Saratoga Investment Corp. (SAR) Q4 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing up by. Welcome to Saratoga Investment Corp.'s Fiscal Fourth Quarter and Year-end 2012 Financial Results Conference Call. Please note that today's call is being recorded. [Operator Instructions] At this time, I would like to turn the call over to the company's Chief Financial Officer, Mr. Rich Petrocelli. Sir, please go ahead.

Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s Fiscal Fourth Quarter and Year-end 2012 Earnings Conference Call. Before we begin, I need to remind everyone that this conference call contains statements that, 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 11:00 a.m. today through May 31. 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.

Thank you, Rich, and welcome, everyone. In fiscal 2012, we reached some very important milestones. As a testament to our increasing financial strength, we are able to invest more than in any time in the past 4 years. We are also able to increase the size of our revolving credit facility. Also in March, our wholly-owned subsidiary received a small investment company license from the U.S. Small Business Administration, which allows us to borrow up to $150 million for a 10-year term at low fixed interest rates. This additional liquidity will enable us to further expand our portfolio of investments in middle-market businesses with a favorable cost of capital. We have a growing pipeline of investments and continue to have an optimistic view of the demand for financing in the markets we address. I will return shortly with the review of our portfolio. But I would like to now turn the call back over to Rich to review our financial results.

Thanks, Chris. Saratoga Investment Corp.'s net investment income for the fourth quarter ended February 29, 2012, was $1.6 million or $0.40 on a weighted average per-share basis. Net gain on investments was $1.5 million or $0.39 on a weighted average per-share basis, resulting in a net increase in net assets from operations of $3.1 million or $0.79 on a weighted average per-share basis. Net asset value per share was $25.12 as of February 29, 2012, compared to $26.26 as of February 28, 2011. The decrease in reported NAV per share for February 28, 2011, was due to the issuance of 599,584 shares of common stock and a payment of $2 million in cash in connection with the company's $9.8 million cash stock dividend declared on November 15, 2011. For fiscal year 2012 ended on February 29, 2012, our net investment income was $5.7 million or $1.66 on a weighted average per-share basis, and our net gain on investments was $7.6 million or $2.21 on a weighted average per-share basis, resulting in a net increase in net assets from operations of $13.3 million or $3.87 on a weighted average per-share basis. Our total investment income for fiscal year 2012 was $13.5 million, a decrease of approximately $0.7 million or 4.7% compared to fiscal year 2007 -- 2011. Our investment income was comprised primarily of $11.3 million of interest income and $2 million of management fee income associated with the investment in the CLO. Our total operating expenses were $7.8 million and consisted of $1.3 million in interest and credit facility expenses, $1.6 million in base management fees, $1.5 million in professional fees; $1.3 million in incentive management fees; $579,000 in insurance expenses, $1 million in administrator expenses, and $604,000 in directors fees and expenses, general, administrative and other expenses. For the fiscal year 2012, total operating expenses decreased approximately $4 million or about 34% compared to the fiscal year ended February 28, 2011. This decrease in total operating expenses was primarily attributable to lower interest in credit facility expenses and lower professional fees. For the fiscal year 2012, interest in credit facility expenses decreased $1.3 million as compared with the same period in 2011, primarily due to a decrease in outstanding debt for the year. Professional fees decreased $1.9 million during fiscal year 2012 as compared to fiscal year, 2011 when the company undertook an evaluation of strategic transaction opportunities, including the refinancing of the company's senior credit facility and the stock purchase transaction with Saratoga Investment Advisors and certain of its affiliates. On February 29, 2012, we had $20 million of borrowings under our revolving credit facility with Madison Capital Funding and a cash balance of nearly $27 million. $25 million of this cash is invested as the seed capital of our SBIC subsidiary. In February, the company amended its senior secured revolving credit facility to, among other things, extend the borrowing capacity under the credit facility for $40 million to $45 million, extend the revolving period from July 30, 2013, to February 24, 2015, and removed the condition that Saratoga Investment may not acquire additional loan assets without the prior written consent of the administrative agent. With the $45 million credit facility and the up-to-$150-million borrowing capacity at the SBIC subsidiary, Saratoga has a total of $195 million of borrowing capacity. That concludes my financial review. I will now turn the call back over to Chris.

Thank you, Rich. Before we open for questions, I would like to review the composition and performance of our investment portfolio. At the close of the fiscal year, the fair value of the company's investment portfolio was $95.4 million, principally invested in 21 portfolio companies and 1 CLO fund with $413.6 million of assets under management. Saratoga Investment's portfolio was composed of 38% first lien term loans, 9.3% second lien term loans, 11.2% senior secured notes, $6.3 million of senior unsecured loans, 2.1% of unsecured notes, 6% equity interests and 27.1% subordinated notes of the CLO. During the fiscal year 2012, Saratoga Investment Corp. invested $38.7 million in new and existing portfolio companies and had $33.6 million in aggregate amount of exits and repayments, resulting in net investments of $5.1 million for the year at the BDC. At the CLO, Saratoga invested $209.7 million in new or existing portfolio companies and $217.5 million of exits and repayments. Some of our underperforming legacy investments were exited or otherwise liquidated during the fiscal year. We had approximately $19.8 million of unrealized gains, due to the reversal of those previously recorded unrealized losses, which related primarily to the exit of Energy Alloys, Grant U.S. Holdings, Bankruptcy Management Solutions and PRACS Institute. In closing, I would like again to thank all of our shareholders for their ongoing support. We're excited for the growth and profitability that lies ahead for Saratoga Investment Corp. I would like to now open the call for questions.

[Operator Instructions] Our first question comes from Greg Mason from Stifel, Nicolaus.

Before I get into some specific questions on the quarter, could you just give us your big picture vision for what Saratoga looks like 3 years from today? What's your goal for the business over the next several years?

Well, being careful not to put out hard numbers on that, we would look to deploy the very favorable leverage that's available through the SBIC. I think the -- with the 10-year bond being where it is, the -- I think that last set of debentures were done at sub 3% done recently. So -- anyway, sub 3% or 4% is the cost for 10-year fixed-rate financing for the SBIC loan facility, and so we're going to be very focused on trying to deploy our investments with that SBIC funding because of the very favorable leverage and structured dynamics there. And so we would -- and so in a big picture basis, we want to very substantially increase the size of our assets under management, deploying that facility.

With the $25 million we've invested in the subsidiary, we have the ability to invest up to $75 million.

And then I know that SBIC facility can grow even further up to you guys investing $75 million and drawing $150 million of debentures. How ultimately can you fund the additional $50 million in that SBIC? Is it through additional debt? What's your thought process there?

Well, I think we have a -- our existing NAV is around $97 million. So within our existing NAV, we've got more than the $75 million to support that. We also have earnings off of our portfolio, and so we would have the ability to fund with exits and redemptions for our existing portfolio, earnings that we retain, and at some point in time, we could examine an equity offering.

Okay. And then getting more specific on this quarter, first, on the new facility or the extension of this facility, does the pricing on that facility remain the same? If I recall, it was pretty expensive from Madison Capital.

Yes, it's same pricing.

Yes, LIBOR plus 550 with 200 floor.

Okay, great. And then...

If I could just make a comment on that. When you say it's expensive, on the one hand, it's expensive, but they also allow us to borrow 50% against mezzanine investments. And most -- as you know, most senior credit facilities don't advance on mezzanine or advance very small amounts on mezzanine. So it's very flexible. And I think the structure of that facility, we think it's probably one of the best structured facilities in the BDC industry. And again, as you know, most senior credit facilities on BDCs are somewhere between 2 years to 4 years total maturity, where on this facility we have a 3-year revolving investment period. And then if we don't renew that period, then there's a 5-year run-off, so it's an 8-year facility, and it's designed to enable us to be able to have the -- all the investments mature in their ordinary course without having a mismatch between our assets and liabilities.

Great. And then one modeling question. Could you break out for the fourth quarter what portion of your incentive fees were for net operating income versus the cap gains accrual?

Just give us a second on that, please.

I guess while you're looking up that, maybe touch on my last question. I know, looking through your portfolio, there's a couple of loans targets in network communications that are held at, call it, $0.50 of your costs. They're all PIK notes, and they seem to be accruing. They're not marked as non-income-producing. So can you talk through us what's going on with those, and what -- if we should have any concerns regarding income from those being shut off into the income statement?

Sure.

So for the 2 securities, our targets, the network, they -- typically, for an evaluation process, we use a discount to maturity given the relevant market conditions. And for those 2 securities, we apply a fairly significant discount just because their extended maturities. So ultimately, those will accrete to par, and then we have no reason to believe that they wouldn't, but at this point, it's sort of a discount-to-maturity analysis. On the incentive fees, approximately 65% of the incentive fees for the quarter are related to debt investment income.

Our final question comes from Bob Rosenbloom from Black Diamond.

Just comparing the fourth quarter to the third quarter, you had an -- a higher asset balance, but you had lower investment income, and I was hope -- slightly lower flat to slightly lower investment income. I was hoping you could help us understand that a little bit better.

The assets were relatively flat quarter-to-quarter. We actually had a fair amount of redemptions in the third quarter.

Okay. It looked like -- if I understood that at least from a fair value basis, and I have to check, you had $85 million at the end of November, you had $95 million at the end of February, and the main change seems to have been the purchase of the HOA Restaurant Group in Saber Investments for about $10 million.

Those assets were put on at the very tail end of the quarter. There's relatively no interest income related to those.

That was I suspected. Great. And then in the third quarter, there was $90,000 plus or minus of other income that you did not have in the fourth quarter. I was wondering what that had related to?

The other income was related to -- I think it was either an amendment or it was a onetime item. It was either an amendment or an exit fee related to an investment.

I'm showing no further questions at this time. I will now turn the call back over to management for closing remarks.

Okay. Well, thank you, everyone, for joining us today. We, again, appreciate your support. We feel like we now have a substantial amount of dry powder within our -- within Saratoga Investment Corp. And our objective now is to invest it prudently and fully deploy our SBIC leverage so that we can generate very substantial returns on equity. So again, we thank you for your support and look forward to speaking with you next quarter. Thank you.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect, and have a wonderful day.