Business Context and Reporting Period
Saratoga Investment Corp. (formerly GSC Investment Corp.) is a non-diversified closed-end management investment company regulated as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The filing covers the quarterly period ended August 31, 2010.
During the period, the Company consummated a significant recapitalization transaction on July 30, 2010. This included a name change, the replacement of its investment adviser with Saratoga Investment Advisors, LLC, a one-for-ten reverse stock split, and the refinancing of its debt facilities.
Key Financial Metrics
| Metric | Six Months Ended Aug 31, 2010 | Six Months Ended Aug 31, 2009 |
|---|---|---|
| Total Investment Income | $5,923,697 | $8,449,744 |
| Net Investment Income | $2,483,928 | $3,643,747 |
| Net Realized Gain/(Loss) | $(2,549,263) | $(1,029,948) |
| Net Unrealized Appreciation/(Depreciation) | $9,419,892 | $(13,338,245) |
| Net Increase in Net Assets from Operations | $9,354,557 | $(10,724,446) |
| Earnings Per Share (Basic & Diluted) | $5.00 | $(12.93) |
| Net Assets (Total) | $79,647,571 | $57,289,331 |
| Net Asset Value Per Share | $29.71 | $69.10 |
| Cash and Cash Equivalents | $1,863,196 | $6,643,998 |
| Revolving Credit Facility Outstanding | $20,000,000 | $36,992,222 |
Material Changes vs. Prior Period
- Recapitalization and Debt Refinancing: The Company terminated its previous revolving securitized credit facility with Deutsche Bank (which was in default) and replaced it with a new $40 million senior secured revolving credit facility with Madison Capital Funding LLC. As of August 31, 2010, $20 million was outstanding under the new facility.
- Management Change: The Company replaced its former investment adviser, GSCP (NJ), L.P., with Saratoga Investment Advisors, LLC. The former adviser waived approximately $2.6 million in accrued and unpaid deferred incentive management fees as part of the transaction.
- Stock Structure: A one-for-ten reverse stock split was effected on August 12, 2010. Shares outstanding increased to 2,680,842 following a private placement of approximately 9.9 million shares (pre-split) to the new adviser and affiliates for $15 million.
- Portfolio Valuation: Total investments at fair value increased to $94.4 million from $89.4 million. This was driven primarily by a $6.1 million unrealized appreciation in the Company's investment in GSC Investment Corp. CLO 2007 LTD., offset by declines in other portfolio companies such as Jason Incorporated and Energy Alloys, LLC.
- Expense Reduction: Total expenses net of waivers decreased significantly to $3.4 million for the six months ended August 31, 2010, compared to $4.8 million in the prior year, largely due to the waiver of deferred incentive fees and reduced interest expense from lower debt balances.
Guidance, Outlook, Risks, and Unusual Items
- Unusual Items: The $2.6 million waiver of deferred incentive fees by the former adviser is a non-recurring item that materially improved net investment income for the period. Additionally, the Company recorded a net realized loss of $2.5 million primarily due to exits and repayments from Legacy Cabinets, Inc.
- Subsequent Event: On September 29, 2010, Terphane Holdings Corp. completed a change-in-control recapitalization. The Company received $5.2 million in cash and $6.6 million in new senior secured notes, restructuring its previously reserved investment.
- Risks:
- Concentration Risk: The investment in GSC Investment Corp. CLO 2007 LTD. represents 24.2% of the portfolio and is a first-loss position subject to significant volatility.
- Liquidity and Leverage: Substantially all assets are pledged as collateral under the new credit facility. The facility contains strict collateral tests (Interest Coverage Ratio, Overcollateralization Ratio) and events of default that could force asset liquidation.
- Valuation Uncertainty: A material weakness in internal controls regarding investment valuation was identified in the prior year. While addressed, valuations of private investments remain subjective and may differ from realized values.
- Adviser Experience: The new investment adviser, Saratoga Investment Advisors, is a newly formed entity with no prior experience managing a BDC or RIC.
Investor Verification Checklist
- Debt Covenants: Verify the Company's compliance with the new Madison Capital Funding facility's collateral tests (Interest Coverage Ratio of 175% and Overcollateralization Ratio of 200%) to ensure no immediate risk of default or forced liquidation.
- CLO Performance: Monitor the performance of the GSC Investment Corp. CLO 2007 LTD. investment, which constitutes nearly a quarter of the portfolio and drives a significant portion of recent unrealized gains.
- Fee Structure: Review the new incentive fee agreement with Saratoga Investment Advisors, specifically the "catch-up" provision and the reset of the capital gains hurdle rate to May 31, 2010.
- Portfolio Quality: Assess the credit quality of "Red" rated investments (40.8% of the portfolio) and the specific outlook for distressed holdings like Jason Incorporated and Energy Alloys.
- Internal Controls: Confirm that the remediation of the previously identified material weakness in internal controls over financial reporting is fully effective.