly dividend distributions to the Company and are paying all senior and subordinate management fees to the Asset Manager Affiliates. With the exception of the Katonah III, Ltd. and the Katonah V, Ltd. CLO Funds, all third-party managed CLO Funds are making dividend distributions to the Company.

 

Fair Value Measurements

 

The Company follows the provisions of Fair Value Measurements and Disclosures, which among other matters, requires enhanced disclosures about investments that are measured and reported at fair value. This standard defines fair value and establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability used in measuring investments at fair value and expands disclosures about assets and liabilities measured at fair value. Fair Value Measurements and Disclosures defines “fair value” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This fair value definition focuses on an exit price in the principal, or most advantageous market, and prioritizes, within a measurement of fair value, the use of market-based inputs (which may be weighted or adjusted for relevance, reliability and specific attributes relative to the subject investment) over entity-specific inputs. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. Subsequent to the adoption of Fair Value Measurements and Disclosures, the FASB has issued various staff positions clarifying the initial standard (see Note 2. “Significant Accounting Policies—Investments”).

 

38
 

 

Fair Value Measurements and Disclosures establishes the following three-level hierarchy, based upon the transparency of inputs to the fair value measurement of an asset or liability as of the measurement date:

 

Level I – Unadjusted quoted prices are available in active markets for identical investments as of the reporting date. The type of investments included in Level I include listed equities and listed securities. As required by Fair Value Measurements and Disclosures, the Company does not adjust the quoted price for these investments, even in situations where the Company holds a large position and a sale could reasonably affect the quoted price.

 

Level II – Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date. Such inputs may be quoted prices for similar assets or liabilities, quoted markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full character of the financial instrument, or inputs that are derived principally from, or corroborated by, observable market information. Investments which are generally included in this category include illiquid debt securities and less liquid, privately held or restricted equity securities for which some level of recent trading activity has been observed.

 

Level III – Pricing inputs are unobservable for the investment and includes situations where there is little, if any, market activity for the investment. The inputs may be based on the Company’s own assumptions about how market participants would price the asset or liability or may use Level II inputs, as adjusted, to reflect specific investment attributes relative to a broader market assumption. These inputs into the determination of fair value may require significant management judgment or estimation. Even if observable market data for comparable performance or valuation measures (earnings multiples, discount rates, other financial/valuation ratios, etc.) are available, such investments are grouped as Level III if any significant data point that is not also market observable (private company earnings, cash flows, etc.) is used in the valuation methodology.

 

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers factors specific to the investment. A majority of the Company’s investments are classified as Level III. The Company evaluates the source of inputs, including any markets in which its investments are trading, in determining fair value. Inputs that are backed by actual transactions, those that are highly correlated to the specific investment being valued and those derived from reliable or knowledgeable sources will tend to have a higher weighting in determining fair value. Ongoing reviews by the Company’s investment analysts, Chief Investment Officer, Valuation Committee and independent valuation firms (if engaged) are based on an assessment of each underlying investment, its current and prospective operating and financial performance, consideration of financing and sale transactions with third parties, expected cash flows and market-based information, including comparable transactions, performance factors, and other investment or industry specific market data, among other factors.

 

The following table summarizes the fair value of investments by the above Fair Value Measurements and Disclosures fair value hierarchy levels as of September 30, 2013 (unaudited) and December 31, 2012, respectively:

 

As of September 30, 2013 (unaudited)
   Level I   Level II   Level III   Total 
Money market account  $   $9,055,634   $   $9,055,634 
Debt securities       93,960,395    163,399,513    257,359,908 
CLO Fund securities           82,152,488    82,152,488 
Equity securities           9,385,053    9,385,053 
Asset Manager Affiliates           82,533,000    82,533,000 
Total  $   $103,016,029   $337,470,054   $440,486,083 

 

39
 

 

As of December 31, 2012
   Level I   Level II   Level III   Total 
Time deposit and money market account  $   $32,486,658   $   $32,486,658 
Debt securities       59,172,476    51,865,406    111,037,882 
CLO Fund securities           83,257,507    83,257,507 
Equity securities           8,020,716    8,020,716 
Asset Manager Affiliates           77,242,000    77,242,000 
Total  $   $91,659,134   $220,385,629   $312,044,763 

 

As a BDC, it is required that the Company invest primarily in the debt and equity of non-public companies for which there is little, if any, market-observable information. As a result a significant portion of the Company’s investments at any given time will likely be deemed Level III investments. The Company believes that investments classified as Level III for Fair Value Measurements and Disclosures have a further hierarchal framework which prioritizes and ranks such valuations based on the degree of independent and observable inputs, objectivity of data and models and the level of judgment required to adjust comparable data. The hierarchy of such methodologies are presented in the above table and discussed below in descending rank.

 

Investment values derived by a third party pricing service are generally deemed to be Level III values. For those that have observable trades, we consider them to be Level II.

 

The Company derives fair value for its illiquid investments that do not have indicative fair values based upon active trades primarily by using the Income Approach and also considers recent loan amendments or other activity specific to the subject asset. Discount rates applied to estimated contractual cash flows for an underlying asset vary by specific investment, industry, priority and nature of the debt security (such as the seniority or security interest of the debt security) and are assessed relative to two indices, a leveraged loan index and a high-yield bond index, at the valuation date. The Company has identified these two indices as benchmarks for broad market information related to its loan and debt investments. Because the Company has not identified any market index that directly correlates to the loan and debt investments held by the Company and therefore uses the two benchmark indices, these market indices may require significant adjustment to better correlate such market data for the calculation of fair value of the investment under the Income Approach. Such adjustments require judgment and may be material to the calculation of fair value. Further adjustments to the discount rate may be applied to reflect other market conditions or the perceived credit risk of the borrower. When broad market indices are used as part of the valuation methodology, their use is subject to adjustment for many factors, including priority, collateral used as security, structure, performance and other quantitative and qualitative attributes of the asset being valued. The resulting present value determination is then weighted along with any quotes from observable transactions and broker/pricing quotes. If such quotes are indicative of actual transactions with reasonable trading volume at or near the valuation date that are not liquidation or distressed sales, relatively more reliance will be put on such quotes to determine fair value. If such quotes are not indicative of market transactions or are insufficient as to volume, reliability, consistency or other relevant factors, such quotes will be compared with other fair value indications and given relatively less weight based on their relevancy. The appropriateness of specific valuation methods and techniques may change as market conditions and available data change.

 

Since 2010, the Company engaged an independent valuation firm to provide a third-party review of our CLO fair value model relative to its functionality, model inputs, and calculations as a reasonable method to determine CLO fair values, in the absence of Level I or Level II trading activity or observable market inputs. The independent valuation firm concluded that the Company’s CLO model appropriately factors in all the necessary inputs required to build a CLO equity cash flow for fair value purposes and that the inputs were being employed correctly.

 

The Company has engaged an independent valuation firm to provide third party valuation consulting services to the Company’s Board of Directors. Each quarter the independent valuation firm will perform third party valuations on the Company’s investments on illiquid securities such that they are reviewed at least once during a trailing 12 month period. These third party valuation estimates were considered as one of the relevant data inputs in the Company’s determination of fair value. The Board of Directors intends to continue to engage an independent valuation firm in the future to provide certain valuation services, including the review of certain portfolio assets, as part of the quarterly and annual year-end valuation process.

 

40
 

 

Values derived for debt and equity securities using public/private company comparables generally utilize market-observable data from such comparables and specific, non-public and non-observable financial measures (such as earnings or cash flows) for the private, underlying company/issuer. Such non-observable company/issuer data is typically provided on a monthly basis, is certified as correct by the management of the company/issuer and/or audited by an independent accounting firm on an annual basis. Since such private company/issuer data is not publicly available it is not deemed market-observable data and, as a result, such investment values are grouped as Level III assets.

 

Values derived for the Asset Manager Affiliates using public/private company comparables generally utilize market-observable data from such comparables and specific, non-public and non-observable financial measures (such as assets under management, historical and prospective earnings) for the Asset Manager Affiliates. The Company recognizes that comparable asset managers may not be fully comparable to the Asset Manager Affiliates and typically identifies a range of performance measures and/or adjustments within the comparable population with which to determine value. Since any such ranges and adjustments are entity specific they are not considered market-observable data and thus require a Level III grouping. Illiquid investments that have values derived through the use of discounted cash flow models and residual enterprise value models are grouped as Level III assets.

 

The Company’s policy for determining transfers between levels is based solely on the previously defined three-level hierarchy for fair value measurement. Transfers between the levels of the fair value hierarchy are separately noted in the tables below and the reason for such transfer described in each table’s respective footnotes. Investments measured at fair value for which the Company has used unobservable inputs to determine fair value are as follows:

 

   Nine Months Ended September 30, 2013 (unaudited) 
   Debt Securities   CLO Fund
Securities
   Equity Securities   Asset Manager
Affiliate
   Total 
Balance, December 31, 2012  $51,865,406   $83,257,507   $8,020,716   $77,242,000   $220,385,629 
Transfers out of Level III¹   (3,275,405)               (3,275,405)
Transfers into Level III²   32,875,096                32,875,096 
Net accretion of discount   130,353    140,204            270,557 
Purchases   161,572,878    11,957,500    1,097,220        177,344,216 
Sales / Paydowns   (64,121,022)   (621,883)   (265,962)       (67,725,485)
Total realized gain (loss) included in earnings   255,338        (551,636)       (296,298)
Total unrealized gain (loss) included in earnings   (15,903,131)   (12,580,840)   1,084,715    5,291,000    (22,108,256)
Balance, September 30, 2013  $163,399,513   $82,152,488   $9,385,053   $82,533,000   $337,470,054 
                          
Changes in unrealized gains (losses) included in earnings related to investments still held at reporting date  $(15,903,131)   (12,580,840)   1,084,715    5,291,000    (22,108,256)

 

¹The transfers to Level II from Level III in the nine months ended September 30, 2013 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and/or broker dealers as a result of liquidity in the credit markets.

 

²Transfers into Level III represent a transfer of $32,875,096 relating to debt securities for which pricing inputs, other than their quoted prices in active markets were unobservable as of September 30, 2013.

 

   Year Ended December 31, 2012 
   Debt Securities   CLO Fund
Securities
   Equity Securities   Asset Manager
Affiliate
   Total 
Balance, December 31, 2011  $83,094,677   $48,438,317   $6,040,895   $40,814,000   $178,387,889 
Transfers out of Level III¹   (5,611,522)               (5,611,522)