Saratoga Investment Corp (SAR) 2014 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s fiscal fourth-quarter and year-end 2014 financial results conference call. Please note that today's call is being recorded. During today's presentation, all parties are 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 Interim Chief Financial Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Thank you, Operator. I would like to welcome everyone to Saratoga Investment Corp.'s fiscal fourth-quarter and year-end 2014 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 by law.

Today for the first time, we will be referencing a presentation during our call. You can find our FY2014 presentation in the events and presentations section of IR website. A link to our investor relations 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 June 3. 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.

Thank you, Henri, and welcome everyone. Firstly, we would like to welcome Henri to our team. We are thrilled to have him join us at this exciting time for the Firm and look forward to working closely with him as we continue to grow and execute Saratoga's total return growth story.

Looking back to when Saratoga took over as manager at the end of July 2010, there were some significant challenges to address, including trading at approximately 50% of price to NAV, no identifiable identity or franchise in the BDC marketplace, significant issues with the legacy portfolio, and being significantly subscale. Since then, management has achieved much, including successfully managing the legacy portfolio and building up a high-quality new portfolio of investments; continuing to add high-quality investment professionals and management; successfully getting an SBIC license, differentiating us from many other BDCs; and more than doubling NAV.

In fiscal 2014, we continue to make progress on our long-term strategy of strengthening our financial foundation by continuing to expand our assets under management to $205 million, improving investment quality and credit, increasing our liquidity by completing a $48.3 million public baby bond offering, broadening our investor base, and continuing to add quality senior management and professionals to our team.

As you can see on slide two, during the past year we continued to significantly grow our asset base and achieved a substantial increase in the percentage of what we view as the highest-rated credits in the BDC portfolio. Utilizing our internal credit and monitoring system, we have seen a 32% year-on-year increase in our assets under management and over 77% of our investments sold the highest internal rating that we award. This increases to over 85% when you exclude our investment in our CLO portfolio.

In addition, 2014 allowed us to develop plans to extend our capital resources, which came to fruition with the completion of our $48.3 million fixed-rate note issuance, which significantly expanded our liquidity resources and our investor base.

We have realized a total return, combining dividends and stock price appreciation, of approximately 108% since May 2010 compared to the BDC index, which has realized a total return of 71% in that period. Yet our current earnings potential, investment portfolio, and stock price offer further opportunities for our shareholders.

I would like to now turn the call back over to Henri to review our financial results.

Thanks, Chris. Looking at the matrix on slide three, we see that for the year ended February 28, 2014, our net investment income was $9.1 million, or $1.85 on a weighted average per-share basis. This represented an increase of $2.1 million, or $0.14 per share, as compared to the same period last year.

During this year, we experienced a net loss on investments of $0.4 million, or $0.08 on a weighted average per-share basis, resulting in a total increase in net assets from operations of $8.7 million, or $1.78 per share. Net realized gains of $1.3 million was offset by net unrealized depreciation of $1.6 million.

Our net investment income for the fourth quarter ended February 28, 2014, was $1.5 million, or $0.28 on a weighted average per-share basis. Adjusted for the intent of fee accrual related to net unrealized capital gains and the second incentive fee calculation, our net investment income was $2 million, or $0.56 per share.

Net gain on investments was $2.2 million, or $0.42 per share, resulting in an increase in net assets from operations of $3.7 million, or $0.69 per share. Net unrealized depreciation for the quarter was $2.1 million and net realized gain was $0.1 million.

Net investment income yield as a percentage of average net asset value was 8.1% and 5.2% for the year and quarter ended February 28, 2014, respectively. Adjusted for the same incentive fee accrual related to net unrealized capital gain, the net investment income yield was 7.9% and 6.9% for the same year and quarter, respectively.

Return on equity was 7.8% and 13.2% for the year and quarter, respectively.

These are performance metrics that we 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 fiscal 2014 was $22.9 million, an increase of approximately $5.9 million, or 54.7%, compared to FY2013. Our investment income was comprised primarily of $20.2 million of interest income and $1.8 million of management fee income associated with the investment in the CLO. For the quarter ended February 28, 2014, our total investment income was $5.7 million.

Our total operating expenses were $13.8 million for fiscal 2014 and consisted of $6.1 million in interest and credit facility expenses, $4 million in base management and incentive fees, $1.2 million in professional fees, $0.4 million in insurance expenses, $1 million in administrator expenses, and $1 million in directors' fees and general, administrative, and other expenses.

For the quarter ended February 28, 2014, our total operating expenses were $4.2 million.

For FY2014, total operating expenses increased approximately $3.8 million, or 38%, 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 base management fees as our asset base continues to grow.

Net asset value was $114.9 million as of February 28, 2014, a $6.2 million increase from an NAV of $108.7 million the year before.

NAV per share was $21.36 as of April 28, 2014, compared to $22.98 as of last year. This decrease in reported NAV per share was due to the issuance of 649,500 shares of common stock and the payment of $2.5 million in cash in connection with the Company's $12.5 million cash stock dividend declared on October 30, 2013.

Slide four shows that during the fiscal year 2014, we completed our $48.3 million fixed-rate note issuance, or baby bonds, that as of February 28, 2014, had a carrying amount and fair value of $48.3 million and $48.6 million, respectively.

In addition, as of year-end, we had no outstanding borrowings in our revolving credit facility with Madison Capital Funding and $50 million in outstanding SBA debentures. With the $45 million available on the credit facility, $100 million additional borrowing capacity at the SBIC subsidiary, and $6.6 million in cash and cash equivalents, we had a total of $151.6 million of available borrowing capacity or liquidity at our disposal as of February 28, 2014.

This available liquidity equates to approximately 73% of the value of our investments. As a result, we are pleased with our liquidity position, 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.

We are also planning to issue a Form N-2 shelf registration in the near future. This is consistent with BDC industry practice, and having a shelf on file with the SEC and keeping that current will allow us to be more efficient in speedily accessing the capital markets at any point in time, should the need arise.

That concludes my financial review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer.

Thank you, Henri. I would like to update everyone on the current market as we see it, as well as review the composition and performance of our investment portfolio.

Current market conditions remain extremely competitive, as there is an abundance of capital chasing a historically low volume of new investment opportunities. This dynamic is particularly evident at the larger end of the middle market.

As you can see on slide five, middle market leverage now equals precrisis levels. At the same time, pricing has contracted considerably. We are seeing a consistent flow of investment opportunities where, in our view, the debt providers are underpricing and taking on too much risk. In this environment, we believe our shareholders will benefit from our experienced investment perspective and our disciplined approach to deploying capital.

We like to reside on the lower end of the middle market and believe this is the place to be on a relative basis with the best risk-adjusted returns. There are also 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-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 six, as of February 28, 2014, over 70% of our SBIC investments are in senior debt securities and the leverage profile of these investments is low, especially when compared to market leverage shown previously on slide five. Because of the leverage and the cost of money advantages inherent in the SBIC program, we can achieve strong returns for our shareholders without moving far out on the risk spectrum. Therefore, 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 seven, you can see how we have grown our SBIC assets to $86.5 million as of February 28, 2014. As a percentage of our total portfolio, SBIC assets have grown from 0% at fiscal year-end 2012 to 42% at fiscal year-end 2014.

It is important to note that as of year ended February 28, 2014, we had $143 million of total untapped SBIC investment capacity, of which $100 million is leverage capacity within our current SBIC license. Now if we were to obtain a second license, our leverage capacity would increase by another $75 million.

In our view, our origination platform is among the very best at our end of the market. 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 underwriting and due diligence procedures.

Now I would like to move on to a discussion of our portfolio. At the close of the fiscal year, the fair value of the Company's investment portfolio was $205.8 million, principally invested in 37 portfolio companies and one CLO fund. Saratoga Investment's portfolio is comprised of 15.7% of middle-market loans, 39% of first-lien term loans, 13.5% of second-lien term loans, 14.6% of senior secured notes, 2.7% of unsecured notes, 9.5% of subordinated notes of Saratoga's CLO, and 5% of common equity.

As of February 28, 2014, the weighted average current yield on Saratoga Investment's portfolio for the 12 months ended February 28, 2014, was 11.8%, which was comprised of a weighted average current yield of 10.7% on first-lien term loans, 11.1% on second-lien term loans, 13.8% on senior secured notes, 15.2% on unsecured notes, 18.6% on our CLO subordinated notes, and 6.2% on middle-market loans.

We continue to experience pressure on yields as competition remains high.

Slide eight demonstrates how the yield on our core BDC assets, excluding our CLO and middle-market loans, have remained stable in the mid-11% range. At the same time, a decrease in our CLO assets under management and higher refinancing costs under the fiscal-year 2014 have both contributed to the CLO's yield decline.

We also invested certain middle-market loans while looking for higher yielding opportunities in the market.

Moving on to slide nine, during the fiscal-year 2014, we invested $121.1 million in new and existing portfolio companies and had $71.6 million in aggregate amount of exits and repayments, resulting in net investments of $49.5 million for the year at our BDC.

For the quarter ended February 28, 2014, we invested $11 million in new or existing portfolio companies and had $6.6 million in aggregate amount of exits and repayments, resulting in net investments of $4.4 million. As you can see on the slide, our investments are highly diversified by type, as well as in terms of geography and industry, with a big focus on business, healthcare, and consumer services.

Of our total portfolio, approximately 5% consists of equity interests. Successful equity investments are and will continue to be an important part of our overall strategy.

The next slide, slide 10, demonstrates how realized gains from the sale of equity investments, combined with other investments, help enhance shareholder capital. For the past two years, we have had a combined $1.8 million of net realized gains from the sale of equity interests or sale or early redemption of other investments, and we believe our consistent performance in this respect is a good indicator of our portfolio credit quality.

Next, I would like to focus on Saratoga CLO, a strategic asset within our portfolio. We have spoken to a number of our investors and prospective investors, and they have asked us to provide greater clarity around the CLO, which we are happy to do, especially as it is successful and contributes to our healthy risk/return profile.

As seen on slide 11, a CLO is a broadly diversified investment portfolio of syndicated corporate senior loans, financed primarily with term loans with matched funding. This investment yields a net interest spread that is paid to the BDC via quarterly cash distributions.

A number of important advantages accrue to us as a result of our investment in the Saratoga CLO, as seen on slide 12. First, it provides a highly attractive return with relatively less risk. Saratoga CLO's weighted average yield for FY2014 was 18.6%. Despite being refinanced and reducing in size to a percentage of our overall portfolio, the expectation is that this investment will still generate low double-digit returns.

Another important advantage is the CLO puts us in regular contact with many Wall Street dealer desks that help keep us abreast of important market intelligence. As a result, it can be a source of standalone investment opportunities for the BDC as well.

As of February 28, 2014, we see on slide 13 that Saratoga CLO had an aggregate principal amount of $301.3 million, invested primarily in senior secured first-lien term loans spread across 148 obligors, with an average exposure of $2 million. Its weighted average maturity is 4.5 years, and all our loans are fully performing with no defaults and the market value exceeding the cost.

This concludes my review of the market and our portfolio activity, and I would like to turn to call back over to our CEO. Chris?

Thank you, Mike. Moving on to our final slide, 14, we are committed to further developing a financial base that supports a growth total return profile, and this remains the clear strategic path that we intend to follow going forward.

As I mentioned at the beginning of today's call, we have achieved much and continue the execution of our long-term strategy to expand our asset base without sacrificing credit quality. We also continue to increase our capacity to source, analyze, close, and manage our investments by adding to our management team.

A key contributor to achieving our growth objectives is fully deploying our SBIC financing, thereby generating 20%-plus returns on the equity invested and utilizing the 2-to-1 leverage of the SBIC. This allows us to reach scale and increase our assets under management and net investment income yield, thereby enabling us to increase returns to shareholders and achieving growth in our net asset and stock values.

Along with our objectives of increasing our net assets and total returns to shareholders, our actions to increase assets under management are geared towards best positioning ourselves to begin paying regular quarterly cash dividends in the future.

In closing, I would again like to thank all of our shareholders for their ongoing support. We are excited for the growth and profitability that lies ahead for Saratoga Investment Corp. and I would like to now open the call for questions.

(Operator Instructions). Casey Alexander, Gilford Securities.

Good morning. First off, it's May 28, so there's two days left in the current quarter. Can you give us an update as to your investment activity in the current quarter?

Hi, Casey, it's Henri. You are right. Year-end tends to flow into quarter-end.

You know, I think we've continued to see some activity in the market, and Mike can give a bit more color on that as well. You know, there are a lot of opportunities that they are looking at, but obviously, the focus is on credit quality. So I think if you look at the last quarter, our growth is probably in that range of being very cautious in a very competitive market to grab opportunities that present itself.

I think this quarter, we expect to close more transactions than we did in the past quarter, probably a little under $20 million of new investment activity.

And how does that -- it's the end of the quarter, so you must have some idea of what your repayment activity is, also.

Yes, there has been minimal payment activity thus far in the quarter.

Okay. So my understanding, if I hear the remarks correctly, is that the portfolio as it exists is an exceedingly healthy portfolio. Is that correct?

That's right.

Okay. And the strategic focus in terms of deployments is geared towards the SBIC subsidiary going forward because that's where the best returns lie, right?

Yes. That's correct, although we do have flexibility in the BDC and we are looking to add quality assets across the platform, although as you correctly point out, the highest return would be in the SBIC subsidiary.

When you take together the SBIC, as well as the middle-market loans which you didn't include in your liquidity presentation, but those really are another measure of liquidity if the appropriate investment opportunities were there, there's really substantial liquidity without having to raise new capital. Isn't that correct?

I think that's fair. I think that was the purpose of the slide as well, Casey, to show how we have a lot of dry powder that we can reinvest and we have a lot of different levers that we can pull and make decisions on how we deploy that capital.

You are right about the middle-market loans. They're liquid investments. We have tended to have them just run off naturally in the past, but that is also a potential source that we did not include in that slide. The focus is obviously on finding the right opportunities in a very competitive market where to deploy one's capital.

Right, okay, so the actual -- there isn't precisely any real need for capital at this point in time. You have ample liquidity. You have an exceedingly healthy BDC portfolio. You have identifiable cash flow. So what I'm curious about is in looking at slide 14, in what way are you not positioned to begin paying regular quarterly cash dividends?

I think, Casey, as we have discussed in the past, there are several objectives we have. One, I think we have been consistent in saying we think being in the high $200 million level of assets is an important scale point, given all the fixed costs.

To who? To who? That may be important to you as a management team, but is that necessarily what's most important to shareholders?

I think what's important to shareholders is to the extent that we pay a cash dividend, it's important that, number one, we earn the cash dividend and, number two, that after paying the cash dividend, we are in a position to basically earn the cash dividend and trade at a level where we would have access to the capital markets.

But right now, you are trading at a 28% discount to NAV, so you don't have access to the capital markets doing it the way that you are doing now. And by your own presentation, you have no need for access to the capital markets right now. You have ample liquidity for every line of business that you would like to deploy assets, including the middle-market portfolio which you don't even include in your -- so again, it doesn't match.

I mean, you don't need an access to capital. You need to do something in order to amortize the discount to NAV. So I still don't understand in what way you are not positioned to begin paying a regular quarterly dividend. You can identify what your cash flow is.

It has to do with leverage as well, Casey. I think it's important for us to make sure -- I think the capital that we do have access to is the retention of our earnings. And by retaining those earnings, we are able to grow our NAV. And if we paid out 100% of our dividends, we wouldn't grow our NAV.

By growing our NAV, we are incrementally able to increase our hold position. By increasing our hold positions, we are able to accelerate our growth. By accelerating our growth, we have the ability to underwrite larger and larger deals, which allows us basically to capture a better investment profile then we have right now.

And we are all the while maintaining our leverage at a reasonable level. The access to the liquidity that we have, as we point out, is almost entirely debt access, other than middle-market loans. And so, we want to make sure that we are not overleveraging ourselves as we scale.

By your own admission, you are being cautious because, as Michael said on slide number five, that the middle-market multiples are back at precrisis levels, so you have to be very cautious about the deals that you are doing.

And in the SBIC, there is a limit to the size of the deals that you can do anyway. They are not larger deals, so again -- yes, we have had this discussion and I think we are going to continue to have this discussion because I think it's important that you also recognize what your shareholders are looking for out of the management team. And at 28% discount to NAV, I think the market is still telling you that maybe this is not necessarily the right path.

Casey, we appreciate your point of view. As you can appreciate, we and the management team are very substantial shareholders of the Company, and so therefore we, in effect, are recipients of this dividend policy and active participants in it as shareholders.

We fully believe that adding to the scale is critically important for us. You mentioned about the SBIC size of portfolio companies -- the size of the companies in the SBIC. We've had numerous instances where we've had the opportunity to make substantially larger investments in our hold positions and we have had to bring in partners or lost the deals because we were unable to hold a larger position and maintain our desired credit quality and profit diversification. So as we scale, it's going to make us a much more effective investor in the SBIC environment.

All right. Thank you for taking my questions.

You are welcome. Thank you, Casey.

Thank you. And I am not showing any further questions at this time. I would now like to turn the call back to Christian Oberbeck for any closing remarks.

Thank you, everyone, for joining us today. We appreciate your support, as we said earlier, and we look forward to our next call and speaking with you next quarter. Thank you very much.

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