SARATOGA INVESTMENT CORP. annual report, FY2024

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Saratoga Investment Corp. — FY2024 Form 10-K

Reporting period: Fiscal year ended February 29, 2024; this is an annual report, not a calendar fourth-quarter filing. The filing also reports fourth-quarter results. Saratoga is an externally managed BDC lending primarily to U.S. middle-market companies.

Financial and portfolio highlights

MetricFY ended Feb. 29, 2024Prior comparable period
Total investment income$143.7 million$99.1 million
Operating expenses$86.8 million$63.9 million
Net investment income (NII)$56.9 million; $4.49 per share$35.2 million; $2.94 per share
Net increase in net assets from operations$8.9 million; $0.71 per share$24.7 million; $2.06 per share
Net realized and unrealized investment result$46.9 million loss, including $47.1 million unrealized depreciation$7.8 million loss, including $15.2 million unrealized depreciation
Cash flows$157.2 million used in operating activities; $101.6 million provided by financing$130.4 million used in operating activities; $173.6 million provided by financing
Assets and NAV at year-end$1,191.2 million total assets; $370.2 million net assets; $27.12 NAV per share$1,078.2 million total assets; $347.0 million net assets; $29.18 NAV per share
  • Investment income rose 45.0%, mainly as investments grew 17.1% to $1,138.8 million and weighted-average portfolio yield increased to 11.4% from 10.7%. Interest from investments was $127.8 million; reported PIK income was $2.5 million.
  • Expenses rose 35.9%. Interest and debt financing expense increased to $49.2 million from $33.5 million; average outstanding debt rose to $798.9 million from $663.0 million, and its weighted-average rate increased to 5.46% from 4.48%.
  • NII increased 61.6%, while net assets from operations fell 63.8%, as higher income was more than offset by investment depreciation. NII was about 39.6% of investment income, versus 35.5% a year earlier.
  • Fourth-quarter investment income was $37.2 million and NII was $12.8 million; net assets from operations increased $5.3 million. Fourth-quarter NAV was $27.12 per share, down from $28.48 at the start of the fiscal year.
  • Year-end investments covered 55 portfolio companies and 139 investments. Fair-value composition was 85.7% first-lien loans, 1.6% second-lien loans, 1.4% unsecured loans, 2.7% structured-finance securities and 8.6% equity interests. Approximately 99.5% of debt investments bore floating rates.
  • Three investments were on non-accrual, with $18.9 million fair value, compared with one investment at $9.8 million a year earlier. Interest receivable was reported net of a $9.5 million reserve. The filing attributes significant markdowns to Pepper Palace, Zollege and Netreo, among others.

Debt, liquidity and distributions

  • Year-end principal debt obligations totaled approximately $820.4 million, including $214.0 million of SBA debentures, $35.0 million drawn under the Encina facility and unsecured notes with stated maturities from 2025 to 2028. The filing separately cites $785.4 million of borrowings, excluding the $35.0 million Encina balance.
  • Cash and cash equivalents were $8.7 million; an additional $31.8 million was held in reserve accounts and is subject to facility restrictions. Encina had a $65.0 million commitment and $35.0 million outstanding, with availability subject to borrowing-base and other conditions.
  • BDC asset coverage was 161.1%, versus 165.9% a year earlier; the applicable minimum is 150%. The filing states that coverage could constrain additional borrowing, distributions or investment activity if it approaches the minimum.
  • Unfunded portfolio commitments increased to $132.4 million from $108.8 million. Management said it believed assets would provide adequate coverage; the filing reports $8.7 million in cash and $31.8 million of available Encina borrowings for this purpose.
  • Distributions from net investment income were $2.82 per share for the fiscal year. A $0.73-per-share distribution was paid March 28, 2024. The company accrued $1.8 million of excise tax on undistributed taxable income for calendar 2023.
  • Common stock total return was -3.92% based on market value and 4.20% based on NAV, compared with 10.35% and 9.46%, respectively, in FY2023. On May 3, 2024, the stock closed at $23.57, a stated 13.1% discount to February 29 NAV.

Changes, outlook and principal risks

  • Portfolio investment activity expanded: Saratoga invested $246.1 million and received $30.3 million in exits and repayments, for $215.8 million of net investments. Fair value of investments rose 17.1% year over year.
  • The manager sold shares through the ATM program during FY2024, raising $49.0 million net, and reimbursed the company $4.5 million under the program’s NAV-price protection. The company repurchased 88,576 shares for approximately $2.2 million.
  • SBIC LP repaid its SBA debentures, surrendered its license in January 2024 and merged into the company. SBIC II and III had $214.0 million of SBA debentures outstanding at year-end.
  • After year-end, on March 27, 2024, the company entered a new Live Oak secured credit facility with $50.0 million initial capacity and potential increases to $150.0 million, subject to conditions. The existing Saratoga CLO reinvestment period ended in April 2024; any refinancing depends on market conditions.
  • The filing provides no quantified earnings or dividend guidance. Management cited market uncertainty, inflation, elevated interest rates, competition and portfolio-company performance as factors that may affect results and investment opportunities.
  • Key risks include leverage and limited asset-coverage headroom; higher funding costs; borrower defaults and refinancing risk; illiquid private-company valuations; and concentration in software-related businesses. The filing says SaaS companies represented 58.4% of total investments. About 77.8% of the debt portfolio was interest-only, with principal generally due at maturity; borrower repayment or refinancing of balloon balances is a risk.
  • The $9.5 million Saratoga CLO subordinated-note investment is a first-loss position beneath the CLO’s other debt. The CLO held $640.8 million of primarily first-lien loans. Saratoga’s valuation depends on models and significant unobservable inputs; the CLO subordinated-note fair value fell from $21.2 million to $9.5 million.
  • Fair value was a significant accounting estimate: $1,129.4 million of company investments were Level 3. The independent auditor issued an unqualified opinion on the financial statements and identified Level 3 investment valuation as a critical audit matter. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not provide an opinion on internal-control effectiveness.

Investor verification priorities

  1. Review the $47.1 million unrealized depreciation, particularly the valuation and recovery assumptions for Pepper Palace, Zollege, Netreo and the Saratoga CLO investment.
  2. Check non-accrual status, cash interest collection, PIK accruals and the $9.5 million interest-receivable reserve, including any portfolio developments after year-end.
  3. Reconcile debt balances and maturity/refinancing needs, including 2025–2028 notes, SBA debentures, facility availability and the 161.1% asset-coverage ratio.
  4. Assess whether cash, restricted reserves and credit availability can support $132.4 million of unfunded commitments, distributions and new investments under stressed conditions.
  5. Verify the sustainability of distributions against taxable income and cash generation, and monitor the stock’s discount to NAV and potential dilution from equity issuance.