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Press release from Marketwire

Deans Knight Income Corporation Releases Interim Financial Statements and Management Report of Fund Performance for the period ended June 30, 2011

Monday, August 08, 2011

Deans Knight Income Corporation Releases Interim Financial Statements and Management Report of Fund Performance for the period ended June 30, 201107:30 EDT Monday, August 08, 2011VANCOUVER, BRITISH COLUMBIA--(Marketwire - Aug. 8, 2011) - Deans Knight Income Corporation (the "Company") (TSX:DNC) is pleased to release its interim Financial Statements and Management Report of Fund Performance for the period ended June 30, 2011.These documents can be found on SEDAR at www.sedar.com or the Company's website: www.dkincomecorp.com.Forward-Looking StatementsThis press release contains forward-looking statements. More particularly, this press release contains forward-looking statements concerning the Company's corporate objectives, the investment of the Company's proceeds from the sale of investments previously made, availability of tax losses and deductions, the anticipated total return to the Company's shareholders and the Company's intention to pay out earned income in the form of monthly dividends. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, undue reliance should not be placed on them because the Company can give no assurance that they will prove to be correct since forward-looking statements address future events and conditions and by their very nature, involve inherent risks and uncertainties. The forward-looking statements contained in this press release are made as of the date hereof and the Company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, unless so required by applicable securities laws.INTERIM MANAGEMENT REPORT OF FUND PERFORMANCEFor the period fromJanuary 1, 2011 to June 30, 2011This interim management report of fund performance (the "Report") contains financial highlights of Deans Knight Income Corporation (the "Company"). This Report should be read in conjunction with the interim financial statements of the Company for the six month period ending June 30, 2011 (the "Financial Statements"), which, if not included with this Report, can be obtained at your request, at no cost by emailing info@dkincomecorp.com, visiting our website at www.dkincomecorp.com for contact details or on SEDAR at www.sedar.com. Shareholders may also contact us to request a free copy of the Company's proxy voting policies and procedures, proxy voting disclosure record or quarterly portfolio disclosure.A Note on Forward-Looking StatementsThis Report contains certain forward-looking statements. These statements relate to future events or future performance, including the Company's targeted dividend payout, investment strategy, behaviour of financial markets and reflect the Company's expectations regarding the growth, results of operations, performance and business prospects and opportunities of the Company and its investments. Such forward-looking statements reflect the Company's current beliefs and are based on information currently available to the Company. In some cases, forward-looking statements can be identified by terminology such as "may", "will", "should", "expect", "plan", "anticipate", "believe", "estimate", "predict", "potential", "continue" or the negative of these terms or other comparable terminology. With respect to such forward-looking statements, the Company has made assumptions regarding, among other things, what type of debt securities will be included in its investment portfolio. A number of factors could cause actual events or results to differ materially from the results discussed in the forward-looking statements. In evaluating these statements, prospective investors should specifically consider various factors, including the risks outlined under "Risk Factors" in the AIF (as defined herein), which may cause actual results to differ materially from any forward-looking statement. Although the forward-looking statements contained in the AIF are based upon what the Company believes to be reasonable assumptions, the Company cannot assure investors that actual results will be consistent with these forward-looking statements. Forward-looking statements are made as of the date of this Report and, other than as required by applicable law, the Company assumes no obligation to update or revise them to reflect new events or circumstances.This Report also contains certain financial and operational information obtained from public sources in respect of certain companies included in the Company's investment portfolio. While management believes this data to be reliable, such information is subject to variations and cannot be verified due to limits on the availability and reliability of data inputs, the nature of the data gathering process and other limitations and uncertainties inherent in such information. Accordingly, the accuracy, currency and completeness of this information cannot be guaranteed. The Company has not independently verified any of the data from third party sources referred to in this Report or ascertained the underlying assumptions relied upon by such sources.Investment Objective and StrategiesThe Company is a closed-end, non-redeemable investment company focused on investing in corporate debt securities. The Company's assets are actively managed by Deans Knight Capital Management Ltd. ("Deans Knight"), a respected British Columbia-based investment firm focused on managing high income and growth mandates for high net worth individuals. Deans Knight, formed in 1992, has an experienced management team and a long history of successful investing in corporate debt securities.The Company's investment objectives are to: (i) maximize the total return for Shareholders, consisting of dividend income and capital appreciation; and (ii) provide Shareholders (as defined herein) with monthly dividends, which have, to date, been set at $0.0583 per month. The Company intends to achieve these objectives by investing primarily in corporate debt securities rated BBB or below by Standard & Poor's Rating Services ("S&P") or an equivalent rating by another nationally recognized statistical rating organization. The Company may also invest in investment grade debt securities rated above BBB and non-rated debt securities from time to time.The Company believes there are attractive investment opportunities today in owning corporate debt of businesses with tangible assets, strong cash flows and reasonable leverage.When evaluating bonds to purchase for the Company, Deans Knight focuses on the following:- amount of security or collateral within a business to offset the value of the bonds;- the position of the debt in the capital structure;- covenants;- liquidity;- the business's ability to reduce or refinance the debt; and- the overall term of the debt and yield to bondholders.Deans Knight employs the above credit-based analysis to identify corporate debt for inclusion in the Company's investment portfolio with attractive valuations in order to maintain its targeted dividend payment.RiskThe overall risks of the Company are as described in its annual information form dated March 15, 2011 (the "AIF"). The Company does not believe there have been any changes over the financial period that has affected the overall level of risk associated with an investment in the Company.Prior to the reorganization and change in business, as discussed in the notes of the Financial Statements, the Company had generated significant tax losses and other tax attributes as a result of its prior businesses and research activities. The Company has recorded, as a tax asset, the full amount of the potential tax benefit of such items to the extent of its projected taxable income. There is no guarantee that the tax authorities will allow the Company to deduct some or all of the tax losses and other attributes. Should the Company be denied the deductions, the recorded amount of the tax assets, as well as such amounts claimed to date, would be recorded as a charge to income. The total tax assets recognized and tax losses and other attributes claimed to date, which are subject to uncertainty, amount to $21,247,000, representing $2.02 per common share at June 30, 2011.Given the type of investments made by the Company, an investment in the Company may be considered to be speculative. An investment in the Company is generally suitable for investors who are looking to receive income, yet who are willing to tolerate volatility in the value of their investment.Results of OperationsAs per the financial statements, the net assets of the Company at June 30, 2011 were $143,428,658, or $13.61 per common share, compared to $143,343,361, or $13.60 per common share at December 31, 2010. The net assets of the Company consisted of the following components: June 30, 2011 -------------------------------------------- Per common $ share(1) %Investments(2) 133,558,796 12.67 93.1Cash and short-term deposits 2,618,721 0.25 1.8Accrued income 1,888,705 0.18 1.3Prepaid expenses 158,159 0.02 0.0Future income tax asset(3) 5,870,000 0.56 4.1Accounts payable and accrued liabilities (665,723) (0.07) (0.3) -------------------------------------------- 143,428,658 13.61 100.0 -------------------------------------------- --------------------------------------------(1) Based on 10,537,263 common shares, including 10,191,592 voting common shares and 345,671 non-voting common shares, as outlined in the notes to the Financial Statements.(2) The details of the investments are outlined in the Summary of Investment Portfolio below.(3) Refer to the Taxation note to the Financial Statements for more detail. December 31, 2010 -------------------------------------------- Per common $ share(1) %Investments(2) 128,449,450 12.19 89.6Cash and short-term deposits 7,137,967 0.68 5.0Accrued income 1,808,756 0.17 1.2Prepaid expenses 89,662 0.01 0.1Future income tax asset(3) 6,550,000 0.62 4.6Accounts payable and accrued liabilities (692,474) (0.07) (0.5) -------------------------------------------- 143,343,361 13.60 100.0 -------------------------------------------- --------------------------------------------(1) Based on 10,537,263 common shares, including 10,191,592 voting common shares and 345,671 non-voting common shares, as outlined in the notes to the Financial Statements.(2) The details of the investments are outlined in the Summary of Investment Portfolio below.(3) Refer to the Taxation note to the Financial Statements for more detail.In early 2009, in the midst of the global recession and financial panic, non-investment grade corporate bond prices collapsed. The spread between high yield bonds and government bonds widened to unprecedented levels not seen before (see graph below). http://media3.marketwire.com/docs/805dnc1.jpg At that time, the Investment Manager felt strongly that the market was overreacting because of fear. It saw many opportunities where they believed that bonds were backed by solid assets, and in the unlikely case of default, full recovery of investments was reasonably assumed.To take advantage of these opportunities, the Company raised $94,100,000 (net of offering costs of $6,268,900) by way of an initial public offering ("IPO") that closed on March 18, 2009. Although the recovery has been disappointing in some respects, unemployment remains stubbornly high and real estate continues to be a soft spot, confidence has gradually been restored. Non-investment grade bond prices have recovered and yield spreads have returned to normal levels.The Company's net asset value has risen 36% since the IPO, excluding the $0.70 per share annual dividend we have maintained since June 30, 2009.As we move through 2011, the U.S. economic recovery is slowing; China's growth is slowing; and Greece's debt woes have called the stability of the Eurozone into question. Nevertheless, the fundamentals of many companies, including the portfolio's investments, are stronger now than prior to the recession. Moreover, the average yield on the Company's bond holdings is still very attractive....double that of investment grade bonds and three times that of government bonds. http://media3.marketwire.com/docs/805dnc2.jpg Given the solid credit quality of the Company's holdings, the current 8.2% yield is very attractive compared to either government or investment grade bonds. The yields provided by government and investment grade bonds are far too low to compensate investors for the risk of rising interest rates. Further to this, the average duration of the Company's portfolio at June 30, 2011 is 4.2 years, compared to 4.7 years for 5-year Canadian Government Bonds' and 5.6 years for Canadian Investment Grade bonds.The Company also attempts to add additional value, by opportunistically investing in private debt financings with equity incentives. In August 2009, the Company purchased a portion of a $10 million, 8% convertible debenture for Whitecap. The Whitecap Debenture had an exercise price of $2.88 and on December 8, 2010, the Company converted the Whitecap Debenture into equity. On June 30, 2011 Whitecap's share price closed at $6.27 per share. Whitecap has grown production from 850 barrels of oil equivalent per day ("boepd") to 6,000 boepd, 60% of which is oil, and the Company believes management can continue to grow production per share and create additional value for shareholders going forward. Deans Knight Income Corp. sold 52% of its holding in Whitecap at $6.16, but still holds 1,254,167 shares (5.5% of the Company's net asset value).Recent DevelopmentsComparison of net asset value and net assetsNational Instrument 81-106 ("NI 81-106") permits investment companies to have two different net asset values: (i) one for financial statements, which will be prepared in accordance with Canadian Generally Accepted Accounting Principles ("GAAP") including Section 3855 (and referred to as "net assets", previously disclosed as "GAAP Net Assets"); and (ii) another for all other purposes, including unit pricing for investor transactions (referred to as "net asset value", previously referred to as "Pricing NAV"). The main difference in calculating net assets and net asset value is that GAAP requires bid price to be used in valuing securities traded in an active market where quoted prices are readily and regularly available, rather than the use of a price between the bid and the ask price currently used for determining net asset value. This difference results in a difference of approximately $0.02 per common share at June 30, 2011, as outlined in the notes to the Financial Statements.International Financial Reporting StandardsThe Company is required to adopt international financial reporting standards ("IFRS"). The Canadian Accounting Standards Board (AcSB) previously announced January 1, 2011 as the date international financial reporting standards (IFRS) will replace current Canadian standards and interpretations as GAAP for publicly accountable enterprises, which include investment companies.However, on January 12, 2011, the AcSB issued a decision to defer adoption of IFRS for investment companies until years beginning on or after January 1, 2013. This is a further delay from the previously issued exposure draft of proposed accounting standard to defer IFRS for investment companies currently applying Accounting Guideline 18 - Investment Companies until years beginning on or after January 1, 2012.Under the above noted decision, the Company's first set of financial statements to be reported on under IFRS will be for the semi-annual period ending June 30, 2013. These statements will include corresponding comparative financial information for 2012, including an opening statement of net assets as at January 1, 2012.The Company has established a transition plan to ensure that it is able to meet its reporting requirements. The plan consists of three main elements, which include:- Identifying differences between the current accounting policies of the Company, which reflect current Canadian GAAP, and those expected to apply under IFRS and the likely financial statement impact resulting from the adoption of IFRS;- Analyzing the impact of the adoption of IFRS on business and reporting processes;- Disclosing the qualitative impact in the December 31, 2009 management report of fund performance and disclosing the quantitative impact, if any, in the December 31, 2012 management report of fund performance.Based on the Company's analysis of current accounting policies and presentation under GAAP against IFRS the adoption of IFRS is not expected to have a material effect on the Company's net assets or net assets per share. The primary impact will be in the areas of presentation and note disclosure. Further, the Company does not believe that the changeover to IFRS will materially affect the Company's existing business arrangements.However, it should be noted that there are additional changes to IFRS expected during 2011 and 2012. This potential for change creates some uncertainty regarding the expected accounting standards that will be applicable upon the Company adopting IFRS. As such, the Company cannot conclusively determine the impact that the adoption of IFRS will have.Throughout the remainder of 2011 and 2012, the Company will continue to monitor new standards and recommendations as they are issued by both the International Accounting Standards Board, who is responsible for the development and publication of IFRS, and the AcSB, to update its analysis as appropriate. By the fourth quarter of the year predating the required adoption, the Company expects to complete its analysis, determine overall financial statement presentation, and complete its assessment. Any changes required with respect to its business arrangements will then be adopted.Related Party TransactionsThe officers, and certain directors, of the Company are also employees of the Investment Advisor, Deans Knight Capital Management Ltd. These officers, and directors, are not paid by the Company. Deans Knight provides investment management services to the Company, as well as administration, financial reporting and other ancillary services required by a publicly listed company. Management fees, for the services outlined above, are computed and paid quarterly, at an annual rate of 1.5% of the net asset value plus applicable taxes, and adjusted for certain non-investment related assets.For the six month period ended June 30, 2011, management fees totaled $1,165,607 (2010 - $980,755). In calculating the amount, the net asset value was reduced by the value of the future income tax asset included in the statement of net assets.A director of the Company is a partner at a law firm that provides legal services to the Corporation. During the six month period ended June 30, 2011, the Corporation incurred $17,895 (2010 - $17,409) in legal services and disbursements received from this related party. At June 30, 2011, accounts payable and accrued liabilities include $1,532 (December 31, 2010 - $1,355) to the law firm for legal fees and disbursements, which have not been billed.Financial HighlightsThe following tables show selected key financial information about the Company and are intended to help you understand the Company's financial performance since it began operating its new business of investing in corporate debt in March 2009.The Company's Net Assets per Common Share (1) Six months Year ended December 31, ended June 30, 2011 2010 2009 $ $ $----------------------------------------------------------------------------Net assets, beginning of period 13.60 12.21 9.12Increase (decrease) from operationsTotal revenue 0.52 0.95 0.62Total expenses (0.14) (0.25) (0.20)Realized gains (losses) for the period 0.41 1.82 1.25Unrealized (losses) gains for the period (0.37) (0.27) 1.21Recovery of future income taxes (0.06) (0.16) 0.62----------------------------------------------------------------------------Total increase from operations 0.36 2.09 3.50----------------------------------------------------------------------------Dividends from income (3) (0.35) (0.70) (0.41)----------------------------------------------------------------------------Net assets at end of period (4) 13.61 13.60 12.21--------------------------------------------------------------------------------------------------------------------------------------------------------(1) The information is derived from the Company's audited annual and unaudited interim financial statements. Common shares outstanding are 10,537,263, including 10,191,592 voting common shares and 345,671 non-voting common shares.(2) Net assets and dividends are based on the actual number of shares outstanding at the relevant time. The increase/decrease from operations is based on the weighted average number of shares outstanding over the period from the date the Company began operating its new business to December 31, 2009.(3) Dividends were paid in cash.(4) The net assets per share presented in the financial statements differs from the net asset value per share calculated for fund pricing purposes due to the provisions of CICA Handbook Section 3855. An explanation of the differences can be found in the notes to the financial statements.Ratios and Supplemental Data Six months Year ended December 31, ended June 30, 2011 2010 2009 $ $ $----------------------------------------------------------------------------Net asset value (000's) 143,343 143,880 128,930Number of common sharesoutstanding (000's) 10,537 10,537 10,537Management expense ratio (1) (2) 1.56% 1.91% 5.51%Portfolio turnover rate (3) 26.7% 86.60% 36.69%Trading expense ratio (4) 0.00% 0.01% 0.01%Net asset value per common share $13.63 $13.65 $12.23Closing market price - common share $12.61 $12.54 $11.40(1) Management expense ratio is based on total expenses for the period and is expressed as an percentage of weekly average net asset values over the period. For 2009, this ratio is calculated from the date the Company began operating its business as an investment fund, on March 17, 2009, to December 31, 2009. (2) The Management expense ratio for 2009 includes offering costs for the IPO of $6,268,800 less the offsetting related future tax benefit of $1,692,500.(3) The Company's portfolio turnover rate indicates how actively the Company manages its portfolio investments. A portfolio turnover rate of 100% is equivalent to the Company buying and selling all of the securities in its portfolio once in the course of the year. The higher a portfolio turnover-rate in a year, the greater the trading costs payable by the Company in the year. There is not necessarily a relationship between a high turnover rate and the performance of the investment portfolio.(4) The trading expense ratio represents total commissions and other portfolio transaction costs expressed as an annualized percentage of daily average net asset value during the period. As the purchasing and selling of bonds do not attract a commission from the buying or selling party.Management FeesDeans Knight provides investment management services to the Company, as well as administration, financial reporting and other ancillary services required by a publicly listed company. Management fees are computed and paid quarterly, at an annual rate of 1.5% of the net asset value plus applicable taxes, and adjusted for certain non-investment related assets.Past PerformanceThis section shows the Company's past performance, since it began operating its business as an investment fund. The past performance information includes changes in net asset value and assumes the reinvestment of all dividends paid to common shareholders. It is important to note that the past performance will not necessarily indicate what performance in the future will be.Year-by-year returnsThe accompanying bar chart shows the Company's performance for the periods shown and illustrates how the Company's performance has changed from period to period. The bar chart shows, in percentage terms, how much an investment made when it began its operation as an investment fund, March 17, 2009 to December 31, 2009, how much an investment made for the year ended December 31, 2010, and how much an investment made for the six month period ending June 30, 2011. http://media3.marketwire.com/docs/805dnc3.jpg Summary of Investment Portfolio----------------------------------------------------------------------------Top 25 Investments % of Net Asset ValueParamount Resources Ltd. 8.250% 13-Dec-17 6.6North American Energy 9.125% 7-Apr-17 6.1Stone Energy Corp. 8.625% 1-Feb-17 6.0Whitecap Resources Inc. N/A N/A 5.5CCS Inc. 11.000% 15-Nov-15 5.4Calfrac Holdings LP 7.500% 1-Dec-20 4.1Southern Pacific Resource Corp. 10.750% 7-Jan-16 4.1Mirabella Nickel Inc. 8.750% 15-Apr-18 4.0Perpetual Energy Inc. 8.750% 15-Mar-18 3.5Harvest Energy, Inc. 7.250% 30-Sep-13 3.3Skylink Aviation Inc. 12.250% 15-Mar-16 3.3Mercator Minerals 6.500% 3-Jan-13 3.1Cott Beverages Inc. 8.375% 15-Nov-17 3.1National Money Mart Company 10.375% 15-Dec-16 3.0Cara Operations Ltd. 9.125% 1-Dec-15 2.7Tembec Industries Inc. 11.250% 15-Dec-18 2.6Trinidad Drilling Ltd. 7.875% 15-Jan-19 2.4Gateway Casinos & 8.875% 15-Nov-17 2.0Entertainment Inc.Black Press Group 10.000% 4-Feb-14 1.9Pacific Rubiales Energy 8.750% 10-Nov-16 1.9Beazer Homes USA, Inc. 9.125% 15-Jun-18 1.9Garda World Security Corp. 9.750% 15-Mar-17 1.8Sure Energy Inc. 6.250% 21-Jan-14 1.7Newalta Corp. 7.625% 23-Nov-17 1.6McMoran Exploration 11.875% 15-Nov-14 1.4----------------------------------------------------------------------------Portfolio Composition % of Net Asset ValueEquity and Warrants 5.7Fixed IncomeCanadian denominated in CAD 40.2Canadian denominated in USD 24.8United States denominated in USD 17.6 --------- 82.6 ---------Convertible DebenturesCanadian denominated in CAD 3.3Other Foreign denominated in AUD 1.1Investment Portfolio 92.7Cash & Short-term Deposits 1.8Other Net Assets 5.5 --------- 100.0 --------- ---------Sector BreakdownEnergy 57.0Consumer Discretionary 9.6Services 6.1Materials & Metals 9.4Forestry 3.8Financial Services 3.0Industrial/Manufacturing 3.8 ---------Investment Portfolio 92.7Cash & Short-term Deposits 1.8Other Net Assets 5.5 --------- 100.0 --------- ---------Deans Knight Income CorporationFinancial StatementsJune 30, 2011(Unaudited)Deans Knight Income CorporationStatement of Net AssetsAs at June 30, 2011 (Unaudited)---------------------------------------------------------------------------- June 30, December 31, 2011 2010 $ $AssetsCurrentInvestments - at fair value (cost - June 30, 2011 - $127,518,870; December 31, 2010 - $118,563,957) 133,558,796 128,449,450Cash and cash equivalents 2,618,721 7,137,967Accrued interest receivable 1,888,705 1,808,756Prepaid expenses 158,159 89,662Future income tax benefits (note 8) 2,250,000 2,150,000---------------------------------------------------------------------------- 140,474,381 139,635,835Non-currentFuture income tax benefits (note 8) 3,620,000 4,400,000---------------------------------------------------------------------------- 144,094,381 144,035,835----------------------------------------------------------------------------LiabilitiesAccounts payable and accrued liabilities (note 6) 665,723 692,474----------------------------------------------------------------------------Net Assets 143,428,658 143,343,361--------------------------------------------------------------------------------------------------------------------------------------------------------Shareholders' EquityCommon shares (note 4) 99,366,429 99,366,429Contributed surplus (note 4) 9,904,504 9,904,504Retained earnings (note 5) 34,157,725 34,072,428---------------------------------------------------------------------------- 143,428,658 143,343,361--------------------------------------------------------------------------------------------------------------------------------------------------------Number of common shares outstanding (note 4) 10,537,263 10,537,263--------------------------------------------------------------------------------------------------------------------------------------------------------Net assets per common share (notes 8 and 11) 13.61 13.60--------------------------------------------------------------------------------------------------------------------------------------------------------Contingencies (notes 2 and 8)Commitment (note 10)Subsequent events (note 12)The accompanying notes are an integral part of these financial statements.Deans Knight Income CorporationStatement of OperationsSix-month period ended June 30, 2011 (Unaudited)---------------------------------------------------------------------------- 2011 2010 $ $Investment incomeInterest and other 5,459,044 5,036,042----------------------------------------------------------------------------ExpensesManagement fees (note 6) 1,165,607 980,755Public company reporting costs 93,067 72,699Directors' fees and expenses 87,086 84,535Audit, accounting and tax fees 37,043 53,384Custodial fees 24,607 15,408Legal fees 17,895 17,409Independent Review Committee fees 4,500 4,500---------------------------------------------------------------------------- 1,429,805 1,228,690----------------------------------------------------------------------------Net investment income 4,029,239 3,807,352----------------------------------------------------------------------------Realized and unrealized gains (losses) on investmentsNet realized gain on securities sold (note 7) 2,064,001 2,572,267Net realized gain on settlement of foreign currency contracts (note 7) 2,203,559 444,042Change in unrealized (depreciation) appreciation on investments (4,457,177) 5,246,375Unrealized appreciation (depreciation) on foreign currency contracts 611,610 (1,438,353)----------------------------------------------------------------------------Net gain on investments 421,993 6,824,331----------------------------------------------------------------------------Increase in net assets from operations before tax 4,451,232 10,631,683Provision for future income tax (note 8) (680,000) (2,190,000)----------------------------------------------------------------------------Increase in net assets from operations 3,771,232 8,441,683--------------------------------------------------------------------------------------------------------------------------------------------------------Increase in net assets from operations per weighted average common share (note 3) 0.36 0.80--------------------------------------------------------------------------------------------------------------------------------------------------------The accompanying notes are an integral part of these financial statements.Deans Knight Income CorporationStatement of Changes in Net AssetsSix-month period ended June 30, 2011 (Unaudited)---------------------------------------------------------------------------- 2011 2010 $ $Increase in net assets from operations 3,771,232 8,441,683Dividends to common shareholders (notes 5 and 10) (3,685,935) (3,685,935)----------------------------------------------------------------------------Increase in net assets during the period 85,297 4,755,748Net assets - Beginning of period 143,343,361 128,681,694----------------------------------------------------------------------------Net assets - End of period 143,428,658 133,437,442--------------------------------------------------------------------------------------------------------------------------------------------------------The accompanying notes are an integral part of these financial statements.Deans Knight Income CorporationStatement of Cash FlowsSix-month period ended June 30, 2011 (Unaudited)---------------------------------------------------------------------------- 2011 2010 $ $Cash flows from operating activitiesIncrease in net assets from operations 3,771,232 8,441,683 Items not affecting cash Net realized gain on securities sold (2,064,001) (2,572,267) Net realized gain on settlement of foreign currency contracts (2,203,559) (444,042) Change in unrealized depreciation (appreciation) on investments 4,457,177 (5,246,375) Unrealized (appreciation) depreciation on foreign exchange contracts (611,610) 1,438,353 Future income tax provision 680,000 2,190,000---------------------------------------------------------------------------- 4,029,239 3,807,352Cost of investments purchased (note 7) (40,887,826) (26,584,338)Proceeds from investments sold (note 7) 36,200,473 24,049,707Net change in non-cash balances related to operations Accrued interest receivable (79,949) (1,070,412) Prepaid expenses (68,497) (77,779) Accounts payable and accrued liabilities (26,751) 116,628---------------------------------------------------------------------------- (833,311) 241,158----------------------------------------------------------------------------Cash flows from financing activitiesDividends paid to common shareholders (note 5) (3,685,935) (3,685,935)---------------------------------------------------------------------------- (3,685,935) (3,685,935)----------------------------------------------------------------------------Net decrease in cash during the period (4,519,246) (3,444,777)Cash and cash equivalents - Beginning of period 7,137,967 6,042,756----------------------------------------------------------------------------Cash and cash equivalents - End of period 2,618,721 2,597,979--------------------------------------------------------------------------------------------------------------------------------------------------------Cash and cash equivalents compriseCash 2,618,721 2,597,979Short-term deposits - ----------------------------------------------------------------------------- 2,618,721 2,597,979--------------------------------------------------------------------------------------------------------------------------------------------------------The accompanying notes are an integral part of these financial statements.Deans Knight Income CorporationStatement of InvestmentsAs at June 30, 2011 (Unaudited)---------------------------------------------------------------------------- Percentage of total fair Par value Average cost Fair value value (1) (2) (2) (3) $ $ $ %Fixed income - CanadianDenominated in Canadian dollarsAir Canada 10.13% 08-01-2015 1,500,000 1,485,690 1,545,000 1.2Black Press Group 10% 02-04-2014 2,750,000 2,750,000 2,750,000 2.1Cara Operations Ltd. 9.13% 12-01-2015 3,750,000 3,750,000 3,890,625 2.9Flint Energy Services 7.5% 06-15-2019 1,750,000 1,732,500 1,723,750 1.3Garda World Security 9.75% 03-15-2017 2,500,000 2,472,105 2,643,750 2.0Gateway Casinos 8.88% 11-15-2017 2,750,000 2,816,875 2,860,000 2.1Mercator Minerals Ltd. 6.50% 01-03-2013 4,500,000 4,500,000 4,500,000 3.4Newalta Corp. 7.63% 11-23-2017 2,250,000 2,250,000 2,345,625 1.8North American Energy Partners Inc. (4) 9.13% 8,750,000 8,793,125 8,815,625 6.6 04-07-2017Paramount Resources 8.25% 12-13-2017 9,250,000 9,250,000 9,458,125 7.1Perpetual Energy Inc. 8.75% 03-15-2018 5,000,000 5,000,000 4,975,000 3.7Sherritt International Corp. 7.75% 10-15-2015 1,500,000 1,165,045 1,606,875 1.2Skylink Aviation Inc. 12.25% 03-15-2016 4,750,000 4,750,000 4,666,875 3.5Sure Energy 6.25% 01-21-2014 2,500,000 2,500,000 2,500,000 1.9Trident Exploration Corp. 8.25% 04-13-2018 1,650,000 1,650,000 1,596,375 1.2Vermilion Energy Inc. 6.50% 02-10-2016 1,750,000 1,750,000 1,780,625 1.3 ----------------------------------------- 56,615,340 57,658,250 43.3 -----------------------------------------Denominated in United States dollarsCCS Inc. 11.00% 11-15-2015 7,750,000 3,879,423 7,809,625 5.8CHC Helicopter 9.25% 10-15-2020 250,000 253,623 218,776 0.2Harvest Operations Corp. 6.88% 10-01-2017 1,750,000 1,783,273 1,742,370 1.3Mirabela Nickel Ltd. 8.8% 04-15-2018 6,000,000 5,811,649 5,727,942 4.3National Money Mart 10.38% 12-15-2016 4,000,000 4,363,855 4,233,277 3.2Pacific Rubiales Energy Corp. 8.75% 2,500,000 2,655,612 2,726,558 2.0 11-10-2016Southern Pacific Resource Corp. LIBOR+8.5% 5,970,000 5,897,667 5,814,440 4.4 01-07-2016Tembec Industries 11.25% 12-15-2018 3,750,000 4,015,216 3,787,891 2.8Trinidad Drilling 7.88% 01-15-2019 3,500,000 3,507,651 3,493,177 2.6 ----------------------------------------- 32,167,969 35,554,056 26.6 -----------------------------------------Total Canadian fixed income 88,783,309 93,212,306 69.9 -----------------------------------------(1) Par values are presented in their source currency(2) All amounts are shown in Canadian dollars(3) Percentages are shown as a percentage of total investments(4) These investments share a common director with the CompanyDeans Knight Income CorporationStatement of Investments...continuedAs at June 30, 2011 (Unaudited)---------------------------------------------------------------------------- Percentage of total fair Par value(1) Average cost(2) Fair value(2) value(3) $ $ $ %Fixed income - United StatesDenominated in United States dollarsABI Escrow Corp. 10.25% 10-15-2018 1,585,910 1,635,073 1,659,283 1.2Beazer Homes USA, Inc. 9.13% 06-15-2018 3,250,000 3,327,056 2,710,888 2.0Calfrac Holdings LP 7.5% 12-01-2020 6,000,000 6,130,329 5,858,123 4.4Cott Beverages Inc. 8.38% 11-15-2017 4,350,000 4,622,109 4,404,440 3.3McMoRan Exploration Co. 11.88% 11-15 2014 2,000,000 2,114,471 2,073,245 1.6Stone Energy Corp. 8.63% 2-01-2017 8,750,000 8,821,638 8,564,189 6.4----------------------------------------------------------------------------Total United States fixed income 26,650,676 25,270,168 18.9----------------------------------------------------------------------------Total fixed income 115,433,985 118,482,474 88.8----------------------------------------------------------------------------Convertible debentures - CanadianDenominated in Canadian dollarsHarvest Energy 7.25% 09-30 -2013 4,595,000 3,036,941 4,721,363 3.5Convertible debentures - AustralianDenominated Australian dollarsWestern Areas NL 8.0% 07-02-2012 1,500,000 1,322,276 1,587,125 1.2---------------------------------------------------------------------------- 4,359,217 6,308,488 4.7----------------------------------------------------------------------------EquitySure Energy Inc.- purchase warrants 625,000 - 292,599 0.2Whitecap Resources Inc. common shares 1,254,167 7,725,668 7,863,625 5.9---------------------------------------------------------------------------- 7,725,668 8,156,224 6.1----------------------------------------------------------------------------Investments subtotal 127,518,870 132,947,186 99.6----------------------------------------------------------------------------HedgesDenominated in United States and Australian dollarsForeign currency exchange contracts (note 9) 67,600,000 - 611,610 0.4---------------------------------------------------------------------------- 127,518,870 133,558,796 100.0--------------------------------------------------------------------------------------------------------------------------------------------------------(1) Par values are presented in their source currency (2) All amounts are shown in Canadian dollars(3) Percentages are shown as a percentage of total investments (4)These investments share a common director with the CompanyThe accompanying notes are an integral part of these financial statements.Deans Knight Income CorporationNotes to Financial StatementsAs at June 30, 2011 (Unaudited)1 Nature of operations and basis of presentationDeans Knight Income Corporation (the "Company") is a corporation continued under the laws of Canada on April 11, 2001. The Company is a closed-end, non-redeemable investment company. It invests, primarily, in corporate debt rated BBB or below by recognized credit rating organizations.Prior to the Company completing its reorganization in May 2008, it was in the business of pharmaceutical research. In May 2008, the Company was reorganized and the pharmaceutical research operations and all assets and liabilities were transferred out of the Company (note 2). In March 2009, the Company completed an initial public offering, whereby it raised gross proceeds of $100,368,900 and began operating its new business of investing in corporate debt.The common shares of the Company will be redeemed on, or around, April 30, 2014, for a cash amount equal to 100% of the net asset value per share.The accompanying financial statements are prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). All amounts are presented in Canadian dollars, unless otherwise noted.2 ReorganizationPrior to the Reorganization, the Company was a life sciences company involved in the research, development and commercialization of innovative products for the prevention and treatment of life-threatening diseases. Forbes Medi-Tech Inc ("Forbes"), who now carries on the prior business of the Company, has provided an indemnity to the Company with respect to liabilities relating to the Company's assets transferred to Forbes and the Company's prior business. In addition, Forbes obtained, on behalf of the Company, product liability insurance for certain claims that may arise in the future in connection with the Company's prior business. To date, no such claims or potential claims have arisen. There can be no assurance that the above noted guarantee will be sufficient to cover any future claims.3 Summary of significant accounting policiesThe following is a summary of significant accounting policies followed by the Company, and these policies are consistent with the most recent annual financial statements. These statements should be read in conjunction with the most recent annual financial statements.Financial instrumentsInvestmentsInvestments are held for trading and are recorded at fair values determined as follows:Fixed income investmentsFixed income investments traded on a public securities exchange or traded on an over-the-counter market are valued at the closing bid price. Where no closing bid price is available, the last sale or close price is used where, in management's opinion, this provides the best estimate of fair value.Unlisted or non-exchange traded investments, or investments where a last bid, sale or close price is unavailable, or investments for which market quotations are, in the Company's opinion, inaccurate, unreliable, or not reflective of all available material information, are valued at their fair value as determined by the Company using appropriate and accepted industry valuation techniques including valuation models. The fair value determined using valuation models requires the use of inputs and assumptions based on observable market data including volatility and other applicable rates or prices. In certain circumstances, the fair value may be determined using valuation techniques that are not supported by observable market data.The resulting values for investments not traded in an active market may differ from values that would be determined had a ready market existed, and the difference could be significant.Forward currency contractsForward currency contracts are recorded at fair value. The proceeds (payments) on contracts settled during the six month period are included in the net realized gain on settlement of foreign currency contracts (note 7). The Company's policy is to hedge 95% - 106% of the fair value of foreign denominated investments with foreign exchange forward sell contracts.Public company equitiesPublicly traded equities are recorded at bid prices as quoted on recognized stock exchanges.The amounts at which the Fund's publicly-traded investments could be disposed of currently may differ from carrying value based on market quotes, as the value at which significant ownership positions are sold is often different than the quoted market price due to a variety of factors such as premiums paid for large blocks or discounts due to illiquidity.WarrantsWarrants are recorded at their estimated fair value, using appropriate and accepted industry valuation techniques.The impact of changes in fair value on net income of the Company arising from changes in estimated fair value for investments is recorded in the statement of operations.Cash and cash equivalentsCash and cash equivalents are accounted for at amortized cost. They consist of cash and deposits with maturities, at the time of purchase, of three months or less and are held with a Canadian chartered bank.Accrued interest receivableAccrued interest is designated as loans and receivables and is accounted for at amortized cost. Due to the immediate and short-term nature, carrying value approximates fair value.Financial liabilitiesFinancial liabilities, consisting of accounts payable and accrued liabilities, are designated as other financial liabilities and are accounted for at amortized cost. Due to the immediate and short-term nature, carrying value approximates fair value.Investment transactionsInvestment transactions are recorded on the trade date. Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of an investment, which include fees and commissions paid to agents, advisors, brokers and dealers, levies by regulatory agencies and securities exchanges, and transfer taxes and duties. These costs are expensed and are included in the statement of operations.Income recognitionIncome from investments is recognized on an accrual basis. Interest income is accrued based on the number of days the investment is held. Gains or losses on the sale of investments, including foreign exchange gain or loss on such investments, are calculated on an average cost basis.Forward foreign currency contractsForward foreign currency contracts (note 9) entered into by the Company are valued at an amount that is equal to the gain or loss that would be realized if the position were to be closed out, which is equivalent to the difference between the deliverable asset and the value of the asset to be received. Changes in the value of a forward contract or the assets deliverable under such a contract are included as unrealized appreciation/depreciation of foreign currency contracts in the statement of operations.Foreign exchangeAssets and liabilities denominated in foreign currencies are translated into Canadian dollars at the exchange rate applicable on the valuation date. Purchases and sales of investments, investment income and expenses are calculated at the exchange rates prevailing on the dates of the transactions.Income taxesThe Company follows the asset and liability method of accounting for income taxes. Future income tax assets and liabilities are measured using rates expected to apply to the taxable income in the years in which the temporary differences are expected to be settled. The Company accounts for uncertain tax positions using the contingent liability model, whereby a provision is established only where it is likely that a payment will be required to be made.A valuation allowance is recognized to the extent it is more likely than not that future income tax assets will not be realized. Management has estimated the income tax provision and future income tax balances taking into account its expectation of future income and an interpretation of the various income tax laws and regulations. It is possible, due to the complexity inherent in estimating income taxes, that the tax provision and future tax balances could change (note 8), and the change could be significant.Use of estimatesThe preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Actual results could differ from those reported and such differences could be material. Significant areas involving the use of estimates include determining the estimated fair value of investments and future income tax assets.Net assets per common shareThe net assets per common share is computed by dividing the net assets of the Company by the total number of common shares outstanding on the balance sheet date.Increase in net assets from operations per weighted average common shareThe increase in net assets from operations per common share represents the increase in net assets from operations divided by the weighted average number of common shares outstanding during the period.The weighted average number of shares outstanding during the six month period ended June 30, 2011 was 10,537,263 (June 30, 2010 - 10,537,263). This weighted average includes both the voting common shares and non-voting common shares of the Company.Comparative figuresCertain of the comparative figures have been reclassified to conform with the current period presentation.4 Capital stockThe Company is authorized to issue an unlimited number of voting common shares without par value, and an unlimited number of non-voting common shares without par value.There have been no changes in the number of voting and non-voting common shares for the periods ended June 30, 2010 and June 30, 2011.The total shares outstanding at June 30 are summarized as follows: June 30, 2011 December 31, 2010 Number of Amount Number of Amount Shares $ Shares $Voting common shares 10,191,592 96,273,343 10,191,592 96,273,343Non-voting common shares 345,671 3,093,086 345,671 3,093,086 ------------------------------------------------Total common shares outstanding 10,537,263 99,366,429 10,537,263 99,366,429 ------------------------------------------------ ------------------------------------------------Contributed surplusThe contributed surplus balance did not change during the six month period,and consists of: June 30, December 31, 2011 2010 $ $Surplus related to stock compensation, warrants and options associated with common shares 8,030,295 8,030,295Surplus relating to warrants associated with previously issued preferred shares 1,874,209 1,874,209 ---------------------------- 9,904,504 9,904,504 ---------------------------- ----------------------------5 Retained earningsThe changes in retained earnings for the six monthperiod ended June 30 were as follows: 2011 2010 $ $Retained earnings - Opening balance 34,072,428 19,410,761Increase in net assets from operations 3,771,232 8,441,683Dividends paid from net investment income (3,685,935) (3,685,935) ----------------------------Retained earnings - closing balance 34,157,725 24,166,509 ---------------------------- ----------------------------6 Related party transactions and balancesManagement fees are paid quarterly to Deans Knight Capital Management Ltd. (the Investment Advisor), a corporation with certain common directors and officers of the Company, for services received in connection with the management of the investment portfolio and financial accounts, among other services provided. Management fees are computed quarterly at an annual rate of 1.5% of net asset value, adjusted for certain non-investment related assets. For the six month period ended June 30, 2011, management fees totalled $1,165,607 (June 30, 2010 - $980,755). At June 30, 2011, $576,164 (December 31, 2010 - $599,474 ) was owed to the Investment Advisor, which was included in accounts payable and accrued liabilities in the statement of net assets and is payable immediately.A director of the Company is a partner at a law firm that provides legal services to the Company. During the six month period ended June 30, 2011, the Company incurred $17,895 (June 30, 2010 - $17,409) in legal services and disbursements received from this related party. At June 30, 2011, accounts payable and accrued liabilities include $1,532 (December 31, 2010 - $1,355) due to the law firm for legal fees and disbursements.7 Net realized gains on investments sold and foreign currency contracts The net realized gain on sale of investments for the six-month period ended June 30 was as follows: 2011 2010 $ $ Proceeds from sale of investments 36,200,473 24,049,707 ---------------------------- Investments at cost - Beginning of period 118,563,957 100,510,397 Add: Cost of investments purchased 40,887,826 26,584,338 ---------------------------- 159,451,783 127,094,735 Less: Investments at cost - End of period (127,518,870) (106,061,337) ---------------------------- Cost of investments sold 31,932,037 21,033,398 ---------------------------- Net realized gains on investments sold 4,267,560 3,016,309 ---------------------------- ----------------------------Net realized gains on investments sold consist of: 2011 2010 $ $ Realized gains on securities sold 2,064,001 2,572,267 Realized gains on settlement of foreign currency contracts 2,203,559 444,042 ---------------------------- 4,267,560 3,016,309 ---------------------------- ----------------------------8 TaxationUncertainty of deductibility of tax lossesPrior to the reorganization and change in business as discussed in notes 1 and 2, the Company had generated significant tax losses and other tax attributes as a result of its prior businesses and research activities. The Company has recorded, as a tax asset, the full amount of the potential tax benefit of such items to the extent of its projected taxable income. There is no guarantee that the tax authorities will allow the Company to deduct some, or all, of the tax losses and other attributes. Should the Company be denied the deductions, the recognized amount of the tax assets, as well as such amounts claimed to date, would be recorded as a charge to income. The total tax assets recognized and tax losses and other attributes claimed to date, which are subject to uncertainty, amount to $21,247,000 (December 31, 2010 - $20,747,249), representing $2.02 per common share at June 30, 2011 (December 31, 2010 - $1.97 per common share).Future tax assetCanadian GAAP requires a valuation allowance to be recognized against any future tax asset to the extent that it is more likely than not that the future income tax asset will not be realized. This is also the Company's stated accounting policy.Prior to commencing operations as an investment corporation in March 2009, the Company had determined that it had not met this test. As such, the Company recorded a full valuation allowance against the potential value of all of its tax losses and deductions available to be taken against future years' taxable income.As the Company's investments in debt securities are now generating interest income, and are expected to continue to generate income during the years of operations through to April 30, 2014, the Company concluded that the valuation allowance should be reduced accordingly. The difference between the total value of these tax benefits less the valuation allowance, being $5,870,000 (December 31, 2010 - $6,550,000), is the amount of the future income tax asset that has been recorded by the Company in the statement of net assets. The valuation allowance is reviewed periodically, based on updated projections of taxable income, and adjusted accordingly by a credit or charge to the statement of operations in that period.The tax effects of temporary differences that give rise to significant components of the future income tax assets at the statutory enacted rates are as follows: June 30, December 31, 2011 2010 $ $Future tax assetsResearch and development expenditures 7,630,000 8,467,000Investment tax credits 6,032,450 6,032,450Share issuance costs 629,900 959,100 ----------------------------Total gross future tax assets 14,292,350 15,458,550Valuation allowance (8,422,350) (8,908,550) ----------------------------Net future tax asset 5,870,000 6,550,000Less: current portion (2,250,000) (2,150,000) ---------------------------- 3,620,000 4,400,000 ---------------------------- ----------------------------The tax balances and income tax expense recognized by the Company are based on management's interpretation of the tax laws. Due to the complexity inherent in tax interpretations, regulations and legislation, there are significant estimates required to compute income tax balances. It is possible that some or all of the Company's significant components of the future income tax assets may not be deductible for tax purposes and, accordingly, the amount of future income taxes and provision for (recovery of) income taxes recorded in the financial statements could change by a material amount.In determining the amount of future income tax assets recognized, management assessed the projected taxable income of the Company. Inherent in all forward looking information is uncertainty and actual amounts could differ from these estimates and the difference could be material. In developing the projection, management has assumed full payment of all contractual interest, that investments maturing prior to April 30, 2014 will be redeemed for par value, that reinvested funds will achieve an 8% yield, and that investments maturing after April 30, 2014 will be sold at their current value.Tax pools available to offset future tax expense and payableThe operations of the Company and related tax interpretations, regulations and legislation are continually changing. As a result, significant estimates are required to compute income tax balances. As at June 30, 2011, the Company has accumulated scientific research and experimental development expenditures in the amount of $30,264,000 available for carry-forward indefinitely. The Company also has accumulated approximately $7,097,000 of unclaimed federal investment tax credits, which expire as follows: Investment tax credits $Year of expiry2018 265,0002019 990,0002020 1,872,0002021 2,483,0002022 298,0002023 187,0002024 496,0002025 506,000 ---------------------------- 7,097,000 ---------------------------- ----------------------------Reconciliation of income tax expenseThe reconciliation of income tax computed at the statutory tax rate toincome tax expense at June 30, using a 26.5 % statutory tax rate(2010 - 28.5%), is: 2011 2010 $ $Increase in net assets from operations before taxes 4,451,232 10,631,683Statutory tax rate 26.5% 28.5% ------------------------Income tax expense at statutory rates 1,179,576 3,030,030Use of prior year losses - (2,672,708)Use of scientific research and experimental development expenditures (847,330) -Changes in valuation allowance 680,000 2,190,000Current tax deductions for offering costs (332,246) (357,322) ------------------------ ------------------------Income tax provision 680,000 2,190,000 ------------------------ ------------------------9 Financial instrumentsThe following tables illustrate the classification of the Company's financial instruments within the fair value hierarchy: Financial assets at fair value - June 30, 2011 ---------------------------------------------------- Level 1 Level 2 Level 3 Total $ $ $ $Corporate debt - 102,085,725 16,396,749 118,482,474Convertible debentures - 6,308,488 - 6,308,488Equity 7,863,625 - 292,599 8,156,224Foreign currency forward contracts - 611,610 - 611,610 ---------------------------------------------------- 7,863,625 109,005,823 16,689,348 133,558,796 ---------------------------------------------------- ---------------------------------------------------- Financial assets at fair value - December 31, 2010 ---------------------------------------------------- Level 1 Level 2 Level 3 Total $ $ $ $Corporate debt - 91,969,703 14,475,875 106,445,578Convertible debentures - 9,334,369 3,617,677 12,952,046Equity 7,826,002 - 400,000 8,226,002Foreign currency forward contracts - 825,824 - 825,824 ---------------------------------------------------- 7,826,002 102,129,896 18,493,552 128,449,450 ---------------------------------------------------- ----------------------------------------------------All investments remained at their respective levels within the fair value hierarchy during the six month period.The following table reconciles the Company's Level 3 fair value measurements: Corporate Convertible debt debentures Equity Total $ $ $ $Balance - December 31, 2009 11,616,418 10,561,008 - 22,177,426Purchases 7,500,000 1,879,862 - 9,379,862Sales (6,061,608) (17,921,531) - (23,983,139)Unrealized appreciation included in net gain on investments 1,421,065 9,098,338 400,000 10,919,403 ----------------------------------------------------Balance - December 31, 2010 14,475,875 3,617,677 400,000 18,493,552 ----------------------------------------------------Purchases 4,500,000 - - 4,500,000Sales (5,000,000) (2,148,120) - (7,148,120)Unrealized appreciation included in net gain on investments 833,749 117,568 (107,401) 843,916 ----------------------------------------------------Balance - June 30, 2011 14,809,624 1,587,125 292,599 16,689,348 ---------------------------------------------------- ----------------------------------------------------Management of financial risksIn the normal course of business, the Company is exposed to various financial risks, including credit risk, liquidity risk and market risk (consisting of interest rate risk, currency risk and other price risk). The Company's overall risk management program seeks to minimize potentially adverse effects of these risks on the Company's financial performance by employing a professional, experienced portfolio adviser, monitoring daily the Company's positions and market events, diversifying the investment portfolio within the constraints of the investment guidelines and periodically using derivatives to hedge certain risk exposures. Further, the Company monitors the portfolio to ensure compliance with its investment strategy, investment guidelines and securities regulations.Fair value riskThe Company's investments are exposed to market price risk and this risk affects the fair value of the investments. All fixed income investments have an inherent risk of loss of capital. The maximum risk resulting from investments is determined by their fair value. The Company seeks to manage valuation risks by careful selection of fixed income investments prior to making an investment and by regular ongoing monitoring of the investment performance of the individual investee companies.Credit riskCredit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment that it has entered into with the Company.All transactions executed by the Company in listed securities are settled/paid for upon delivery using approved brokers. The risk of this settlement not occurring is considered minimal, as delivery of securities sold is only made once the broker has received payment. Payment is made on a purchase once the securities have been received by the broker. The trade will fail if either party fails to meet its obligation. Since the Company invests in high-yield debt instruments and derivatives, this represents the main concentration of credit risk. The fair value of debt securities includes consideration of the creditworthiness of the debt issuer. The maximum credit exposure of these assets is represented by their carrying amounts. This maximum exposure may be offset to varying degrees in each investment, based on the collateral held, if any. Collateral may include such things as a general security agreement over all assets, or specific security over specific assets. It may also entitle the debt holder to take over the overall business, through restructuring of the investment.The Company's credit risk exposure by credit ratings on its investments is listed as follows: As a % of net assets ------------------------ June 30, December 31, 2011 2010Credit ratingBB 5.5 10.7B 50.9 36.0CCC 21.3 21.3CC - 1.0Not rated(1) 15.0 20.0 ------------------------ 92.7 89.0 ------------------------ ------------------------(1) Unrated debt securities consist primarily of equity securities, convertible debentures and promissory notes in publicly traded companies.Credit ratings are obtained from various credit rating agencies and sources. Where one or more rating is obtained for a security, the lowest rating has been used.The Company's credit risk exposure by sector on its investments is as follows: As a % of net assets ------------------------ June 30, December 31, 2011 2010SectorEnergy 57.0 57.1Consumer goods 9.6 9.4Materials and metals 9.4 6.0Services 6.1 3.6Industrial/manufacturing 3.8 2.2Forestry 3.8 4.3Financial services 3.0 3.0Chemicals - 3.4 ------------------------ 92.7 89.0 ------------------------ ------------------------Interest rate riskInterest rate risk arises from the possibility that changes in interest rates will affect future cash flows or fair values of financial instruments.The Company invests primarily in interest-bearing financial instruments. As such, the Company is exposed to the risk that the value of such financial instruments will fluctuate due to changes in the prevailing levels of market interest rates. The table below summarizes the Company's exposure to interest rate risk by term to maturity: Fair value ---------------------------- June 30, December 31, 2011 2010 $ $MaturityLess than 1 year 611,610 5,825,8241 - 3 years 16,058,487 16,154,6453 - 5 years 29,187,309 27,443,442Greater than 5 years 79,545,166 70,799,537 ---------------------------- 125,402,572 120,223,448 ---------------------------- ----------------------------As at June 30, 2011, if the prevailing interest rates had been raised or lowered by 1%, assuming a parallel shift in the yield curve, with all other factors remaining constant, net assets could possibly have decreased or increased, respectively, by approximately $5,150,000, or approximately 3.6% of net assets (December 31, 2010 - $4,900,000, or approximately 3.4% of net assets).Liquidity riskAs the Company is a publicly traded, closed-end investment company with a fixed number of common shares outstanding, unlike an open-ended mutual fund, it is not exposed to the liquidity risk associated with daily cash redemptions of securities.Investments in fixed income investments may not be able to be liquidated quickly at an amount close to their fair value to respond to specific events such as deterioration in the creditworthiness of any particular issuer. Fixed income investments purchased by the Company may be subject to resale restrictions such as hold periods. The resulting values for fixed income investments may differ from values that would be realized had a ready market existed.The Company actively reviews its investment portfolio, and the fixed income market, to assess liquidity risk on its holdings.Currency riskCurrency risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates. The Company invests a portion of its assets is securities that are denominated in a currency other than the Canadian dollar, which represents the functional currency of the Company. Consequently, the Company is exposed to currency risk as the value of the portfolio securities denominated in currencies other than the Canadian dollar will vary due to changes in foreign currency exchange rates.The Company enters into foreign currency contracts with financial institutions to hedge the value of foreign currency denominated investments. The fair value of these contracts is reflected in investments. Gains or losses arising from these contracts offset the gains or losses from the underlying investments. The unrealized gains or losses are reflected in unrealized appreciation/depreciation on foreign currency contracts on the statement of operations.The tables below indicate the foreign currency to which the Company had significant exposure in Canadian dollar terms. The tables also illustrate the potential impact to the Company's net assets, all other variables held constant, as a result of a 5% change in this currency relative to the Canadian dollar, assuming the forward currency contracts in place did not offset the foreign currency risk. As at June 30, 2011 -------------------------- Cash and Foreign cash exchange Impact on Investments equivalents contracts Total net assets $ $ $ $ $CurrencyUnited States dollars 60,824,223 1,165,454 611,458 61,378,239 3,068,912As a % of net assets 42.4 0.8 0.4 42.8 2.1Australian dollars 1,587,125 - 173 1,586,952 79,348As a % of net assets 1.1 - - 1.1 0.1 As at December 31, 2010 -------------------------- Cash and Foreign cash exchange Impact on Investments equivalents contracts Total net assets $ $ $ $ $CurrencyUnited States dollars 61,640,143 5,024,395 916,045 67,580,583 3,379,029As a % of net assets 43.1 3.5 0.6 47.3 2.4Australian dollars 3,617,677 - (90,221) 3,527,456 176,373As a % of net assets 2.5 0.0 -0.1 2.5 0.1At June 30, 2011, the Company had outstanding foreign exchange contracts to sell US$66,000,000 and AUS$1,600,000 against future commitments at exchange rates ranging between 0.9736 and 0.97436 for US dollar foreign exchange contracts and 1.0320 for the AUS dollar foreign exchange contract. Those contracts have maturities ranging up to July 28, 2011 and are with AAA rated Canadian bank counterparties.10 Capital managementThe capital of the Company is divided into voting and non-voting common shares, each having an unlimited authorized amount. The number of voting and non-voting shares outstanding, and changes thereto, are outlined in note 4.The Company manages its capital in accordance with the Company's investment objectives. The Company's investment objectives are to: (i) maximize the total return for common shareholders, consisting of dividend income and capital appreciation; and (ii) provide shareholders with monthly dividends targeted to payout a minimum of 75% of net earnings annually. Net earnings in reference to the Company's dividend payments to shareholders exclude any realized and unrealized capital gains and losses from debt securities in the portfolio and any income or loss not derived from debt securities in the portfolio. The Company commenced its dividend payments on June 30, 2009, making monthly payments of $0.0583 per voting and non-voting common share, or $614,322. During the six month period ended June 30, 2011, the Company made dividend payments of $3,685,935 (June 30, 2010 - $3,685,935).The Company is committed to continue paying a monthly dividend of $0.0583 per voting and non-voting common share for the three months ending September 30, 2011, totalling $1,842,966.11 Comparison of net asset value per share and net assets per shareIn accordance with Section 3.6(1) of National Instrument 81-106, the Company's net asset value per share, the net assets per share calculated in accordance with Canadian GAAP for financial reporting purposes, and an explanation of the differences between such amounts, are required disclosures in the notes to the financial statements. For investments that are traded in an active market, Canadian GAAP requires that bid prices be used in the fair value of instruments, rather than the use of the last traded price, as currently used for the purpose of determining net asset value. This change accounts for the difference between the net asset value and the net assets. June 30, December 31, 2011 2010 $ $Net asset value per share 13.63 13.65Canadian GAAP adjustments 0.02 (0.05)Net assets per share 13.61 13.6012 Subsequent eventsThe Company announced a monthly dividend of $614,322, or $0.0583 per common share, payable on each of July 29, 2011, August 31, 2011 and September 30, 2011.FOR FURTHER INFORMATION PLEASE CONTACT: Craig LangdonDeans Knight Income CorporationChief Executive Officer and Director(604)669-0212ORMark MylesDeans Knight Income CorporationChief Financial Officer(604)669-0212