Saratoga Investment Corp.
Q1 2009 Earnings Call Transcript

Published: 15 Jul 2008

[Operator:]

Welcome to the GSC Investment’s first quarter fiscal 2009 financial results conference call. (Operator Instructions) At this time for opening remarks I would like to turn the call over to the Chief Financial Officer, Rick Allorto.

[Richard Allorto:]

I would like to welcome everyone to GSC Investment Corp.’s first quarter 2009 earnings call. Before we begin I will read a brief statement. This conference call contains statements to the extent they are not resuscitations of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual outcomes and results could differ materially of those forecast due to the impact of many factors. We do not undertake to update our forward-looking statements unless required by law. A replay of this conference call will be available from 1

[Thomas Inglesby:]

I will begin with some brief remarks and then Rick will provide you with a detailed review of our first quarter 2009 financial results. We are pleased with our first quarter results. We are generally pleased with our portfolio and its position and believe our investment strategy will enable us to weather the current private cycle. Since the inception of our company we have worked on diversifying our investment portfolio, while continuing to pay an attractive dividend. Based on the yesterday’s closing price we have an annualized dividend yield of 16%. At the end of the first quarter, our five largest corporate debt investments represented 26% of our investment portfolio, down from 40% a year ago; only one investment was greater than 5%. Our largest cycle investment is the equity trench of a self managed CLO. Although it is 19% of our investment portfolio, this CLO equity trench is highly diversified, implied to over 145 underlying investments. The value of our investment portfolio on May 31 was $156.4 million. The decline in the size of our investment portfolio from the previous quarter was due in part to the repayment of our investment and strategic industry. The yield on our portfolio declined during the quarter 10% reflecting the declining yield from our floating rate asset which comprised 48% of our portfolio. This decline has little effect on our investment income, given the similar decline in our floating rate borrowing costs. We declared a regular quarterly dividend of $0.39 per share on May 22. Our objective as far as dividend is to closely track the net investment income generated by our portfolio. I will discuss our portfolio in greater detail and provide an overview of the global market after Rich reviews our financial results.

[Richard Allorto:]

GSC Investment Corp’s net income for the first quarter ended May 31 was $2.8 million or $0.34 per share. Our net investment income was $3.2 million or $0.39 per share and our net loss on investments was $184,000 or $0.5 per share. As of May 31 stockholders equity was $97 million, ended the quarter with an asset value of 175 per share. Our total investment income for the quarter ended May 31 was $5.7 million, which included 523,000 management fee income [inaudible] with the new CLO investment. Total operating expenses for the quarter before manager reimbursement is $2.8 million consisted primarily of $833,000 interest and credit facility expense, $748,000 in base management fee, $340,000 of incentive management fees, $248,000 in administrative expenses, $648,000 in general and administrative expenses. We also recorded $298,000 in manager expense reimbursement. Our total operating expenses after manager reimbursements were $2.5 million. Our manager has agreed to reimburse the company from operating expenses to the expense that the total annual operating expenses exceeded an amount equal to 1.55% stockholders equity. The expense reimbursement included base, an incentive management fees and interest and credit facility expense. For the quarter we recorded $50,000 in cash reimbursement. This reimbursement agreement expired effective March 23, 2008 will no longer benefit from this reimbursement. Under our administration agreement, we are not required to reimburse the administrator, so we have $500 million of assets. Accordingly we expect to continue to benefit from it as we enter throughout fiscal 2009. For the quarter we recorded $248,000 cash reimbursement. This quarter we incurred a net realized loss of $287,000 on the scale of redemption of investment and a fair value of our portfolio decreased by $85,000. As a result of the Strategic Industries redemption, we reversed $2.6 million of prior unrealized losses during this quarter. However, this result was set by additional write-downs in the portfolio. The largest write-down for the quarter was our investment in [inaudible] $2.2 million, regarding this investment based upon market quotation as of the end of the quarter. Additional details on unrealized losses in the portfolio are available in our shareholder presentation which can be found on our website. As of May 31, 33% of our investment are liquid, 13% was valued by an independent third-party valuation firm, 17% were valued based upon market quote, 37% were valued internal. Consequently, approximately 63% of our investments were valued based primarily on market input with the existence of independent third-party evaluation firms. As of May 31, the company has 47 investments, 39 portfolio companies, average investment size of $3.3 million. Portfolios were comprised of 18% first lien term loan, 31% second lien term loan, 18% senior secured notes, 14% unsecured notes and 19% coordinated notes of our CLO and other equity and limited partnership interests. As of May 31 we had borrowed an aggregate of $50.7 million under our credit facility and $39.3 million of un-drawn commitments remaining. This concludes my review of our financial results. I’ll now turn the call back to Tom.

[Thomas Inglesby:]

I would now like to review our investment portfolio and comment on the leverage financed market. During the quarter, we did not have any non-performing or delinquent investments in our portfolio. However, in May we added two investments to our watch list, giving us in total of four watch list investments. These four investments represent 11% of our portfolio. Our 6.5 million investments in the Atlantis Plastics first lien term loan is the only watch list investment for which we currently affect less than a part we are covering. The company is currently in the positive base-hold and we are seeking to maximize our recovery. We marked Atlantis Plastics at 61 at the end of the quarter. We had a defensive investment strategy, where we seek to earn a high recovery on investments that under-perform. We implement this strategy by seeking investment size and capital structure with low debt multiples ahead to do our investment. For example, the average second lien investment in our portfolio has a debt-to-equity multiple of 4.8 times, with 2.9 terms of EBITDA ahead of it in a capital structure. We believe these conservative leverage multiplies protect us in the event of either a default or of restructuring. I would now like to spend a few minutes detailing the impact of the CLO to the company’s earnings. As I mentioned in our last earnings call, we priced our CLO in mid-December and invested it between December and March. This was during the period of sharply falling asset price. By taking advantage of the low market decline we were able to invest in the CLO one month ahead of schedule at the prices and interest spread better than the model. At May 31, the average purchase price was 93.5 versus a model price of 95.75 and our average asset spread was 279 basis points versus a model spread of 270 basis points over LIBOR. As a result, we believe this investment over implied will have an effective interest rate of 20.36% subject to of course, to a number of factors such as timing, the number of default and actual recovery. In addition, the company, the manager of the CLO also received a management fee of 50 basis points on the outstanding principal amount of the CLO’s asset. On the first CLO payment date of July 22, we will receive only a partial payment because we will have incurred six full months of CLO debt-to-service or we’ll have been fully invested for only about three month. The full income benefit of the CLO will now be reflected in our financial statement until the third quarter. As of May 31, the CLO has assets of $414.3 million consisting of predominantly senior secured first three months. No investment in the CLO portfolio was a payment default for delinquent. I would now like to discuss the market condition. The market remains challenged. The leveraged loan market continues to trade well below the highs of 2007. While the backlog of unsold transaction has decreased from $200 billion to about $30 billion or $40 billion, we attained continued deterioration and volatility in the credit markets in early 2008. The technical factors and lack of liquidity that played the market in 2007 have some of these only to be replayed by credit concern in many economic factors. Very few new CLO’s have been raised this year. For the last several years, CLO’s have been the most active loan investment. LIBOR is approximately 190 basis points lower than it was at the beginning of the year, making loans less attractive and so return on investments. Lastly companies that are directly exposed to the consumer and/or have direct exposure to the commodity input costs are reporting very weak earnings. High-yield bond spreads have mirrored the performance of the loan price. Many bonds appeared to be over priced given the highly leveraged subordinated risk inherent in the capital structure. As with the loan we are concerned about the impact of the weakened consumer at higher input costs and high-yield bond issuers. Activity in the middle market was redefined as companies with EBITDA between $10 million and $50 million remains low. The deals that have come to the market have cleared the off market terms largely financed by a regional bank that are less price sensitive and hedged on four CLO investments. We expect continued market volatility for the remainder of 2008. We also expect an increase in both covenant breaches and default. I would like to reiterate the following points for this cost. First, we are pleased with our earnings. For the quarter we reported net earnings of $2.8 million and net investment income of $3.2 million. We expect the CLO will be accretive to earning and that we will realize the full income effects from the CLO’s beginning in the third quarter of our fiscal year. Second, we are focused on maintaining the credit quality of our portfolio. We are mindful of the prospects of the weakening economies and we continue to monitor our portfolio closely. Third our portfolio continues to generate net investment income to cover our dividend. We expect that the current credit quality of our portfolio will enable us to continue to pay our dividend out of net investment income. Lastly, I will mention that we do not currently believe additional stock at its current price will be in the best interest of existing shareholders. We will continue our rights offerings if we were to believe that we can invest the proceeds in a manner that is accretive to our shareholders. However, as a result of the strategic industry repayment we have sufficient liquidity to make additional investments. Therefore, while we believe reinvestment opportunities available in the market are attractive, we are not under pressure to raise positional capital. This concludes our remarks. We would now like to open the call for questions.

[Operator:]

(Operator Instructions) Your first call comes from Greg Mason - Stifel Nicolaus.

[Greg Mason:]

I want to dig into the CLO earnings impact a little bit more. This quarter it looks like you had some impact from the CLO. In your press release you said that you had about an 8% yield, but you aren’t supposed to get a payment until July; was there some accrual this quarter that you record in the earnings from the CLO impact?

[Thomas Ingelsby:]

Yes, it was. The accrual is basically at approximately an 8% come cash-on-cash yield. The net cash-on-cash was on the original $30 million investment.

[Greg Mason:]

And how should I know in the fiscal third quarter it should go to 20%, what expectations should we look at next quarter?

[Thomas Ingelsby:]

Next quarter will be a blend of an 8% of accrual from June 1 to July 22 and then July 23 to the end of the quarter we’ll be at the approximately 20.4 % accruals.

[Greg Mason:]

Could you talk about your four watch list credits, you already touched on Atlantis Plastics. Could you talk about the other three and why you expect those to be paid at par and what are the issues there?

[Thomas Ingelsby:]

Well the large investment, ones we mentioned in the past, first we discussed Atlantis and second is our investment in EuroFresh where the company has bolted its liquidity and we see improving conditions. We think that they’ve got profits which excludes them from the current tomato frenzy with the way they grow their tomatoes and so we are generally optimistic that the company will have improving earning and our position in capital structure is high enough with people below it that care about preserving their investment that will be a nice peck at them. That’s our judgment. We also have a large investment coming from [inaudible] about $10 million. If the senior secured note is very high in the capital structure, I believe the $1.01, the leverage multiple growth will be reasonable. They have large operations in Brazil. They make plastic from Atlantic Packaging and we think they’re just a recent aspect here. They wouldn’t be on our watch list for credit reasons but more the fact that they’ll ensure next year and because we are not sure in the current market conditions. We believe we’ll be in [inaudible] demand. Our four conditions are very small investments, about $9.5 in a company called NC Litigation which of course is some certain operating issues and reduced earnings. They also have a good equity funding below them, so there is no liquidity issues there. We just put it on our watch list replacing the weaker earnings.

[Greg Mason:]

On your remaining portfolio, can you talk about what you are seeing in the underlying performance, the underlying EBITDAs of your companies in general?

[Thomas Ingelsby:]

We can, we’ve got the portfolio itself. We have about one-third of our company that has earnings ahead of last year and a little over half of our companies with earnings behind last year. So, we’re seeing modestly weaker earning across the actual balance sheet investment and the investments in our CLO, we have the strengthened earning versus the prior year. That portfolio is about two-third’s of our companies are performing ahead of the prior year. So still more we’re very mindful of what’s going on in the world, we’re very happy with where most of our investments are positioned in the capital structure and we’re certainly watching some of our companies very, very carefully.

[Operator:]

At this time we have no further questions.

[Thomas Ingelsby:]

Ladies and gentlemen, thank you again for joining us on this call. Please feel free to contact us, if you have any question. We look forward in seeing you on our next call.