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) 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 report covers the quarterly period ended May 31, 2018.
Key Financial Metrics
| Metric | Q2 2018 (Ended May 31) | Q2 2017 (Ended May 31) |
|---|---|---|
| Total Investment Income | $10,488,018 | $8,707,448 |
| Net Investment Income | $3,927,648 | $3,504,449 |
| Net Increase in Net Assets from Operations | $3,842,315 | $1,014,087 |
| Earnings Per Share (Basic & Diluted) | $0.61 | $0.17 |
| Total Assets | $362,017,715 | $329,690,117 (Feb 28, 2018) |
| Total Net Assets | $144,844,747 | $143,691,367 (Feb 28, 2018) |
| Net Asset Value (NAV) Per Share | $23.06 | $22.96 (Feb 28, 2018) |
| Total Debt Outstanding | $212,110,500 | $212,110,500 (Feb 28, 2018) |
| Cash and Cash Equivalents | $13,730,811 | $13,777,491 (Feb 28, 2018) |
| Asset Coverage Ratio | 294.6% | 293.0% (Feb 28, 2018) |
Material Changes vs. Prior Period
- Revenue Growth: Total investment income increased by 20.4% ($1.8 million) compared to the prior year quarter, driven by a 4.1% increase in total investments, accelerated amortization of market discount, and higher interest income from the Saratoga CLO.
- Expense Increases: Total operating expenses rose 26.1% ($1.4 million). This was primarily due to a $0.9 million increase in incentive management fees (reflecting higher net investment income above the hurdle rate) and a $0.2 million increase in interest and debt financing expenses due to higher average SBA debenture balances.
- Unrealized Gains: The company recorded a net change in unrealized appreciation of $643,205, a significant improvement from a depreciation of $2,585,951 in the prior year. Key drivers included appreciation in Easy Ice, LLC and HMN Holdco, LLC, partially offset by depreciation in Elyria Foundry, L.L.C.
- Portfolio Composition: The portfolio remained heavily weighted toward Business Services (62.9% of fair value) and Healthcare Services (11.8%). Non-performing investments decreased significantly from $9.5 million to $2.2 million.
Guidance, Outlook, and Risks
- Accounting Changes: The company adopted ASC 606 (Revenue from Contracts with Customers) effective March 1, 2018. This resulted in the delayed recognition of unrealized incentive fee income until realized, reducing reported assets and net assets by approximately $65,300 at the beginning of the period.
- Regulatory Changes: The Board approved becoming subject to a minimum asset coverage ratio of 150.0% (down from 200.0%) under the Small Business Credit Availability Act, effective April 16, 2019. This may allow for increased leverage in the future.
- Dividends: A dividend of $0.50 per share was declared on February 26, 2018, and paid on March 26, 2018. A subsequent dividend of $0.51 per share was declared on May 30, 2018, payable June 27, 2018.
- Risks: The company faces risks related to the Tax Cuts and Jobs Act of 2017, which lowered the federal tax rate and could impact industry structures. Additionally, the company relies on the Small Business Administration (SBA) for debenture funding; a second SBIC license application is pending but the previous "green light" letter has expired.
Investor Verification Checklist
- Debt Structure: Verify the composition of the $212.1 million in debt, specifically the $137.7 million in SBA-guaranteed debentures and $74.5 million in 6.75% fixed-rate notes due 2023.
- Non-Accrual Status: Confirm the status of the $2.2 million in non-performing investments (down from $9.5 million) and the specific portfolio companies involved (e.g., TM Restaurant Group, M/C Acquisition Corp.).
- ASC 606 Impact: Review the reconciliation of financial statements to understand the impact of the new revenue recognition standard on incentive fee income and NAV.
- Unfunded Commitments: Note the $4.7 million in off-balance sheet unfunded commitments to portfolio companies.
- Asset Coverage: Monitor the asset coverage ratio (currently 294.6%) against the regulatory minimums (200% currently, 150% effective 2019) to assess leverage capacity.