Saratoga Investment Corp (SAR) 2016 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp's fiscal first-quarter 2016 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. I would like to welcome everyone to Saratoga Investment Corp's fiscal first-quarter 2016 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 fiscal first-quarter 2016 shareholder presentation in the events and presentations section of our investor relations website. A link to the IR page is in the earnings press release distributed last night. A replay of this conference call will also be available from 1:00 PM today through July 22. Please refer to our earnings press release for further 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 we acquired Saratoga Investment Corp. we have been singularly focused on a long-term objective of increasing the quality and size of our asset base with the ultimate purpose of building Saratoga Investment Corp. to a best-in-class BDC. As highlighted on slide 2, during the first quarter of 2016 we continued the momentum gained during the fiscal year 2015 towards realizing our long-term objectives. To briefly recap, first we have continued to steadily build and improve our asset base, yield, and return on equity. Each metric saw an important increase on a quarter-over-quarter basis that we will discuss in further detail shortly.

Second, the overall strengthening of our financial foundation has enabled our regular quarterly cash dividends policy. We will pay a quarterly dividend of $0.33 per share for the first fiscal quarter of 2016, payable on August 31, 2015, for all stockholders of record on August 3, 2015. This is the third quarterly increase of 22% to our regular quarterly cash dividend. Shareholders continue to be able to participate in our dividend reinvestment plan if they prefer. During the quarter we also paid a special dividend of $1 per share.

Third, our basal liquidity remained strong and promises to improve. On April 2, 2015, we received a green light and go forth letter from the SBA for a second SBIC license, which, if approved, will allow us to grow our assets by an additional $112.5 million. And effective May 29, 2015, we entered into a debt distribution agreement with Ladenburg Thalmann through which we may offer for sale from time to time up to $20 million in aggregate supply out of our existing Baby Bonds issuance through an at-the-market offering. As of yesterday we sold bonds with the principle of $5.7 million at an average premium of 1.3%.

And finally, we continue to see an expansion and diversification in our shareholder base including additional analyst coverage recently added to our stock. In addition to these corporate milestones, during this quarter we continued on our path of further strengthening our financial foundation and building scale by expanding our assets under management to $263 million, a 9% increase from $241 million at the end of last quarter, improving our investment quality and credit with over 95% of our loan investments now having our highest rating, and increasing performance with our key performance indicators for fiscal [first] quarter 2016 as compared to last year's first quarter. Our adjusted net investment income is up 33% to $2.9 million. Adjusted NII on net asset value increased to 9.3%, up 180 basis points from 7.5%. Adjusted NII per share of $0.53, up 33% from $0.40, and our return on equity is up 1780 basis points to 24%. We are very excited about these accomplishments and will go into greater detail on each one on today's call.

As I have mentioned, we remain committed to further advancing the overall size and quality of our asset base. As you can see on slide 3, our upward trend of quality and quantity of assets has continued. With $263 million in assets under management in our BDC as of May 31, 2015, we have seen a 9% increase in assets since last quarter and 176% increase since fiscal year 2012, with over 95% of our loan investments currently holding the highest internal rating that we award. Thus, our overall loan quality continues to increase while we continue to grow assets in a very measured way.

With that, I would now like to 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. Before starting to go through our financial results, I would like to highlight again the importance of assessing our net investment income metrics on an adjusted basis. This quarter is a good example of where a significant unrealized capital gain impacts net investment income. As we will discuss later, we had a very strong capital gains quarter of more than $5 million, which is highly accretive to net asset value. However, these capital gains are not included in net investment income, while the second incentive fee expense related to this gain does reduce net investment income. Therefore, we provide adjusted NII metrics by adjusting for the incentive fee accrual to thereby eliminate the one-sided impact of capital gains in assessing our NII financial results.

Now, moving on and looking at our quarterly key performance metrics on slide 4, we see that for the quarter ended May 31, 2015, our net investment income was $1.8 million or $0.53 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 that I mentioned earlier, our net investment income was $2.9 million or $0.53 per share. This represented an increase of $0.7 million as compared to the same period last year and $0.2 million compared to the quarter ended February 28, 2015.

In the first quarter of fiscal 2016 we experienced a net gain on investments of $5.6 million or $1.03 on a weighted average per share basis, resulting in a total increase in net assets from operation of $7.4 million or $1.36 per share. The $5.6 million net gain on investments was largely comprised of $5.5 million net unrealized appreciation on investment including a significant unrealized gain of $4.2 million relating to one specific legacy investment which has actually been realized since quarter end.

Net investment income yield as a percentage of average net asset value was 5.8% for the quarter ended May 31. Adjusted for the incentive fee accrual related to net unrealized capital gains, the net investment income yield was 9.3%, up from 7.5% last year and up from 8.8% last quarter. Return on equity was 24.0% for this quarter. These are all performance metrics that we feel are important indicators of our success 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.

As these metrics improve quarter over quarter it continues to highlight the following two important points about the value of our asset growth. Firstly, as our SBIC assets continue to grow as compared to our overall assets under management, the greater net investment income on these investments financed through lower cost SBA debentures contributes more to our bottom line. This is demonstrated again with SBIC assets increasing this quarter to 58% of our investments.

And secondly, we see the benefit of scale becoming more visible as our operating expenses stabilize and reduce as a percentage of our total assets. Our total investment income was $7.6 million for the fiscal first quarter of 2016. Total investment income increased $1.4 million or 23.1% compared to the first fiscal quarter last year. Our total investment income for the quarter was comprised primarily of $6.9 million of interest income, $0.4 million of management fee income associated with the investment in the CLO, and $0.3 million of other income. As a reminder, other income includes dividends received from portfolio companies as well as origination, structuring, and advisory fees.

Our total operating expenses were $5.8 million for the fiscal first quarter and consisted of $2 million in interest and debt financing expenses, $2.9 million in base and incentive management fees, $0.6 million in professional fees and administrative expenses, and $0.3 million in insurance expenses, directed fees and general, administrative and other expenses. For this fiscal first-quarter total operating expenses as presented increased by $1.9 million as compared to the same period last year. This increase in total operating expenses was primarily attributable to higher interest in credit facility financing expenses supporting the growth of our asset base as well as increased management and incentive fees. These increased incentive fees reflect the outperformance of our growing asset base, but this quarter also includes a $0.9 million incentive fee accrual related to one specific legacy investment for which a $4.2 million unrealized gain was recognized during the quarter. Mike will elaborate on this later in further detail. Total expenses excluding interest and debt financing expenses, base management fees and incentive management fees, actually offset this increase slightly and decreased by $42,000 as compared to last year's first-quarter or from 1.8% of average assets under management for the same period last year to 1.4% for this quarter. This demonstrates the benefit of scale as our assets continue to increase while our cost structure remains consistent.

NAV was $123.5 million as of May 31, 2015, a $0.9 million increase from an NAV of $122.6 million as of February 28. NAV per share was $22.75 as of May 31, 2015, compared to $22.70 as of year-end. During these three months and despite a significant dividend being declared this quarter, NAV per share actually increased by $0.05 per share, primarily reflecting $1.36 of earnings offset by the $1.27 dividend declared during the quarter. As you might have noted, our prior-period numbers for May 31, 2014, have revised to reflect adjustments outlined in our notes to the financial statements included in our Form 10-K including the early adoption of the new accounting standard.

Slide 5 outlines the dry powder available to us as of May 31 this year. As of the end of the fiscal first-quarter, we had $11.8 million outstanding in borrowings under our revolving credit facility with Madison Capital Funding and $79 million in outstanding SBA debentures. Our Baby Bonds had a carrying amount and fair value of $48.5 million and $49.7 million, respectively. With the $33.2 million available on the credit facility, $71 million additional borrowing capacity at our SBIC subsidiary, and $6.6 million in cash and cash equivalents, we had a total of $110.8 million available liquidity at our disposal as of May 31. This available liquidity equates to approximately 42% of the value of our investment, meaning we can grow our assets under management by a further 42% without any additional external financing.

We remain 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 also continue to assess all our various capital and liquidity sources and will manage our sources and uses on a real-time basis to ensure optimization. In fact, effective on May 29, 2015, we entered into a debt distribution agreement with Ladenburg Thalmann through which we may offer for sale from time to time up to $20 million in aggregate principal amount of our existing Baby Bonds issuance through an at-the-market offering. This is a benefit of having our N-2 shelf registration statement allowing us to capitalize for market opportunities. As of yesterday, we had sold bonds with principal of $5.7 million at an average premium of 1.3%, enabling us to further enhance our liquidity and plan ahead for future capital needs such as the remainder of our first SBIC license and the funding of our second SBIC license. These new issuances are under the exact same terms as the original Baby Bond offering in 2013.

Now I would like to move on to slide 6 through 8 and review the composition and performance of our investment portfolio. Slide 6 highlights the portfolio composition and yield of our portfolio at the end of the quarter. As of May 31, the fair value of the Company's investment portfolio was $263 million, principally invested in 35 portfolio companies and one CLO fund. Our portfolio was composed of 59.8% of first-lien term loans, 15.4% of second-lien loans, 6.8% of syndicated loans, 2.2% of unsecured notes, 6.4% of subordinated notes of the Saratoga CLO, and 9.4% of common equity. The weighted average current yield on the portfolio for the three months ended May 31, 2015, was 12.0%, which was comprised of a weighted average current yield of 11.2% on first-lien term loans, 11.0% on second-lien term loans, 6.3% on syndicated loans, 10.8% on unsecured notes, and 28.8% on our CLO subordinated notes. Despite downward pressure on yields due to continued competition, our yields have remained strong as compared to the previous fiscal quarters.

To further illustrate this point, slide 7 demonstrates again how the yield on our core BDC assets excluding our CLO and syndicated loans has remained consistently above 11% while our asset base has continued to grow. Subsequent to the decrease in our CLO assets under management and higher refinancing costs related to this, the CLO's yield has also remained strong and, in fact, increased. Syndicated yields have remained largely stable.

Moving on to slide 8, during the fiscal first quarter 2016 we invested $23.2 million in new and existing portfolio companies and had $7.3 million in exits and repayments, resulting in net investments of $15.9 million for the quarter at our BDC. As you can see on slide 8, our investments continue to be highly diversified by type as well as in terms of geography and industry with a large focus on business, consumer, and healthcare services as well as software as a service while spread over 15 distinct industries. It is worth noting that we have no significant exposure to the oil and gas industry.

Of our total investment portfolio, 9.4% consists of equity interest. Equity investments are and will continue to be an important part of our overall investment strategy. Slide 9 demonstrates how realized gains from the sale of equity investments combined with other investments has helped enhance shareholders' capital. For the past three years we have had a combined $5.2 million of net realized gains from the sale of equity interest or 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.

Thank you, Henri. I would like to take a couple of minutes to update everyone on the current market as we see it. Then I will discuss our strategy and performance as we operate in this environment. The market's extremely competitive conditions persist as there remains an abundance of capital chasing and historically low volume of new investment opportunities. As you can see in the chart on slide 10, middle-market leverage has surpassed pre-crisis levels and is still continuing its upward trajectory. Excess liquidity within the private equity community as well as increase in the number of middle-market lenders relative to the quantity of new deal opportunities have helped drive debt and purchase multiple expansion. In addition, several data sources and our own experience indicate that gross investment yields have remained tight and are accompanied by wider leverage levels and narrower equity cushions. Despite the NII pressure facing many BDCs, we have not seen a widening of yields.

The general sentiment is that standard deals remain in high demand while more aggressive deals have seen investor scrutiny. As mentioned earlier, the lower middle market's increased leverage is very much being driven by fewer investment opportunities. Slide 11 is quite remarkable and demonstrates how the number of transactions for deal sizes in the US below $25 million year to date in 2015 were down 49% from year-to-date 2014. Calendar year 2015 is off to a very slow start with 432 private equity deals closing today compared to 843 for the same period last year. Despite this trend, we remain optimistic of our own pipeline and originations.

With regards to our own pipeline and originations, we have made great strides in expanding our relationships and are confident these relationships will create higher origination activity in the future. We are now dedicating additional resources to our origination effort, which we believe will allow us to accelerate our growth while maintaining our disciplined approach.

We also continue to believe that the lower middle-market is the most attractive market segment to deploy capital. And the fundamentals here remains strong, leading to the best risk-adjusted returns, in our view. Additionally, the sheer quantity of businesses at this end of the market make it less efficient and less competitive. Despite the rise of market-wide leverage, we have been able to invest deals with relatively low multiples. In the chart on slide 12 you can see that 56% percent of the market's debt to EBITDA multiples were 4.1 times or higher. Historically, the majority of our closed deals are beneath that level with average SAR leverage for the last two years still below four times, even though average SAR leverage for the three deals closed in Q1 was 4.5 times.

We are very careful to exercise extraordinary investment discipline and investing only credits with attractive risk-return profiles. As we've noted before, deals are not necessarily low risk when they have low leverage and high risk when they have high leverage. We decline plenty of low-leverage loans to weak credits and frequently pursue higher-leverage loans to strong companies. The most important thing for us is that we remain thorough and disciplined in assessing the risk profile of each underlying business and that we craft the capital structure to match the relative strength of each portfolio company.

Slide 12 also demonstrates the growth that we have had in the number of executed investments. With the strong execution track record the past couple of quarters as well as year-over-year growth, our executed investments doubled from seven in 2013 to 14 in calendar year 2014. In the first half of calendar year 2015 we saw seven deals close, a number on pace with 2014's performance, despite the pressures of the aforementioned comparative market differences. We achieved this growth in an extremely competitive market, which speaks to our strength in origination efforts and, as overall portfolio quality has improved, to the risk profile of our investment profile and the investment philosophy of the firm.

Along those lines, some of you may have noticed the favorable realization on network communications or NCI. NCI was a legacy investment that existed before Saratoga took over to cover management of the BDC and was in an old media company focused on real estate end markets, a combination that saw performance deteriorate substantially in 2009. We worked with NCI to restructure its debt around the new operating environment, permitting the borrower time and runway to introduce digital products. When the company was sold this quarter, we received full recovery on its restructured notes including PIK interest and a meaningful return on equity, which combined amounted to $6.5 million. We believe our experience with NCI illustrates, again, the sound judgment and experience of the investment team that is growing Saratoga's investment portfolio.

Our objective is to maximize our risk-adjusted returns in a manner that utilizes our low cost of capital and the two-to-one leverage advantage we possess through the SBIC license. By focusing on the smaller, less competitive end 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 13, as of May 31, 2015, over 74% of our SBIC investments are in senior debt securities, which is relatively unchanged from last quarter. The leverage profile of these investments is very low, especially compared to market leverage.

Because of the leverage and low cost of capital advantages inherent in the SBIC program, we can achieve strong returns for our shareholders without moving far out on the risk spectrum. Therefore and as demonstrated this past quarter, 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 14, you can see our SBIC assets increased to $151.5 million as of May 31, 2015, from $135.8 million last quarter. As a percentage of our total portfolio, SBIC assets have grown from 0% of our total portfolio as of fiscal year-end 2012 to 58% this quarter. This growth in SBIC assets is an important part of our continued increase in net investment income as the lower financing costs helped grow our NII yield at a healthy pace.

Also it is important to note that as of the fiscal quarter ended May 31, 2015, we had $85.6 million of total available SBIC investment capacity, of which $70 million is leverage capacity within our current SBIC license. Now, if we were to obtain a data second license our leverage capacity would increase by another $75 million and the ability to increase assets by an additional $112.5 million. Fundamentally, our strategy in this market is to focus on our core strengths -- our origination platform, our experienced and disciplined underwriting, and our SBIC funding capacity. In our view our origination platform is among the very best at our end of the market and we are dedicating more resources toward it. 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. This past year we met an important milestone that has been an important goal for us since our inception, namely to commence the payment of regular quarterly cash dividends. From the start, we said our expectation was that this dividend would continue to increase, which it has, by 22% per quarter over the last three quarters. As outlined on slide 15, over the past 12 months Saratoga has paid quarterly dividends of $0.18 per share for the quarter ended August 31, 2014; $0.22 per share for the quarter ended November 30, 2014; $0.27 per share for the quarter ended February 28, 2015. Saratoga also paid a special dividend of $1 per share on June 5, 2015. July 8, 2015, Saratoga Investment announced that its Board of Directors has declared a dividend to shareholders of $0.33 per share for the quarter ended May 31, 2015, payable on August 31, 2015 to all stockholders of record at the close of business on August 3, 2015.

Consistent with our new policy, shareholders will have the option to receive payment of the dividend in cash or receive shares of common stock pursuant to the Company's dividend reinvestment plan or DRIP plan, which Saratoga adopted in conjunction with the new dividend policy and provides for the reinvestment of dividends on the behalf of stockholders. Our goal with this policy remains to allow stockholders who want cash to receive their dividends and 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. Experience has shown that those stockholders who hold their shares with a broker must affirmatively instruct their brokerage prior to the record date if they prefer to receive this dividend and future dividends in common stock. The number of shares of common stock to be delivered shall be determined by dividing the total dollar amount by 95% of the average of the market prices per share at the close of trading in the 10 trading days immediately preceding and including the payment date. For more information, see the stock information section of the Company's investor relations website.

Moving on to slide 16, all of our initiatives are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We hope to drive the size and quality of our investor base while continuing to add institutions to the roster. During this past quarter we added further analyst coverage and hope to continue to expand that as well.

We have spoken today about many of the components of our competitiveness as highlighted on slide 16. Earnings yield of more than 9%, dividend yield of approximately 7.7% and growing, ample low-cost liquidity, strong earnings per share and expansion of assets under management. In addition, we have it only limited exposure to the oil and gas industry and had no realized write-down as many other BDCs have experienced. Believe that Saratoga Investment is on the path to being a premier BDC in the marketplace, and we feel we have already demonstrated superior shareholder returns. We have achieved annualized rates of return in excess of 18% for the past one-, three- and five-year periods, positioning the Company as one of the top four or better performing EDCs for each period.

Moving on to slide 17, our objectives are simple -- to continue to execute our long-term strategy to expand our asset base without sacrificing credit quality while benefiting from scale. We also continue to increase our capacity to source, analyze, close, and manage our investments by adding to our management team and capabilities. Our primary focus remains on maximizing the potential high teen returns on equity invested in our SBIC and utilizing the 2-for-1 leverage that it 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 are 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 from Gilford Securities.

Mike, my first question is for you. Looking at slide 11, normally elevated leverage levels are also associated with extremely elevated deal activity such as at the pre-crisis levels. What do you think it means that we are experiencing elevated deal leverage multiples at a point in time where we are having a decrease in deal activity?

I wish I had a crystal ball to give you a perfect answer on that. The perspective I would share with you is my experience is that elevated leverage levels are more correlated to a benign credit environment where people feel like they can do no wrong by investing capital. That often works in conjunction with a very robust deal environment.

In this case, deal flow is down but it is still a benign credit environment. And there's a lot of capital out there. So when we see a transaction, it is often the case that many other people are competing for that deal. And we are seeing that even more so at the lower end of the middle market. I think the competition there is less, as we've referenced in the prepared remarks, but still very competitive simply because there's a lot of capital out there and fewer deals. And what happens is in that environment is the buyers of those companies can push leverage and create a sort of an auction environment at times as well.

And of course, the private equity firms are also paying really hefty prices for companies in this environment as well. Some of that has to do with just the very low interest-rate environment, too. So there's a lot of factors that are at play here. I think what we try to do is just stick to our guns, do very thorough due diligence and make sure that we are populating our portfolio with deals that have a very good risk-adjusted return. And with the cost of capital that we have in the SBIC we can do that and still make it very accretive for our shareholders and be aggressive in the right circumstances.

You have been doing this through multiple cycles. And I'm sure you remember how you felt when you were doing deals in 2007 and 2008 and 2006. How does your spider, so to speak, tell you about the environment now versus then? And are you trying to gear yourself towards different types of deals to prepare the portfolio in any way for the future?

That's a good question. I think the thing that you should know is that when we underwrite a credit we are always thinking about how it may perform in a downturn. But it would be really hard for us to say the sky is falling, let's prepare ourselves for six months from now, when the market is going to turn, et cetera, et cetera. We are really -- we're not trying to time the market, by any stretch. Instead, we are really just looking at every credit with the mindset that -- to make sure that if it goes through a down cycle, an economic down cycle, that the Company will perform well and our principal will be safe. And we spent a lot of time doing analysis around that for every credit that we invest in. Really hard to compare market to market what this one feels like versus prior ones. The one thing I do know is if we remain disciplined and continue to find the right credits, we will be fine even if there is a downturn.

Casey, to add to that, I think what we've talked about in our presentation, what we've sought to do is increase the credit quality of what we are investing in -- much more senior loans, much more [dollar type] of loans, and those type of credit positions on the balance sheet being at the top of the balance sheet are like a bull work against the potential future downturn. But I think, as Mike says, we are not predicting any downturn. In fact, US economy seems to be okay. People are more complaining about it being not be as robust as they'd like it to be but not necessarily thinking there's an imminent decline in it. So we are not economists. We are not trying to predict the future here. What we're trying to do is structure ourselves soundly in what we are doing now so that we can handle what may come or may not come.

Okay, thank you for that. Look, I have one more question. When Saratoga originally did that Baby Bond deal, you took a certain amount of the proceeds and put it into broadly syndicated loans that were lower yielding until you had a deal home for those assets. I can't understand the calculus involved in selling more of the Baby Bonds as opposed to you still have not sold all of the syndicated loans. You still have $16 million of syndicated loans on the books that can be used. You still have the lower-cost SBIC facility, substantial amount of SBIC subsidiaries still at your disposal. I struggle to understand the calculus for why distributing more Baby bonds versus those other alternatives which would be more accretive to shareholders.

Well, Casey, I think part of the answer is corporate financial management. And it's very important for any company and certainly a company like ourselves to have multiple sources of liquidity. And the Baby Bonds and the appetite for that community to own Saratoga Investment securities right now specifically in Baby Bonds and ultimately helping to increase the awareness and the presence of Saratoga in the capital markets is an important strategic element. We don't want to rely on too narrow a series of sources of capital. So part of it is diversification of our capital source.

Secondly, the precise use of proceeds on the most recent issuance of these Baby Bonds has been to repay our line of credit. And our line of credit has a three-year revolver. And the Baby Bonds still have five-plus years of term to them. So we are getting a security that might be marginally a little more expensive today. However, it has a much longer duration and provides a much more stable source of capital and also frees up our line of credit for Madison for other potential uses. And we have a lot of different types of deal opportunities, some of which have come to fruition, where we need to be able to deploy the Madison facility. And we want to make sure we keep that as liquid as we can, for whatever circumstances.

With regards to the SBIC capital and availability, I think it's fair to say that we are doing our best to add to that portfolio as rapidly while being as prudent as we can. And so we continue to do that. We would be -- that is really a function of the deals that we approved to do in that portfolio. And the debt available at the SBIC is only available for SBIC type of investments. And so we are -- inside our firm we are maximizing what we are doing in that direction and we have been showing a lot of growth and we will continue to show growth there. But that's where that capital is.

And with regards to the remaining bonds, I think the average yield on those is not terrible. What is that?

The yield to maturity is around 7% on that because we are issuing it out of premium.

(Multiple speakers) yield on our existing $18 million.

Syndicated markets.

I'm sorry; it's about 6.4% on the syndicated.

So those are actually earning more than our Madison facility, for example. So I think in the very short run like this month or something, yes, there are some marginal capital differences. But in terms of the capital structure and the corporate financial structure and our access to different sources of financing, we believe we continue to create a foundation that's very sound for Saratoga. And in the grand scheme of our total capital structure the amount of Baby Bonds we are selling is actually quite small.

All right, thank you for taking my questions.

David Chiaverini from Cantor Fitzgerald.

Excellent quarter, you guys. I have a follow-up question on the capital structure theme. Why issue -- and I'm most interested in the DRIP program. Why issue shares at a discount to book through the DRIP when it's dilutive to shareholders in book value?

Well, historically I think there's a long line of companies that have issued shares at a discount including AT&T even, historically. So that is not an unusual feature, necessarily, for a DRIP program. With regards to the DRIP program in particular, clearly we are trading at a discount to NAV. But we do have a lot of growth and we do need to support the financing of our growth. And we do have shareholders that are interested in acquiring more stock. And we do have shareholders that have approached us and are having difficulty acquiring more stock because of the float in our stock, in the overall stock of Saratoga.

And so, we are very interested in allowing our shareholders to invest further in the Company. I think the structure of the DRIP is such that all shareholders are treated equally. In other words, any shareholder that wants to participate in the DRIP can participate. So it's really a voluntary exercise to either participate or not participate. So all shareholders have an equal opportunity there.

The other thing I would add to the DRIP -- I think, again, if we focus on precise dilution around the DRIP, that's one thing. But I think on a broader picture, if you look at our overall strategy, I think, as we said in our presentation, our stock appreciation -- in other words, for somebody who owns a share of our stock five years ago, three years ago, a year ago, we are talking about 18% compound annual rates of return on our shares. And so the ownership of our stock, all things considered, all strategies employed, has been very rewarding and has been in the top four BDC stocks in every period. So, we are trying to take all of that into consideration as we pursue our strategy to grow and improve our stock price.

Okay. And a follow-up to that -- given the growth objectives and the opportunities there, is a buyback off the table?

I'm sorry? Is the buyback --?

Is doing some share repurchases off the table?

No, not at all. We authorized a share buyback program; and we have it in place, and we have a certain amount of authorization. And yes, that is a facility that we have available to deploy, yes.

And what valuation, given that the stock is trading around 75% of book value, what would be a good value to start implementing that buyback?

Well, we don't have a specific metric in terms of a specific price point that we have determined. And it is something that we would evaluate on a day-by-day, week-by-week, month-by-month basis. As I mentioned earlier, our stock has been appreciating. I think we've had some recent gains right now in terms of our capital gain, et cetera. So I think our NAV has -- probably the announcement last night of our earnings and this call -- I don't think a lot of the marketplace was expect improvement in NAV just because it wasn't public. Now it is public and we would want to let the market digest the fact that there's new information of our improvement in NAV. Despite paying out a lot of dividends, our NAV actually increased. So we would like to see the market digest that and respond to that.

Again, we believe our stock is very attractive relative to the other BDCs based on our performance. But again, yes, we have a stock buyback program available, and we are prepared to use it when we see a moment to use it. But no, we have not put a specific stock price target on that.

Got it. And then a separate question on the SBIC. And I see that you increased the loans outstandings by about $15 million in the quarter. But I noticed that the SBA debentures has been flat out for three quarters in a row at $79 million. I was just curious. Can you talk about the expected ramp of getting more SBA debentures and the timing of that and when you could actually dip into that second license once it's approved?

Two things on that front -- number one, part of that has to do with ultimately we are permitted to get to a 2-to-1 leverage point in the SBIC. However, we need to put the equity in first and then increase the debt subsequently to that. And so, we have invested sufficient equity to create an allowance for a certain amount of leverage. And what we have in dealing with is redemptions. We've had a fair number of redemptions. And we've also had a fair number of redeployments. And so that's part of the reason why that number has stayed at that level.

With regards to the second license, once we hopefully successfully receive the full license, we are able to commence investing in that SBIC immediately. And we would intend to do so.

And then Mike actually made, I think, the comment in his remarks, David, that -- so we have access to $85 million more through the SBIC currently, for which we'd only need to put in the $15 million, as Chris said. So there's big availability there without even putting in any more money as we speak at the moment.

And you wouldn't start investing in the second license until you have fully utilized the leverage on the first license. Right?

Not necessarily.

Not necessarily. But the idea would be to take full advantage of the first license as well. But there's not a restriction on our capacity to also invest in that second license. But we certainly would want to optimize the first license and try to get that to the full 2-to-1 leverage level. And in terms of how fast we can deploy that, I think in the prepared remarks we talked about the difficulty in the marketplace. It's a very competitive marketplace with not as much deal flow. The vast majority of our efforts are really concentrated on trying to deploy capital within that SBIC, given the value proposition it offers to our shareholders. And we are continuing to do that.

I think the pace at which we have invested historically is a pace that feels good now. It's probably a good indication of how we are feeling today. We are putting a lot of effort into increasing that pace. For us, fortunately, despite the market being difficult and transaction volume being down, we started -- when we took over management of this Company and got our SBIC license we really came out into the marketplace for the first time. So as much as overall deal flow is down, we are growing our relationships and seeing more and more opportunities to invest capital.

So that gives us some confidence that we can accelerate our pace of investment over time. Can't tell you exactly what that pace is going to be. But we tend to look at it over not so much quarter to quarter but really, are we developing more good relationships that will lead to good opportunities to deploy capital. And that's how we evaluate our self in that respect.

And one further specific response to your question on SBIC fund versus SBIC fund 2 -- I think, as you can appreciate, there's quite a lot of rules, regulations, procedures, et cetera, around the SBIC funds in terms of sequencing of funding, et cetera. And so at the time at which we hopefully receive our second SBIC license we will be required to make an equity investment in that fund. And then that fund and that equity investment and then be levered 2-to-1. So it will be in our interest to deploy that capital to get that fund up to its 2-to-1 leverage even though we might have capacity in fund one. So the inside of the overall SBIC equation and licenses one and licenses two, et cetera -- there's a bunch of little procedures then step functions that make the sequencing maybe not as smooth as the ultimate endpoint would be.

Got it. That's very helpful. Thank you.

Mickey Schleien from Ladenburg.

Just wanted to make sure I understand page 5 of the investor presentation. It would seem to imply -- and given that this is pre- the ATM facility, it would seem to imply that you could use the collateral already existing in the credit facility and the advance rates to inject their additional equity in the SBIC to gain access to the full [150] of debentures. Is that correct, or am I misinterpreting that?

Yes, it's correct.

Practically, yes.

Okay. Now, given that you have the ATM facility in place and you are starting to raise some capital, that would also obviously be a way you could fully fund SBIC. Correct?

That's correct.

Correct, yes.

All right, thank you. I also wanted to make sure I understood page 12. So this is the -- specifically, in terms of leverage, the 4.5 -- that refers to deals you've closed during the quarter. That's not the average for the portfolio? Is that right?

That's right. No, our whole portfolio didn't rise to 4 point --

So what is the average? Can you tell us?

Do you have that number handy?

It's under 4. It's probably like [3.738], I believe. Yes.

And that must be up just a little bit, then, versus the previous quarter?

Marginally, the net amount of this quarter's increase is obviously, from a waiting perspective, very marginal impact to the overall.

And on that chart, the bar that shows deals closed -- that includes follow-on offerings. Correct? I only saw one new actual portfolio investment.

That does include follow-on investments to existing portfolio companies. And we do measure it that way because we think it's -- as we build our portfolio it's indicative of -- or I guess a better way to say it is that it gives us another avenue to deploy capital. We like nothing better than to find a business that we underwrite and is doing well and we can support that management team and that business model with more capital. It's a good way to enhance our growth. But yes, it does include follow-on investments as well.

Okay. And switching gears to another topic, the reinvestment period for the CLO ends in a little bit over a year. I've seen a lot of noise in results, once we go post reinvestment period, which tends to cause a lot of indigestion and doesn't really help stock prices. I'm just curious what you can tell us about the plans for that CLO post the reinvestment period.

It's fair to say that we are quite a long ways from that period of time. But I guess what we would point out is that the last time we came into a reinvestment period, what we did was we refinanced the CLO. So that is certainly an option to be pursued at that point in time. I think, you look at the return on our investment in that CLO, it's very favorable. And it makes sense to -- at this point in time, if it were now, we would certainly be pursuing a refinancing of it. Exactly what will do at that point in the future -- we just don't know all the market dynamics that will be at work. But again, the last time we were faced with this type of scenario, which was post [divestment] period, what we did was refinanced it to be able to continue the very high returns on that investment.

Right, I understand. But like you said, who knows where the market dynamics will be a year from now? In what position are you in terms of equity holder to call that deal? Can you do that by yourself or do you need to work with the other equity owners?

We own 100% of the equity and we can call it at any time.

You can call it? Okay. My last question is a modeling question. It seems that PIK interest income rose. It's not a large number in and of itself, but on a relative basis it increased to some extent. Is that idiosyncratic or was there something -- what drove that?

Do you mean gross interest income off the income statement?

No, PIK income, payment in kind income increased fairly meaningfully quarter to quarter. I just was wondering if that was idiosyncratic to some particular deal. Or are you looking to do more PIK deals? Or just what happened? And if you don't have that in front of you, we can do that off-line.

No; we actually -- there was -- because of the network realization that we had and the redemption was with PAR and PIK, we had been reserving a portion of the PIK historically. And so included in the PIK income is a reversal of some of the reserve that we had placed on it previously.

I understand. Those are all my questions for today. Thanks for your time.

Andrew Kerai from BDC Income Fund.

Congrats on a very strong quarter again. The first is just a housekeeping item on network communication. So if I understood you correctly you said that you had realized that post quarter end. So if I'm running the math correctly, it looks like there's about a $3.5 million gain combined on the equity and the PIK notes, which would be then required for distribution. Is your plan to basically distribute that out as another special dividend some time as the fiscal year moves along here?

Clearly, that's an important and substantial gain for us. We haven't made a determination specifically what to do with that particular gain at this particular moment in time. Again, our distribution policy is driven very much by the regulations around the BDC and our tax returns and are taxable requirements to distribute income. And we evaluate that periodically and very substantially at every year end. So the exact treatment that gain would fit into our overall gains and our overall regular dividend policy is part of an ongoing consideration. But we haven't concluded yet if we are going to do something specific relative to that gain.

Great. No, certainly makes sense. And then noticed on PrePaid Legal it looks like you guys swapped out of about $2 million or, I should say, sold about $2 million of the first-lien debt, went into -- increased your exposure to the second-lien debt, increased by about $5 million. Just maybe if you could give some comments on this particular credit, why you felt like moving down the capital structure made sense, given the [325] basis points pickup in yield on what I will call basically an increased overall exposure but also obviously going down in the capital structure for that particular name.

Like all of the deals in our portfolio, we are constantly monitoring the performance of the company. In this case, we were monitoring their portfolio performance and had an opportunity to upsize our position in the second-lien and became quite comfortable with it. And as part of that, in evaluating our overall exposure to the credit, we decided that it made sense and it would benefit the shareholders to downsize our position in the first lien, given the rate of interest that it offered. So it's a good opportunity for us to enhance the yield and take more exposure in a credit that we have a lot of comfort with.

Great. No, certainly makes sense. And then just for HMN Holdco, notice you took off the PIK component on your first lien. And you wrote up the equity, if you look at the warrants, by about $0.5 million. I just wondered, one, what was the logic of taking up the PIK piece. And was that equity appreciation just reflective of the decrease in the value of the debt? Was that basically just to swap from the debt valuation to the equity side, given that there's not that 2% PIK component that's going to come due and accrue here in about four years?

That company is performing very well. So the write-up in the equity or warrants is reflective of the performance of the company. I'd have to look at and get back to you precisely on the PIK component. That deal is structured so that as the performance of the business improves there is a grid that we negotiated with the majority owner, such that their interest rate comes down over time as their risk profile reduces. So that may be what you are seeing in the numbers. I'd have to check.

Okay, great. No. Thank you; I appreciate that. And then Elyria Foundry -- noticed the mark stayed the same this quarter. Just given that it's a couple quarters out here on the restructuring, any update you can give on that business would certainly be helpful.

We continue to monitor that company carefully. I think it's fair to say that the business has still a lot of challenges ahead of it. Many of their customers are in end markets that are difficult. So the new ownership is focused on that. And I think one of the offsets to the challenges that the company is currently facing and working through is that they have practically no debt. The only debt that have on the balance sheet is the first lien (technical difficulty). So the company is producing a lot more cash flow than its fixed charges are, so it's building up and accumulating cash as well, which is somewhat of an offset to some of the challenges they are facing and helps improve the enterprise value from that standpoint. But we continue to watch that one closely.

Great. No, certainly appreciate the color. Thank you for taking my questions and congrats on a great quarter, again.

Joshua Horowitz from Palm Global Small [C].

What a tremendous job everyone has been doing! I just wanted to say congratulations and great job. Once again, I feel like I'm repeating myself every quarter. But everything the Company says and the management says ends up getting done exactly as you describe it. So thanks for that.

All of my questions have been answered. It's been a pretty thorough call, and I'm glad to see there's a lot of investor interest. So I guess at this point I would just say we hope that you continue to work to shrink the discount to net asset value and continue to execute as you have been.

Keith Dalrymple from Dalrymple Finance.

Thank you. I have a question about the general environment, if you guys could comment a little more on that. If I take your comments thus far, they are basically that there is more lenders and more capital and cheaper capital but few transactions. When I look at that, I would say that that implied that companies didn't have a great need for capital, which in turn would imply that it's a low- or no-growth environment. Does that jibe with what you are seeing out there, or is there something I'm missing here?

It's interesting. I think there are a lot of factors at play. Generally, we are seeing solid performance from our portfolio of companies and just the deals with the companies that we are looking at. But overall in the middle-market we are not seeing business is growing at a really rapid rate. So that may corroborate what your statement was as well.

I think another factor at play is that the price of -- the private equity firms, the people that are buying these companies, are facing some of the same dynamics that we are. In this low interest-rate environment, prices are really high. There's a lot of capital out there and not as many assets that are changing hands. And so that's making it difficult as well. A lot of the private equity firms are looking at the prices that things are going for and having a challenge to pull the trigger on deals, so deal flow in general is down.

Great, thank you.

(Operator Instructions) That looks like all the questions that we have for today. So I would like to turn the call back over to management for closing remarks.

Again, we would like to thank everyone for joining us today. We appreciate your support and we look forward to speaking with you next quarter.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you may all disconnect your telephone lines. Everyone have a great day.