Business Context and Reporting Period
Company: Kohlberg Capital Corporation (KCAP), a Business Development Company (BDC) and Regulated Investment Company (RIC).
Reporting Period: Quarterly period ended September 30, 2011.
Business Model: The Company originates, structures, and invests in senior secured term loans, mezzanine debt, and selected equity securities in privately-held middle-market companies. It also owns 100% of Katonah Debt Advisors (KDA), an asset manager of Collateralized Loan Obligation (CLO) funds.
Filing Status: This Form 10-Q is incomplete. It excludes separate summarized financial information for KDA and related affiliates required by Regulation S-X. Consequently, the financial statements have not been reviewed by an independent registered public accounting firm, and executive certifications were not provided. An amendment is expected.
Key Financial Metrics
| Metric | Sept 30, 2011 | Dec 31, 2010 |
|---|---|---|
| Net Asset Value (NAV) per Share | $8.29 | $8.21 |
| Total Assets | $261.7 million | $279.8 million |
| Total Liabilities | $71.9 million | $92.9 million |
| Stockholders' Equity | $189.7 million | $186.9 million |
| Cash and Cash Equivalents | $37.1 million | $77.2 million (incl. restricted) |
| Outstanding Debt | $60.0 million (Convertible Notes) | $86.7 million (Secured Credit Facility) |
| Asset Coverage Ratio | 416% | 246% |
Results of Operations (Nine Months Ended Sept 30, 2011)
- Total Investment Income: $20.9 million (vs. $22.4 million in 2010).
- Total Expenses: $8.9 million (vs. $15.7 million in 2010).
- Net Investment Income: $12.0 million (vs. $6.7 million in 2010).
- Net Realized Losses: $(13.7) million (vs. $(10.8) million in 2010).
- Net Change in Unrealized Appreciation: $10.7 million (vs. $(3.4) million in 2010).
- Net Increase in Net Assets from Operations: $9.0 million (vs. $(7.4) million in 2010).
- Net Income per Share (Basic): $0.39 (vs. $(0.33) in 2010).
Material Changes vs. Prior Period
- Debt Restructuring: The Company fully repaid its $86.7 million secured credit facility on January 31, 2011. In March 2011, it issued $60 million of 8.75% Convertible Senior Notes due 2016. This reduced average debt outstanding and interest expense significantly compared to the prior year.
- Expense Reduction: Total expenses decreased by approximately $6.8 million year-over-year, primarily due to a reduction in professional fees related to legal proceedings and restatement costs incurred in 2010.
- Portfolio Valuation: Net unrealized appreciation increased by $10.7 million, driven largely by the write-off of a debt security (reducing unrealized depreciation) and fair value adjustments on debt securities and the affiliate asset manager.
- Liquidity: Cash and cash equivalents decreased from $77.2 million (including restricted cash) to $37.1 million as the restricted cash was released upon debt repayment and utilized for operations and investments.
Guidance, Outlook, and Risks
- Dividend Policy: The Company declared a quarterly dividend of $0.18 per share for the third quarter of 2011. Management intends to distribute at least 90% of taxable income to maintain RIC status.
- Outlook: Management expects to grow the portfolio by raising additional capital and utilizing leverage. They anticipate continued distributions from KDA and capital appreciation from the asset management business.
- Regulatory Risk (Filing Deficiency): The filing is currently deficient due to the omission of KDA financial data. The Company is evaluating whether separate financial statements for KDA are required. This evaluation prevents the independent auditor from completing their review and has rendered the Company ineligible to use Form N-2 for primary offerings until reports are timely filed.
- Valuation Risk: Substantially all investments are Level III (unobservable inputs). Fair value is determined by the Board of Directors using models and market data, which involves significant judgment.
- Legal Proceedings: A consolidated class action lawsuit regarding 2008-2009 financial disclosures was dismissed with prejudice in October 2011, though the plaintiff may appeal. An SEC formal investigation into valuation methodologies remains ongoing.
Investor Verification Checklist
- Amended Filing: Verify the filing of an amendment to this 10-Q that includes the required separate financial information for Katonah Debt Advisors (KDA) and the independent auditor's review.
- SEC Investigation Status: Monitor updates regarding the SEC's formal investigation into the Company's valuation methodologies.
- Dividend Sustainability: Confirm that the declared dividends are fully covered by GAAP net investment income and distributable tax income, noting the impact of KDA distributions.
- Convertible Notes Conversion: Assess the dilution impact of the $60 million Convertible Senior Notes (conversion price ~$8.44) relative to the current market price and NAV.
- Portfolio Concentration: Review the concentration risk, noting that the ten largest portfolio companies represented 61% of total fair value, with KDA alone representing 16.7%.