Business Context and Reporting Period
Saratoga Investment Corp. (Saratoga) is a non-diversified closed-end management investment company regulated as a Business Development Company (BDC) and taxed as a Regulated Investment Company (RIC). The company invests primarily in leveraged loans and mezzanine debt of private U.S. middle-market companies. This filing covers the quarterly period ended May 31, 2015.
Key Financial Metrics
| Metric | Q2 2015 (Ended May 31) | Q2 2014 (Ended May 31) |
|---|---|---|
| Total Investment Income | $7.56 million | $6.14 million |
| Net Investment Income | $1.77 million | $2.06 million |
| Net Increase in Net Assets from Operations | $7.38 million | $1.76 million |
| Earnings Per Share (Basic & Diluted) | $1.36 | $0.33 |
| Total Assets | $272.75 million | $263.56 million (Feb 28, 2015) |
| Total Net Assets | $123.49 million | $122.60 million (Feb 28, 2015) |
| Net Asset Value (NAV) Per Share | $22.75 | $22.70 (Feb 28, 2015) |
| Total Debt Outstanding | $139.10 million | $136.90 million (Feb 28, 2015) |
| Cash and Cash Equivalents | $6.56 million | $20.06 million (Feb 28, 2015) |
Note: Debt includes $11.8M revolving credit facility, $79.0M SBA debentures, and $48.3M notes payable.
Material Changes vs. Prior Period
- Operating Performance: Net increase in net assets from operations surged to $7.38 million from $1.76 million in the prior year, driven primarily by a $5.54 million net unrealized appreciation on investments, compared to a $0.38 million depreciation in the prior year.
- Revenue Growth: Total investment income increased 23.1% to $7.56 million, reflecting a 20.1% increase in total investments to $262.7 million.
- Expense Increase: Total expenses rose 41.9% to $5.79 million. This was largely due to a 375% increase in incentive management fees ($1.80 million vs. $0.38 million) and higher interest expenses due to increased debt levels.
- Portfolio Composition: The portfolio grew to $262.7 million. Software as a Service (22.8%) and Business Services (20.0%) remained the largest industry allocations.
- Liquidity: Cash and cash equivalents decreased significantly from $20.06 million to $6.56 million, primarily due to net investment purchases of $23.2 million and dividend payments.
Guidance, Outlook, and Risks
- SBIC Expansion: On April 2, 2015, the SBA issued a "green light" letter inviting Saratoga to continue its application for a second SBIC license. Approval could allow the issuance of an additional $75 million in SBA-guaranteed debentures.
- Debt Offering: On May 29, 2015, the company entered an At-the-Market (ATM) agreement to sell up to $20.0 million of its 7.50% notes. As of July 14, 2015, approximately $5.7 million in principal had been sold.
- Dividends: The company declared a dividend of $1.00 per share on May 14, 2015, and a subsequent dividend of $0.33 per share on July 8, 2015. Distributions often exceed net investment income, resulting in a return of capital.
- Risks: The company faces credit risk from its portfolio of private loans and market risk from valuation fluctuations. A significant portion of the portfolio (Level 3 assets) relies on unobservable inputs and management judgment. The company also faces liquidity constraints if it cannot raise additional capital, as its stock has historically traded below NAV.
Investor Verification Checklist
- Unrealized Gains: Verify the sustainability of the $5.54 million unrealized appreciation, which drove the majority of the quarter's earnings, specifically regarding the valuation of the Saratoga CLO and Network Communications, Inc. investments.
- Dividend Coverage: Confirm the extent to which recent dividends ($1.27 per share declared in the quarter) are covered by net investment income versus return of capital, given the "Distribution in excess of net investment income" balance of $(29.03) million.
- Debt Covenants: Review the asset coverage ratio (313.8% as of May 31, 2015) to ensure continued compliance with the 200% requirement under the 1940 Act and the specific collateral tests of the Madison Capital Funding credit facility.
- SBIC License Status: Monitor the progress of the second SBIC license application, as approval is not guaranteed and is critical for the planned $75 million capital raise.
- Unfunded Commitments: Assess the impact of $11.2 million in unfunded commitments to portfolio companies on future liquidity and cash flow requirements.