Saratoga Investment Corp (SAR) 2018 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 2018 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 and Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Thank you. I would like to welcome everyone to Saratoga Investments Corp.'s Fiscal First Quarter 2018 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 2018 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 1:00 p.m. today through July 20. Please refer to our earnings press release for details.

I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.

Thank you, Henri, and welcome, everyone. The most recent fiscal quarter reflects the continued success of our efforts and activities in pursuit of credit quality, growth and earnings. In addition, we have continued to strengthen our capital structure to further expand and enhance our capabilities, the completion of which will now benefit us for many years.

Saratoga Investment has risen to and continues at the top of the industry in terms of key performance indicators and, in many categories, far outpaces our competitors. Importantly, we have accomplished this in a highly competitive and challenging market environment. We continue to progress towards our long-term objective of increasing the quality and size of our asset base, with the ultimate purpose of building Saratoga Investment Corp. into a best-in-class BDC, generating meaningful and consistent returns for our shareholders.

Slide 2 highlights our continued progress and achievements during the past quarter. To briefly recap, first, we continued the strengthening of our financial foundation this year by maintaining a high level of investment credit quality with 96.3% of our loan investments having our highest rating, up from 94.1% last quarter, generating return on equity of 7.1% on a trailing 12-month basis. Excluding our legacy investments in Targus Group International and Elyria Foundry Company, LLC that pre-dates Saratoga's management of the BDC, as well as the various impacts related to the extinguishment of our 2020 baby bonds, our return on equity for this last 12-month period ended May 31, 2017, was 7.9%. This LTM ROE is net of a $5.3 million unrealized loss on our My Alarm Center investment, which we will discuss later in the call.

Total unrealized losses on the whole portfolio for Q1 was $2.6 million, reflecting the fact that the remainder of the portfolio had a $2.7 million unrealized gain in Q1. And we maintained a gross unlevered IRR of 12.2% on our total unrealized portfolio with gross unlevered IRR increasing to 16.2% on total realizations of $210 million.

Second, we expanded our assets under management to $329.7 million, a 12.6% increase from $292.7 million as of February 28, 2017, and a 24.7% increase from $264.4 million as of May 31, 2016. From a longer-term perspective, our current AUM reflects a 247% increase from $95 million at the end of fiscal year 2012.

In addition, this quarter continues the success of our growing origination platform. In Q1 fiscal year 2018, we originated investments totaling $45 million, offset by repayments this quarter of only $5.9 million. Our growth in AUM over the past few years is evidence of our continued long-term upward trajectory in asset growth and reflects the growth we are seeing in our pipeline.

Third, we recently completed an amendment to our revolving credit facility that is important to our long-term objectives and strategy. On May 18, 2017, we entered into an amendment to our senior secured revolving credit facility with Madison Capital Funding LLC. We extended the commitment termination date to September 17, 2020, and the maturity date to September 17, 2025, both increasing by more than 3 years.

Fourth, the continued strengthening of our financial foundation has enabled us to increase our quarterly dividend for the 11th consecutive quarter. We paid a quarterly dividend of $0.47 per share for the first fiscal quarter of 2018 on June 27, 2017. This was an increase of $0.01 per share over the past quarter's dividend of $0.46 per share. All of our dividend payments have been exceeded by our adjusted net investment income for the same periods. As a result, we are still comfortably overearning our dividend currently by 9%, which distinguishes us from most of the other BDCs, and we're only 1 of 4 BDCs having increased dividends over the past year.

Fifth, our base of liquidity remains strong and promises to improve. We continue to have significant dry powder to meet future potential opportunities in a changing credit and pricing environment. Our existing available year-end liquidity allows us to grow our -- sorry, quarter-end liquidity allows us to grow our current assets under management by 19% without any new external financing. This incremental investment capacity places us in a leading position vis-à-vis our competitors, whose existing capacity averages 12.9%.

And finally, on March 16, 2017, we entered into an equity distribution agreement with Ladenburg Thalmann & Co. through which Saratoga may offer for sale, from time to time, up to $30 million of its common stock through an at-the-market or ATM offering. As of July 11, 2017, the company sold 117,354 shares for gross proceeds of $2.6 million at an average price of $22.49. Aggregate net proceeds was $2.6 million net of transaction costs. This quarter saw a continued steady performance within our key performance indicators as compared to the quarters ended February 28, 2017, and May 31, 2016.

Our adjusted NII is $2.9 million this quarter, up 12.7% versus $2.6 million last year and up 2.5% versus $2.9 million last quarter. Our adjusted NII per share is $0.50 this quarter as compared to $0.46 last year and $0.49 last quarter. And our adjusted NII yield is 9.2% this quarter, up 90 basis points versus 8.3% last year and up 40 basis points versus 8.8% last quarter. Henri will provide more detail later on any significant variances. Overall, we remain extremely pleased with these accomplishments.

As we've mentioned often in the past, we remain committed to further advancing the overall size of our asset base while maintaining its high credit quality. As you can see on Slide 3, on a year-by-year comparative basis, our assets under management have steadily risen with healthy growth this past quarter, and the quality of our credits remains high, actually having increased in Q1. We look forward to continuing this positive trend.

With that, I would like to turn the call back over to Henri to review our financial results as well as the composition and performance of our portfolio.

Thank you, Chris. Slide 4 highlights our key performance metrics for the quarter ended May 31, 2017, in our usual format. Net investment income of $3.5 million, or $0.60 on a weighted average per share basis, was up from $0.19 and $0.44 for the quarters ended February 28, 2017 and May 31, 2016, respectively.

When adjusting for the incentive fee accrual related to net unrealized capital gains in the second incentive fee calculation, adjusted NII per share was $0.50, up $0.04 from $0.46 per share last year and up $0.01 from $0.49 per share last quarter. The increase from last quarter and last year primarily reflects a higher level of investments and resultant higher interest income with assets under management up 24% from last year and up 13% from last quarter.

Importantly, more than half of the $45 million originations were closed during the last month of the quarter and are not yet fully reflected in our results. These impacts resulted in NII yield of 11.0% for the quarter or 9.2% when adjusted for the incentive fee accrual. This adjusted NII yield is up 90 basis points from 8.3% last year and up 40 basis points from 8.8% last quarter.

For this first quarter, we experienced a net loss on investments of $2.5 million or $0.42 per weighted average share, resulting in a total increase in net assets resulting from operations of $1.0 million or $0.17 per share. The $2.5 million net loss on investments was comprised of $0.1 million in net realized gains and $2.6 million in net unrealized depreciation.

The net unrealized depreciation was primarily due to a $5.3 million unrealized loss on our My Alarm Center investment, reflecting increased leverage levels combined with declining market conditions in the sector, which we will discuss in more detail later. This was partially offset by $1.4 million unrealized appreciation in our Saratoga CLO investment, $1.1 million unrealized appreciation in our Mercury Network, LLC investment and $1.0 million unrealized depreciation on our legacy Elyria investments.

I'd also like to continue to highlight our return on equity as an important performance indicator, which includes both realized and unrealized gains. Return on equity was 7.1% for the last 12 months. This is up from 3.4% for the 12 months ended May 31, 2016. Excluding the $1.5 million loss on extinguishment of the baby bonds; the interest and deferred financing cost on the old baby bonds during the core notice period, while the 2023 baby bonds were already issued and outstanding; and the impact of our 2 legacy investments, Targus and Elyria, that pre-dates Saratoga's management of the BDC, our return on equity for the last 12 months was 7.9%.

This figure is close to the BDC industry mean and is net of the $5.3 million unrealized loss on My Alarm Center. We expect our ROE to continue to improve as: one, our increased Q1 asset base is earning interest for the full period going forward; and two, we further deploy cash and grow assets with the benefits of scale becoming more visible and the operating expenses stabilizing and diminishing as a percentage of assets.

A quick note on expenses. Total expenses, excluding interest and debt financing expenses, base management fees and incentive management fees, stayed relatively unchanged at $1.1 million in Q1 this year as compared to last year, but decreased from 1.4% to 1.3% as a percentage of average total assets.

As you can see on Slide 5, NAV this quarter was $127.6 million as of May 31, 2017, a $0.3 million increase from NAV of $127.3 million for year-end. NAV per share was $21.69 as of quarter end compared to $21.97 as of year-end and $22.11 as of Q1 last year. NAV changes this quarter includes $2.7 million of dividends declared and $2.5 million of net realized and unrealized losses, offset by $3.5 million in net investment income.

In addition, $0.6 million of stock dividend distributions were made as well as $1.4 million shares sales through our ATM equity offering, resulting in net positive NAV for the quarter. In addition, our NAV increase is net of the $5.3 million unrealized write-down of our investment in My Alarm Center. Our net asset value had steadily increased since 2011, and we continue to benefit from our history of consistent realized gains.

Moving on to our waterfall Slide 6, you will see a reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. This helps break down the numbers into a couple of more manageable variances. Starting at the top, NII per share increased from $0.49 per share at Q4 to $0.50 per share at Q1. The significant movements were a $0.06 increase in total interest income, a $0.01 increase in CLO incentive fee income and a $0.01 decrease in operating expenses, offset by a $0.01 increase in interest and debt financing expenses, $0.02 increase in base management fees and a $0.01 dilution impact from the increased shares, resulting in a $0.01 total increase. As a slide footnote, all changes are shown net of incentive fees.

Moving on to the lower half of this slide, this reconciles NAV per share from $21.97 at Q4 to $21.69 for this quarter. The $0.60 generated by our NII for the quarter was more than offset by the $0.42 net depreciation on investments and $0.46 in dividend declared for Q4 with a Q1 record date. The ATM and DRIP issuances during the quarter was $0.01 accretive to NAV per share.

Slide 7 outlines the dry powder available to us as of quarter-end, which is $63.6 million in total. We remain pleased with our liquidity position, especially taking into account the overall conservative nature of our balance sheet and the fact that all our debt is long term in nature. Actually, all 5 years plus and mostly fixed rate. For the most part, we have therefore fixed our interest cost in this rising rate environment. In addition, we have the ability to continue to grow our assets by 19% without the need for external financing. At the same time, over 85% of our investments have floating rates. And although they have LIBOR floors, we are through all but 4 of them already, which means we will be a big beneficiary of rising short-term rates.

As you can see on Slide 8, we have analyzed the potential impact of changes in interest rates on interest income from investments. Assuming that our investments as of May 31, 2017, were to remain constant for a full fiscal quarter and no actions were taken to alter the existing interest rate terms, a hypothetical change of 100 basis points in interest rates will increase our interest income by approximately $0.6 million per quarter. This is all incremental to our existing earnings without any other changes.

Now we'd like to move on to Slides 9 through 11 and review the composition and yield of our investment portfolio. Slide 9 is our usual slide highlighting the portfolio composition and yield at the end of Q1. Our composition and weighted average current yields remain consistent with the past, with $330 million invested in 31 portfolio companies and one CLO fund and more than 56% of our investments in first lien, up from 54% last quarter.

On Slide 10, you can see how the yield on our core BDC assets, excluding our CLO and syndicated loans, as well as our total assets yield has remained relatively consistent in the 11% range for the past several years, despite high levels of repayment and the need to continue to replace these assets. This quarter, we saw our overall yield actually increase to 11.4%. This reflects increases in both the CLO and BDC yields, with the BDC yield actually increasing quite significantly from 11.0% to 11.3%, reflecting the higher return being received on the bulk of our assets.

Turning to Slide 11. During the first fiscal quarter we made investments of $45 million in 5 new or existing portfolio companies and had $5.9 million in 2 exits or repayments, resulting in a net increase in investments of $39.1 million for the year at our BDC. Our investments remain highly diversified by type as well as in terms of geography and industry, spread over 10 distinct industries with a large focus on business, consumer and health care services. We continue to have no direct exposure to the oil and gas industry, a fact that has served us well.

Of our total investment portfolio, 6.8% consists of equity interest. Equity investments remain an important part of our overall investment strategy. As you can see on Slide 12, our net realized gains for the first fiscal quarter of 2018 were $0.1 million. For the past 5 fiscal years, we have also had a combined $17.8 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 and has helped grow our NAV.

And 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 will take a couple of minutes to describe the current market as we see it, then I will comment on our portfolio performance and investment strategy.

There has been no real change to the market's extremely competitive conditions since we last spoke in May. Slide 13 indicates a continued downward trend in the number of transactions per deal sizes in the U.S. below $25 million. The number of transactions in the last 12 months ended May 31, 2017, is already down significantly as compared to the same period last year. And it is not just volume, total transaction value for the 5 months ended May 31, 2017, is significantly lower than it was last year as well and significantly trailing in annualized run rate.

As a result, spreads in the broader middle market tightened further, driven by a supply-demand imbalance and aggressive leverage and competition for high-quality credits. In addition, new stretch senior and junior capital entrants are further driving up competition, with the expectation of economic growth and the dearth of quality opportunities creating excess liquidity. This excess liquidity is giving new receptivity to storied paper and higher leverage profiles.

Nevertheless, we really like where we are in the lower middle market, and we have seen less change in spreads in this market segment where we operate. Our experience continues to support our belief that the lower middle market is still the most attractive market segment to deploy capital and the most likely to deliver the best risk-adjusted returns. In addition, we believe long-term secular trends bode well for the BDC industry as a whole.

Now on Slide 14, you can see the debt multiples in the industry have increased markedly, as lenders become slightly more aggressive in their pursuit of higher quality credits. As of March 31, 2017, 80% of leverage multiples are now above 4x as opposed to 67% as of December 31, 2016. This has led to spreads further tightening. Multiples for Saratoga Investment are at the low end of the industry average, remaining relatively unchanged this quarter at 4.3x.

Irrespective of the fluctuation of market leverage levels historically, we have been able to invest in deals with relatively low multiples. We are careful to exercise extraordinary investment discipline and invest only in credits with attractive risk/return profiles and exceptionally strong business models, where we are confident that the enterprise value of the businesses will sustainably achieve the last dollar of our investment.

In addition, this slide illustrates our consistent ability to generate new investments despite difficult market dynamics. With 11 originations in the first half of calendar year 2017, including 6 new portfolio companies and 5 follow-ons, we have already established an origination level that outpaces past years and matches our strongest 6-month pace while applying consistent investment criteria.

Moving on to Slide 15, our team skill set, experience and relationships continue to mature and our significant focus on business development has led to new strategic relationships that have become sources for new deals. This slide highlights that our number of deals sourced and evaluated has increased materially over the past couple of years, despite competitive market conditions. 50% of these deals come from companies without institutional ownership. The rest come from private equity sponsors.

The chart also illustrates our originations discipline. While the size of the funnel at the top has increased, term sheets issued has not increased by the same percentage, still remaining below 2015 levels due to the inconsistent quality we found in the marketplace. No matter how many deals we see, the overarching goal remains to maintain the same high level of credit quality.

However, the increase in deals we have reviewed this past year has help us find good credits, with our deals executed growing from 16 last year to 22 deals executed in the last 12 months. What is especially noteworthy is that the strength of our pipeline has enabled us to close deals with 3 new portfolio companies in the past calendar quarter and 6 new portfolio companies this past half year, giving further validation to our strengthening business development platform.

We continue to identify quality deals in 3 main ways: first, by building targeted new relationships with top-quality investors and deal sources; second, by gaining repeat business from existing relationships; and third, by deploying capital in support of existing portfolio companies that are healthy and growing. In the last 12 months since calendar second quarter 2017, our transaction volume reflected a healthy mix of all 3 of these avenues of growth.

Last quarter, we provided some color on our ability to support existing portfolio companies and the value of add-ons as demonstrated through our Easy Ice investment. As a reminder, last quarter, we increased our first-lien investment in Easy Ice to $26.7 million to facilitate a change of control transaction and also invested $8 million in a significant preferred equity position. This demonstrated our ability to answer the call and help facilitate growth of healthy portfolio companies that we know well, an activity that has produced generous returns for our shareholders.

Easy Ice continues to perform well and is growing rapidly. Although the size of this investment is larger than normal for us, we made the investment with [trust and] confidence that we can downsize our position. As previously discussed, the recapitalization of the company remains in advanced stages and we continue to expect there to be a repayment of a significant portion of the first-lien investment in the near term.

Our overall portfolio quality is strong and is even stronger when taking into account the assets originated by us since taking over the BDC management in 2010. As you can see on Slide 16, the gross unleveraged IRR on realized investments made by Saratoga Investment management team is 17.5% on approximately $138.5 million invested in our SBIC, and 13.6% on approximately $71.1 million invested in the rest of our BDC. On a combined basis, the gross unlevered IRR is 16.2% on $209.6 million of realizations.

On the chart in the right, you can also see the total gross unlevered IRR on our $272.2 million of SBIC unrealized investments is 12.5%, and 11.1% in our BDC on $54.3 million of investments since Saratoga took over management. The combined weighted total is 12.2% on $326.5 million of investments across our combined SBIC and BDC.

Now within the track record numbers discussed above are 2 investments we're discussing further. First is a $9.8 million first-lien investment called Taco Mac, including a small revolver credit facility that currently carries $1.1 million of unrealized depreciation, reflecting declining business fundamentals. We put this investment on nonaccrual in Q4. And while there have been developments the past couple of months, we continue to work closely with the company and other first-lien lenders to pursue various options. We will keep this investment on nonaccrual until this is resolved.

Second is a $10.3 million second-lien investment called My Alarm Center that currently carries $7.6 million of unrealized depreciation, of which $5.3 million is recognized this quarter. The valuation reflects increased leveraged combined with declining business fundamentals in the sector. As discussed on last quarter's earnings call, we put this investment on nonaccrual in Q1. There are currently various restructuring and sale options being pursued. However, the unrealized write-down recognized this quarter reflects the changing nature of the discussions during the past couple of months.

Now as a reminder, this quarter is a good example of how a solid, high-quality portfolio interacts as a whole, with a meaningful proportion of the unrealized depreciation on My Alarm Center being partially offset by $2.8 million of net appreciation in the fair values of other investments.

With respect to our SBIC, our objective remains to maximize our risk-adjusted returns in a manner that utilizes the low cost of capital and the 2:1 leverage advantage we possess through the -- our SBIC license. This less competitive end of the market allows us to reduce the risk profile of our portfolio while delivering highly accretive returns to our investors.

As you can see on Slide 17, the mix of securities in our portfolio is conservative, with 65.3% of our investments first lien. And the leverage profile of these 22 investments remains relatively low at 4.4x, especially when compared to the overall market leverage. We continue to have discussions with the SBA about timing of a potential second license.

Moving on to Slide 18, you could see our SBIC assets increased to $233 million as of May 31, 2017, up from $221.5 million as of February 28, 2017. It is important to note as well that as of quarter ended May 31, 2017, we had $17.2 million total available SBIC investment capacity, including cash, of which $15 million is leveraged capacity within our current SBIC license. This represents approximately 25% of our overall available firm capacity as of quarter-end.

Overall, we believe this quarter's results demonstrate the growing strength of our origination and sourcing capabilities. Our growth in NII this quarter is a product of our growing base of high-quality assets. While we emphasize growth in assets and earnings, credit quality remains our top focus.

Since taking over management of the BDC, excluding our syndicated loan investments, Saratoga has invested $536 million across 54 portfolio companies. Our gross unlevered IRR on these realized and unrealized investments is 14%. Producing these results has required us to be extremely disciplined in our approach to underwriting and asset selection, and we remain committed to this approach.

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

Thank you, Mike. As many of you know, our quarterly cash dividend payment program has grown by 161% since the program launched. As outlined on Slide 19, during fiscal year 2017, we declared and paid dividends of $1.93 per share, gradually raising the dividends through the year.

In addition, we have continued to pay increasing quarterly dividends regularly throughout fiscal year 2018, including $0.46 per share for the quarter ended February 28, 2017, and $0.47 per share for the quarter ended May 31, 2017. We are also still overearning our dividend by 9%, giving us one of the higher dividend coverages in the BDC industry.

As you can see on Slide 20, we have had a 9.3% year-over-year dividend growth, third highest within our BDC competition and only -- and 1 of only 4 BDCs have grown dividends in the past year. We have now had 11 sequential quarters of dividend increases, while most BDCs have either had no increases or decreased the size of their dividend payments. We believe our continually increasing dividend is an important differentiation within the BDC marketplace.

We are also pleased to see our relative standing in the industry consistently improve over time. As you can see on Slide 21 and reflecting our strong key performance indicators we have discussed earlier, our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 46%, significantly beating the BDC index at 23%.

Turning to Slide 22, when viewed over a longer time horizon such as 7 years, which is when we took over the management of the BDC, our 3- and 7-year return places us in the top 2 of all BDCs.

On Slide 23, you can see our outperformance placed in the context of the broader industry. We continue to achieve high marks across a diversity of categories, including interest yield on the portfolio, latest 12-months NII yield, latest 12-months return on equity, expense ratio, dividend coverage, dividend growth, NAV per share and investment capacity. Of note is that our assets have grown and we begin to benefit from scale with both latest 12-month NII yield and expense ratio now very much in line with the industry and actually beating the mean.

Moving on to Slide 24, all of our initiatives we have discussed in this call are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We believe that our differentiated characteristics outlined in this slide are the kinds of investment characteristics which will attract institutions and individual investors as we drive the size and quality of our investor base.

These characteristics include a strong and growing dividend, solid return on equity, ample low-cost available and long-term liquidity with which to grow our current asset base, solid earnings per share and NII yield with substantial growth potential, steady high-quality expansion of AUM and an attractive risk profile with protection against potential interest rate risk. The high credit quality of our portfolio is buttressed by our minimal exposure to cyclical industries, including oil and gas. With this overall performance, Saratoga Investment remains solidly on the path to being a premier BDC in the marketplace.

Finally, looking at Slide 25, we've accomplished a lot in this quarter and are proud of our financial results. Our simple and consistent objectives continue to be executing 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. By continuing to execute on these consistent objectives, we believe we will continue to beat the industry in shareholder return performance.

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) Our first question is from Casey Alexander with Compass Point Research.

Most of my questions are for Mike, but one for Henri real quick. The cash on the balance sheet, how much of the cash is within the SBA subsidiary?

It's very little this quarter. I think it's about $2 million -- I think it was about $2 million or $3 million. Most of the cash that we had on the balance sheet was in our BDC.

Okay. Great. As it relates to Easy Ice, Mike, the language hasn't changed since last quarter, that you expect to be repaid in the near term, which -- I don't know, it felt like when you talked about it last quarter, that meant that we were going to see a repayment this quarter. Has something changed in relation to the closing of this change of control?

Let me -- obviously, I have to be careful because it's a private company, and I can't get into too many of the details. But what I can say, Casey, is that we continue to be extremely excited about the position that we're in with this company and continue to feel really good about its performance and its prospects for the future. As can often take place in the sort of deal world, sometimes events transpire where there can be delays in getting something done. The delays that we faced are not anything negative toward the company. They are just deal-related things that have taken a little bit to get through. Our objective -- we certainly could have done something sooner, but our objective was to optimize the capital structure in a way that would benefit our shareholders at the greatest level that we can, and that's what we're aiming to do here. So the language is the same and we still feel the same way about it, and we do think that the transaction should take place in the very near term.

Mike, can you then explain why in last quarter's schedule of investment, the preferred equity was simply listed as an equity position and now it's listed as a 10% PIK position?

Casey, this is Henri. I can't recall what it was listed on at year-end, but we can confirm that as it's listed this quarter, it's correct, it is a 10% PIK position.

Okay. Because it was not listed that way in the year-end schedule of investments.

Well, we can look into that, but just to make it clear, there isn't anything fundamentally in our outlook on the business or excitement about this investment opportunity. We really think it represents something that we've done extremely well. If you sort of look back at many of our most successful investments, there are ones where we made initial investments, sometimes on the small side, we got to know management, we got to know the business very well, we supported their growth. In this case, certainly, we upsized our investment at a level that's more than we will generally do. We recognize this is outsized, but we gave it careful consideration. And the things that we weighed in making that decision were, if we don't step up here, we're likely to get refinanced. We know the management team very well and we have an opportunity to put ourselves in this position. We also know the business very well and we feel like -- and feel confident that there's terrific growth opportunities with this business. So in upsizing our position, it put us in a spot where we have this ownership position, significant ownership position in the business, and we, together with management, are partnering to grow the enterprise value. And I think in the long run, our shareholders will benefit greatly for that. Now there has -- we've got a little bit of work to do to downsize our exposure to that investment, but we're very confident that we can do that and the business is performing extremely well. And as we said, we think in the very near term, you'll see reduced exposure to that investment.

Well, would you guys anticipate the same level of income being generated from that investment in fiscal Q2? Or would you expect the first lien to be taken out before the end of fiscal Q2?

Well, I mean, we're going to end up with more junior securities with a high rate of interest. So I haven't run the math on the gross returns, but we can get back to you. I think what I would say is that our yield on what we have remaining in -- the investment that we have remaining will be where we want -- just a profile of what we want across our portfolio.

Okay. Because -- I mean, I'm wondering what kind of attachment multiple you have on this investment. When if $8 million is a control position, which means the total value of the company is less than $32 million, and your loan -- first-lien loan is $27 million, you've lent almost as much as the entire equity is of the firm, so I'm wondering what kind of attachment multiple you have on this investment. I mean, I recognize this is outside the bounds of sort of the normal risk pattern for Saratoga, but it seems highly leveraged.

We think it's a fabulous risk/return opportunity, and stay tuned. I mean, I think, we feel very good about the investment. I can't get into sort of the exact attachment points and so forth.

Okay. On Elyria Foundry, the value of that investment increased -- of that equity increased 3.5x in 1 quarter, which seems like an extraordinary increase in the value of any equity position quarter-to-quarter. Is there any color on that?

Yes. I mean that's one way to frame it, but the reality is and -- it's a business that has a lot of operating leverage. It's -- the write-up in the investment is reflective purely of an improvement in the performance of the underlying business and the math around that really has not changed in terms of the value drivers. So it's reflective of improved performance there and the outlook for that business is positive.

Okay. And let me finally turn to Mercury Network because this one is -- I'm sure that there's an explanation for this, but I certainly can't see it from the outside. Coming into the quarter, you had 413,000 shares that was valued at $1,065,000 or $2.57 per share. You added 167,000 shares and added $444,000 to your cost basis, which means you added stock to your position at $2.65 a share, a little higher than what it was marked at, at the end of the quarter. But then you marked it at the end of this quarter at $2.63 million or $4.53 per share, 70% higher than what you paid for stock during the quarter. That seems like a remarkable markup.

Well, Casey, again, being a private company, we have to be careful what we say about it, but I think there are transactions involved.

The rules according to Hoyle are -- in private equity are sort of you can't mark something more than what you paid for it in the quarter. And to mark it up 70% above what you paid for it in the quarter just seems like a remarkable markup. And all I can do is say, I'm an outsider looking at this, I can do the math and that seems like an extraordinary markup.

Casey, that markup is based on the transaction.

Our next question is from Mickey Schleien with Landenburg.

I want to follow up on Casey's first question. Henri, you said most of the...

Hello, Mickey?

Can you hear me? Hello? Can you hear me?

We can now.

Now we can hear you, Mickey.

Terrific. I wanted to follow-up on Casey's first quarter question. Henri, you said most of the cash is outside the SBIC. Is that correct?

That's correct, yes.

If that's the case, Henri, why were you carrying a relatively high cash balance as well as a corresponding balance on the revolver? Wouldn't it -- it's not as efficient as we would expect.

Well, obviously, Casey, as you could probably see, what we did is we drew down on our revolving credit facility and that was, obviously, done right before quarter-end in anticipation of a transaction that we were closing just post-quarter-end. And that's why you see a big cash balance, which is primarily in the BDC, and then also see the draw-down on the revolving credit facility.

Okay. Now that makes sense. And...

(inaudible) that's since closed.

And as Mike was saying, we can add that, that transaction for which we had earmarked that cash has closed since quarter-end.

Okay. I haven't looked at the Q completely. Was that transaction mentioned in the subsequent event section or is there anything you can tell us about it?

No. We generally don't comment on our subsequent events and nor is it required about deals, either deals or repayments subsequent to quarter-end and before the issuance of the financials.

But it's a new portfolio company, it's just another investment.

Okay. And in terms of CLO investment incentive fee income, could you -- if I recall correctly, that's the first time you've reported it or maybe broken it out because now it's material. Could you tell us what drove that and is that something that could be recurring in nature?

Sure. That's -- so that relates to the incentive fee that the CLO earns if it -- I guess, or the BDC earns if the CLO's overall returns exceeds 12%. And so to your question, it wasn't something that we've broken out for the first time. It's actually the first quarter in which the overall return of the CLO exceeded the 12% hurdle rate. And so the way to sort of think of it is now part of the waterfall cash flow we receive every quarter. We'll continue to have, while the return -- if the return stays above 12%, we'll continue to have a proportion which relates to this incentive fee component. And so that was the case for the first time now in Q1.

Henri, my question is, so what happened during the quarter that allowed the 12% to be achieved? Was it LIBOR going through floors or was something else going on in the portfolio that caused that?

No. It's a cumulative total return calculation. So it's just that the first -- this is the first time that the cumulative returns' [life today] has exceeded this 12% hurdle rate.

Okay. My last question relates to the second SBIC license. I know the green-light letter expired and you sort of had to start over again. Can you provide us any update on where that process stands? And if at all possible, any expectations on when you'll hear back from the SBA?

Sure, Mickey. As you can appreciate, our policy around the SBA is really to only make discussions when we have specific events like a green-light letter or a receipt of a license. What we can tell you is we are in active dialogue with the SBA, but it's really not something that our policy is to talk much further than that without specific events.

Chris, can you confirm that you've actually applied or reapplied for a second license?

Again, I think our policy is to -- again, the SBA has its own inner workings and the way they -- and so we just really want to be very careful about not getting in front of anything that the SBA would be doing or considering. And so we prefer to be specific once -- a green-light letter, for example, would be the time that we'd want to talk about that.

All right. And actually, I have one more follow-up question, perhaps for Mike. I noticed some deterioration in valuations at Ohio Medical. Was that due to reduced reimbursements? Or is there something else going on there that you can talk about?

That's not a reimbursement-based business model, but it's just reflective of softness in the underlying business. We think that -- this is a sponsored transaction. The sponsor has continued to support the investment with -- they have a significant equity investment in this business, and so we're -- it's just reflective of the softness in the business.

And what's causing the softness, Mike?

It's just the end market is soft. It remains a leader in its position and the management team and the sponsor is working hard to try to improve some declining sales that they've experienced.

And I'm showing no further questions. I would now like to turn the call back over to Christian Oberbeck for any are further remarks.

Well, again, we appreciate the support of all of our shareholders and we appreciate the interest of all of you on this call today, and we want to thank you all for joining us. We look forward to speaking with you next quarter.

Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone, have a good day.