Saratoga Investment Corp (SAR) 2015 Q2 法說會逐字稿

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.

(Operator Instructions). 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.

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'll be referencing a presentation during our call. You can find our Q2 2015 presentation in the events and presentation 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 1:00 PM today through October 21. 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. Since 2010 we have been singularly focused on the strategy of increasing the quality and size of our asset base with 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 a further 8% this quarter to $237 million from $219 million at the end of the fiscal first quarter of 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 costs.

In addition, since our last conference call, we've 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 of up to 200,000 shares of common stock at prices below net asset value.

We're very excited about these accomplishments and will go into greater detail on each during today's call. In turn, we hope to expand and diversify our customer base with these strategic improvements.

We remain committed to advancing further the overall size and quality of our asset base. As you can see on slide 3, the upward trend of quality and quantity of assets has continued. With $237 million in assets under management and 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 would 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.

Thank you, Chris. Looking at our key performance metrics on slide 4, 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 investment 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 appreciation 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 yields 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 TP last year and an increase of $0.3 million or 5.4% from the 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 of incentive management fees, $0.5 million in professional fees and administrator 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 totaled 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 31 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 31 compared to $21.69 as of the same time last quarter and $21.36 as of February 28, 2014.

Slide 5 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 on 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 of 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 vote. 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 will 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 basic liquidity. As you can see on slide 6, 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 flaw on both base rate and LIBOR borrowing by a combined 150 basis points. And finally, it reduced some of the accompanying annual administrative costs by $150,000 annually.

Now we would like to move on to slide 7 and 8 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 yield due to continued competition, our yields have remained strong as compared to the previous fiscal quarter.

Slide 7 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 ove the past year have both contributed to the CLO's yield decline as compared to prior years, although this quarter it saw a slight increase. Middle market yields also increased as compared to previous quarters.

Moving on to slide 8, during the fiscal second-quarter 2015, we invested $51.8 million in new and existing portfolio companies and had $15.7 million in aggregate amount of exit and repayments, resulting in net investments of $16.1 million for the quarter at BDC. As you can see on this 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 healthcare services while spread over 18 different industries.

Of our total investment portfolio, almost 6% consists of equity interests. Successful equity investments are and will continue to be an important part of our overall business strategy.

This next slide, slide 9, 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 interests, all sale of 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. ou. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer, for an overview of the investment markets.

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 precrisis levels. As you can see on slide 10, this is still the case.

By looking at slide 11, you can see that this trend continues in the broader leverage loan market. On the left, you'll see that large leverage loans taken as a whole remain closer to historical levels. However, on the right, you can see that change of control LBOs, which correlate more closely to our investment activity, continue to push the leverage envelope even beyond precrisis 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 has progressed overall leverage has contracted slightly, largely at the expense of mezzanine as stretch senior unitranche providers continue to offer compelling solutions 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. [Pittsbook] data reports that the number of US transactions for deal sizes below $25 million has declined to 127 deals as of September 26, 2014, a little less than half of last year's 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 experienced investment perspective and our measured approach to deploying capital.

With all the frothy dynamics we just discussed, we continue to believe that the lower end of the middle market is the place to be on a relative basis with the best risk-adjusted returns. Despite (technical difficulty) 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 the 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 creative returns to our investors.

As you can see on slide 13, as of August 31, 2014, over 77% of our SBIC investments are in senior debt securities, which is up from 73.8% in May 2014, and the leverage profile of these investments is low, especially when compared to the market leverage shown on previous slides.

Because of the leverage and 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.

Now moving on to slide 14, you can see how we've grown our SBIC assets to $114.9 million as of August 31, 2014. As a percentage of our total portfolio, SBIC assets have grown from 0% at fiscal year-end 2012 to almost half of our portfolio this quarter.

It is important to note that as of quarter ended August 31, 2014, we had $115.4 million of untapped SBIC investment capacity, of which $86 million is leverage capacity within our current SBIC license. If we were to obtain a second license, our 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.

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

Thank you, Mike. Since our last quarter end, we're very pleased to meet an important milestone that's been a strategic goal for us since our inception, namely 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 by the dividend record date will have their dividend automatically reinvested into additional shares of its common stock.

Effectively, this allows stockholders who want cash to receive their dividends in cash. However, it also provides the opportunity for many stockholders we've 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 our net investment income in future quarters.

On the same day as 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 combined are important corporate tools being employed by us in realizing the firm's vision. 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 the potential 20% plus returns on the equity invested in our SBIC and utilizing the 2 to 1 leverage that provides. This is the optimal means to increase our assets under management and net investment income yield, enabling us to increase returns to shareholders and achieve growth in our net asset and stock values.

In closing, I would again like 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., and I would now like to open the call for questions.

(Operator Instructions). Casey Alexander, Gilford Securities.

Well, first of all, I think you started off the dividend policy just right, and I think you've done everything right with it, including the dividend reinvestment plan, the share repurchase plan. I think it's excellent. I do see that there is significant -- 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?

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

Well, that certainly makes maintaining my model a lot easier. (laughter)

Secondly, I think the balance on the middle market loans has come down again. Was that just that 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.

Yes, absolutely. Our objective is to let that portfolio run off by and large and redeploy that capital through 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.

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.

That's correct. That's a fair point.

It's one of the sources of cash levers, Casey, exactly.

Yes, the loan investments held in strong credit ratings, it's great. It's really, really high. It did come down about 3 percentage points during the quarter. Is that due to a migration of a deal, or is that due to the fact that new investments come in at a satisfactory rating, and therefore, that forces it down if nothing moves up?

No, it was -- I think all the investments we've had that have come in, Casey, have been at the top rating.

Okay.

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

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 for it?

Correct. So yes, so it's an 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.

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 hasn't gone up just yet since then, but I'll tell you what, compared to the rest of the BDC universe, I think it's acting very well. Because the rest of the BDC universe has been shellacked pretty good the last month.

Great. Thanks, Casey.

(Operator Instructions). And I see no further questions on the phone lines.

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.

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.