UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

 

 

 

Commission file number: 814-00725

 

 

 

 

KAYNE ANDERSON ENERGY

DEVELOPMENT COMPANY

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(713) 493-2020

 

 

 

 

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 þ     No o

 

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  o     Accelerated filer o     Non-accelerated filer þ

 

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

 

Indicate the number of shares of outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common stock, $0.001 par value per share, 10,027,585 shares outstanding as of October 9, 2007.

 

 

TABLE OF CONTENTS

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

CONSOLIDATED SCHEDULE OF INVESTMENTS
AS OF AUGUST 31, 2007
(amounts in 000’s)
(UNAUDITED)

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

 

CONSOLIDATED SCHEDULE OF INVESTMENTS (CONTINUED)

AS OF AUGUST 31, 2007

(amounts in 000’s)

(UNAUDITED)

 

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

 

CONSOLIDATED SCHEDULE OF INVESTMENTS (CONTINUED)

AS OF AUGUST 31, 2007

(amounts in 000’s)

(UNAUDITED)

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

 

CONSOLIDATED SCHEDULE OF INVESTMENTS (CONTINUED)

AS OF AUGUST 31, 2007

(amounts in 000’s)

(UNAUDITED)

 

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

 

CONSOLIDATED SCHEDULE OF INVESTMENTS (CONCLUDED)

AS OF AUGUST 31, 2007

(amounts in 000’s, except per unit amounts)

(UNAUDITED)

 

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY
SCHEDULE OF INVESTMENTS
AS OF NOVEMBER 30, 2006
(amounts in 000’s)

 

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

SCHEDULE OF INVESTMENTS (CONTINUED)

AS OF NOVEMBER 30, 2006

(amounts in 000’s)

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY
SCHEDULE OF INVESTMENTS (CONCLUDED)
AS OF NOVEMBER 30, 2006
(amounts in 000’s)

 

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

 

CONSOLIDATED STATEMENT OF ASSETS AND LIABILITIES

(amounts in 000’s, except share and per share amounts)

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED AUGUST 31, 2007
(amounts in 000’s)
(UNAUDITED)

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

 

CONSOLIDATED STATEMENT OF CHANGES IN NET ASSETS

(amounts in 000’s, except share amounts)

 

 

 

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED AUGUST 31, 2007
(amounts in 000’s)
(UNAUDITED)

 

 

 

Supplemental disclosure of cash flow information:

 

Non-cash financing activities not included herein consist of reinvestment of distributions pursuant to the Company’s dividend reinvestment plan of $721.

 

During the nine months ended August 31, 2007, state and franchise taxes paid were $1 and interest paid was $486.

 

See accompanying notes to consolidated financial statements.

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

 

Kayne Anderson Energy Development Company (the “Company”) was organized as a Maryland corporation on May 24, 2006. The Company is an externally managed, non-diversified closed-end management investment company that has elected to be treated as a business development company under the Investment Company Act of 1940, as amended (the “1940 Act”). The Company’s investment objective is to generate both current income and capital appreciation primarily through equity and debt investments. The Company seeks to achieve this objective by investing at least 80% of its net assets together with the proceeds of any borrowings (“total assets”) in securities of companies that derive the majority of their revenue from activities in the energy industry, including: (a) Midstream Energy Companies, which are businesses that operate assets used to gather, transport, process, treat, terminal and store natural gas, natural gas liquids, propane, crude oil or refined petroleum products; (b) Upstream Energy Companies, which are businesses engaged in the exploration, extraction and production of natural resources, including natural gas, natural gas liquids and crude oil, from onshore and offshore geological reservoirs; and (c) Other Energy Companies, which are businesses engaged in owning, leasing, managing, producing, processing and sale of coal and coal reserves; the marine transportation of crude oil, refined petroleum products, liquefied natural gas, as well as other energy-related natural resources using tank vessels and bulk carriers; and refining, marketing and distributing refined energy products, such as motor gasoline and propane to retail customers and industrial end-users. The Company commenced investment operations on September 21, 2006.

 

 

A. Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ materially from those estimates.

 

B. Interim Periods — The unaudited consolidated financial statements contained in this report include all material adjustments of a normal and recurring nature that, in the opinion of management, are necessary for a fair statement of the results for the interim periods. The results of operations for the interim periods presented in this Form 10-Q are not necessarily indicative of the results to be expected for the full year or any other interim period. Certain reclassifications have been made to prior period amounts in order to conform to current year presentation. The accompanying consolidated financial statements included herein should be read in conjunction with the financial statements and related notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended November 30, 2006.

 

C. Principles of Consolidation — The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries which directly and indirectly own securities in the Company’s portfolio. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The Company forms subsidiary limited partnerships (which have elected to be treated as taxable entities) and limited liability companies to make and hold certain of its private portfolio investments. These portfolio investments are consolidated in the Company’s schedule of investments, statements of assets and liabilities, statements of operations, statements of cash flows and statements of changes in net assets.

 

The Company will typically own 98% of its subsidiary limited partnerships directly and own the remaining 2% through a wholly owned limited liability company. The Company allocates a portion of its expenses to its limited partnerships based on the relative size of the portfolio investments held by the limited partnership. These expenses and any income tax benefit/expense related to the Company’s subsidiaries are consolidated in the Company’s

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

schedule of investments, statements of assets and liabilities, statements of operations, statements of cash flows and statements of changes in net assets.

 

D. Calculation of Net Asset Value — The Company determines its net asset value as of the close of regular session trading on the NYSE (normally 4:00 p.m. Eastern time) no less frequently than the last business day of each quarter. Net asset value is computed by dividing the value of the Company’s assets (including accrued interest and dividends), less all of its liabilities (including accrued expenses, dividends payable and any borrowings) by the total number of common shares outstanding.

 

E. Investment Valuation — Readily marketable portfolio securities listed on any exchange other than the NASDAQ Stock Market, Inc. (“NASDAQ”) are valued, except as indicated below, at the last sale price on the business day as of which such value is being determined. If there has been no sale on such day, the securities are valued at the mean of the most recent bid and asked prices on such day, except for short sales and call option contracts written, for which the last quoted asked price is used. Securities admitted to trade on the NASDAQ are valued at the NASDAQ official closing price. Portfolio securities traded on more than one securities exchange are valued at the last sale price on the business day as of which such value is being determined at the close of the exchange representing the principal market for such securities.

 

Equity securities traded in the over-the-counter market, but excluding securities admitted to trading on the NASDAQ, are valued at the closing bid prices. Fixed income securities that are considered corporate bonds with a remaining maturity of 60 days or more are valued by using the mean of the bid and ask prices provided by an independent pricing service. For fixed income securities that are considered corporate bank loans with a remaining maturity of 60 days or more, the fair market value is determined by the mean of the bid and ask prices provided by the syndicate bank or principal market maker. When price quotes are not available, fair market value will be based on prices of comparable securities. Fixed income securities that mature within 60 days are valued on an amortized cost basis.

 

The Company’s portfolio includes securities that are privately issued or illiquid. For these securities, as well as any other portfolio security held by the Company for which reliable market quotations are not readily available, valuations will be determined in good faith by the board of directors under a valuation policy and a consistently applied valuation process. Unless otherwise determined by the board of directors of the Company, the following valuation process, approved by the board of directors, will be used for such securities:

 

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

 

 

During the course of such valuation process, whenever possible, privately-issued equity investments are valued using comparisons of financial ratios of the portfolio companies that issued such equity securities to any peer companies that are public. The value is then discounted to reflect the illiquid nature of the investment, as well as the Company’s minority, non-control position. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the Company uses the pricing indicated by the external event to corroborate the valuation. 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 in privately-issued securities may differ significantly from the values that would have been used had a ready market existed for such investments, and the differences could be material.

 

Factors that the Company may take into account in fair value pricing its investments include, as relevant, the portfolio company’s ability to make payments and its earnings and discounted cash flow, the markets in which the portfolio company does business, comparison to publicly traded securities, the nature and realizable value of any collateral and other relevant factors.

 

Unless otherwise determined by the board of directors, securities that are convertible into or otherwise will become publicly traded (e.g., through subsequent registration or expiration of a restriction on trading) will be valued through the process described above, using a valuation based on the market value of the publicly traded security less a discount. The discount will initially be equal in amount to the discount negotiated at the time of purchase. To the extent that such securities are convertible or otherwise become publicly traded within a time frame that may be reasonably determined, the investment adviser may determine an amortization schedule for the discount in accordance with a methodology approved by the Valuation Committee.

 

Any derivative transaction that the Company enters into may, depending on the applicable market environment, have a positive or negative value for purposes of calculating net asset value. Any option transaction that the Company enters into may, depending on the applicable market environments, have no value or a positive/negative value. Exchange traded options and futures contracts are valued at the closing price in the market where such contracts are principally traded.

 

Determination of fair values can involve subjective judgments and estimates. Accordingly, the notes to the financial statements hereby refer to the uncertainty with respect to the possible effect of such valuations, and any change in such valuations, on the Company’s financial statements.

 

At August 31, 2007, the Company held 74.8% of its net assets applicable to common stockholders (53.5% of total assets) in securities that were fair valued pursuant to the procedures adopted by the board of directors. The

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

aggregate fair value of these securities at August 31, 2007 was $184,985. At November 30, 2006, the Company did not hold any securities that were fair valued pursuant to the procedures adopted by the board of directors.

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement on Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements.” This standard establishes a single authoritative definition of fair value, sets out a framework for measuring fair value and requires additional disclosures about fair value measurements. SFAS No. 157 applies to fair value measurements already required or permitted by existing standards. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The changes to current generally accepted accounting principles from the application of this Statement relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. As of August 31, 2007, the Company does not believe the adoption of SFAS No. 157 will impact the financial statement amounts; however, additional disclosures may be required about the inputs used to develop the measurements and the effect of certain of the measurements on changes in net assets for the period.

 

F. Repurchase Agreements — The Company has agreed to purchase securities from financial institutions subject to the seller’s agreement to repurchase them at an agreed-upon time and price (“repurchase agreements”). The financial institutions with whom the Company enters into repurchase agreements are banks and broker/dealers which KAFA considers creditworthy. The seller under a repurchase agreement is required to maintain the value of the securities as collateral, subject to the agreement, at not less than the repurchase price plus accrued interest. KAFA monitors daily the mark-to-market of the value of the collateral, and, if necessary, requires the seller to maintain additional securities, so that the value of the collateral is not less than the repurchase price. Default by or bankruptcy of the seller would, however, expose the Company to possible loss because of adverse market action or delays in connection with the disposition of the underlying securities.

 

G. Short Sales — A short sale is a transaction in which the Company sells securities it does not own (but has borrowed) in anticipation of or to hedge against a decline in the market price of the securities. To complete a short sale, the Company may arrange through a broker to borrow the securities to be delivered to the buyer. The proceeds received by the Company for the short sale are retained by the broker until the Company replaces the borrowed securities. In borrowing the securities to be delivered to the buyer, the Company becomes obligated to replace the securities borrowed at their market price at the time of replacement, whatever the price may be.

 

All short sales are fully collateralized. The Company maintains assets consisting of cash or liquid securities equal in amount to the liability created by the short sale. These assets are adjusted daily to reflect changes in the value of the securities sold short. The Company is liable for any dividends or distributions paid on securities sold short.

 

The Company may also sell short “against the box” (i.e., the Company enters into a short sale as described above while holding an offsetting long position in the security which it sold short). If the Company enters into a short sale “against the box,” the Company segregates an equivalent amount of securities owned as collateral while the short sale is outstanding.

 

At August 31, 2007, there were no open short sales.

 

H. Option Writing — When the Company writes an option, an amount equal to the premium received by the Company is recorded as a liability and is subsequently adjusted to the current fair value of the option written. Premiums received from writing options that expire unexercised are treated by the Company on the expiration date as realized gains from investments. The difference between the premium and the amount paid on effecting a closing purchase transaction, including brokerage commissions, is also treated as a realized gain, or if the premium is less than the amount paid for the closing purchase transaction, as a realized loss. If a call option is exercised, the premium is added to the proceeds from the sale of the underlying security in determining whether the Company has

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

realized a gain or loss. If a put option is exercised, the premium reduces the cost basis of the securities purchased by the Company. As the writer of an option, the Company bears the market risk of an unfavorable change in the price of the security underlying the written option.

 

During the three and nine months ended August 31, 2007, the Company did not enter into written option transactions.

 

I. Security Transactions — Security transactions are accounted for on the date the securities are purchased or sold (trade date). Realized gains and losses are reported on an identified cost basis. For publicly-traded securities, dividend and distribution income is recorded on the ex-dividend date. For privately-held securities, dividend and distribution income is recorded on the declaration date.

 

J. Investment Income and Return of Capital Estimates — Distributions received from the Company’s investments in master limited partnerships (“MLP”) generally are comprised of income and return of capital. For the three and nine months ended August 31, 2007, the Company estimated that 90% of the MLP distributions received would be treated as a return of capital. For the three and nine months ended August 31, 2007, the Company recorded as return of capital the amounts of $2,187 and $4,625, respectively, of dividends and distributions received from its investments. The return of capital resulted in an equivalent reduction in the cost basis of the associated investments. For the three months ended August 31, 2007, Net Realized Gains and Net Change in Unrealized Gains (Losses) in the accompanying Statement of Operations were increased by $37 and $2,150, respectively, attributable to the recording of such dividends and distributions as reduction in the cost basis of investments. For the nine months ended August 31, 2007, Net Realized Gains and Net Change in Unrealized Gains (Losses) in the accompanying Statement of Operations were increased by $223 and $4,402, respectively, attributable to the recording of such dividends and distributions as reduction in the cost basis of investments. The Company records investment income and return of capital based on estimates made at the time such distributions are received. Such estimates are based on historical information available from MLPs and other industry sources. These estimates may subsequently be revised based on information received from MLPs after their tax reporting periods are concluded.

 

Interest income is recognized on the accrual basis, including amortization of premiums and accretion of discounts.

 

K. Dividends and Distributions to Stockholders — Dividends and distributions to stockholders are recorded on the ex-dividend date. The character of dividends made during the year may differ from their ultimate characterization for federal income tax purposes. The Company is unable to make final determinations as to the character of the dividend until after the end of the calendar year. The Company informs its common stockholders in January following the calendar year of the character of dividends deemed paid during the fiscal year.

 

L. Partnership Accounting Policy — The Company records its pro-rata share of the income/(loss) and capital gains/(losses), to the extent of dividends it has received, allocated from the underlying portfolio partnerships and adjusts the cost of the underlying partnerships accordingly. These amounts are included in the Company’s Statement of Operations.

 

M. Income Taxes — The Company intends to qualify for the tax treatment applicable to regulated investment companies under Subchapter M of the Internal Revenue Code of 1986, as amended, and among other things is required to make the requisite distributions to its stockholders, which will relieve it from federal income or excise taxes. However, the Company’s taxable subsidiaries created to make and hold certain investments are generally subject to federal and state income taxes on their income.

 

For the three and nine months ended August 31, 2007, the Company recorded a deferred income tax benefit of $233 and $331, respectively, and deferred income tax expense of $550 and $900, respectively, related to the investment activities of the Company’s taxable subsidiaries. Total income taxes have been computed by applying

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

the federal statutory income tax rate plus a blended state income tax rate totaling 37% to the net investment income and unrealized gains on investments before taxes of the Company’s taxable subsidiaries.

 

Income and capital gain distributions made by regulated investment companies often differ from the financial statement basis net investment income and net realized gains. For the Company, the principal reason for these differences is the return of capital treatment of dividends and distributions from MLPs and certain other investments. Net investment income and net realized gains for financial statement purposes may differ from taxable income for federal income tax purposes primarily due to wash sales and disallowed partnership losses from MLPs.

 

As of August 31, 2007 and November 30, 2006, none of the Company’s losses were disallowed as a result of wash sales for federal income tax purposes.

 

The tax basis of the components of distributable earnings can differ from the amounts reflected in the Statement of Assets and Liabilities due to temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. As of November 30, 2006, components of the distributable earnings on a tax basis for the Company were as follows:

 

 

On January 12, 2007, the Company paid an initial dividend of $0.22 per common share, totaling $2,200. The tax character of this dividend was categorized as ordinary income.

 

For the quarters ended February 28, 2007 and May 31, 2007, the Company paid full quarterly dividends of $0.32 per common share and $0.40 per common share totaling $7,204. The tax character of these dividends has yet to be determined, and the Company will make a final determination in the first quarter of 2008.

 

At August 31, 2007 and November 30, 2006, the identified cost of investments for Federal income tax purposes was $326,991 and $233,914, respectively. Gross unrealized appreciation and depreciation of investments for Federal income tax purposes were as follows:

 

 

In July 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”). This standard defines the threshold for recognizing the benefits of tax-return positions in the financial statements as “more likely than not” to be sustained by the taxing authority and requires measurement of a tax position meeting the “more likely than not” criterion, based on the largest benefit that is more than 50 percent likely to be realized. FIN No. 48 is effective as of the beginning of the first fiscal year beginning after December 15, 2006. At adoption, companies must adjust their financial statements to reflect only those tax positions that are “more likely than not” to be sustained as of the adoption date. As of August 31, 2007, the Company has not evaluated the impact that will result from adopting FIN No. 48.

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

N. Organizational and Offering Costs — The Company treats organizational costs as an expense. Offering costs of approximately $845 incurred in connection with the sale of shares of common stock were charged to paid-in capital when shares of the Company were issued in September 2006. During the nine months ended August 31, 2007, this amount was adjusted to $812 based on actual costs incurred.

 

O. Indemnifications — Under the Company’s organizational documents, its officers and directors are indemnified against certain liabilities arising out of the performance of their duties to the Company. In addition, in the normal course of business, the Company enters into contracts that provide general indemnification to other parties. The Company’s maximum exposure under these arrangements is unknown, as this would involve future claims that may be made against the Company that have not yet occurred, and may not occur. However, the Company has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote.

 

 

A. Investment Management Agreement — The Company has entered into an investment management agreement with KAFA under which the Company has material future rights and commitments. Pursuant to the investment management agreement, KAFA has agreed to serve as investment adviser and provide significant managerial assistance to portfolio companies to which the Company is required to provide such assistance. Payments under the investment management agreement include (1) a base management fee, (2) an incentive fee, and (3) reimbursement of certain expenses.

 

On July 10, 2007, the Company and KAFA entered into an agreement where KAFA voluntarily agreed to waive the portion of the management fee and any incentive fee under the investment management agreement with respect to any investments made with proceeds from borrowings under the Treasury Secured Revolving Credit Facility (the “Treasury Facility”), which the Company established on June 4, 2007. This agreement to waive a portion of the management fee will terminate at the earlier of the termination of the Treasury Facility or the investment management agreement.

 

Base Management Fee.  The Company pays an amount equal on an annual basis to 1.75% of average total assets to KAFA as compensation for services rendered. This amount is payable each quarter after the end of the quarter. For purposes of calculating the base management fee, the “average total assets” for each quarterly period are determined by averaging the total assets at the last day of that quarter with the total assets at the last day of the prior quarter (or as of the commencement of operations for the initial period if a partial quarter). Total assets shall equal gross asset value (which includes assets attributable to or proceeds from the use of Leverage Instruments), minus the sum of accrued and unpaid dividends and distributions on common stock and accrued and unpaid dividends on preferred stock and accrued liabilities (other than liabilities associated with leverage used by the Company). Liabilities associated with leverage include the principal amount of any borrowings, commercial paper or notes that the Company may issue, the liquidation preference of outstanding preferred stock, and other liabilities from other forms of leverage such as short positions and put or call options held or written by the Company.

 

During the first twelve months of the Company’s investment activities (from September 25, 2006 until September 24, 2007), KAFA has contractually agreed to waive or reimburse the Company for base management fees in an amount equal on an annual basis to 0.50% of average total assets.

 

Incentive Fee.  The incentive fee consists of two parts. The first part of the incentive fee (the “Net Investment Income Fee”), which is calculated and payable quarterly in arrears, equals 20% of the excess, if any, of Adjusted Net Investment Income for the quarter over a quarterly hurdle rate equal to 1.875% (7.50% annualized) of average net assets for the quarter. Average net assets is calculated by averaging net assets at the last day of the quarter and at the last day of such prior quarter or commencement of operations (net assets is defined as total assets less total liabilities (including liabilities associated with Leverage Instruments) determined in accordance with GAAP).

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

For this purpose, “Adjusted Net Investment Income” means interest income (including accrued interest that the Company has not yet received in cash), dividend and distribution income from equity investments (but excluding that portion of cash distributions that are treated as a return of capital) and any other income, including any other fees, such as commitment, origination, syndication, structuring, diligence, monitoring and consulting fees or other fees that the Company receives from portfolio companies (other than fees for providing significant managerial assistance to portfolio companies) accrued during the fiscal quarter, minus operating expenses for the quarter (including the base management fee, any interest expense, dividends paid on issued and outstanding preferred stock, if any, and any accrued income taxes related to net investment income, but excluding the incentive fee). Adjusted Net Investment Income does not include any realized capital gains, realized capital losses or unrealized capital gains or losses. Accordingly, the Company pays an incentive fee based partly on accrued interest, the collection of which is uncertain or deferred. Adjusted Net Investment Income includes, in the case of investments with a deferred interest feature (such as original issue discount, debt instruments with payment-in-kind interest and zero coupon securities), accrued income that the Company has not yet received in cash. For example, accrued interest, if any, on investments in zero coupon bonds (if any) will be included in the calculation of the incentive fee, even though the Company will not receive any cash interest payments in respect of payment on the bond until its maturity date. Thus, if the Company does not have sufficient liquid assets to pay this incentive fee or dividends to stockholders, the Company may be required to liquidate assets. The calculations will be appropriately pro rated for any period of less than one quarter.

 

The second part of the incentive fee (the “Capital Gains Fee”) is determined and payable in arrears as of the end of each fiscal year (or upon termination of the investment management agreement, as of the termination date), and will equal (1) 20% of (a) net realized capital gains (aggregate realized capital gains less aggregate realized capital losses) on a cumulative basis from the closing date of this offering to the end of such fiscal year, less (b) any unrealized capital losses at the end of such fiscal year based on the valuation of each investment on the applicable calculation date compared to its adjusted cost basis (such difference, “Adjusted Realized Capital Gains”), less (2) the aggregate amount of all Capital Gains Fees paid to KAFA in prior fiscal years. The calculation of the Capital Gains Fee includes any capital gains that result from the cash distributions that are treated as a return of capital. In that regard, any such return of capital will be treated as a decrease in the cost basis of an investment for purposes of calculating the Capital Gains Fee.

 

Realized capital gains on an investment will be calculated as the excess of the net amount realized from the sale or other disposition of such security over the adjusted cost basis for the security. Realized capital losses on a security will be calculated as the amount by which the net amount realized from the sale or other disposition of such security is less than the adjusted cost basis of such security. Unrealized capital loss on a security will be calculated as the amount by which the adjusted cost basis of such security exceeds the fair value of such security at the end of a fiscal year. All fiscal year-end valuations will be determined in accordance with generally accepted accounting principles, the 1940 Act and pricing procedures of the Company.

 

For the three months ended August 31, 2007, the Company paid $900 in base management fees, net of $351 in fee waivers, and reversed accrued incentive Capital Gains Fees of $409 due to unrealized losses at the end of the period and accrued zero in Net Investment Income Fees. The Company does not pay a management fee or any incentive fee with respect to any investments made under the Treasury Facility.

 

For the nine months ended August 31, 2007, the Company paid $2,455 in base management fees, net of $973 in fee waivers and accrued incentive Capital Gains Fees of zero. This includes the third quarter reversal of accrued incentive Capital Gains Fees, due to unrealized losses at the end of the quarter. The Company does not pay a management fee or any incentive fee with respect to any investments made under the Treasury Facility.

 

B. Portfolio Companies — From time to time, the Company may “control” or may be an “affiliate” of one or more portfolio companies, each as defined in the 1940 Act. In general, under the 1940 Act, the Company would

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

“control” a portfolio company if the Company owned 25% or more of its outstanding voting securities and would be an “affiliate” of a portfolio company if the Company owned 5% or more of its outstanding voting securities. The 1940 Act contains prohibitions and restrictions relating to transactions between investment companies and their affiliates (including the Company’s investment adviser), principal underwriters and affiliates of those affiliates or underwriters.

 

The Company believes that there is significant ambiguity in the application of existing SEC staff interpretations of the term “voting security” to complex structures such as privately negotiated limited partnership interests of the kind in which the Company invests. As a result, it is possible that the SEC staff may consider that certain securities investments in private limited partnerships are voting securities under the staff’s prevailing interpretations of this term. If such determination is made, the Company may be regarded as a person affiliated with and controlling the issuer(s) of those securities for purposes of Section 17 of the 1940 Act.

 

In light of the ambiguity of the definition of voting securities, the Company does not intend to treat any class of securities that it holds as “voting securities” unless the security holders of such class have the ability, under the partnership agreement, to remove the general partner (assuming a sufficient vote of such securities, other than securities held by the general partner, in favor of such removal) or the Company has an economic interest of sufficient size that otherwise gives it the de facto power to exercise a controlling influence over the partnership. The Company believes this treatment is appropriate given that the general partner controls the partnership, and without the ability to remove the general partner or the power to otherwise exercise a controlling influence over the partnership due to the size of an economic interest, the security holders have no control over the partnership.

 

The Company had the following portfolio investments at August 31, 2007, among others, for which the Company assessed its ability to “control,” or its status as an “affiliate” of, such portfolio companies, as each term is defined under the 1940 Act. As further described in the following paragraphs, the Company believes that it does not “control” and is not an “affiliate” of any of the following portfolio companies.

 

Millennium Midstream Partners, LP — At August 31, 2007, the Company held approximately 39% of the partnership interest of Millennium Midstream Partners, LP (“Millennium”). One of the Company’s Vice Presidents serves as a director on the board of the general partner for Millennium. The Company believes that it does not “control” and is not an “affiliate” of Millennium, each as defined in the 1940 Act. In this regard, the Company believes that the securities of Millennium should not be considered voting securities for purposes of the 1940 Act because of the limited scope and character of the rights of such securities. The Company also believes that neither the Company nor its Vice President, acting alone as a director, has the power to exercise a controlling influence over the management or policies of this partnership or the general partner of Millennium.

 

VantaCore Partners LP — At August 31, 2007, the Company held approximately 5% of the partnership interest of VantaCore Partners LP (“VantaCore”). One of the Company’s Vice Presidents serves as a director on the board of the general partner for VantaCore. The Company believes that it does not “control” and is not an “affiliate” of VantaCore, each as defined in the 1940 Act. In this regard, the Company believes that the securities of VantaCore should not be considered voting securities for purposes of the 1940 Act because of the limited scope and character of the rights of such securities. The Company also believes that neither the Company nor its Vice President, acting alone as a director, has the power to exercise a controlling influence over the management or policies of this partnership or the general partner of VantaCore.

 

Direct Fuels Partners, L.P. — At August 31, 2007, the Company held approximately 38% of the partnership interest of Direct Fuels Partners, L.P. (“Direct Fuels”). The Company’s President and Chief Executive Officer serves as a director on the board of the general partner for Direct Fuels. The Company believes that it does not “control” and is not an “affiliate” of Direct Fuels, each as defined in the 1940 Act. In this regard, the Company believes that the securities of Direct Fuels should not be considered voting securities for purposes of the 1940 Act because of the

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

limited scope and character of the rights of such securities. The Company also believes that neither the Company nor its President and Chief Executive Officer, acting alone as a director, has the power to exercise a controlling influence over the management or policies of this partnership or the general partner of Direct Fuels.

 

International Resource Partners LP — At August 31, 2007, the Company held approximately 28% of the partnership interest of International Resource Partners LP (“IRI”). The Company currently does not have a member of its management team serving as a director on the board of the general partner for IRI. The Company believes that it does not “control” and is not an “affiliate” of IRI, each as defined in the 1940 Act. In this regard, the Company believes that the securities of IRI should not be considered voting securities for purposes of the 1940 Act because of the limited scope and character of the rights of such securities. The Company also believes that the Company does not have the power to exercise a controlling influence over the management or policies of this partnership or the general partner of IRI.

 

C. Other Affiliations — For the three and nine months ended August 31, 2007, KA Associates, Inc., an affiliate of KAFA, earned zero and less than $1 in brokerage commissions from portfolio transactions executed on behalf of the Company.

 

Robert V. Sinnott is member of the Company’s board of directors and a senior executive of Kayne Anderson Capital Advisors, L.P. (“KACALP”), the managing member of KAFA. Mr. Sinnott also serves as a director on the board of Plains All American GP LLC, the general partner of the general partner of Plains All American Pipeline, L.P., a publicly traded partnership. Various advisory clients of KACALP and KAFA, including the Company, own units in Plains All American Pipeline, L.P., its general partner and/or Plains All American GP LLC.

 

 

For the nine months ended August 31, 2007, the Company purchased and sold securities in the amount of $274,292 and $48,101 (including U.S. Treasury Bills, but excluding other short-term investments), respectively.

 

 

From time to time, certain of the Company’s investments may be restricted as to resale, particularly private investments that are not registered under the Securities Act of 1933 and cannot, as a result, be offered for public sale for a non-exempt transaction without first being registered. Such restricted investments are valued in accordance with the procedures established by the board of directors and more fully described in Note 2 — Significant Accounting Policies. The table below shows the number of units, warrants or principal held, the acquisition date,

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

aggregate cost, and fair value as of August 31, 2007, value per unit or warrant of such security, percent of net assets applicable to common stockholders and percent of total assets which the security comprises.

 

 

 

 

 

On June 4, 2007, the Company established two credit facilities, each with a three-year term (with a stated maturity of June 4, 2010), totaling $200,000. The first facility, the Senior Secured Revolving Credit Facility (the “Investment Facility”) has initial availability of $100,000 with the ability to increase availability to $250,000. Interest on the Investment Facility will be charged at the London Interbank Offered Rate (“LIBOR”) plus 125 basis points or the prime rate plus 25 basis points. The second facility, the Treasury Secured Revolving Credit Facility (the “Treasury Facility”) permits the Company to borrow up to $100,000 and invest the proceeds in U.S. government securities. Interest on the Treasury Facility will be charged at LIBOR plus 20 basis points or the prime rate.

 

Senior Secured Revolving Credit Facility (the “Investment Facility”) — The obligations under the Investment Facility are secured by substantially all of the Company’s assets, and are guaranteed by the Company’s existing and future subsidiaries, other than special purpose subsidiaries. The Investment Facility contains affirmative and reporting covenants and certain financial ratio and restrictive covenants, including: (a) maintaining a ratio, on a consolidated basis, of total assets (excluding collateral under the Treasury Facility) less liabilities (other than indebtedness) to aggregate indebtedness (excluding indebtedness under the Treasury Facility and non-recourse indebtedness of special purpose subsidiaries) of the Company and its subsidiaries, of not less than 2.50:1.0,

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

(b) maintaining the value of the portion of the Company’s portfolio that can be converted into cash within specified time periods and valuations at no less than 10% of the principal amount outstanding under the Investment Facility (less fully cash collateralized letters of credit) during any period when adjusted outstanding principal amounts exceed a specified threshold percentage of the Company’s adjusted borrowing base, (c) maintaining a consolidated shareholders equity at each fiscal quarter end of not less than the greater of: 40% of the consolidated total assets of the Company and its subsidiaries, and $100,000 plus 25% of the net proceeds from any sales of equity securities by the Company and its subsidiaries subsequent to the closing of the Investment Facility, (d) limitations on additional indebtedness, (e) limitations on liens, (f) limitations on mergers and other fundamental changes, (g) limitations on dividends and other specified restricted payments, (h) limitations on disposition of assets, (i) limitations on transactions with affiliates, (j) limitations on agreements that prohibit liens on properties of the Company and its subsidiaries, (k) limitations on sale and leaseback transactions, (l) limitations on specified hedging transactions, (m) limitations on changes in accounting treatment and reporting practices, (n) limitations on specified amendments to the Company’s investment management agreement during the continuance of a default, (o) limitations on the aggregate amount of unfunded commitments, and (p) limitations on establishing deposit, securities or similar accounts not subject to control agreements in favor of the lenders. The Investment Facility also contains customary representations and warranties and events of default.

 

As of August 31, 2007, the Company had $66,000 of borrowings under its Investment Facility at a weighted average interest rate of 7.14%. The remaining amount available for borrowing under the Investment Facility was $34,000 at August 31, 2007.

 

Treasury Secured Revolving Credit Facility (the “Treasury Facility”) — The obligations under the Treasury Facility are secured by U.S. government securities held in certain accounts and are guaranteed by the Company’s existing and future subsidiaries, other than special purpose subsidiaries. The Treasury Facility contains affirmative and reporting covenants and certain financial ratio and restrictive covenants, including: (a) maintaining a ratio, on a consolidated basis, of total assets (excluding cash collateral) less liabilities (other than indebtedness) to aggregate indebtedness (excluding indebtedness under the Treasury Facility and non-recourse indebtedness of special purpose subsidiaries) of the Company and its subsidiaries, of not less than 2.50:1.0, (b) maintaining the value of the portion of the Company’s portfolio that can be converted into cash within specified time periods and valuations at no less than 10% of the principal amount outstanding under the Treasury Facility during any period when adjusted outstanding principal amounts exceed a specified threshold percentage of the Company’s adjusted borrowing base, (c) maintaining a consolidated shareholders equity at each fiscal quarter end of not less than the greater of: 40% of the consolidated total assets of the Company and its subsidiaries, and $100,000 plus 25% of the net proceeds from any sales of equity securities by the Company and its subsidiaries subsequent to the closing of the Treasury Facility, (d) maintaining a ratio, on a consolidated basis, of cash collateral to the aggregate principal amounts outstanding under the Treasury Facility, of not less than 1.01:1.0, (e) limitations on additional indebtedness, (f) limitations on liens, (g) limitations on mergers and other fundamental changes, (h) limitations on dividends and other specified restricted payments, (i) limitations on disposition of assets, (j) limitations on transactions with affiliates, (k) limitations on agreements that prohibit liens on properties of the Company and its subsidiaries, (l) limitations on sale and leaseback transactions, (m) limitations on specified hedging transactions, (n) limitations on changes in accounting treatment and reporting practices, (o) limitations on specified amendments to the Company’s investment management agreement during the continuance of a default, and (p) limitations on the aggregate amount of unfunded commitments. The Treasury Facility also contains customary representations and warranties and events of default.

 

As of August 31, 2007, the Company had $25,000 of borrowings under its Treasury Facility at a weighted average interest rate of 5.77%. The remaining amount available for borrowing under the Treasury Facility was $75,000 at August 31, 2007.

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)

 

At August 31, 2007, the Company was in compliance with all financial and operational covenants required by the Investment and Treasury Facilities.

 

 

The Company has 200,000,000 shares of common stock authorized. Of the 10,027,585 shares of common stock outstanding at August 31, 2007, KAFA owned 60 shares. Transactions in common shares for the period November 30, 2006 through August 31, 2007 were as follows:

 

 

 

The following is a schedule of financial highlights for the nine months ended August 31, 2007 and the period ended September 21, 2006 (inception) through November 30, 2006.

 

 

KAYNE ANDERSON ENERGY DEVELOPMENT COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONCLUDED)
(amounts in 000’s, except share, warrant, right and per share amounts)
(UNAUDITED)