Saratoga Investment Corp.
Q1 2017 Earnings Call Transcript

Published: 14 Jul 2016

[Operator:]

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Saratoga Investment Corporation’s Fiscal First Quarter 2017 Financial Results Conference Call. Please note that today’s call is being recorded. [Operator Instructions] At this time, I’d like to turn the call over to Saratoga Investment Corporation’s Chief Financial Officer, Mr. Henri Steenkamp. Sir, please go ahead.

[Henri Steenkamp:]

Thank you. I would like to welcome everyone to Saratoga Investment Corp.’s fiscal first quarter 2017 earnings conference call. Today’s conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal first quarter 2017 shareholder presentation in the Events and Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available from 1 PM today through July 21. Please refer to our earnings press release for details. I would now like to turn the call over to our Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.

[Christian Oberbeck:]

Thank you, Henri, and welcome, everyone. As we reflect on our fiscal first quarter 2017, following a successful fiscal 2016, we’d like to highlight some of the continued progress and achievements during this quarter for Saratoga. Some of these are outlined on slide 2. Since becoming the manager of Saratoga Investment Corp., we have been singularly focused on a long-term objective of increasing the quality and size of our asset base, with the ultimate purpose of building Saratoga Investment Corp. into a best-in-class BDC, generating meaningful returns for our shareholders. Fiscal first quarter 2017 continued our trend of outperformance. As highlighted on slide 2, during the past quarter, many of our metrics illustrate our achievements and continued momentum. To briefly recap, first, we continued on our path of strengthening our financial foundation by increasing our net asset value to $127.1 million, a 1.6% increase from $125.1 million as of last quarter, which was also our year-end; increasing our net asset value per share from $22.06 to $22.11 as compared to last quarter; maintaining our investment quality and credit with 98.4% of our loan investments now having our highest rating, our highest percentage ever since this credit rating was used; and as importantly no investments are on nonaccrual; and generating an annualized return on equity of 10.4% for the quarter outperforming the last 12 months’ BDC industry average of approximately 0.3%. Second, we slightly expanded our assets under management to $264 million, a 1% increase from $263 million as of May 31, 2015, but a sequential decrease of 7% from $284 million as of February 29, 2016. This decrease from year-end reflects redemptions of $20.6 million during the quarter. This quarter also reflects a 179% increase from $95 million at the end of fiscal year 2012. Our growth in AUM over the last few years is evidence of our continued long-term upward trajectory in asset growth, while recognizing that originations and redemptions can be lumpy when viewed on a quarterly basis, as is the case on a comparative quarter over quarter basis today. Third, the continued strengthening of our financial foundation has enabled us to increase our quarterly dividend for the seventh consecutive quarter. We will pay a quarterly dividend of $0.43 per share for the fiscal first quarter of 2017, payable on August 9, 2016 for all stockholders of record on July 29, 2016, an increase of $0.02 over the prior quarter’s dividend of $0.41 per share. All of our dividend payments have been exceeded by our adjusted net investment income for the same periods. As a result, we are comfortably earning our dividend which distinguishes us from many other BDCs. Fourth, our base of liquidity remains strong and promises to improve. Through our debt distribution agreement with Ladenburg Thalmann, we may offer for sale up to $20 million of aggregate principal amount of our existing Baby Bonds issuance through an aftermarket offering. We did not issue any new bonds of this program this quarter and we continue to have significant dry powder to meet future potential opportunities in a changing credit and pricing environment. Our existing available quarter-end liquidity allows us to grow our current assets under management by 45% without any new external financing. And finally, we continue to have in place our share repurchase program that allows us to repurchase up to 400,000 shares of our common stock. As of July 12, 2016, we repurchased 79,224 shares at a weighted average price of $15.23 per share under this plan and we will continue to assess this as a way of deploying our capital and improving shareholder returns. This quarter also saw an increase in performance within our key performance indicators as compared to the previous quarter ended February 29, 2016. Our adjusted NII is up 3% to $2.6 million, and our adjusted NII per share is up $0.01 to $0.46 per share. Our adjusted NII yield is up 30 basis points to 8.3%, and our annualized return on equity is up 100 basis points to 10.4% as compared to our fiscal year 2016 return on equity of 9.4%, comfortably beating the industry average of approximately 0.3% negative. Overall, we remain very satisfied with these accomplishments and we’ll go into greater detail on each one on today’s call. As I’ve mentioned, we remain committed to further advancing the overall size and quality of our asset base. As you can see on slide 3, our upward trend of quality and quantity of assets remain stable. With $264 million in assets under management in our BDC as of May 31, 2016, we have seen a 1% increase in assets as compared with last year, but were down approximately 7% since last quarter. This decrease from year-end reflects redemptions of $20.6 million during the quarter. As we’ve shared in the past, redemptions and originations will always remain lumpy in the short term. 98.4% of our loan investments hold our highest internal credit rating that we award and importantly we have no investments on nonaccrual. Thus, our overall loan quality continues to increase, while we continue to pursue measured asset growth. With that, I would like to now turn the call back over to Henri to review in greater detail our full financial results as well as the composition and performance of our portfolio.

[Henri Steenkamp:]

Thank you, Chris. Looking at our quarterly key performance metrics on slide 4, we see that for the quarter ended May 31, 2016, our net investment income was $2.5 million, or $0.44 on a weighted average per share basis. Adjusted for the incentive fee accrual related to net unrealized capital gains in the second incentive fee calculation, our net investment income was $2.6 million, or $0.46 per share. This represented a decrease of $0.2 million compared to the same period last year, but an increase of $0.1 million compared to the quarter ended February 29, 2016. Total investment income increased 1.4% to $7.9 million for this year’s first quarter as compared to $7.8 million for the fourth quarter of 2016 and increased 4.6% from $7.6 million for the same quarterly period last year. This increased investment income was generated from an investment base that has grown by 0.6% from the first quarter last year, but has decreased by 6.9% on a sequential quarterly basis. Despite this asset decrease, investment income has still increased since last quarter primarily due to higher interest income this quarter and less other income as a proportion of total investment income that benefited last quarter. The investment income increase year over year was offset by, one, increased debt and financing expenses from higher outstanding notes payable and SBA debentures outstanding this full quarter, reflective of the growing investment and asset base, with some of it not yet fully deployed; two, increased base and incentive management fees generated from the management of this larger pool of investments; and three, slightly increased total expenses, excluding interest and debt financing expenses, base management fees and incentive fees as compared to last year. These increased expenses reflect higher administrator and deal research fees. In the first quarter of fiscal 2017, we experienced a net gain on investments of $0.7 million, or $0.13 on a weighted average per share basis, resulting in a total increase in net assets from operations of $3.3 million, or $0.57 per share. The $0.7 million net gain on investments was largely comprised of $6.1 million of net realized gain from investments, offset by $5.4 million of net unrealized depreciation. The net realized gain primarily relates to the realization of our investment in Take 5 oil change during the quarter of $6.0 million, while the net unrealized depreciation is really due to the reversal of this gain from unrealized to realize as well as a further write down of $1.4 million on our legacy Elyria investment. The remaining value of this Elyria investment is now $0.6 million. Net investment income yield as percentage of average net asset value was 8.0% for the quarter ended May 31, 2016. Adjusted for the incentive fee accrual related to net unrealized capital gains, the net investment income yield was 8.3%, down from 9.3% for the same period last year and up from 8.0% for the fourth quarter 2016. Much focus is always placed on net investment income, but we have highlighted in the past the importance we place on return on equity as an important financial indicator, which includes both realized and unrealized gains. Return on equity was 10.4% for this quarter, up from negative 1.3% last quarter and 9.4% for the full fiscal 2016, and also significantly beat the current market average of negative 0.3%. We believe our ROE growth has been very consistent and an important indicator of our success in pursuing our strategy of growing the asset base, building scale and generating competitive yields, while continuing to focus on the quality of our portfolio. Our total operating expenses were $5.4 million for the first quarter 2017 and consisted of $2.4 million in interest and debt financing expenses, $2.0 million in base and incentive management fees, $0.7 million in professional fees and administrator expenses and $0.4 million in insurance expenses, directors fees and general administrative and other expenses. For the first quarter 2017, total operating expenses decreased by $0.4 million as compared to the same period last year. This decrease was primarily due to lower second incentive management fees as last year had a higher net gain on investments, offset by higher interest and credit facility financing expenses this year reflecting our growing asset base. Total expenses, excluding interest and debt financing expenses, base management fees and incentive management fees, increased from $0.9 million for the quarter ended May 31, 2015 to $1.0 million for this year’s first quarter. This was primarily due to higher administrator and deal research fees, but remained unchanged at 1.4% of average total assets for both quarters. We expect to further benefit from scale as our assets continue to increase while our cost structure remains relatively consistent As ROE and other metrics continue to improve, it demonstrates two important points about the value of our asset growth. First, as our SBIC assets continue to grow as compared to our overall assets under management, the greater net investment income on these investments financed through lower-cost SBA debentures contributes more to our bottom line. SBIC assets are currently 69% of total assets, with $46 million of debentures yet to be drawn on our first license that we have already fully funded. And second, we see the benefit of scale becoming more visible as our operating expenses stabilize and reduce as a percentage of our total assets. As you can see on slide 5, net asset value has steadily increased over the past six years. This quarter NAV was $127.1 million as of May 31, 2016, a $2 million increase from an NAV of $125.1 million for the quarter ended February 29, 2016. NAV per share increased to $22.11 as of May 31, 2016, compared to $22.06 as of year-end. Since last quarter, NAV per share increased by $0.05 per share, primarily reflecting the $0.9 million or $0.16 per share increase in net assets and this is net of the $0.41 per share dividend paid during the year, offset by the dilutive impact of the 77,995 net shares issued during the quarter. These shares consisted of 123,492 shares issued pursuant to the dividend reinvestment plan representing two quarter’s dividend payments, offset by 45,497 shares that were repurchased. Slide 6 outlines the dry powder available to us as of May 31, 2016. As of this date, we had zero outstanding in borrowings and our revolving credit facility with Madison Capital and $103.7 million in outstanding SBA debentures. Our Baby Bonds had a carrying amount and fair value of $61.8 million and $62.8 million, respectively. With the $45 million available on the credit facility, $46.3 million additional borrowing capacity at our SBIC subsidiary and $27.5 million in cash and cash equivalents, primarily in our SBIC subsidiary, we had a total of $118.8 million of available liquidity at our disposal as of the end of our first quarter 2017. This available liquidity equates to approximately 45% of the value of our year-end investments, meaning we can grow our current assets under management by a further 45% without any additional external financing. We also continue to assess all our various capital and liquidity sources, and we’ll manage our sources and uses on a real-time basis to ensure optimization. As we had previously discussed, our debt distribution agreement with Ladenburg Thalmann & Company allows us to offer for sale from time to time up to $20 million in aggregate principal amount of the notes through an at-the-market offering on a rolling 12-month basis. We are entering the second year of this offering. This is a benefit of having our N-2 shelf registration statement allowing us to capitalize on market opportunities. As of May 31, 2016, we sold 539,725 bonds with a principal of $13.5 million at an average price of $25.31 for aggregate net proceeds of $13.4 million under this program. This is the same as at year end and no bonds were added this quarter. This enables us to further enhance our liquidity and plan ahead for future capital needs such as the funding of a second SBIC license. These new issuances are also under the exact same terms as the original Baby Bond offering in 2013. We remain pleased with our liquidity position, especially taking into account the conservative composition of our balance sheet and the ability we continue to have to substantially grow our assets without the need for external financing. Now I’d like to move on to slides 7 through 9 and review the composition and performance of our investment portfolio. Slide 7 highlights the portfolio composition and yield at the end of the quarter. As of May 31, 2016, the fair value of the company’s investment portfolio was $264 million, principally invested in 52 portfolio companies and one CLO fund. Saratoga investment portfolio was composed of 49.7% of first-lien term loans, 33.9% of second-lien term loans, 4.7% of subordinated notes in a CLO, 4.9% of syndicated loans and 6.8% of common equity. The weighted average current yield was 11.1%, which was comprised of a weighted average current yield of 10.7% on first-lien term loans, 11.3% on second-lien term loans, 6.9% on syndicated loans, and 17.3% on our CLO subordinated notes. Despite downward pressure on yields due to continued competition, our yields have remained strong and consistent as compared to the previous fiscal quarters. To further illustrate this point, slide 8 demonstrates how the yield on our core BDC assets, excluding our CLO and syndicated loans, has remained consistently around 11% for the past several quarters. While the syndicated yield decreased slightly this quarter, this was offset by the increase in the CLOs yield that does tend to fluctuate. Moving on to slide 9, during the first quarter of 2017, we made no investments in new or existing portfolio companies and had $20.6 million in exits and repayments, resulting in a net reduction in investments for the quarter at our BDC. As you can see on slide 9, our investments continue to be highly diversified by type as well as in terms of geography and industry, with a large focus on business, consumer and healthcare services, while spread over 12 distinct industries. You’ll also notice that we had recharacterized what was previously titled software as a service into the existing industry categories. It is worth noting that we have no direct exposure to the oil and gas industry, a fact that has served us extremely well during this past fiscal year. Of our total investment portfolio, 6.8% consists of equity interests. Equity investments are and will continue to be an important part of our overall investment strategy. Slide 10 demonstrates how realized gains from the sale of equity investments combined with other investments have helped enhance shareholder capital. For the past four years prior to this quarter, we have had a combined $5.3 million of net realized gains from the sale of equity interest or sale or early redemption of other investments. This consistent performance continues to be a good indicator of our portfolio credit quality. In the first quarter 2017, we continued this trend and were able to show an additional net realized gain of $6.1 million, reflecting our success in investments we have originated. That completes my financial and portfolio review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer, for an overview of the investment market.

[Michael Grisius:]

Thank you, Henri. I would like to start by taking a couple of minutes to update everyone on the current market as we see it. The market’s extremely competitive conditions persist, and Q1 2017 was no different. Slide 11 indicates how many pure deals are being done in the market. The number of transactions for deal sizes in the US below $25 million in 2015 was down 23% from calendar year 2014 and calendar year 2016 is off to slow start as well, continuing that trend. Only 610 debt deals in that size range closed as of May 31, 2016 compared to last year’s 947 for the same time period. That’s a year over year reduction of 36%. At this pace, we anticipate the calendar year 2016 is likely to be a slower year than 2015. As a result, pricing remains under pressure as lenders compete for mandates. There is evidence suggesting that yields across the broader middle market for most credit types have increased slightly over the last quarter, but these increases are modest, generally no more than 25 basis points. We have seen no widening of spreads in the lower middle market where we operate. Our experience has been that strong credits are aggressively sought after. In the face of these difficult market trends, we continue to believe that the lower middle market is the most attractive market segment to deploy capital and the fundamentals here remain strong, leading to the best risk adjusted returns in our view. In our case, we have created a primary originated portfolio of healthy low leverage assets with a robust average yield of 11%. In addition, powerful long-term secular trends bode well for the BDC industry as a whole. Banks continue to shift toward large borrowers due in part to the regulatory hurdles facing smaller banks serving the middle market. In addition, Saratoga Investment’s target market is rich with potential opportunities. Small businesses with revenues between $10 million and $150 million in revenues represent nearly 90% of the opportunity set. In the chart on slide 12, you can see that multiples in the industry seem to be climbing again after last quarter’s isolated downward trajectory. According to KeyBanc metrics, 75% of all middle market deals as of March 31, 2016 were leveraged over 4.1 times as compared to 44% in December 2015. However, irrespective of the fluctuation of market leverage levels historically, we have been able to invest in deals with relatively low multiples. This quarter, our total leverage was 3.9 times, similar to the previous quarter, despite the fact that leverage is climbing for the rest of the industry. Therefore, the majority of our closed deals remain beneath market levels as they have been consistently in the past. We are very careful to exercise extraordinary investment discipline and invest only in credits with attractive risk return profiles. We will, of course, make select investments in higher leverage loans provided that through our own underwriting we conclude that the credit characteristics of each business can support a higher debt profile. Of importance to us when doing deals with higher leverage is ensure that our dollars are invested in companies with exceptionally strong business models where we are confident that the enterprise value of the businesses will sustainably exceed the last dollar of our investment. In addition, this slide demonstrates the overall upward trend we’ve experienced in our number of executed investments. With a strong execution track record in recent periods as well as year over year growth, our executed investments increased to 16 in fiscal year 2015. In the first half of calendar year 2016, we saw five deals close, with the sixth closing right after quarter end, reflecting lower quality deal flow in the market. Having invested capital through multiple economic cycles, we know that originations tend to be lumpy and we understand the importance of never allowing our desire to grow assets to interfere with our credit judgment. I’d like to go into a little more detail regarding our pipeline on slide 13. Our deal flow remains robust. Moreover, since 2013, the number of deals we’ve sourced and looked at has increased materially, 60% of these coming from companies without institutional ownership and the remainder from private equity sponsors. In calendar year 2015, we looked at 613 deals and executed on 16. In the last 12 months ended June 30, 2016, the number of deals that we’ve looked at has increased slightly in comparison to 2015, but the number of term sheets issued and deals that we’ve closed have dropped slightly. A confluence of factors are producing this result, the more robust origination platform that we’ve invested in over the past couple of years, the difficult market conditions and lack of quality deals and the prudence that comes with disciplined investment judgment. We are seeing more deals, but we are turning more down. Despite a slight dip in recent production, we believe the strength of our deal flow will allow us to continue to grow our portfolio at a pace consistent with the past. Our reputation for being fair minded and supportive investors has increased our pace of referrals from small business owners and management teams. In addition, we continue to increase our private equity sponsor and intermediary relationships. Using our own internal evaluation system, we have grown or Tier 1 deal sourcing relationships from eight in 2012 to approximately 100 today. We believe this will allow us to further accelerate our pace of investment, while we remain diligent and careful in our investment approach. Since taking over management of the BDC, we have understood the importance of getting the assets right. As a consequence, our highest priority was to build one of the premier execution teams in the business. We believe we have accomplished that. And we view our professional staff as best in class. Saratoga has continued investing in talent, combining experience with expertise. We remain focused on continuously adding to our talent, as we have over the last five years, and feel that we are well positioned to continue to benefit from the momentum we have built. Our overall portfolio quality is strong and is even stronger when taking to account only the assets originated by us since taking over the BDC management in 2010. As you can see on slide 14, the gross unlevered IRR on our realized investments made by Saratoga management team is 17.4% on approximately $103 million of investments in our SBIC and 14.9% on approximately $40 million of investments in the rest of our BDC. Similarly, for the first six months of calendar 2016, we have seen four realizations on investments totaling $31 million, which generated gross unleveraged returns of 23.1%. While payoffs can present a challenge because they naturally curtail our asset growth, we believe they are also a strong indicator of the strength of our investment team and our investment selection process. Realizations mostly occur when companies have performed well and they either enter into a change-of-control transaction or are refinanced with cheaper capital. On the chart on the right, you can also see that gross unlevered IRR on our unrealized investments. The total gross unlevered IRR on all of our $181 million of SBIC unrealized investments is 15.1%. In addition, our gross returns in the SBIC have remained consistently strong across vintage years. The total gross unlevered IRR on the rest of our BDC unrealized investments since Saratoga took over management is 9.5% on approximately $46 million of investments. This is reflective of some of the mark-to-market valuation activities. Combined, our total SBIC and BDC unrealized investments of $226 million are producing a gross unlevered IRR of 14.6%. With respect to our SBIC, our objective remains to maximize our risk adjusted returns in a manner that utilizes the low cost of capital and the 2-to-1 leverage advantage we possess through our SBIC license. By focusing on the smaller less competitive end of the market, we are able to reduce the risk profile of our portfolio, while delivering highly accretive returns to our investors. As you can see on slide 15, as of May 31, 2016, over 49% of our SBIC investments are in senior debt securities, which is slightly down from last quarter due to recent redemptions and an increase in first-lien last out second lien investments. The leverage profile of these investments remains very low at 3.6 times, especially when compared to market leverage. Because of the leverage and low cost of capital advantage is inherent in the SBIC program, we can achieve strong returns for our shareholders without moving far out in the spectrum. Therefore and as demonstrated this past year, we intend to grow our net investment income by continuing to dedicate the majority of our effort and resources to growing that portion of our portfolio. Moving on to slide 16, you can see our SBIC assets decrease slightly to $182.7 million as of May 31, 2016 from $200.6 million last quarter. Most of the realizations we had this quarter were in our SBIC portfolio. As a percentage of our total portfolio, SBIC assets have grown from 0% of our total portfolio at fiscal year-end 2012 to 71% at the end of last fiscal year, with a slight reduction this quarter to 69%, reflecting these realizations. Also, it is important to note, as of the quarter ended May 31, 2016, we had $72 million total available SBIC investment capacity, including cash, of which $46.3 million is leverage capacity within our current SBIC license. If we were to obtain a second license, our leverage capacity would increase by another $75 million or more, based on the new regulations with the ability to increase assets by at least $112.5 million. In our view, our origination platform is among the very best at our end of the market and we continue to dedicate more resources toward it. We are seeing a steady flow of SBIC eligible investments and are optimistic about our ability to grow that portfolio at a healthy rate, while remaining extremely diligent in our overall underwriting and due diligence procedures. This concludes my review of the market. I’d like to turn the call back to our CEO, Chris?

[Christian Oberbeck:]

Thank you, Mike. From the start of our quarterly cash dividend payment program 21 months ago, our expectation was this dividend would increase substantially and it has, by 139% since the dividend program launched. As outlined on slide 17, during the fiscal year 2016, we declared and paid dividends of $2.36 per share, gradually raising the dividend through the year from $0.27 for the quarter ended February 28, 2015 to $0.40 per share for the quarter ended of November 30, 2015. Last year, we also included a special dividend of $1 per share. In addition, during Q1, we announced and paid a dividend of $0.41 per share for the fiscal quarter ended February 29, 2016 and on July 7, 2016, our Board of Directors declared a dividend of $0.43 for the quarter ended May 31, 2016 to be paid on August 9, 2016 to all stockholders of record at the close of business on July 29, 2016. This is a further increase of $0.02 to our quarterly dividend. Shareholders continue to have the option to receive payment of the dividend in cash or receive shares of common stock, pursuant to our dividend reinvestment plan, or DRIP plan, which we adopted in conjunction with the new dividend policy and provides the reinvestment of dividends on behalf of our stockholders. For more information, see the Stock Information section of our Investor Relations section of our website. Slide 17 also shows how we are currently still over-earning our dividend. This quarter’s dividend of $0.43 per share compares to our adjusted NII per share of $0.46 for the quarter, which means we are currently over-earning our dividend by 7%. This gives us one of the highest dividend coverage ratios in the BDC industry. We also further exercised our share repurchase plan during the quarter ended May 31, 2016. During fiscal year 2015, we announced the approval of an open-market share repurchase plan that allows us to repurchase up to 200,000 shares of our common stock at prices below our NAV, as reported in our then most recently published financial statements. In October, this share repurchase plan was extended for another year and increased to 400,000 shares through October 2016. As of July 12, 2016, Saratoga repurchased 79,224 shares at a weighted average price of $15.23 per share under this plan. We are also pleased to see our relative standing in the industry consistently improve over time. As you can see on slide 18, and reflecting our strong key performance indicators we have discussed earlier, our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 6.5% with much of the rest of the industry in negative territory with the BDC index at a negative 3.4%. When viewed over a longer time horizon such as either three years or six years which is when we took over the management of the BDC, we have performed with distinction relative to the rest of the industry. Our three-year total return is 29%, which places us fourth in the industry overall, while our six-year total return is 169%, placing us third compared to all other BDCs. And despite putting up the strong historical total returns, our price to NAV remains at a 23% discount, reflecting the opportunity for potential future incremental returns. Moving on to slide 20, you will see a scatter chart illustrating our comparative outperformance in a different way, plotting our return on equity against our value as reflected by price to NAV. As you can see, we’ve outperformed the BDC market from a return on equity perspective on the right side of the graph, while our price to NAV has not yet reflected this performance. We believe that no competitor currently generates a higher return with a better credit profile and at a better value than we do. We feel that these and other metrics that we’ve discussed today underscore the strength of the investment strategy we have pursued since taking over the management of Saratoga in 2010, and we believe that as we continue to outperform from a return on equity perspective that our position will be moving up on this chart. All of our initiatives we have discussed on this call are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We believe that our differentiated characteristics outlined on slide 21 will help drive the size and quality of our investor base, including the addition of more institutions. These characteristics include a strong and growing dividend, industry-leading return on equity, ample low-cost available liquidity, solid earnings per share, NII yield with substantial growth potential, and steady high-quality expansion of AUM. The high credit quality of our portfolio is buttressed by our minimal exposure to the oil and gas industry and no investments on nonaccrual. With this performance, Saratoga Investment is solidly on the path to being a premier BDC in the marketplace. Moving on to slide 22, our final slide, we’ve accomplished a lot in the past year and are proud of our financial results. There’s no change to our simple and consistent objectives

[Operator:]

[Operator Instructions] And our first question comes from Casey Alexander from Compass Point Research.

[Casey Alexander:]

I had a couple of questions. Last year you noted that you did the catch-up dividend in order to meet the RIC requirement. There hasn’t been any discussion about it this year. Is your plan this year to just let the excess net investment income spill over?

[Christian Oberbeck:]

We will probably have a catch-up dividend this year, but it would be substantially smaller than it was last year. That is something we’re still working to calculate and we will address that shortly.

[Casey Alexander:]

Henri, can you tell me how much of the cash is within the SBA subsidiary?

[Henri Steenkamp:]

Most of it, Casey, I think it’s around 25 or 25.5 of the amount that’s on the balance sheet is in the SBIC subsidiary, reflecting – some of the redemptions we had during the quarter in that – in our SBIC.

[Casey Alexander:]

So you’re kind of in a situation where you’re almost reverse levered and that you’re paying interest on some debt that you just have cash against instead of investments. As you get that money to work and continue to grow the portfolio, does it make sense to take a more balanced view of your liability structure and try to get into that line of credit a little bit more so that even if you have some redemptions you can pay that down as opposed to paying interest on leverage that you’re not currently using?

[Christian Oberbeck:]

Casey, I think that’s definitely an optimal situation and that’s something that we would like to be. And I think one of the things that’s just – the way our investments pattern has occurred is while we’ve made some significant investments in SBIC, we just also had a lot of realizations in the SBIC. And once you draw the debentures there, they’re just – they’re drawn. And those aren’t a revolver as you point out. And really what we need to do is get our – all that cash reinvested and we’re in process, we have deals already close this quarter and we would expect to take care of that cash imbalance shortly. But again, once we’ve drawn the debentures, they’re not redeemable, if you will. I mean, they are, but you shouldn’t because they’re such attractive financing. So ideally I think we would be into the revolver, but again it has to do with the concentration of our investments and the very positive returns on those investments in the SBIC.

[Michael Grisius:]

Mechanically, Casey, I mean it’s a very good point, but the way the SBIC program works is that when an asset qualifies for the program, you draw on the debentures to fund that investment. And if you get the money back, good news is you can redeploy that capital and get the advantage of that really long-term interest-only cheap financing from the government, but it doesn’t have the revolver capacity. It can’t swing up and down unfortunately. But if you were to instead fund more of that on the revolver, then it’s out of the SBIC subsidiary for good. The SBA doesn’t want you to fund it up at the BDC and then depending on timing sort of push it down to the SBIC. It’s just sort of the mechanics of the program. We don’t manage that SBIC license with the expectation that we’re going to be sitting on excess cash. One of the downsides of the performance that we’ve had with our investments is that we’ve done very well and sometimes results in some significant realizations, redemptions and we just happen to be at a moment in time where we’re sitting on some cash. We don’t expect that’s going to last long looking at our pipeline. So we shouldn’t be in a position where it’s a real drag on shareholder earnings.

[Casey Alexander:]

I appreciate that answer, Mike. Let me ask you, of this pipeline, is the pipeline meeting the leverage profile that you’ve been used to or are you also starting to get squeezed up into the top end of the toothpaste tube in terms of leverage? And how many deals are you turning down or specifically on terms, there are companies that you would like to invest in, but the competitive terms have just pushed them to the point where you don’t see it worth it to you?

[Michael Grisius:]

That’s a really good question. And I’ll tell you to the last part of that, I’ll address first. For us, mostly we have just not seen the quality that we like. I think we’ve done a very good job creating relationships and making sure that we’re seeing as many of the right types of deals as we should. And you can see that reflected in the number of deals that are coming in house in that one slide, but you see fewer term sheets being issued. And that’s really reflective of quality; it’s not reflective of us wanting to win the deal and then the competitive terms are so aggressive that we decide to back away. So we’re in the fortunate position where we’re not just getting squeezed away because the leverage profile of the investments is too great. I will remind you that when we think of our portfolio, certainly leverage is a metric and it’s a metric for risk. But I’ll tell you some of the best deals that the investment professionals around here have done are ones that on the face of it have a little bit higher leverage profile, many of those have a higher equity contribution than the businesses that deserve more leverage as well. So while that is a metric that we pay attention to and I think overall it’s reflective of the quality of our portfolio, the fact that we’ve got a lower leverage profile, some of our best quality assets are ones that on the face of it have a little bit higher leverage.

[Casey Alexander:]

So your point is then the cheap is sometimes cheaper.

[Michael Grisius:]

Absolutely. I can tell you we’re sort of talking about it, I’ve been doing this for so long. I think over my career, the one deal that I did that didn’t work out so well was I think a deal that was 2.5 terms leverage on the face of it. And at the end of the day the business had some dynamics that were tough. It was many moons ago, but it’s sort of a reminder that leverage is one metric, but we spend all of our time thinking about the sustainability of the business model and why it’s going to have a sustained enterprise value and there’s a lot of variables, a lot of work that goes into that. Sometimes you’ll position yourself that you could be 5 times in the balance sheet, but it’s a business that has an enterprise value that’s north of ten and we can get comfortable that it’ll stay there. That may be a better investment than one that’s at 3 times leverage that somebody is buying for five, but it’s got other dynamics that may make it a tougher credit.

[Casey Alexander:]

And lastly, Henri, this is just a maintenance question. The higher administrative expenses, is that permanent for modeling purposes? Is that a step up that it’s going to stay or does that have something to do with additional year end expenses?

[Henri Steenkamp:]

No. That is permanent. Last year, during their renewal of the administrator agreement around mid-year, our cap was increased from $1 million to $1.3 million. So that wasn’t in Q1 last year; it was still at the $1 million. But now the last three quarters it’s been at a run rate of $1.3 million annualized. So that is permanent.

[Operator:]

Our next question comes from Mickey Schleien from Ladenburg.

[Mickey Schleien:]

My first question maybe for Mike, I noticed that Targus was converted from cash to pick pay, which could imply that the company is struggling. Could you give us an update on how they’re doing?

[Michael Grisius:]

Well, there’s been a recapitalization of the balance sheet. So our debt capital is reflecting the under-performance of the business. And I’ll remind you this is a legacy asset as well, it was converted to equity capital. So that transaction has taken place and we’re hopeful that the business is now at a level that is not only stabilized but has a chance of recovering to some degree.

[Henri Steenkamp:]

And Mickey just also to remind, it was mostly written off, actually totally written off last year end as part of the restructuring. And prior to that, although it was cash, it was on nonaccrual status. So there wasn’t any cash interest actually flowing through the P&L.

[Mickey Schleien:]

Just a technical question, in your unitranche deals, when you sell the first piece and I don’t really know how often this occurs, how many turns of leverage does that usually represent?

[Christian Oberbeck:]

That’s a really good question because you see a lot of those structures in the marketplace and we’ve been involved in crafting them for many years, so understand it very well. I can tell you there’s not a set answer as to how much senior capital comes in front of you. We typically don’t structure deals like that where we’re selling the first lien or the first out piece off. When we structure something that way we usually do it in concert with a senior lender partner and we together come up with a capital structure that – with a facility that we think is competitive in the marketplace and so they’re done at the front end, not a sale process. And usually the senior debt is a component of it, the first out piece is a component of it. It might be half of the capital structure, but there’s no one rule of thumb.

[Mickey Schleien:]

And Mike, in the deals where there is a – I shouldn’t use the word sale, I understand, because if you sell it then that creates a lot of accounting issues. But in situations where you have a bank ahead of you on a unitranche deal, do you list those as first lien investments or second lien on your SOI?

[Michael Grisius:]

If it’s a – so you’re referring to actually schedule of investments, right, Mickey?

[Mickey Schleien:]

Yes. So if you do a unitranche investment and with a commercial bank partner which has some piece of the deal ahead of you, do you list that as first lien or second lien? I didn’t see a footnote that would describe that.

[Michael Grisius:]

I think we generally would – if it’s like a first lien last out, we would highlight that in our schedule investments. An example was Community that we had up to some point towards the end of last year, there actually were listed as the first lien but it would be first lien last out. What you see you is sort of first lien highlighted on the SOI is just a first lien loan.

[Mickey Schleien:]

So in other words, there’s probably no unitranche currently in the portfolio. Henri, we’ve talked about this before, but we are getting closer and closer to the end of the reinvestment period for the CLO. Can you give us any thoughts on refinancing that vehicle, updated thoughts?

[Henri Steenkamp:]

I think not too much of an update than what we provided last time. As we said then, we still had – I think last time we spoke still three quarterly payments remaining. We still have two now currently before the reinvestment period ends and I think we definitely talk about it and still considering the various options. But there is still a couple of quarters to go as one would generally do this refinancing once you go past the reinvestment period. But Mickey, consistent with what we said in the past, CLO is an important part for us, of our BDC and it’s something that we do place a lot of value on.

[Christian Oberbeck:]

And one further comment, Mickey, is that as one who watches the CLO market carefully, there’s been a tremendous amount of volatility this year. Late last year, early this year period of time, CLO valuations were down, spreads were difficult, there were not a lot of CLOs being done. And all that has reversed itself at this point in time. So the refinancing environment is much more favorable today than it was on our last call and it was on two calls ago. Whether that remains to be the case or not is unclear. So there’s a market dynamic as to when it makes sense to pull the trigger on a refinancing as well, having to do with spreads and asset spreads, liability spreads. So all that’s in a dynamic that we’re watching very carefully. And as Henri has said, we’re very interested in finding a path, but we also need to find a path that’s fundamentally in the right profit profile for the firm.

[Mickey Schleien:]

Chris, I was hoping, given that you are a relatively small company, your forecasts for your company are very sensitive to the pace of investments that we assume. And I know you in your prepared remarks talked about a stronger second quarter. But can you give us – we are halfway through this second fiscal quarter, can you give us at least a scope or a range of what you think you might see in terms of the gross originations this quarter?

[Christian Oberbeck:]

I think we’re reluctant to do that right now just because we have a number of deals we’ve closed and we have a number of deals that we feel are going to close soon, but we also have a number of potential redemptions. And there is just a dynamic there that we would prefer not to predict on this call at this moment.

[Michael Grisius:]

Mickey, it is a good point. As a smaller business, our balance sheet can be a little bit whippy quarter to quarter just reflecting that. We tend to look at the business and I’ve been doing this for a long time, I think it’s a real important thing from a credit perspective as well as I know our shareholders want to make sure that our assets are really high quality, we look at the business really over sort of a longer period, 12 months or so. What progress are we making? And first and foremost, we evaluate ourselves by saying are we seeing the right transactions? Are we getting add backs to try to win the right deals from the right people? And there’s still work in progress there and that’s one of things that we’re most excited about is that we’re still getting our name out there. There are a number of people in the marketplace, in the smaller end of the middle market is massive. It’s just an ocean of different deal providers and investors. So we’re still getting our name out there and we want to increase the number of opportunities we get with quality co-investors and people that we can work with. That’s how we evaluate ourselves. Now having said that, if you ask the question not quarter to quarter, but over just maybe use a 12-month metric, do we feel like with the deals that we’re looking at that the chances that we’re getting to invest capital that our originations can outpace our redemptions, the answer is yes and we think that we can grow at a pace that’s consistent with what we’ve done in the past. But that won’t – you’re going to see some lumpiness quarter to quarter and I think that’s an important thing. I would even say and I think I maybe said this before, but I would say that if you see a BDC that is investing at a consistent pace quarter to quarter that is a sign of trouble. It’s not how the business works, it just doesn’t work that way.

[Mickey Schleien:]

I hear you, Mike. But with much larger BDCs, it tends to be a little smoother and I understand everything you are saying, but obviously our customers are looking for a quarterly forecast and in the end we have to assume something. But it’s actually a segue into my last question. If I recall correctly, the amount of private funds other than the CLO that’s managed by the external manager is quite limited and the BDC does not co-invest. Is that correct?

[Christian Oberbeck:]

Yes.

[Mickey Schleien:]

So given that structure, Chris, have you given thought to converting to an internally-managed BDC, which potentially could improve your efficiency ratio and realize a higher valuation for the stock?

[Christian Oberbeck:]

I think we’re generally aware of a lot of the conversations in the industry. I think the point that you make is one that has been in discussion across the industry for a period of time. It is something that we consider when we look at it. We also look at the marketplace in particular and in the marketplace in particular the vast majority of funds are externally managed. And there don’t seem to be many conversions taking place like you just described. So it’s something we are aware of and have thought about and considered. But we don’t see that as an industry trend, if you will, and it’s something that we’re not planning on doing. It’s something that we’re generally aware of at this time.

[Operator:]

[Operator Instructions] I’m not showing any further questions in queue at this time. This concludes today’s Q&A session. I would now like to turn the call back over to Christian Oberbeck for closing remarks.

[Christian Oberbeck:]

We’d like to thank everyone for joining us today and we look forward to speaking with you next quarter.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.