Saratoga Investment Corp.
Q2 2014 Earnings Call Transcript

Published: 16 Oct 2013

[Operator:]

Good day, ladies and gentlemen. Welcome to the Saratoga Investment Corp. Second Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to turn the call over to Rich Petrocelli, Chief Financial Officer. You may begin.

[Richard A. Petrocelli:]

Thank you. I'd like to welcome everyone at Saratoga Investment Corp.'s Fiscal Second Quarter 2014 Earnings Conference Call. Before we begin, I need to remind everyone that this conference call contains statements, to the extent they are not recitations 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 from those forecasted due to many factors, which are described in the company's filings with the U.S. Securities and Exchange Commission. We do not undertake to update our forward-looking statements unless required to do so by law. A replay of this conference call will be available from noon today through October 22. Please refer to our earnings press release for details. I would now like to introduce our Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.

[Christian L. Oberbeck:]

Thank you, Rich, and welcome, everyone. In the fiscal second quarter of 2014, we continue to see opportunities in our financial strength and growing pipeline have enabled us to make significant new investments, adding 8 new portfolio companies. We invested $54.9 million in both new and existing portfolio companies during the quarter. And our significant financial resources will enable us to invest in future situations as they arise. The credit quality of the portfolio has continued to improve as we've increased both the amount and proportion of internally rated strong credit. As we look at our growing pipeline, we continue to see and harness opportunities for investment in leveraged loans and mezzanine debt issued by many U.S. middle-market companies. I will return shortly with a review of our portfolio, but I would like to now return the call back over to Rich to review our financial results.

[Richard A. Petrocelli:]

Thanks, Chris. Saratoga Investment Corp's net investment income for the fiscal second quarter ended August 31, 2013, was $2.3 million or $0.48 per share. Net loss of -- on investments was $2.3 million or $0.49 per share, resulting in a net decrease in net assets from operations of $40,000 or $0.01 per share. Net asset value per share was $23.77 as of August 31, 2013; $23.78 as of May 31, 2013; and $22.98 as of February 28, 2013. Our total investment income for the quarter was $5.4 million, an increase of approximately $1.2 million or about 29% compared to the fiscal second quarter of 2013. Our investment income was comprised primarily of $4.8 million of interest income and approximately $481,000 of management fee income associated with the investment in the CLO. Our total operating expenses were $3.1 million during the quarter and consisted of $1.6 million in interest and debt financing expenses, $811,000 in base management fees, $235,000 in professional fees, $119,000 in insurance expenses, $250,000 in administrator expenses and $136,500 in director's fees and expenses, general and administrative and other expenses. There were no incentive management fees payable in the quarter. For the 3 months ended August 31, 2013, total operating expenses compared to the 3 months ended August 31, 2012, were higher by more than $300,000, largely due to higher interest and debt financing expenses in the 2014 fiscal second quarter. On August 31, 2013, we had $48.3 million in notes payable outstanding, no borrowings under our $45 million revolving credit facility with Madison Capital Funding, $11.6 million in cash and cash equivalents and $16.6 million in cash and cash equivalents in reserve accounts. As of August 31, 2013, the company's Small Business Investment Company subsidiary had $25 million of regulatory capital and $40 million of SBIC debentures outstanding. That concludes my financial overview. I will now turn the call back over to Chris.

[Christian L. Oberbeck:]

Thanks, Rich. Before we open for questions, I would like to review the composition and performance of our investment portfolio. At the quarter ended August 31, 2013, the fair value of the company's investment portfolio was $187.8 million, principally invested in 34 portfolio companies and 1 CLO fund with $419.5 million of assets under management. Saratoga Investment's portfolio was composed of 19.8% middle market loans, 42.2% first lien term loans, 8.7% second lien term loans, 13% senior secured notes, 2.9% unsecured notes, 4.9% of equity interests and 10.5% of subordinated notes of the CLO. During the 2014 fiscal second quarter, Saratoga Investment Corp. invested $54.9 million in new or existing portfolio of companies and had $29.6 million in aggregate amount of exits and repayments, resulting in net investments of $25.3 million for the quarter. On October 1, 2013, the Saratoga CLO priced a refinancing of its notes. The refinanced Saratoga CLO has assets of $300 million and will have a reinvestment period through October 2016. As a result of increased pricing on the notes and the smaller asset base, interest income and equity distributions in the future will be lower than historical amounts. Saratoga Investment Corp. will continue to own 100% of the subordinated notes and receive a 50 basis point management fee for the life of the Saratoga CLO. The refinancing is expected to close on October 17, 2013. The company's new investments during the quarter included health systems, Trinet HR Corp., PrePaid Legal Services and DS services. Additionally, we invested $37 million of the proceeds of our $48.3 million bond offering to make middle market loan investments, including BMC Software, Distribution International, Keystone Automotive, Smile Brands, Surgical Specialties and Vest Holdings [ph]. In closing, I would again like to thank all our shareholders for their ongoing support. We're excited about the growth and profitability that lies ahead for Saratoga Investment Corp. and would now like to open the call for questions.

[Operator:]

[Operator Instructions] First question comes from Casey Alexander, Gilford Securities.

[Casey J. Alexander:]

The vast majority of the unrealized depreciation appears to have come from the existing CLO in the portfolio. But I see that at the end of the quarter, it is still marked at about $2.9 million above its cost basis. Does that mean that in this current quarter, assuming that the refinanced CLO closes, that we can expect another $2.9 million of depreciation to be charged to the current quarter that we're in?

[Richard A. Petrocelli:]

I think it's -- no, I would not make that assumption at this point. I think it's difficult to say what the...

[Casey J. Alexander:]

It's being refinanced. It has been refinanced at par, doesn't it?

[Richard A. Petrocelli:]

Well, the cost basis is really not a relative number at this point. The cost basis is -- was based originally on the $30 million that was invested back in 2008. And the GAAP treatment of the effective interest method has sort of -- has amortized that over time. The new valuation reflects most of the reality of today's market environment and the refinancing.

[Casey J. Alexander:]

Okay. So you think that mark-to-market pretty much does it in relation to the refinancing that's expected to close tomorrow?

[Richard A. Petrocelli:]

I would say as of August 31, yes. And as of -- take into account most of what has happened at the refinancing. Obviously, markets continue to change and we can't project all that right at this point in time.

[Casey J. Alexander:]

Okay. You mentioned that some of the proceeds of the $48 million bond offering that one of the investments of the proceeds went into was BMC Software. BMC Software is a $6 million investment with a 7-year term and a 5% coupon. And the coupon that you're paying on the notes is 7.5%. Can you explain to me how that investment makes sense?

[Christian L. Oberbeck:]

Sure. The -- clearly, that's not an investment that we want to have permanently for the BDC. However, we did a significant bond offering in May as you all know. And we had a significant excess cash on our balance sheet. And as you can see from our performance in the quarter, we had $55 million of investments, but we had $25 million or so of redemptions. And so the cash on hand, given the new financing, was substantial. And we felt that investing on a company like BMC Software at 5% was certainly a lot more advantageous than investing in money markets at effectively 0. And so while it doesn't cover the coupon on the note, it certainly is a lot better than other alternatives. I'd also point out that I think it's important that we were able to do that and basically keep our cash earning at a pretty substantial rate relative to the short-term money market fund. And that's given our expertise in the CLO space and in our capabilities in the probably syndicated loan market, allow us to put that money to work quickly and in that fashion in what we think is a very high-quality investment; and importantly, a very liquid investment. And so what we would anticipate is as time goes on here and as our net investment pace continues that we would be using an investment like BMC Software as a source of liquidity to invest in our other opportunities, principally in -- we probably look to liquidate that and use that, those proceeds to invest in the SBIC subsidiary, for example, as our cash needs to move in that direction.

[Casey J. Alexander:]

Okay, I get it. So essentially, broadly syndicated loans are like your enhanced money market fund until you can find representative middle-market investments to recycle the money into.

[Christian L. Oberbeck:]

That's correct.

[Casey J. Alexander:]

Yes, okay. What is the -- in your filings, it's not really disclosed. But can you share with us at this point in time what the size of the piece of the subordinated notes are that you're going to be keeping from the new CLO?

[Richard A. Petrocelli:]

The same investment we've had. So we're rolling our -- basically, our subordinated notes stay in place. And the rest of the capital structure's refinanced around the $300 million of assets.

[Casey J. Alexander:]

So it's all the other pieces that are being restructured, not your piece.

[Christian L. Oberbeck:]

That's correct, right.

[Casey J. Alexander:]

Except for the fact that the amortization freezes on your piece.

[Christian L. Oberbeck:]

Right.

[Casey J. Alexander:]

For another 3 years.

[Christian L. Oberbeck:]

That's correct, the ultimate maturity.

[Casey J. Alexander:]

So is then the current interest run rate on the subordinated note, as it was in this last quarter, representative of what it's likely to be in the next quarter? Should be freezing.

[Christian L. Oberbeck:]

No. No, well, it's declined in size, okay? At the end of the quarter, it was -- obviously, at the end of the year, it was close to $400 million. At the end of the quarter, it was $320 million. Today, it's $300 million total assets in the CLO.

[Casey J. Alexander:]

Right, but that's extra management fee. I get that, okay? But your yield off of your subordinated piece should stabilize at this level.

[Christian L. Oberbeck:]

No, that will affect the yield on the subordinated piece as well because they're less assets earning spread. And the spread has tightened given the fact that we priced it in today's environment compared to the pricing back in the 2008 environment.

[Casey J. Alexander:]

Well, do you have any color as to what that's likely to fall to?

[Richard A. Petrocelli:]

At this point, the management fee will fall by approximately 25%.

[Casey J. Alexander:]

Yes, I see that $750,000 a quarter.

[Richard A. Petrocelli:]

From 400 to 300, all right. And we expect the -- at this point, we would expect the equity, the interest income from the subordinated notes as well as the distributions to decline between 35% and 45% from their peak, but stabilized at that amount for the next -- at least the next 3 years.

[Casey J. Alexander:]

Okay. And now, since you've, at least, since you stabilized the CLO and you know where you're going to be for the next 3 or 4 years and you've raised capital in unsecured debt market, now that you've got the water kind of leveled as it relates to the CLO, does this stability of the operations increase your ability to then start to examine potentially a regular quarterly dividend?

[Christian L. Oberbeck:]

Yes, it does. I mean, as you astutely point out, stabilization of the CLO, while it's going to be lower, it's going to be more stable. And then there's a crossover point a couple of years out where the investment really starts to pay off much more substantially than just running off what we had. And so that's an important building block for the company to know that it can rely on that sort of level of earnings. And so yes, this is -- that is an important development in the path towards us being able to examine and actually effectuate a regular dividend.

[Casey J. Alexander:]

Yes, okay. Well, we look forward to that, and I appreciate.

[Operator:]

. I see no further questions. I will turn the call over back to the hosts for any additional comments.

[Christian L. Oberbeck:]

Well, there being no further questions, we want to thank everyone for joining us today. We look forward to speaking with you next quarter. And we're very excited about the future of Saratoga Investment Corp. Thank you very much.

[Operator:]

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