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 a Regulated Investment Company (RIC). The company invests primarily in leveraged loans and mezzanine debt of private U.S. middle-market companies. This Form 10-Q covers the quarterly period ended August 31, 2012, and the six-month period ended on that date.
Key Financial Metrics
| Metric | Six Months Ended Aug 31, 2012 | Six Months Ended Aug 31, 2011 |
|---|---|---|
| Total Investment Income | $7,782,471 | $6,435,922 |
| Total Expenses | $5,195,435 | $3,137,049 |
| Net Investment Income | $2,587,036 | $3,298,873 |
| Net Realized Gain (Loss) | $447,348 | $(7,959) |
| Net Unrealized Appreciation | $5,027,500 | $705,665 |
| Net Increase in Net Assets from Operations | $8,061,809 | $3,981,305 |
| Earnings Per Share (Basic & Diluted) | $2.08 | $1.22 |
| Net Asset Value (NAV) Per Share | $27.20 | $25.12 (Beginning of Period) |
| Total Net Assets | $105,441,959 | $97,380,150 (Beginning of Period) |
| Revolving Credit Facility Outstanding | $14,850,000 | $20,000,000 (Beginning of Period) |
| Cash and Cash Equivalents | $674,057 | $1,325,698 (Beginning of Period) |
Material Changes vs. Prior Period
- Investment Income: Increased by 20.9% ($1.3 million) compared to the prior six-month period, driven primarily by higher interest income from the company's investment in Saratoga CLO and other portfolio investments.
- Expenses: Total expenses increased by 65.6% ($2.1 million). This was primarily due to a significant increase in incentive management fees (from a negative accrual in 2011 to $1.3 million in 2012) and higher interest and credit facility expenses due to increased outstanding debt levels.
- Unrealized Gains: Net unrealized appreciation on investments surged to $5.0 million, compared to $0.7 million in the prior year. Key drivers included a $3.2 million increase in the value of the Saratoga CLO investment and a $1.9 million increase in the Targus Holdings, Inc. equity investment.
- Portfolio Composition: The portfolio grew from $95.4 million to $115.7 million in fair value. Structured Finance Securities (Saratoga CLO) remained the largest asset class at 23.4% of the portfolio.
Guidance, Outlook, and Risks
- Dividend Policy: The Board of Directors determined not to pay any dividends during the quarter ended August 31, 2012, to preserve capital for portfolio growth and diversification.
- Liquidity and Capital Resources: The company has a $45 million senior secured revolving credit facility with Madison Capital Funding LLC. As of August 31, 2012, $14.9 million was outstanding, with a borrowing base of $27.9 million. The company maintains a strong asset coverage ratio of 810%.
- SBIC License: The company's subsidiary, Saratoga Investment Corp. SBIC, LP, received an SBA license in March 2012. While it has $25 million in regulatory capital, it currently has no SBA-guaranteed debentures outstanding.
- Legal Proceedings: A complaint was filed on August 31, 2012, by GSC Acquisition Holdings, LLC in bankruptcy court seeking approximately $2.6 million related to alleged fraudulent transfers of deferred incentive fees by the former investment adviser. Saratoga believes the claims are without merit and intends to defend vigorously.
- Market Risk: The company is exposed to credit risk regarding portfolio company defaults and market risk regarding the valuation of private investments, which are determined by the Board of Directors in good faith.
Investor Verification Checklist
- Legal Action Status: Verify the outcome of the bankruptcy complaint filed by GSC Acquisition Holdings, LLC regarding the $2.6 million claim.
- Dividend Reinvestment: Confirm the company's strategy for future distributions given the decision to retain earnings for growth and the historical trading of stock below NAV.
- Debt Covenants: Monitor compliance with the "Collateral Tests" (Interest Coverage, Overcollateralization, and Weighted Average FMV) under the Madison Capital Funding credit facility.
- Valuation Methodology: Review the Board's approval of fair value for Level 3 assets, particularly the $27.1 million valuation of the Saratoga CLO subordinated notes, which relies on discounted cash flow models.
- SBIC Leverage: Track progress on obtaining SBA capital commitments to utilize the potential $150 million in SBA-guaranteed debentures.