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 filing covers the quarterly period ended May 31, 2014.
Key Financial Metrics
| Metric | Q2 2014 (Three Months Ended May 31) | Q2 2013 (Three Months Ended May 31) |
|---|---|---|
| Total Investment Income | $6.14 million | $6.02 million |
| Net Investment Income | $2.06 million | $2.47 million |
| Net Increase in Net Assets from Operations | $1.76 million | $3.80 million |
| Earnings Per Share (Basic & Diluted) | $0.33 | $0.80 |
| Net Asset Value (NAV) Per Share | $21.69 | $23.78 |
| Total Investments at Fair Value | $218.71 million | $164.84 million (May 31, 2013) |
| Total Debt Outstanding | $117.00 million | $98.30 million (May 31, 2013) |
| Cash and Cash Equivalents | $12.70 million | $31.56 million (May 31, 2013) |
| Asset Coverage Ratio | 320.2% | 337.9% (Feb 28, 2014) |
Material Changes vs. Prior Period
- Profitability Decline: Net increase in net assets from operations decreased by approximately 54% to $1.76 million from $3.80 million in the prior year period. This was driven by a shift from net unrealized appreciation of $0.80 million in 2013 to net unrealized depreciation of $0.38 million in 2014.
- Expense Increase: Total expenses rose 15.1% to $4.08 million. Interest and debt financing expenses increased significantly to $1.79 million (from $1.13 million) due to the full quarter impact of $48.3 million in 7.50% notes issued in May 2013 and increased SBA debentures.
- Portfolio Growth: Total investments at fair value increased to $218.71 million from $205.84 million at the end of the prior fiscal quarter (Feb 28, 2014), reflecting net investments of $12.9 million during the period.
- Debt Utilization: The company drew $4.7 million on its revolving credit facility during the quarter, whereas the balance was $0 at the end of the prior quarter. SBA debentures increased from $50.0 million to $64.0 million.
Outlook, Risks, and Management Commentary
- Unrealized Loss Drivers: Significant unrealized depreciation was recorded for Elyria Foundry Company, LLC ($0.92 million decline) due to declines in oil and gas end markets. Conversely, the investment in Saratoga CLO saw unrealized appreciation of $0.55 million due to a decline in the discount rate used for valuation.
- Liquidity and Capital: The company maintains a strong asset coverage ratio of 320.2%, well above the 200% requirement. However, management notes that the common stock has historically traded below NAV, which may limit the ability to raise equity capital. The company relies on SBA debentures and the dividend reinvestment plan for growth.
- Dividend Policy: No dividends were declared during the quarter ended May 31, 2014. The company intends to distribute substantially all taxable income to maintain RIC status, often utilizing a combination of cash and stock distributions.
- Legal Proceedings: A complaint filed in August 2012 by GSC Acquisition Holdings, LLC seeks to recover approximately $2.6 million related to deferred incentive fees waived in 2010. The company believes the claims are without merit and intends to defend vigorously.
- Portfolio Quality: As of May 31, 2014, 78.5% of the portfolio was rated "Green" (strong credit) and 3.4% "Red" (payment default risk). The Saratoga CLO portfolio had 97.4% rated Green/Yellow, with five investments in default totaling $7.7 million.
Investor Verification Checklist
- Debt Servicing: Verify the impact of the 7.50% notes on future cash flows, as interest expense has risen materially.
- Valuation Sensitivity: Review the assumptions used for Level 3 fair value measurements, particularly the discount rates for the Saratoga CLO and EBITDA multiples for equity interests, given the volatility in unrealized gains/losses.
- Credit Facility Covenants: Confirm continued compliance with the Madison Capital Funding credit facility covenants, specifically the Interest Coverage Ratio and Overcollateralization Ratio, given the recent drawdown.
- Legal Exposure: Monitor the status of the GSC Acquisition Holdings lawsuit regarding the $2.6 million claim.
- Dividend Sustainability: Assess the company's ability to maintain distributions given the decline in net investment income and the reliance on stock dividends to satisfy RIC requirements.