Business Context and Reporting Period
Saratoga Investment Corp. (the "Company") is a non-diversified closed-end management investment company regulated as a Business Development Company (BDC) under the Investment Company Act of 1940. The Company's investment objective is to generate current income and, to a lesser extent, capital appreciation from investments in leveraged loans, mezzanine debt, and equity securities of middle-market companies. This Form 10-Q covers the quarterly period ended August 31, 2011.
Key Financial Metrics
| Metric | Six Months Ended Aug 31, 2011 | Six Months Ended Aug 31, 2010 |
|---|---|---|
| Total Investment Income | $6,435,922 | $5,923,697 |
| Net Investment Income | $3,298,873 | $2,483,928 |
| Net Realized Gain/(Loss) | $(7,959) | $(2,549,263) |
| Net Unrealized Appreciation/(Depreciation) | $690,391 | $9,419,892 |
| Net Increase in Net Assets from Operations | $3,981,305 | $9,354,557 |
| Earnings Per Share (Basic & Diluted) | $1.22 | $5.00 |
| Net Asset Value (NAV) Per Share | $27.48 | $29.71 |
| Total Investments at Fair Value | $86,216,975 | $80,024,761 |
| Cash and Cash Equivalents | $512,592 | $10,735,755 |
| Revolving Credit Facility Outstanding | $0 | $4,500,000 |
Material Changes vs. Prior Period
- Operating Results: Net increase in net assets from operations decreased to $4.0 million for the six months ended August 31, 2011, compared to $9.4 million in the prior year period. This decline was primarily driven by a significant reduction in net unrealized appreciation ($0.7 million vs. $9.4 million), partially offset by an increase in net investment income.
- Expense Reduction: Total operating expenses decreased significantly to $3.1 million (net of waivers) from $6.3 million in the prior year. This reduction is largely attributable to a $2.6 million reversal of previously accrued deferred incentive management fees related to the prior investment adviser and a decrease in professional fees following the 2010 recapitalization.
- Liquidity and Debt: The Company fully repaid its $4.5 million outstanding balance under the revolving credit facility during the period. As of August 31, 2011, there were no borrowings outstanding. Cash and cash equivalents declined from $10.7 million to $0.5 million, reflecting investment activity and debt paydowns.
- Portfolio Valuation: Total investments at fair value increased to $86.2 million from $80.0 million. The portfolio composition shifted, with First Lien Term Loans increasing to 32.8% of the portfolio and Structured Finance Securities (primarily the Saratoga CLO investment) representing 29.5%.
Outlook, Risks, and Management Commentary
- Unrealized Depreciation: A significant portion of the unrealized depreciation for the period was driven by the investment in PRACS Institute, LTD., which was written down to zero fair value due to declining prospects. Conversely, the investment in Saratoga CLO saw a $4.9 million increase in unrealized appreciation due to improved cash flow projections and lower discount rates.
- Liquidity Strategy: The Company is pursuing the formation of a Small Business Investment Company (SBIC) subsidiary to access SBA-guaranteed debentures, which could provide lower-cost capital. The SBA has issued a "green light" letter, but no license has been granted yet.
- Capital Raising: Stockholders approved a proposal allowing the Company to sell shares below net asset value (NAV) for one year, subject to a floor of 85% of NAV. This is intended to facilitate equity capital raising despite the stock historically trading at a discount to NAV.
- Risk Factors: The Company faces risks related to the illiquidity of its portfolio, the potential for dilution if shares are sold below NAV, and the performance of its significant investment in Saratoga CLO, which is a leveraged position in a portfolio of senior secured loans.
Investor Verification Checklist
- Verify the valuation methodology and assumptions used for the Saratoga CLO investment, which constitutes 29.5% of the portfolio and contributed significantly to unrealized gains.
- Review the status of the PRACS Institute, LTD. investment, which was written down to zero, and assess the impact on future income.
- Confirm the progress of the SBIC license application with the Small Business Administration and the potential timeline for accessing SBA-guaranteed debt.
- Monitor the Company's ability to raise equity capital given the historical trading discount to NAV and the constraints of the 85% floor policy.
- Assess the Company's liquidity position given the low cash balance ($0.5 million) and the reliance on the $40 million revolving credit facility (currently undrawn) for future investment activity.