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 May 31, 2013.
Key Financial Metrics
| Metric | Q2 2013 (Ended May 31) | Q2 2012 (Ended May 31) |
|---|---|---|
| Total Investment Income | $6,017,762 | $3,619,182 |
| Total Expenses | $3,548,073 | $2,346,392 |
| Net Investment Income | $2,469,689 | $1,272,790 |
| Net Increase in Net Assets from Operations | $3,799,851 | $3,190,767 |
| Earnings Per Share (Basic & Diluted) | $0.80 | $0.82 |
| Net Asset Value (NAV) Per Share | $23.78 | $25.94 |
| Total Investments at Fair Value | $164,839,101 | $155,080,387 |
| Cash and Cash Equivalents | $31,555,038 | $149,025 |
| Total Liabilities | $95,743,280 | $65,724,669 |
| Asset Coverage Ratio | 332.9% | 547.3% |
Debt and Liquidity
- Revolving Credit Facility: $0 outstanding as of May 31, 2013 (down from $24.3 million at Feb 28, 2013). Borrowing base availability was $32.2 million.
- SBA Debentures: $40.0 million outstanding (up from $36.0 million).
- Notes Payable: $48.3 million outstanding (issued in May 2013; $0 at Feb 28, 2013). These are 7.50% fixed-rate notes due 2020.
- Liquidity: Cash and cash equivalents increased significantly to $31.6 million, driven by the issuance of new notes and the paydown of the revolving credit facility.
Material Changes vs. Prior Period
- Revenue Growth: Total investment income increased 66.3% year-over-year, primarily due to a higher average portfolio size and increased interest income from investments ($5.17 million vs. $3.11 million).
- Expense Increase: Total expenses rose 51.2% year-over-year. This was driven by higher interest and debt financing expenses ($1.13 million vs. $0.63 million) and increased management fees due to portfolio growth.
- Capital Structure Shift: The company significantly altered its debt profile by issuing $48.3 million in new long-term notes and paying down its entire $24.3 million balance on the revolving credit facility. This reduced short-term leverage but increased long-term fixed-rate debt.
- Portfolio Composition: Investments in Business Services grew to 22.2% of the portfolio, while Structured Finance Securities (Saratoga CLO) decreased to 14.3%.
Guidance, Outlook, and Risks
- Outlook: Management expects income from the Saratoga CLO investment to decline in future periods as the reinvestment period ended in January 2013, requiring principal payments to pay down outstanding notes rather than reinvest.
- Capital Raising: The company intends to fund growth through future equity offerings and debt issuances. However, the ability to raise equity capital may be limited as the stock has historically traded below NAV. Stockholders have authorized share sales at no less than 85% of NAV until September 28, 2013.
- Risks:
- Legal Proceedings: A complaint was filed in August 2012 by GSC Acquisition Holdings, LLC seeking approximately $2.6 million related to a waiver of deferred incentive fees by the former investment adviser. The company believes the claims are without merit.
- Internal Controls: As a non-accelerated filer, independent auditors are not currently required to assess internal controls. If market capitalization exceeds $75 million, auditor certification will be required.
- Asset Coverage: The company must maintain an asset coverage ratio of at least 200% under the 1940 Act to issue additional debt or declare dividends.
Investor Verification Checklist
- Debt Covenants: Verify continued compliance with the 200% asset coverage ratio and the specific collateral tests (Interest Coverage, Overcollateralization) for the Madison Capital Funding facility.
- CLO Performance: Monitor the cash flow projections and credit quality of the Saratoga CLO portfolio, as it represents a significant portion of income and is subject to unique risks.
- Legal Status: Track the status of the GSC Acquisition Holdings lawsuit regarding the $2.6 million claim.
- Dividend Policy: Confirm the company's ability to meet RIC distribution requirements, potentially utilizing stock dividends if cash is constrained.
- Valuation Methodology: Review the board's approval of fair value estimates for Level 3 assets, which comprise the entire investment portfolio.