Saratoga Investment Corp.
Q2 2015 Earnings Call Transcript

Published: 15 Oct 2014

[Operator:]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to Saratoga Investment Corp's Fiscal Second Quarter 2015 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation all parties will be in a listen-only mode. Following management's prepared remarks we will open the lines for questions. At this time, I would like to turn the call over to Saratoga Investment Corp's Chief Financial Officer, Mr. Henri Steenkamp. Sir, please go ahead.

[Henri Steenkamp:]

Thank you, operator. I would like to welcome everyone to Saratoga Investment Corp's fiscal second quarter 2015 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 Q2 2015 presentation in the Events & 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 be available from 1 pm today through October 21st. 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. Since 2010, we have been singularly focused on the strategy of increasing the quality and size of our asset base for the ultimate purpose of building Saratoga Investment Corp into a best-in-class BDC. In the fiscal second quarter of 2015, we continued on this path and further strengthened our financial foundation by expanding our assets under management of further 8% this quarter to $237 million from $219 million at the end of the fiscal first quarter 2015 and increasing them 15% year-to-date. Improving our investment quality and credit and improving our base of liquidity. Our liquidity profile continued to improve as we amended our revolving credit facility extending the maturity date through September 17, 2022 while reducing the borrowing rate by 150 basis points and lowering the annual administrative cost. In addition, since our last conference call, we have reached a number of significant milestones in the company's development including, adopting a new dividend policy to pay regular quarterly cash dividends, adopting a new dividend reinvestment plan that provides for reinvestment of dividends on behalf of shareholders, and improving an open market share repurchase plan that allows for the repurchase about to 200,000 shares of common stock at prices below net asset value. We are very excited about these accomplishments and we're going to greater detail on each during today's call. In turn, we hope to expand and diversify our investor base to these strategic improvements. We remain committed to advancing further the overall size and quality of our asset base. As you can see on slide three, the upward trend of quality and quantity of assets has continued. With $237 million in assets under management in our BDC as of August 31, 2014, we've seen an 8% increase since the last quarter and a 15% increase year-to-date, with over 88% of our loan investments holding the highest internal rating that we award. The continued increase in assets during the quarter is also reflected in some of our key performance metrics this quarter compared to the quarter ended May 31, 2014, with adjusted net investment income per share increasing 6% from $0.40 to $0.43 and adjusted net investment income yield on net asset value increasing 30 basis points from 7.4% to 7.7%. With that, I'd 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 key performance metrics on slide four, we see that for the quarter ended August 31, 2014, our net investment income was $2.1 million or $0.39 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 $2.3 million or $0.43 per share. This represented an increase of $0.2 million as compared to the same period last year and $0.1 million compared to the quarter ended May 31, 2014. In the second quarter of fiscal 2015, we experienced a net gain on investments of $1.1 million or $0.19 on a weighted average per share basis resulting in a total increase in net assets from operations of $3.1 million or $0.58 per share. The net gain on investments comprised a net realized gain of $0.4 million and net unrealized depreciation of $0.7 million. Net investment income yield as a percentage of average net asset value was 7% for this quarter. Adjusted for the incentive fee accrual related to net unrealized capital gains, the net investment income yield was 7.7% up from 7.5% for the same quarter last year and up from 7.4% last quarter. Return on equity was 10.6% this quarter up from negative 0.1% for the same quarter last year and up from 6.1% last quarter. These are performance metrics that we continue to feel are important indicators of how successful we are in pursuing our strategy of growing the asset base, building scale and generating competitive yield while continuing to focus on the quality of our portfolio. Our total investment income for the fiscal second quarter 2015 was $6.5 million, an increase of $1.1 million or 20.1% compared to the same period last year and an increase of $0.3 million or 5.4% from a quarter ended May 31, 2014. Our investment income was comprised primarily of $6.1 million of interest and dividend income and $0.4 million of management fee income associated with the investments in our CLO. Our total operating expenses were $4.4 million for the fiscal second quarter and consisted of $1.8 million in interest and debt financing expenses, $1.8 million in base and incentive management fees, $0.5 million in professional fees and administrative expenses and $0.2 million in insurance expenses, directors' fees and general, administrative and other expenses. For this fiscal second quarter, total operating expenses increased by $0.3 million as compared to last quarter and $1.3 million as compared to the same period last year. This increase in total operating expenses was primarily attributable to higher interest and credit facility financing expenses as well as increased management fees as our asset base continues to grow. The quarter ended August 31, 2013 also included an incentive management fee credit of $0.2 million calculated on the net unrealized losses of that quarter, which offset total operating expenses. While this quarter included a $0.2 million expense based on the quarter’s net unrealized capital gains. Net asset value was $119.8 million as of August 31, 2014, a $3.1 million increase from an NAV of $116.7 million as of May 31st, and a $4.9 million increase from an NAV of $114.9 million as of February 28, 2014. NAV per share was $22.27 as of August 31st, compared to $21.69 as of the same time last quarter and $21.36 as of February 28, 2014. Slide five outlines the dry powder available to us as of August 31, 2014. As of the end of this second quarter, we had $8.9 million outstanding in borrowings under our revolving credit facility with Madison Capital Funding and $64 million in outstanding SBA debentures. Our baby bonds had a carrying amount and fair value of $48.3 million and $49.4 million respectively. With the $36.1 million available on the credit facility, $86 million additional borrowing capacity at our SBIC subsidiary and $3.5 million in cash and cash equivalents, we had a total of $125.6 million of available borrowing capacity or liquidity at our disposal as of August 31, 2014. This available liquidity equates to approximately 53% of the value of our investments, meaning we can grow our assets under management by a further 53% without any additional external financing. As a result we are pleased with our liquidity positions especially taking into account the conservative composition of our balance sheet and the ability we have to substantially grow our assets without the need for external financing It is also worth pointing out that during our recent annual meeting of stockholders, the proposal allowing us to issue and sell shares of common stock below current net asset value per share was passed by shareholder votes. We have never availed ourselves of this option despite having this proposal also approved in prior years. We continue to believe this option is a method of enhancing our ability to obtain financing to pursue favorable investment opportunities and also provides us with the flexibility to further capitalize our SBIC subsidiary if the need ever arose. Given the attractive features of SBIC debt which we'll touch on later, we believe that having this flexibility is important to our ability to enhance stockholder value. Since the close of the quarter we have made important upgrades in our base of liquidity. As you can see on slide six, on September 17, 2014 the company entered into a second amendment to the revolving facility with Madison Capital Funding LLC, which accomplished a number of important objectives. Firstly, it extended the commitment termination date from February 24, 2015, to September 17, 2017. Secondly, it extended the maturity date of the revolving facility from February 24, 2020 to September 17, 2022. Thirdly, it reduced the applicable margin rate and floor on both base rate and LIBOR borrowings by a combined 150 basis points. And finally it reduced some of the accompanying annual administrative costs by $150,000 annually. Now we'd like to move on to slide seven and eight and review the composition and performance of our investment portfolio. At the close of the quarter ended August 31, 2014 the fair value of the company's investment portfolio was $236.3 million, principally invested in 39 portfolio companies and one CLO fund. Saratoga Investment's portfolio was composed of 11.3% of middle-market loans, 48.9% of first lien term loans, 12.4% of second lien term loans, 10.6% of senior secured notes, 2.5% of unsecured notes, 8.5% of subordinated notes of our Saratoga CLO and 5.8% of common equity. The weighted average current yield on Saratoga Investment's portfolio for the three months ended August 31, 2014 was 12.2% which was comprised of a weighted average current yield of 11.0% on first lien term loans, 11.5% on second lien term loans, 14.7% on senior secured notes, 14.2% on unsecured notes, 23.9% on our CLO subordinated notes and 6.5% on middle-market loans. Despite downward pressure on yields due to continued competition, our yields have remained strong as compared to the previous fiscal quarter. Slide seven demonstrates how the yield on our core BDC assets excluding our CLO and middle-market loans has remained stable in the mid to high 11% range, while our asset base has continued to grow. At the same time, a decrease in our CLO assets under management and higher refinancing costs over the past year have both contributed to the CLOs yield decline as compared to prior years, although this quarter saw a slight increase. Middle market yield also increased as compared to previous quarters. Moving on to slide eight, during the fiscal second quarter 2015 we invested $31.8 million in new and existing portfolio companies and had $15.7 million in aggregate amount of exits and repayments, resulting in net investments of $16.1 million for the quarter at our BDC. As you can see on the slide, our investments continue to be highly diversified by type as well as in terms of geography and industry with a large focus on business and health care services widespread over 18 different industries. Of our total investment portfolio almost 6% consists of equity interest, successful equity investments are and will continue to be an important part of our overall investment strategy. This next slide, slide nine demonstrates how realized gains from the sale of equity investments combined with other investments has helped enhance shareholder’s capital. For the past two years, we've had a combined $2.3 million of net realized gains from the sale of equity interest, all sale or early redemption of other investments. This consistent performance continues to be a good indicator of our portfolio credit quality. That concludes 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 take a couple of minutes to update everyone on the current market as we see it. The market dynamics I shared during the past two calls have not fundamentally changed. Conditions remain extremely competitive as there remains an abundance of capital chasing a historically low volume of new investment opportunities. Last quarter we noted that the middle market leverage now equals pre-crisis levels. As you can see on slide ten, this is still the case. Looking at slide 11, you can see that this trend continues in the broader leverage loan market. On the left, you’ll see the large leverage loans taken as a whole remain closer to historical levels. However on the right, you can see the change of control [obvious] (ph) which correlate more closely to our investment activity, continue to push the leverage on below even beyond pre-crisis levels. Against this backdrop, pricing remains under pressure as lenders compete for mandates. This broader market color however does not necessarily paint an accurate picture of the lower middle market where we compete primarily. Slide 12 gives a better look at the lower middle market defined as EBITDA below $25 million. You can see that as the year's progressed, overall leverage has contracted slightly largely at the expense of mezzanine, senior unitranche providers continue to offer compelling solution in terms of competitive pricing, ease of execution and documentation simplicity. As mentioned earlier an abundance of capital is chasing a historically low volume of new investment opportunities. Facebook data reports that the number of U.S. transactions for deal size is below $25 million, has declined to 127 deals as of September 26, 2014, a little less than half of last years 261 transactions. We remain disciplined as we continue to see a consistent flow of investment opportunities where in our view the debt providers are underpricing and taking on too much risk. We believe our shareholders will benefit from our experience investment perspective and our measured approach to deploying capital. With all the [property] (ph) dynamics we’ve just discussed, we continue to believe that the lower end of the middle market is a place to be on a relative basis with the best risk adjusted returns. Despite dynamics there are substantial opportunities found here as banks and other capital providers are less focused on this end of the market. Our objective is to maximize our risk adjusted returns in a manner that utilizes the low cost of capital and 2

[Christian Oberbeck:]

Thank you, Mike. Since our last quarter end, we are very pleased to meet our important milestone as been a strategic goal for us since our inception, mainly to commence the payment of a regular quarterly cash dividend. As outlined on slide 15, on September 24, 2014, we announced that our Board of Directors adopted a new dividend policy to pay a regular quarterly cash dividend to our shareholders. In addition, we also adopted a new dividend reinvestment plan that provides the reinvestment of dividends on behalf of our stockholders, unless the stockholder has elected to receive dividends in cash. If Saratoga Investment declares a dividend, our stockholders who have not opted out of the reinvestment plan on the dividend record date, will have their dividend automatically reinvested into additional shares of its common stock. Effectively, this will allow the stockholders who want cash to receive their dividends in cash. However, it also provides the opportunity for many stockholders we have spoken to who are interested in reinvesting their dividends to receive additional shares of common stock. For more information, see the "Stock Information" section of the Company's Investor Relations website. As part of this new dividend policy, we’ll pay a regular quarterly dividend of $0.18 per share for the quarter ended August 31, 2014 payable on November 28, 2014 to all stockholders of record at the close of business on November 3, 2014. And then we also declared a second dividend of $0.22 per share for the quarter ended November 30, 2014 that will be payable on February 27, 2015 to all stockholders of record at the close of business on February 2, 2015. We anticipate continuing to increase the per share dividends subject to a net investment income in future quarters. On the same day of the announcement of our dividend policy, we also announced the approval of an open market share repurchase plan that allows us to repurchase up to 200,000 shares of common stock at prices below our net asset value as reported in our then most recently published financial statements. All of these initiatives combine our important corporate tools being employed by us in realizing the firm's vision. And we feel extremely positive about these important steps taken in the company's development and continued evolution. Moving on to our final slide 16, we are pleased with our recent accomplishments and focused on our objectives for the year ahead. We continue to execute our long term strategy to expand our asset base without sacrificing credit quality while benefiting from scale. We continue to increase our capacity to source, analyze, close and manage our investments by adding to our management team. Our primary focus remains on maximizing potential 20% plus returns on the equity invested in our SBIC and utilizing the 2

[Operator:]

Thank you. (Operator Instructions) Our first question comes from the line of Casey Alexander from Gilford Securities.

[Casey Alexander:]

Good morning.

[Christian Oberbeck:]

Good morning, Casey.

[Casey Alexander:]

Well, first of all I think you had started off the dividend policy just right. And I think you've done everything right, whether including the dividend reinvestment plan, share repurchase plan, I think it's excellent. I do see that there is a significant – there still going to be significant undistributed income. So is there still a plan to mop-up the undistributed income in a stock dividend at the end of the year?

[Christian Oberbeck:]

Our current intention at this point in time is the two dividends that we have declared. So when we continue – we will be in compliance with our requirements with these two forward dividends. So there will not be – we're not planning a stock based dividend at year end.

[Casey Alexander:]

Well that certainly makes maintaining my model a lot easier. Secondly, I think the balance on the middle market loans has come down again, was that just – are you allowing those to mature out or was something sold out of the middle market portfolio and redeployed because I think that's actually helping your yields as that draws down?

[Christian Oberbeck:]

Yes, absolutely. Our objective is to let that portfolio run off by and large and redeploy that capital for the SBIC which offers much higher returns. We expect to continue to have redemptions in that middle market portfolio. It’s a little hard to anticipate those redemptions but that portfolio declining is due to redemptions that we've had in the portfolio.

[Casey Alexander:]

Couldn’t we actually say that you have instead of 125 million in dry powder, you really have 150 million in dry powder because that's available to you to redeploy into traditional middle market loans if the deals are there to be done.

[Christian Oberbeck:]

That's correct.

[Michael Grisius:]

Absolutely. [Indiscernible] cash level, exactly.

[Casey Alexander:]

The loan investments have been strong credit ratings - it's great, it's really, really high. It did come down about three percentage points during the quarter. Is that due to a migration of a deal or is that due to the fact that new investments are coming at a satisfactory rating and therefore that forces it down if nothing moves up?

[Christian Oberbeck:]

I think all the investments we have, that have come in Casey, have been at the top rating.

[Casey Alexander:]

Okay.

[Christian Oberbeck:]

There was a small migration in a deal during the quarter that has actually subsequently been resolved. So that was the only reason for that slight down tick that you saw.

[Casey Alexander:]

Okay. The reduction in administrative fees related to the credit facility. Do we see that reduction actually in the interest expense line, is that where we would look forward?

[Christian Oberbeck:]

Correct. So it's annual fee which gets amortized over the year. So you’re going to see that annual fee will go slightly down in the interest expense line over the next year because of that reduction.

[Casey Alexander:]

Okay. Great. All right. I think that's all the questions that I have but again I think you guys did the dividend just right, and actually I know the stock haven't gone up just yet since then but I'd tell you what, compared to the rest of the BDC universe, it's effecting very well because the rest of the BDC universe has been shellacked pretty good the last month.

[Christian Oberbeck:]

Yes. Great, thanks Casey.

[Casey Alexander:]

Thank you.

[Operator:]

Thank you. (Operator Instructions) And I see no further questions in the phone lines.

[Christian Oberbeck:]

Well, on behalf of Saratoga Investment Management Corp, we thank everyone for joining us today and we look forward to speaking with you next quarter. Thank you all.

[Operator:]

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.