Saratoga Investment Corp (SAR) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s fiscal second-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 second-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 second-quarter 2016 shareholder presentation in the events and presentations section of our investor relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will be available from 1 PM today through October 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. This past quarter we celebrated five years since we became the manager of Saratoga Investment Corp. and we would like to start our earnings call by reviewing our primary focus and long-term objective during these five years which was increasing the quality and size of our asset base with the ultimate purpose of building Saratoga Investment Corp. into the best-in-class BDC generating meaningful returns for our shareholders.

As highlighted on slide two, during the second fiscal quarter of 2016, we continued the momentum gained during the first fiscal quarter and last year toward realizing our long-term strategic objectives. To briefly recap first, we have endeavored to maintain a robust high-quality asset base with a strong yield and return on equity. While our assets under management contracted slightly in this quarter due to an unusual concentration of redemptions, something that we saw industry wide, our metrics remain strong on a quarter-over-quarter basis. We will discuss this in further detail shortly.

Second, the overall strengthening of our financial foundation has enabled a continuing increase in our regular quarterly cash dividends. We will pay a quarterly dividend of $0.36 per share for the second fiscal quarter of 2016 payable on November 30, 2015 for all stockholders of record on November 2, 2015. This further increase represents a doubling of our regular quarterly cash dividend in the past 12 months and shareholders continue to be able to participate in our dividend reinvestment plan if they prefer.

Third, our base of liquidity remains strong and promises to improve. As mentioned before on April 2, 2015, we received a green light and go fourth 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. We continued the completion of the formal application. Effective May 29, 2015, we entered into a debt distribution agreement with Ladenburg Thalmann to 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. As of August 31, 2015, we sold bonds with a principle of $8.9 million at an average premium of 1.4%.

Finally, our Board of Directors recently extended our share repurchase program that allows us to repurchase up to 400,000 shares of our common stock for another year to October 2016. In addition to the extension, they also increased it to 400,000 shares. During this quarter and as part of this formal plan and its existing terms, we repurchased 2500 shares. We were also encouraged to continue to see the expansion and diversification of our shareholder base.

In addition to these corporate achievements during this quarter we continued on our path of further strengthening our financial foundation and building scale by consistent originations of $18.9 million sustaining assets under management among significant redemptions this quarter. Improving our investment quality and credit with over 97% of our loan investments now having our highest rating; expanding our net asset value to $125.3 million, a 1.5% increase from $123.5 million at the end of last quarter; and increasing performance with our key performance indicators for fiscal second-quarter 2016 as compared to last year's second quarter. Our adjusted net investment income is up 25% to $2.9 million.

Adjusted NII on net asset value increased to 9.3%, up 150 basis points from 7.8%. Adjusted NII per share of $0.52 is up 21% from $0.43 and our return on equity for this quarter ended August 31, 2015, was 4% versus 10.8% last year reflecting primarily the annualized impact of the unrealized depreciation in this quarter that we will be discussing later.

We are happy about these continued accomplishments and will go into greater detail on each one during today's call.

As I have mentioned, we remain committed to further advancing the overall quality and size of our asset base. As you can see on slide three, our upward trend of quality and quantity of assets has largely continued. As I mentioned earlier, we saw an unusually concentrated number of redemptions this quarter with $18.9 million of originations offset by $27.4 million of redemptions resulting in a 4% reduction in assets under management to $252.2 million as of August 31, 2015.

Nevertheless, we have seen 165% increase in assets under management since fiscal year 2012 with over 97% of our current loan investments holding the highest internal rating that we award up from 96% last quarter. Thus our overall loan quality continues to increase while we remain committed to growing assets in a measured way.

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 quarterly key performance metrics on slide four, we see that for the quarter ended August 31, 2015 our net investment income was $3.7 million or $0.66 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 discussed at length last quarter, our net investment income was $2.9 million or $0.52 per share. This represented an increase of $0.6 million as compared to the same period last year and an increase of $0.2 million compared to the quarter ended May 31, 2015.

In the second quarter of fiscal 2016, we experienced a net loss on investment of $2.4 million or $0.43 on a weighted average per share basis resulting in a total increase in net assets from operations of $1.2 million or $0.22 per share. The $2.4 million net loss on investments was comprised largely of $6.1 million in net unrealized losses on investments offset by $3.7 million in net realized gains. Most of this quarter's unrealized losses and realized gains are driven by legacy investments where the unrealized loss primarily from our Elyria Foundry investment and the realized gain primarily from the network communications redemption that was discussed last quarter.

Net investment income yield as a percentage of average net asset value was 11.8% for the quarter ended August 31, 2015. Adjusted for the incentive fee accrual related to net unrealized capital gains, the net investment income yield was 9.3%, up from 7.2% last year and unchanged from 9.3% last quarter. Return on equity was 4% for this quarter.

These all remain 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 prioritize the quality of our portfolio. As these metrics continue to improve quarter over quarter, it highlights 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 this quarter with SBIC assets increasing to 59% of our total 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 $7.8 million for the fiscal second quarter. Total investment income increased $1.3 million or 19.8% compared to the second fiscal quarter last year. Our total investment income for this quarter was comprised primarily of $6.8 million of interest income, $0.4 million of management fee income associated with our investments in the CLO, and $0.6 million of other income. Other income includes dividends received from portfolio companies as well as origination, structuring and advisory fees.

Our total operating expenses were $4.1 million for the fiscal second quarter and consisted of $2.1 million in interest and debt financing expenses, $1.1 million in base and incentive management fees, $0.6 million in professional fees and administrator expenses, and $0.2 million in insurance expenses, directors fees and general administrative and other expenses including a $0.1 million excise tax credit.

For this fiscal second quarter, total operating expenses decreased by $0.3 million as compared to the same period last year. This decrease was primarily attributable to the incentive fee credit related to the net loss on investments recognized during the quarter. Total expenses excluding interest and debt financing expenses, base management fees and incentive management fees increased slightly from $766,000 for the quarter ended August 31, 2014 to $843,000 for the quarter ended August 31, 2015, which remained unchanged at 1.3% of assets under management for both quarters.

As you might have noted, our prior period numbers for August 31, 2014 have been revised to reflect adjustments outlined in our notes to the financial statements included in our Form 10-K including the early adoption of a new accounting standard.

Despite heavy redemptions and a slight reduction in our assets, the unrealized loss on investments this quarter and our growing dividend net asset value continues to grow furthering the consistent growth delivered over the past five years.

As you can see on slide five, our NAV has grown from $86 million as of February 28, 2011 to $125 million as of August 31, 2015, an increase of 45% over this period. This $125.3 million current NAV also represents a $1.8 million increase from $123.5 million as of May 31, 2015, and a $2.7 million increase from $122.6 million as of yearend.

For the six months ended this quarter, $8.7 million of dividends declared was more than offset by $5.4 million of net investment income, $3.8 million of net realized gains and $3.0 million of stock dividend distributions.

NAV per share was $22.42 as of August 31 compared to $22.70 as of February 28, 2015. During these six months, NAV per share decreased by $0.28 primarily reflecting the $2.7 million or $0.50 per share increase in net assets which is net of the $1.60 dividend paid during this fiscal year. This was offset by the dilutive impact of the 186,000 shares issued pursuant to the dividend reinvestment plan during this period.

Moving on, slide six outlines the dry powder available to us as of August 31, 2015. As of the end of the fiscal second quarter, we had $2 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 $57.2 million and $57.5 million respectively.

With the $43 million available on the credit facility, $71 million additional borrowing capacity at our SBIC subsidiary, and $12.6 million in cash and cash equivalents, we had a total of $126.6 million of available liquidity at our disposal at quarter end. This available liquidity equates to approximately 50% of the value of our investments meaning we can grow our assets under management by a further 50% 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. As we had previously discussed, last quarter we launched an at the market offering of our existing Baby Bonds issuance through which we may offer for sale from time to time up to $20 million in aggregate principal amount. This is the benefit of having our N2 shelf registration statement allowing us to capitalize on market opportunities.

As of August 31, 2015, we had sold 357,807 bonds with a principal of $8.9 million at an average premium of 1.4% 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 we would like to move on to slides seven through nine and review the composition and performance of our investment portfolio.

Slide seven highlights the portfolio composition and yield at the end of the quarter. As of August 31, the fair value of the Company's investment portfolio was $252 million principally invested in 32 portfolio companies and one CLO fund. Saratoga's portfolio was composed of 62.1% of first lien term loans; 16.7% of second lien term loans; 6.6% of syndicated loans; 0.1% of unsecured notes; 6.6% of subordinated notes of the Saratoga CLO, and 7.9% of common equity. The weighted average current yield on the portfolio as of August 31 was 12.6% which was comprised of a weighted average current yield of 11.1% on first lien term loans, 10.4% on second lien term loans, 7% on syndicated loans, 10.0% on unsecured notes and 37.8% 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 eight demonstrates how the yield on our core BDC assets excluding our CLO and syndicated loans has remained consistently around 11% over the past four years. The CLO's yield has remained strong and in fact continued to increase significantly this quarter. Syndicated yields have also been moving steadily upwards.

Moving on to slide nine, during the fiscal second quarter, we invested $18.9 million in new and existing portfolio companies and had $27.4 million in exits and repayments resulting in net redemptions of $8.5 million for the quarter. 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, consumer and healthcare services as well as software as a service while spread over 13 distinct industries. It is worth noting that we have no significant direct exposure to the oil and gas industry.

Of our total investment portfolio, 7.9% consists of equity interest; equity interests are and will continue to be an important part of our overall investment strategy.

Slide 10 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 $8.9 million of net realized gains from the sale of equity interest or a 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. 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.

Over the past couple of quarters, we have found ourselves reviewing a large number of deals. However, it seems to be harder to find high quality transactions in the pipeline of opportunities that exist.

Slide 11 shows the results of a quarterly survey of Junior debt participants for calendar Q2. Consistent with our own experience, it demonstrates how Junior debt providers reviewed a higher number of opportunities this past quarter with 93% of respondents reviewing more than 25 which is up from the prior two quarters.

In addition, 100% of respondents submitted at least one letter of intent during the first quarter. However, despite this increase in opportunities reviewed and LOIs submitted, closed transaction activity was down significantly this quarter as the majority of respondents closed either zero or just one transaction during the quarter.

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 in the non-syndicated market.

Our experience is that high quality deals remain in high demand with most quality investment opportunities being pursued by multiple parties and competitive processes.

Slide 12 further demonstrates how fewer deals are being done. The number of transactions for deal sizes in the US below $25 million year to date in 2015 were down 44% from year to date 2014. Calendar year 2015 is off to a very slow start with only 642 private equity deals closing in the smaller deal market to date compared to 1,144 for the same period last year.

In the face of these market trends we remain optimistic of our own pipeline and originations. The growing strength of our origination platform and our expanding presence in the lower end of the middle market has allowed us to increase our origination volume over time and gives us confidence that we can continue to deploy capital at a healthy pace.

With the objective of increasing our capital deployment in high-quality investments, we allocated a second full-time person to our origination team. As we have dedicated more resources to our business development effort and our presence in the marketplace has grown, we have generated an increasing number of investment opportunities.

Our reputation for being fair-minded and supportive investors has increased our pace of referrals from small business owners and management teams. In addition, we have recently more than doubled our private equity sponsor relationships. We believe this in turn will allow us to further accelerate our pace of investment while we remain diligent and careful in our investment approach.

The BDC market can be generally bifurcated into two groups and the outlook for investment activity is dependent on which group a BDC is in. For the vast majority of BDCs that participate in the larger deal market, their origination activity is very much a function of private equity activity and the state of the capital markets. This group of larger BDCs tends to compete for many of the same larger market transactions. As a consequence, their performance and origination activity is highly correlated with one another and is largely dependent on deal activity among a more concentrated group of large private equity sponsors.

However, where we reside at the smaller end of the market, our origination activity is more a function of our presence in the small business marketplace. Given the sheer quantity of smaller businesses that occupy the lower end of the middle market, we are confident that we can increase our pace of investment by continuing to grow our qualified deal pipeline. Moreover, we have significant room to expand our deal sourcing relationships as we are still not known by many participants in the market although we have made significant strides in expanding our relationships and are confident these relationships will create higher origination activity in the future.

We also continue to believe that the lower middle market is the most attractive market segment to deploy capital and the fundamentals here remain strong leading to the best risk-adjusted returns in our view.

In the chart on slide 13, you can see that multiples in the industry have continued to shoot upwards. 92% of the market's debt to EBITDA multiples were 4.1 times or higher this past calendar quarter, a significant increase from 56% in Q1.

Historically the majority of our closed deals are beneath that level with the average SAR leverage for all of our deals at 3.99 times even though SAR leverage for the three deals we did in Q2 2016 was 5.6 times.

We are very careful to exercise extraordinary investment discipline and invest only in credits with attractive risk return profiles. Of important to us when doing deals with higher leverage is to ensure that our dollars are invested in companies with exceptionally strong business models where we are confident that the enterprise value of the businesses will sustainably exceed the last dollar of our investment.

As we have also 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 to 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 13 also demonstrates the growth 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 7 in 2013 to 14 in calendar year 2014. So far in calendar year 2015, we have seen 10 deals close, a number that is still on pace with last year's performance despite the current pressures in the marketplace and being able to close deals that we discussed earlier.

Our growth the past couple of years has been in an extremely competitive market which speaks to our strengthening origination efforts and as overall portfolio quality has improved to the risk profile of our investment portfolio and the investment philosophy of the firm.

The tougher environment that currently exists in closing deals highlights the importance of having a robust pipeline and as you can see on slide 14, we have made great strides in expanding our relationships and are confident these relationships have created high origination activity.

In the past three months, the firm established 76 new relationships and engaged in 388 business development activities. The pace of opportunities seen and term sheets issued have both increased by 24% so far this year. Even though our number of deals closed dropped slightly on an LTM basis, this was not due to fewer opportunities but rather continued prudence and investment discipline in a tougher credit environment.

With additional origination and due diligence resource that we have added to the team recently, we were able to evaluate more deals and are on track to close the same amount of deals in 2015 as in 2014 despite the fact that market conditions have become increasingly adverse. All of this while improving our investment quality. We view this as an achievement. However, we expect to improve upon this performance.

With respect to our SBIC, 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 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 15 as of August 31, 2015, approximately 81% of our SBIC investments are in senior debt securities which is up from 75% last quarter. The leverage profile of these investments is very low especially when compared to market leverage.

Because of the leverage and lower 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.

With that in mind, moving on to slide 16, you can see our SBIC assets continue to grow to $150 million as of August 31, 2015, from $136 million at year end. As a percentage of our total portfolio, SBIC's assets have grown from 0% of our total portfolio at fiscal yearend 2012 to 59% this quarter. This growth in SBIC assets is an important part of our continued increase in net investment income as the lower financing cost help grow our NII yield at a healthy pace.

Also it is important to note that as of the fiscal quarter ended August 31, 2015, we had $86.9 million total available SBIC investment capacity of which $71 million is leverage capacity within our current SBIC license. If we were to obtain a second license, our leverage capacity would increase by another $75 million with 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 experience 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. Through our origination platform and our growing list of business relationships, 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 over to our CEO. Chris?

Thank you, Mike. This past year we achieved an important goal for us since our inception of paying regular quarterly cash dividends. From the start, we said our expectation was that this dividend would continue to increase which it consistently has done since we commenced this program and after today's further increase, we have now doubled our quarterly dividend since we instituted the policy 12 months ago.

As outlined on slide 19, over the past five quarters, 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; and $0.33 per share for the quarter ended May 31, 2015. Saratoga has also paid a special dividend of $1 per share on June 5, 2015.

On October 7, 2015, Saratoga Investment Corp.'s Board of Directors declared a dividend to shareholders of $0.36 per share for the quarter ended August 31, 2015 payable on November 30, 2015 to all stockholders of record at the close of business on November 2, 2015. Based on our current share price this represents a dividend yield of almost 9%.

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 behalf of its stockholders.

Our goal with this policy remains to allow stockholders who want cash to receive their dividends in cash. However, it also provides the opportunity for many stockholders we have spoken to who are also 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 brokers 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 should be determined by dividing the total dollar amount by 95% of the average of the market prices per share at the close of trading on 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.

In addition and as mentioned earlier, our existing share repurchase plan that allows us to repurchase 200,000 shares of common stock at prices below NAV has been extended for another year and also increased to 400,000 shares. During this quarter and as part of this formal plan and its existing terms, the Company repurchased 2500 shares.

On slide 18 in addition to being very proud about the growth of our NAV while not only maintaining but increasing the quality of our assets, we are also delighted to see our total return being industry leading. As you can see on slide 18, our total return which includes both capital appreciation and dividends has outperformed the BDC Index quite considerably over the last 12 months. Our total return has been almost 18% while that of the industry at large was negative. This continues our track record as one of the top five or better performing BDCs on a total return basis over the past one-, three- and five-year periods.

Moving on to slide 19, 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. We have spoken today about many of the components of our competitiveness as highlighted on slide 19 -- earnings yield of more than 9%, dividend yield of almost 9% and growing, ample low-cost liquidity, strong earnings per share and expansion of assets under management.

In addition, we have had only limited exposure to the oil and gas industry and had no realized write-downs as many other BDC's have experienced. We 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 returns in excess of 18% for the past one-, three- and five-year periods positing the Company as one of the top five or better performing BDCs for each period.

Moving on to slide 21, our objectives are simple and consistent: 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 the equity invested in our SBIC and utilizing the 2 to 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.

I would now like to open the call for questions.

(Operator Instructions). Casey Alexander, Ladenburg Thalmann.

I am not sure what the problem was. Good morning. Henri, do you have the breakdown of the fixed-rate to floating-rate percentages of the qualifying portion of the portfolio?

Yes, it is relatively consistent with last quarter. I will check it. I think it is around 57% floating-rate again. 56% floating-rate, 44% fixed.

Okay, thank you. Secondly, the reserved cash, is that cash that came into the SBA subsidiary as a result of redemption?

That is correct. Effectively what ends up in our reserved line on our balance sheet is the cash that we hold in our actual SBIC subsidiary. So any cash that might come from a redemption or obviously when we draw any SBA debentures would go into that cash line on the balance sheet.

Okay. So that is clearly money that is going to be redeployed?

Correct.

Lastly, just in relation to -- I get the Elyria Foundry, it was a big move in an equity position on a commodity related company and the debt position stayed fairly stable. I would love a little bit of commentary on Smile Brands, that is marked at around 66% of par and had a pretty decent mark in the portfolio. Can you give me some color on Smile Brands, please?

Yes, that is a private equity sponsored transaction that has faced some challenges, they have some softness in their revenue line and have incurred a lot of additional expenses trying to grow those revenues but haven't had as much success doing so as they would like. And as a consequence, their cash flow has come down and the valuation adjustment reflects that under decline in EBITDA. That credit was just restructured last week in a way that increased the interest-rate and the equity sponsor put an infusion in cash into the balance sheet as well.

The important thing to note, Casey, is that we are at the top of the capital stack in that investment. We have a first lien security and I think we feel like we are well secured by the enterprise value but that is the state of play. I think the sponsor is working hard to try to improve things at the Company.

All right, that is good news to hear that the sponsor stepped up. Thank you for taking my questions.

David Chiaverini, Cantor Fitzgerald.

Thanks. Good morning. A couple of questions for you. You mentioned about how deal activity has been low for the overall middle market but you are seeing decent deal flow at the lower end of the middle market. Is it safe to assume that you expect net portfolio growth to resume on an upward trend in coming quarters?

That is our expectation. Right now we have competing influences. The market -- on the one hand the market is tougher, the credit environment is tougher so you see that in sort of the leverage profile that we outlined on one of the slides. We are also seeing just more competition in general even at our end of the market even though we feel like our end of the market is less competitive in the larger market, we are seeing an increase in competition and sort of tougher credit profiles.

Now offsetting that and what gives us confidence that we can resume growing our portfolio on a net basis is that we are continuing to grow our presence in the marketplace. We talked about that a little bit further too and one thing I would remind you is that when we received our SBIC license in 2012, we really started in this business at a standing start.

So as we've continued to grow our portfolio and do transactions, it gives us more credibility, has enabled us to grow our relationships with not only private equity sponsors but business owners in general and so you see that in our growing pipeline of activity and we think that with that growing pipeline of activity, we will still find more deals that we want to do and execute on than we will have redemptions.

I think the other side of that question is redemptions and we basically had -- unfortunately we made some very good loans that got repaid so and then it was a concentration of them in this quarter. We don't expect that concentration to occur in subsequent quarters. We think our origination was solid this quarter, it is just the redemptions were a little more concentrated than they might have been in other quarters. So we view that redemption side as more of anomalous and not necessarily reflective of a trend.

Okay, got it. Next question is on -- as you get the deal flow and you take on more borrowings, can you talk about balancing the pros and cons of going with increasing the amount outstanding of the SBA debentures? I noticed that they've been at $79 million for the past few quarters versus you have been issuing Baby Bonds at a higher interest rate than the SBA debentures. Can you talk about the merits between the two?

As we have outlined in our discussion today and in general, our primary objective is to originate and deploy the SBA capital. Again, I think the originations were concentrated in our portfolio of SBIC loans and so our objective is to do that. The SBIC, we have certain criteria in terms of what types of investments can go into that portfolio and so it is a combination of redemptions and criteria that sort of drive the net asset growth inside the SBIC versus at the BDC level. We feel fortunate that we can originate on both platforms and it gives us a lot of flexibility in addressing the market because we are not limited to SBIC style and criteria alone so we can be very flexible with our presence in the marketplace.

But yes, our objective is the SBIC portfolio however that is where some of the redemptions have been so it is really not an either or, it is we are working on both and they just have different dynamics.

Okay, that is helpful. Next question, following up on your comments on Smile Brands and how the equity sponsor had a cash infusion, was the cash infusion enough that you may perhaps be able to write up the first lien loan from 2.9 million up to closer to the 4.4 million cost?

No, I don't think we look at it that way. I think the sponsor has some work ahead of them. Obviously we've got to be careful because it is a private company but I think the sponsor has worked ahead of it and the bank group was willing to work with the sponsor and they are cooperating as well and they are working hard to try to improve the fundamentals of the business. And I think you won't see that valuation move upward until we see some fundamentals improvement in the business.

Okay. And the other portfolio company that was mentioned in the prepared comments, Elyria Foundry and how there was a write-down there, can you talk about the performance of that company? I know it is in the challenged metals industry but how comfortable do you feel with the revolver I see that that is being carried at cost. Is the trend such that there could be any risk with the valuation on the revolver?

We feel very comfortable about the revolver and its position on the balance sheet. In fact we think that the risk-adjusted returns on the revolver are fabulous. This is a company that could have been sold for a significantly higher price just based on the value of the assets, sort of the plant and equipment and the asset that Elyria owns. And so we feel like where we are for the top of the capital stack with our revolver is a very solid position.

As it relates to the equity and the write down that you see there, that is just the company continuing to struggle as it is shifting its customer base, some of its customers which were relatively concentrated are having some challenges in the end markets they sell to and this is a business that has a fair degree of operating leverage, etc. so when the revenues come down, it really affects their EBITDA significantly.

But we think that the company has a pretty valuable asset and is looking to shift its customer base and grow the revenue profile and if they are successful in doing that, they should have improved performance over time and that is what the management has confidence in as does the equity ownership.

And two further comments, Elyria is a legacy investment that existed before we became involved, before we took over the management of Saratoga Investment Corp. and the debt aspect of the business was converted -- the reason it is an equity investment is because all the debt was converted to equity and so that revolving credit is the only debt on the company. There is no other debt and all the other equity is owned by the former debtholders which included us. And so there is actually cash flow generation at the company even though they are in challenged times. And so it is very well structured to address and deal with some of its problems some of which are cyclical, some of which are fundamental business issues.

So again, we don't feel worried at all about the revolver and we do continue to watch and work with the company on the equity side very closely.

Okay, that is very helpful. And then my last question is when I run the calculation -- so book value is down 1.4% and it looks like half of the book value decline came from dilution from the dividend reinvestment program. Can you talk about why this program makes sense when reimbursements occur at such significant discounts to book value and leads to dilution because it seems like -- and you increased the authorization from $200,000 to $400,000 which I think is great and it seems at this valuation roughly 75% of book value, you should be buying shares back as opposed to issuing shares. Can you make some comments on that?

Sure. There are several things in your question. First, let's just talk about the shareholder repurchase plan. We had a plan of $200,000, we increased it to $400,000 but basically a big chunk of that increase was sort of reflective of the increased volume in our shares and so since we instituted the plan, we have had a doubling of the volume which we are very happy about. We are very interested in promoting as much trading volume as we can. And so that was really just a tuning of that purchase program relative to the trading volume and the stock.

With regards to the dilution from that plan, I think ever since we became involved five years ago before we started paying regular cash dividends, we basically have an equity reinvestment plan, we paid 80% in stock and 20% in cash and we have a relatively small company. We've been working to achieve scale and we are getting much closer to achieving scale as having mentioned our expense metrics and the like are very much right on track with the industry now. They were a little higher relative to the industry before so we are making our progress on scale.

And then what we have effectively done is we have grown by retaining our earnings and that retention of earnings, the reinvestment rate on those earnings is very high. In the SBIC, it is high teens, even 20s depending on the investment. So every dollar that is retained by the company gets reinvested at a very high rate of return because of our dynamics specifically in the SBIC but also across the Company.

What we have endeavored to do when we went to the regular cash dividend was to continue the opportunity for shareholders to reinvest. I think that on the one hand it is dilution but on the other hand it is what we view as a very fair program. In other words, all shareholders are given the right to reinvest in this dividend and so in other words, we are not selling stock to one party or another party, we are offering all shareholders the ability voluntarily to either invest in the stock effectively at a slight discount to what the market is or to take cash. And every quarter they have a chance to do it, they can mix and match if they want to do one quarter one thing and one quarter another but I think what is really important is the utilization of those retained earnings which is to grow our asset base into scale and then the further backdrop to that is we are one of the very best-performing BDCs over the last one-, three- and five-year periods of time.

So the total return on our stock, everything included, dilution included, but we don't view it as dilution because it is our existing shareholders doing it, but our total return has exceeded 18% over all that period of time.

So we are a top-performing stock on a total return basis. And so right now we are very total return focused and over time when we improve and when the market basically recognizes more fully our achievements, we don't think we are getting as much credit for our performance as we should and that is reflected in the stock price. It is sort of a slight discount maybe to the industry average. We think we should be at a premium given our overall performance and as we move toward that level I think the dilution aspect of this will go away. But I think what is important to note is that retained earnings is being utilized in a very high return basis.

Okay, thanks very much.

(Operator Instructions). Mickey Schleien, Ladenburg Thalmann.

Good morning, everyone. I wanted to ask a broad question, actually two questions. As we are heading into next year, I was curious what your thoughts or sort of base case scenario is for the US economy in terms of GDP gross, what the Fed may or may not be doing, what your expectations are for defaults? And also if you could give us some sense of how your borrowers are doing in terms of their revenue growth and margins?

Let me try to address that, Mickey. Let me just say directly we don't spend a lot of time trying to predict the macroeconomic state of the economy. We really -- we are mindful of it, we pay attention to it and the approach that we take is when we underwrite a business and look to an investor to lend to a business we want to look for businesses that are going to hold up well in almost all economic environments. Everybody of course faces some pressure if the economy goes down. But we spend a lot of time underwriting each business and going through scenarios where doing what if scenarios, going back to the last recession and saying how much did their sales decline during that period and would hold up with this capital structure, etc.

So the core of our focus is really finding good businesses and making sure that they are ones that we feel will perform even if the economy goes through a tougher time. So it is hard for us to really have a crystal ball and predict what the outlook is going to be.

I'm sorry, your second question was?

Before I go to the second question, Mike, can I interpret that answer as another way of saying that perhaps you are being defensive in terms of how you are allocating your capital today?

Yes, and generally we are. It is a reactive piece of capital so I guess a perfect example is one of the reasons you don't see us with very much energy exposure at all, we don't have any direct energy exposure for sure. I think if we had more of a momentum investing philosophy, we would have been there two years ago when we are seeing these deals constantly and would have seen an upward to the right trajectory in EBITDA for a lot of these businesses and said well, let's go for it. Let's make a loan and hope that the energy prices don't change. We just don't do that in general. So that is just not the approach that we take. We tend to be a little bit more defensive.

We are certainly aggressive in trying to lend to and partner with businesses that we think are very solid and sound and we are aggressive in that respect but it is only when we feel like they are a good business that will hold up pretty well in most economic times.

So --

I'm sorry, further to the macro perspective, I think all of us and all that public dialogue you see about it, this recovery has not been a highly robust recovery. It has sort of recovered but it has been sort of a weak recovery along the way and there is always a potential of a reversal and certainly the news in general has not been that great. So it is not that that would radically change what Mike said. We are really looking for niche companies and that is the beauty of the aspect of our market is that a lot of the companies we invest in, the GDP is not that relevant to. They have their own niches, they have their own growth opportunities. They are sort of independent of the broad economy.

And so it doesn't necessarily affect us that much but again in terms of the overall backdrop, we have been in a what has felt like a pretty precarious environment for a lot of number of years. And so we have as Mike said, have had a defensive posture every time we have made a loan and I think it is reflected in a steady asset growth where some of our peers in the industry have had very rapid asset growth but we have had a very steady measured level of asset growth as we find these companies that we think are sort of all weather, all season companies that we can feel comfortable investing in almost regardless of the economic climate.

And then to your second question, Mickey, if you are ready for us to go on to it.

Well, I was just going to ask, Chris, whatever you are assuming in terms of where we are in the credit cycle, are there particular industries that you are attracted to now?

I don't know if I would characterize it as particular industries so much as niche companies. And again because of these size we are at, we are looking at lots of service companies, companies that have software components but they are not software companies, they are focused on specific applications of software in sort of highly niche areas.

So it is not so much industries. I think what might be better to characterize is what we are avoiding and what we are avoiding is cyclical companies, commodity oriented businesses which energy would be part of. And as we said, we have basically zero direct energy exposure but there is a lot of other commodity related businesses that are out there and we kind of avoid those. We look for companies where they have sort of leading market positions, pricing power, strong gross margins, stable marketplaces, room to grow within their market niches.

High recurring cash flow, high free cash flow and really good management teams.

Right. Okay. The other part of my question was we are getting just such mixed signals about our economy and obviously outside the US even more mixed signals. So I always like to ask how your customers are doing, how your borrowers are doing in terms of revenue and margins. You get to see their numbers at least quarterly and probably monthly in many cases. So what is the thermometer saying right now?

As a general statement, I would say a lot of our companies are US based companies and US focused and so the US economy is -- I'm not saying it is the strongest in the world but it has held its own a lot better than a lot of the other places in the world so our economic environment in the United States is good and attractive. And so and our companies are niches inside of that.

So we have not with the exception of Smile Brands and then Elyria Legacy Investments had some certain exposures but in general our companies are US focused businesses and the US economy in general is doing well and our companies are doing quite well and also our credit positions inside these companies with our sort of first dollar credit first lien elections that we haven't executing on, we feel our credit position on top of that is very strong. Mike, do you want to (multiple speakers)?

By and large though to answer your question directly, by and large our portfolio in total, the portfolio companies are performing better than they had in the previous years. Just a broad statement across the portfolio but by and large, they are also underperforming where they expect.

Now that can be sort of -- that is something that you have to take with a grain of salt though because no two company ownerships are alike in terms of how they put their projections together. Some ownership groups will put real aggressive projections to try to drive management to goals that they probably can't really reach and others tend to sandbag so it is hard to say. But across the portfolio I would say that by and large they are not performing as well as they would have liked but better than last year.

And Mike, is that to some extent driven by in the sponsored companies where the private equity sponsors are asking for overly aggressive budgets?

In some cases and in some cases not. It just really depends. I think though that if you look at it across the portfolio, it probably tells you something about where the economy is. I think it is a pretty representative group of businesses in the US and they are doing pretty well and performing better than they did last year by and large but not as well as they would like.

Okay, I appreciate all of your time this morning. Thank you.

I am not showing any further questions. I would like to turn the call back to Christian Oberbeck for any further remarks.

I would like to thank everyone for joining us today and we look forward to speaking with you next quarter.

Thank you everyone for joining us today. We look forward to speaking with you next quarter.