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, primarily through leveraged loans and mezzanine debt issued by private U.S. middle-market companies. This Form 10-Q covers the quarterly period ended May 31, 2016.
Key Financial Metrics
| Metric | Q2 2016 (Unaudited) | Q2 2015 (Unaudited) |
|---|---|---|
| Total Investment Income | $7.91 million | $7.56 million |
| Net Investment Income | $2.54 million | $1.77 million |
| Net Realized Gain | $6.10 million | $0.07 million |
| Net Unrealized Depreciation | ($5.35 million) | $5.54 million (Appreciation) |
| Net Increase in Net Assets from Operations | $3.29 million | $7.38 million |
| Earnings Per Share (Basic & Diluted) | $0.57 | $1.36 |
| Total Assets | $295.87 million | $295.05 million (Feb 29, 2016) |
| Total Liabilities | $168.74 million | $169.90 million (Feb 29, 2016) |
| Net Assets | $127.13 million | $125.15 million (Feb 29, 2016) |
| Net Asset Value (NAV) Per Share | $22.11 | $22.06 (Feb 29, 2016) |
| Debt Outstanding | $165.45 million | $141.36 million (May 31, 2015) |
| Cash and Cash Equivalents | $27.47 million | $7.03 million (Feb 29, 2016) |
Note: Debt includes $103.66 million in SBA debentures and $61.79 million in Notes Payable. The revolving credit facility had no outstanding borrowings as of May 31, 2016.
Material Changes vs. Prior Period
- Operating Results: Net increase in net assets from operations decreased to $3.29 million from $7.38 million in the prior year quarter. This decline was primarily driven by a shift from net unrealized appreciation of $5.54 million in 2015 to net unrealized depreciation of $5.35 million in 2016.
- Realized Gains: Net realized gains increased significantly to $6.10 million, compared to $0.07 million in the prior year. This was largely due to the sale of the Company's investment in Take 5 Oil Change, L.L.C., which generated a realized gain of approximately $6.0 million.
- Expense Reduction: Total operating expenses decreased by 7.3% to $5.37 million. This reduction was primarily due to a $1.1 million decrease in incentive management fees, specifically the capital gains portion, which dropped from $1.1 million to $0.1 million.
- Debt Structure: While the revolving credit facility was fully paid down (from $11.8 million in May 2015 to $0 in May 2016), total debt increased due to higher outstanding SBA debentures ($103.7 million vs. $79.0 million) and Notes Payable ($61.8 million vs. $48.3 million).
- Portfolio Composition: The portfolio saw net repayments of $20.6 million with no new investments during the quarter. The weighted average current coupon remained stable at 11.5%.
Guidance, Outlook, and Risks
- Dividends: On July 7, 2016, the Board declared a dividend of $0.43 per share for the quarter ended May 31, 2016, payable August 9, 2016. Shareholders may elect to receive cash or stock under the Dividend Reinvestment Plan (DRIP).
- Capital Resources: The Company maintains an asset coverage ratio of 305.7%, well above the 200% requirement under the 1940 Act. The Company has $2.0 million in unfunded commitments to portfolio companies.
- SBIC License: The Company received a "green light" letter from the SBA in April 2015 to pursue a second SBIC license, which could allow for an additional $150 million in SBA-guaranteed debentures. However, receipt of a license is not guaranteed.
- Valuation Risks: A significant portion of the portfolio (Level 3 assets) is valued using unobservable inputs, including market comparables and discounted cash flow models. Changes in assumptions regarding default rates, recovery rates, and market yields could materially affect the fair value of investments.
- Legal Proceedings: The Company is defending against a complaint filed in August 2012 by GSC Acquisition Holdings, LLC, alleging fraudulent transfers related to the termination of a prior management agreement. The Company believes the claims are without merit.
Investor Verification Checklist
- Realized Gain Source: Verify the impact of the Take 5 Oil Change sale on the $6.1 million realized gain and confirm the remaining portfolio's exposure to similar exit opportunities.
- Unrealized Depreciation Drivers: Review the specific portfolio companies contributing to the $5.35 million unrealized depreciation, particularly Elyria Foundry Company, L.L.C., to assess credit quality and recovery prospects.
- Debt Maturity Profile: Confirm the maturity dates and interest rates of the $165.45 million in outstanding debt, noting that $61.8 million in Notes Payable matures in 2020 and $103.7 million in SBA debentures have a 10-year maturity.
- Dividend Sustainability: Assess whether the declared dividend of $0.43 per share is fully covered by net investment income or if it requires a return of capital, given the "Distribution in excess of net investment income" line item of $(26.03) million.
- SBIC Progress: Monitor the status of the second SBIC license application, as approval is contingent on SBA discretion and could significantly alter the Company's leverage capacity.