UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended November 30, 2014
Commission File Number: 1-33376
SARATOGA INVESTMENT CORP.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
535 Madison Avenue
New York, New York
(212) 906-7800
(Registrant’s telephone number, including area code)
Not applicable
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of January 14, 2015 was 5,401,899.
TABLE OF CONTENTS
PART I
Item 1.
Item 2.
Item 3.
Item 4.
PART II
Item 1A.
Item 5.
Item 6.
Signatures
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Saratoga Investment Corp.
Consolidated Statements of Assets and Liabilities
ASSETS
Investments at fair value
Non-control/non-affiliate investments (amortized cost of $222,452,952 and $185,266,607, respectively)
Control investments (cost of $16,384,467 and $16,555,808, respectively)
Total investments at fair value (amortized cost of $238,837,419 and $201,822,415, respectively)
Cash and cash equivalents
Cash and cash equivalents, reserve accounts
Interest receivable, (net of reserve of $411,334 and $150,058, respectively)
Deferred debt financing costs, net
Management fee receivable
Other assets
Total assets
LIABILITIES
Revolving credit facility
SBA debentures payable
Notes payable
Dividend payable
Management and incentive fees payable
Accounts payable and accrued expenses
Interest and debt fees payable
Due to manager
Total liabilities
Commitments and contingencies (See Note 7)
NET ASSETS
Common stock, par value $.001, 100,000,000 common shares authorized, 5,379,616 and 5,379,616 common shares issued and outstanding, respectively
Capital in excess of par value
Distribution in excess of net investment income
Accumulated net realized loss from investments and derivatives
Net unrealized appreciation on investments and derivatives
Total net assets
Total liabilities and net assets
NET ASSET VALUE PER SHARE
See accompanying notes to consolidated financial statements.
3
Consolidated Statements of Operations
(unaudited)
INVESTMENT INCOME
Interest from investments
Non-control/Non-affiliate investments
Payment-in-kind interest income from Non-control/Non-affiliate investments
Control investments
Total interest income
Interest from cash and cash equivalents
Management fee income
Other income
Total investment income
EXPENSES
Interest and debt financing expenses
Base management fees
Professional fees
Administrator expenses
Incentive management fees
Insurance
Directors fees and expenses
General & administrative
Other expense
Total expenses
NET INVESTMENT INCOME
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain from investments
Net unrealized depreciation on investments
Net gain/(loss) on investments
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS
WEIGHTED AVERAGE—BASIC AND DILUTED EARNINGS PER COMMON SHARE
WEIGHTED AVERAGE COMMON STOCK OUTSTANDING—BASIC AND DILUTED
4
Consolidated Schedule of Investments
November 30, 2014
Company
Investment Interest Rate /Maturity
Non-control/Non-affiliated investments—181.3% (b)
National Truck Protection Co.,Inc. (d), (g)
National Truck Protection Co., Inc. (d)
Take 5 Oil Change, L.L.C. (d), (g)
Legacy Cabinets Holdings (d), (g)
BMC Software, Inc. (d)
Dispensing Dynamics International (d)
Easy Ice, LLC (d)
Emily Street Enterprises, L.L.C.
Emily Street Enterprises, L.L.C. (g)
Help/Systems Holdings, Inc. (Help/Systems, LLC) (d)
Knowland Technology Holdings, L.L.C.
Vector Controls Holding Co., LLC (d)
Vector Controls Holding Co., LLC (d), (g)
Targus Group International, Inc. (d)
Targus Holdings, Inc. (d), (g)
Targus Holdings, Inc. (d)
Avionte Holdings, LLC (g)
Avionte Holdings, LLC
CFF Acquisition L.L.C. (d)
Expedited Travel L.L.C. (g)
Expedited Travel L.L.C.
PrePaid Legal Services, Inc. (d)
M/C Acquisition Corp., L.L.C. (d), (g)
M/C Acquisition Corp., L.L.C. (d)
Group Dekko, Inc. (d)
5
TB Corp. (d)
First Lien Term Loan
5.75% Cash, 6/19/2018
Unsecured Note
13.50% (12.00% Cash/1.50% PIK), 12/20/2018
TM Restaurant Group L.L.C.
Bristol Hospice, LLC
Senior Secured Note
11.00%(10.00% Cash/1.00% PIK),
11/29/2018
IDOC, LLC
9.75% Cash, 8/2/2017
Roscoe Medical, Inc. (d), (g)
Roscoe Medical, Inc.
Second Lien Term Loan
11.25% Cash, 9/26/2019
Smile Brands Group Inc. (d)
7.50% Cash, 8/16/2019
Surgical Specialties Corporation (US), Inc. (d)
Zest Holdings, LLC (d)
6.50% Cash, 8/16/2020
Distribution International, Inc. (d)
7.50% Cash, 7/16/2019
HMN Holdco, LLC
14.00% Cash, 5/16/2019
HMN Holdco, LLC (g)
Elyria Foundry Company, L.L.C. (d), (g)
17.00% (13.00% Cash/4.00% PIK), 1/31/2015
Network Communications, Inc. (d), (g)
Network Communications, Inc. (d)
Unsecured Notes
8.60% PIK, 1/14/2020
Censis Technologies, Inc.
First Lien Term Loan B
11.00% Cash, 7/24/2019
Censis Technologies, Inc. (g), (h)
Community Investors, Inc. (g)
Community Investors, Inc.
First Lien, Last Out Term Loan
11.83% Cash, 9/30/2019
Finalsite Holdings, Inc.
10.25% Cash, 11/21/2019
Identity Automation Systems (g)
Identity Automation Systems
Pen-Link, Ltd. (d)
Advanced Air & Heat of Florida, LLC
Sub Total Non-control/Non-affiliated investments
6
Control investments—15.9% (b)
Saratoga Investment Corp. CLO2013-1, Ltd. (a), (d), (e), (f)
Sub Total Control investments
TOTAL INVESTMENTS—197.2% (b)
Saratoga Investment Corp. CLO 2013-1, Ltd.
7
February 28, 2014
Non-control/Non-affiliated investments—162.1% (b)
PATS Aircraft, LLC
National Truck Protection Co., Inc. (d, g)
Take 5 Oil Change, L.L.C. (d, g)
Legacy Cabinets Holdings (d, g)
ARSloane Acquistion, LLC
Emily Street Enterprises, L.L.C. (d)
Emily Street Enterprises, L.L.C. (d, g)
Help/Systems Holdings, Inc.(Help/Systems, LLC) (d)
Knowland Technology Holdings, L.L.C. (d)
Trinet HR Corporation (SOI Holdings, Inc.) (d)
Vector Controls Holding Co., LLC (d, g)
Targus Holdings, Inc. (d, g)
Expedited Travel L.L.C. (d)
8
M/C Acquisition Corp., L.L.C. (d, g)
USS Parent Holding Corp. (d, g)
DS Waters of America, Inc. (d)
HOA Restaurant Group, L.L.C. (d)
TM Restaurant Group L.L.C. (d)
Oceans Acquisition, Inc. (d)
McMillin Companies L.L.C. (d, g, h)
Distribution International, Inc.. (d)
Elyria Foundry Company, L.L.C. (d)
Elyria Foundry Company, L.L.C. (d, g)
Network Communications, Inc. (d, g)
Community Investors, Inc. (d, g)
Community Investors, Inc. (d)
Pen-Link, Ltd.
9
Control investments—17.0% (b)
Saratoga Investment Corp. CLO 2013-1, Ltd. (a) (d), (e), (f)
TOTAL INVESTMENTS—179.1% (b)
10
Consolidated Statements of Changes in Net Assets
INCREASE FROM OPERATIONS:
Net investment income
Net increase in net assets from operations
DECREASE FROM SHAREHOLDER DISTRIBUTIONS:
Distributions declared
Net decrease in net assets from shareholder distributions
CAPITAL SHARE TRANSACTIONS:
Stock dividend distribution
Net increase in net assets from capital share transactions
Total increase in net assets
Net assets at beginning of period
Net assets at end of period
Net asset value per common share
Common shares outstanding at end of period
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Consolidated Statements of Cash Flows
Operating activities
NET INCREASE IN NET ASSETS FROM OPERATIONS
ADJUSTMENTS TO RECONCILE NET INCREASE IN NET ASSETS FROM OPERATIONS TO NET CASH USED BY OPERATING ACTIVITIES:
Paid-in-kind interest income
Net accretion of discount on investments
Amortization of deferred debt financing costs
Proceeds from sale and redemption of investments
Purchase of investments
(Increase) decrease in operating assets:
Interest receivable
Due from manager
Receivable from unsettled trades
Increase (decrease) in operating liabilities:
NET CASH USED BY OPERATING ACTIVITIES
Financing activities
Borrowings on debt
Paydowns on debt
Issuance of notes
Debt financing cost
Payments of cash dividends
NET CASH PROVIDED BY FINANCING ACTIVITIES
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
CASH AND CASH EQUIVALENTS, END OF PERIOD
Supplemental information:
Interest paid during the period
Supplemental non-cash information:
Cash dividend payable
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization and Basis of Presentation
Saratoga Investment Corp. (the “Company”, “we”, “our” and “us”) is a non-diversified closed end management investment company incorporated in Maryland that has elected to be treated and is regulated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). We commenced operations on March 23, 2007 as GSC Investment Corp. and completed our initial public offering (“IPO”) on March 28, 2007. We have elected to be treated as a regulated investment company (“RIC”) under subchapter M of the Internal Revenue Code (the “Code”). We expect to continue to qualify and to elect to be treated for tax purposes as a RIC. Our investment objective is to generate current income and, to a lesser extent, capital appreciation from our investments.
GSC Investment, LLC (the “LLC”) was organized in May 2006 as a Maryland limited liability company. As of February 28, 2007, the LLC had not yet commenced its operations and investment activities.
On March 21, 2007, the Company was incorporated and concurrently therewith the LLC was merged with and into the Company, with the Company as the surviving entity, in accordance with the procedure for such merger in the LLC’s limited liability company agreement and Maryland law. In connection with such merger, each outstanding limited liability company interest of the LLC was converted into a share of common stock of the Company.
On July 30, 2010, the Company changed its name from “GSC Investment Corp.” to “Saratoga Investment Corp.”.
We are externally managed and advised by our investment adviser, Saratoga Investment Advisors, LLC (the “Manager”), pursuant an investment advisory and management agreement dated July 30, 2010 (the “Management Agreement”). Prior to July 30, 2010, we were managed and advised by GSCP (NJ), L.P.
On March 28, 2012, our wholly-owned subsidiary, Saratoga Investment Corp. SBIC, LP (“SBIC LP”), received a Small Business Investment Company (“SBIC”) license from the Small Business Administration (“SBA”).
The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) and include the accounts of the Company its special purpose financing subsidiary, Saratoga Investment Funding, LLC (previously known as GSC Investment Funding LLC) and SBIC LP. All intercompany accounts and transactions have been eliminated in consolidation. All references made to the “Company,” “we,” and “us” herein include Saratoga Investment Corp. and its consolidated subsidiaries, except as stated otherwise.
Note 2. Summary of Significant Accounting Policies
Use of Estimates in the Preparation of Financial Statements
The preparation of the accompanying consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and income, gains (losses) and expenses during the period reported. Actual results could differ materially from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include short-term, liquid investments in a money market fund. Cash and cash equivalents are carried at cost which approximates fair value. Per section 12(d)(1)(A) of the 1940 Act, the Company may not invest in another registered investment company such as, a money market fund if such investment would cause the Company to exceed any of the following limitations:
13
Cash and Cash Equivalents, Reserve Accounts
Cash and cash equivalents, reserve accounts include amounts held in designated bank accounts in the form of cash and short-term liquid investments in money market funds representing payments received on secured investments or other reserved amounts associated with our $45.0 million senior secured revolving credit facility with Madison Capital Funding LLC. The Company is required to use these amounts to pay interest expense, reduce borrowings, or pay other amounts in accordance with the terms of the senior secured revolving credit facility.
Investment Classification
The Company classifies its investments in accordance with the requirements of the 1940 Act. Under the 1940 Act, “Control Investments” are defined as investments in companies in which we own more than 25.0% of the voting securities or maintain greater than 50.0% of the board representation. Under the 1940 Act, “Affiliated Investments” are defined as those non-control investments in companies in which we own between 5.0% and 25.0% of the voting securities. Under the 1940 Act, “Non-affiliated Investments” are defined as investments that are neither Control Investments nor Affiliated Investments.
Investment Valuation
The Company accounts for its investments at fair value in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements. ASC 820 requires the Company to assume that its investments are to be sold at the statement of assets and liabilities date in the principal market to independent market participants, or in the absence of a principal market, in the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact.
Investments for which market quotations are readily available are fair valued at such market quotations obtained from independent third party pricing services and market makers subject to any decision by our board of directors to approve a fair value determination to reflect significant events affecting the value of these investments. We value investments for which market quotations are not readily available at fair value as approved, in good faith, by our board of directors based on input from our Manager, the audit committee of our board of directors and a third party independent valuation firm. Determinations of fair value may involve subjective judgments and estimates. The types of factors that may be considered in determining the fair value of our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments, market yield trend analysis, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow and other relevant factors.
We undertake a multi-step valuation process each quarter when valuing investments for which market quotations are not readily available, as described below:
In addition, all our investments are subject to the following valuation process:
14
Our investment in Saratoga Investment Corp. CLO 2013-1, Ltd. (“Saratoga CLO”) is carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for equity interests in collateralized loan obligation funds similar to Saratoga CLO, when available, as determined by our Manager and recommended to our board of directors. Specifically, we use Intex cash flow models, or an appropriate substitute, to form the basis for the valuation of our investment in Saratoga CLO. The models use a set of assumptions including projected default rates, recovery rates, reinvestment rate and prepayment rates in order to arrive at estimated valuations. The assumptions are based on available market data and projections provided by third parties as well as management estimates. We use the output from the Intex models (i.e., the estimated cash flows) to perform a discounted cash flows analysis on expected future cash flows to determine a valuation for our investment in Saratoga CLO.
Because such valuations, and particularly valuations of private investments and private companies, are inherently uncertain, they may fluctuate over short periods of time and may be based on estimates. The determination of fair value may differ materially from the values that would have been used if a ready market for these investments existed. Our net asset value could be materially affected if the determinations regarding the fair value of our investments were materially higher or lower than the values that we ultimately realize upon the disposal of such investments.
Investment Transactions and Income Recognition
Purchases and sales of investments and the related realized gains or losses are recorded on a trade-date basis. Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company stops accruing interest on its investments when it is determined that interest is no longer collectible. Discounts and premiums on investments purchased are accreted/amortized over the life of the respective investment using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of discounts and amortizations of premium on investments.
Loans are generally placed on non-accrual status when there is reasonable doubt that principal or interest will be collected. Accrued interest is generally reserved when a loan is placed on non-accrual status. Interest payments received on non-accrual loans may be recognized as a reduction in principal depending upon management’s judgment regarding collectability. Non-accrual loans are restored to accrual status when past due principal and interest is paid and, in management’s judgment, are likely to remain current, although we may make exceptions to this general rule if the loan has sufficient collateral value and is in the process of collection.
Interest income on our investment in Saratoga CLO is recorded using the effective interest method in accordance with the provisions of ASC Topic 325-40, Investments-Other, Beneficial Interests in Securitized Financial Assets, (“ASC 325-40”), based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the investment from the date the estimated yield was changed.
Other Income
Other income includes dividends received, origination fees, structuring fees and advisory fees, and is recorded in income when earned.
Paid-in-Kind Interest
The Company holds debt investments in its portfolio that contain a payment-in-kind (“PIK”) interest provision. The PIK interest, which represents contractually deferred interest added to the investment balance that is generally due at maturity, is generally recorded on the accrual basis to the extent such amounts are expected to be collected. We stop accruing PIK interest if we do not expect the issuer to be able to pay all principal and interest when due.
Deferred Debt Financing Costs
Financing costs incurred in connection with our credit facility are deferred and amortized using the straight line method over the life of their respective facilities. Financing costs incurred in connection with our SBA debentures are deferred and amortized using the effective yield method over the life of the debentures.
Contingencies
In the ordinary course of its business, the Company may enter into contracts or agreements that contain indemnifications or warranties. Future events could occur that lead to the execution of these provisions against the Company. Based on its history and experience, management feels that the likelihood of such an event is remote.
15
In the ordinary course of business, the Company may directly or indirectly be a defendant or plaintiff in legal actions with respect to bankruptcy, insolvency or other types of proceedings. Such lawsuits may involve claims that could adversely affect the value of certain financial instruments owned by the Company.
Income Taxes
The Company has filed an election to be treated for tax purposes as a RIC under Subchapter M of the Code and, among other things, intends to make the requisite distributions to its stockholders which will relieve the Company from federal income taxes. Therefore, no provision has been recorded for federal income taxes.
In order to qualify as a RIC, among other requirements, the Company is required to timely distribute to its stockholders at least 90.0% of its investment company taxable income, as defined by the Code, for each fiscal tax year. The Company will be subject to a nondeductible U.S. federal excise tax of 4.0% on undistributed income if it does not distribute at least 98.0% of its ordinary income in any calendar year and 98.2% of its capital gain net income for each one-year period ending on October 31.
Depending on the level of taxable income earned in a tax year, the Company may choose to carry forward taxable income in excess of current year dividend distributions into the next tax year and pay a 4.0% excise tax on such income, as required. To the extent that the Company determines that its estimated current year annual taxable income will be in excess of estimated current year dividend distributions for excise tax purposes, the Company accrues excise tax, if any, on estimated excess taxable income as taxable income is earned.
In accordance with certain applicable Treasury regulations and private letter rulings issued by the Internal Revenue Service, a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20.0% of the aggregate declared distribution. If too many stockholders elect to receive cash, each stockholder electing to receive cash will receive a pro rata amount of cash (with the balance of the distribution paid in stock). In no event will any stockholder, electing to receive cash, receive less than 20.0% of his or her entire distribution in cash. If these and certain other requirements are met, for U.S federal income tax purposes, the amount of the dividend paid in stock will be equal to the amount of cash that could have been received instead of stock.
ASC 740, Income Taxes, (“ASC 740”), provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. Tax positions deemed to meet a “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the current period. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the consolidated statements of operations. During the fiscal year ended February 28, 2014, the Company did not incur any interest or penalties. Although we file federal and state tax returns, our major tax jurisdiction is federal. The 2011, 2012 and 2013 federal tax years for the Company remain subject to examination by the IRS. As of November 30, 2014 and February 28, 2014, there were no uncertain tax positions.
Dividends
Dividends to common stockholders are recorded on the ex-dividend date. The amount to be paid out as a dividend is determined by the board of directors. Net realized capital gains, if any, are generally distributed at least annually, although we may decide to retain such capital gains for reinvestment.
We have adopted a dividend reinvestment plan (“DRIP”) that provides for reinvestment of our dividend distributions on behalf of our stockholders unless a stockholder elects to receive cash. As a result, if our board of directors authorizes, and we declare, a cash dividend, then our stockholders who have not “opted out” of the DRIP by the dividend record date will have their cash dividends automatically reinvested into additional shares of our common stock, rather than receiving the cash dividends. We have the option to satisfy the share requirements of the DRIP through the issuance of new shares of common stock or through open market purchases of common stock by the DRIP plan administrator.
Capital Gains Incentive Fee
The Company records an expense accrual on the consolidated statements of operations, relating to the capital gains incentive fee payable on the consolidated statements of assets and liabilities, by the Company to its investment adviser when the unrealized gains on its investments exceed all realized capital losses on its investments given the fact that a capital gains incentive fee would be owed to the investment adviser if the Company were to liquidate its investment portfolio at such time. The actual incentive fee payable to the Company’s investment adviser related to capital gains will be determined and payable in arrears at the end of each fiscal year and will include only realized capital gains for the period.
16
New Accounting Pronouncements
In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, (“ASU 2014-11”). ASU 2014-11 makes limited changes to the accounting for repurchase agreements, clarifies when repurchase agreements and securities lending transactions should be accounted for as secured borrowings, and requires additional disclosures regarding these types of transactions. The guidance is effective for fiscal years beginning on or after December 15, 2014, and for interim periods within those fiscal years. Management is currently evaluating the impact these changes will have on the Company’s consolidated financial statement disclosures.
Risk Management
In the ordinary course of its business, the Company manages a variety of risks, including market risk and credit risk. Market risk is the risk of potential adverse changes to the value of investments because of changes in market conditions such as interest rate movements and volatility in investment prices.
Credit risk is the risk of default or non-performance by portfolio companies, equivalent to the investment’s carrying amount.
The Company is also exposed to credit risk related to maintaining all of its cash and cash equivalents, including those in reserve accounts, at a major financial institution and credit risk related to any of its derivative counterparties.
The Company has investments in lower rated and comparable quality unrated high yield bonds and bank loans. Investments in high yield investments are accompanied by a greater degree of credit risk. The risk of loss due to default by the issuer is significantly greater for holders of high yield securities, because such investments are generally unsecured and are often subordinated to other creditors of the issuer.
Note 3. Investments
As noted above, the Company values all investments in accordance with ASC 820. ASC 820 requires enhanced disclosures about assets and liabilities that are measured and reported at fair value. As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
ASC 820 establishes a hierarchal disclosure framework which prioritizes and ranks the level of market price observability of inputs used in measuring investments at fair value. Market price observability is affected by a number of factors, including the type of investment and the characteristics specific to the investment. Investments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value.
Based on the observability of the inputs used in the valuation techniques, the Company is required to provide disclosures on fair value measurements according to the fair value hierarchy. The fair value hierarchy ranks the observability of the inputs used to determine fair values. Investments carried at fair value are classified and disclosed in one of the following three categories:
In addition to using the above inputs in investment valuations, the Company continues to employ the valuation policy approved by the board of directors that is consistent with ASC 820 and the 1940 Act (see Note 2). Consistent with our Company’s valuation policy, we evaluate the source of inputs, including any markets in which our investments are trading, in determining fair value.
17
The following table presents fair value measurements of investments, by major class, as of November 30, 2014 (dollars in thousands), according to the fair value hierarchy:
Syndicated loans
First lien term loans
Second lien term loans
Senior secured notes
Unsecured notes
Structured finance securities
Equity interest
Total
The following table presents fair value measurements of investments, by major class, as of February 28, 2014 (dollars in thousands), according to the fair value hierarchy:
The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the nine months ended November 30, 2014 (dollars in thousands):
Balance as of February 28, 2014
Net unrealized gains (losses)
Purchases and other adjustments to cost
Sales and redemptions
Net realized gains from investments
Balance as of November 30, 2014
The following table provides a reconciliation of the beginning and ending balances for investments that use Level 3 inputs for the nine months ended November 30, 2013 (dollars in thousands):
Balance as of February 28, 2013
Balance as of November 30, 2013
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Purchases and other adjustments to cost include purchases of new investments at cost, effects of refinancing/restructuring, accretion/amortization of income from discount/premium on debt securities, and PIK.
Sales and redemptions represent net proceeds received from investments sold, and principal paydowns received, during the period.
The net change in unrealized gain/(loss) for the nine months ended November 30, 2014 and 2013, on investments held as of November 30, 2014 and 2013, was $573,734 and $(3,890,205), respectively, and is included in net unrealized appreciation (depreciation) on investments in the consolidated statements of operations.
The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value measurements of assets as of November 30, 2014 were as follows (dollars in thousands):
Equity interests
The valuation techniques and significant unobservable inputs used in recurring Level 3 fair value measurements of assets as of February 28, 2014 were as follows (dollars in thousands):
19
For investments utilizing a market comparables valuation technique, a significant increase (decrease) in the market yield, in isolation, would result in a significantly lower (higher) fair value measurement, and a significant increase (decrease) in any of the EBITDA valuation multiples, in isolation, would result in a significantly higher (lower) fair value measurement. For investments utilizing a discounted cash flow valuation technique, a significant increase (decrease) in the discount rate, in isolation, would result in a significantly lower (higher) fair value measurement.
The composition of the Company’s investments as of November 30, 2014, at amortized cost and fair value were as follows (dollars in thousands):
The composition of the Company’s investments as of February 28, 2014, at amortized cost and fair value were as follows (dollars in thousands):
For loans and debt securities for which market quotations are not available, we determine their fair value based on third party indicative broker quotes, where available, or the assumptions that a hypothetical market participant would use to value the security in a current hypothetical sale using a market yield valuation methodology. In applying the market yield valuation methodology, we determine the fair value based on such factors as market participant assumptions including synthetic credit ratings, estimated remaining life, current market yield and interest rate spreads of similar securities as of the measurement date. If, in our judgment, the market yield methodology is not sufficient or appropriate, we may use additional methodologies such as an asset liquidation or expected recovery model.
For equity securities of portfolio companies and partnership interests, we determine the fair value based on the market approach with value then attributed to equity or equity like securities using the enterprise value waterfall valuation methodology. Under the enterprise value waterfall valuation methodology, we determine the enterprise fair value of the portfolio company and then waterfall the enterprise value over the portfolio company’s securities in order of their preference relative to one another. To estimate the enterprise value of the portfolio company, we weigh some or all of the traditional market valuation methods and factors based on the individual circumstances of the portfolio company in order to estimate the enterprise value. The methodologies for performing
20
investments may be based on, among other things: valuations of comparable public companies, recent sales of private and public comparable companies, discounting the forecasted cash flows of the portfolio company, third party valuations of the portfolio company, considering offers from third parties to buy the company, estimating the value to potential strategic buyers and considering the value of recent investments in the equity securities of the portfolio company. For non-performing investments, we may estimate the liquidation or collateral value of the portfolio company’s assets and liabilities. We also take into account historical and anticipated financial results.
Our investment in Saratoga CLO is carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for equity interests in collateralized loan obligation funds similar to Saratoga CLO, when available, as determined by our Manager and recommended to our board of directors. Specifically, we use Intex cash flow models, or an appropriate substitute, to form the basis for the valuation of our investment in Saratoga CLO. The models use a set of assumptions including projected default rates, recovery rates, reinvestment rate and prepayment rates in order to arrive at estimated valuations. The assumptions are based on available market data and projections provided by third parties as well as management estimates. We use the output from the Intex models (i.e., the estimated cash flows) to perform a discounted cash flows analysis on expected future cash flows to determine a valuation for our investment in Saratoga CLO at November 30, 2014. The significant inputs for the valuation model include:
The Company and SBIC are both considered to be investment companies for financial reporting purposes and have applied the guidance in Topic 946, “Financial Services — Investment Companies”. There have been no changes to the Company or SBIC’s status as investment companies during the quarterly period ended November 30, 2014.
Note 4. Investment in Saratoga Investment Corp. CLO 2013-1, Ltd. (“Saratoga CLO”)
On January 22, 2008, we invested $30.0 million in all of the outstanding subordinated notes of GSC Investment Corp. CLO 2007, Ltd., a collateralized loan obligation fund managed by us that invests primarily in senior secured loans. Additionally, we entered into a collateral management agreement with GSC Investment Corp. CLO 2007, Ltd. pursuant to which we act as collateral manager to it. The Saratoga CLO was refinanced in October 2013 and its reinvestment period ends in October 2016. The Saratoga CLO remains 100% owned and managed by Saratoga Investment Corp. We receive a base management fee of 0.25% and a subordinated management fee of 0.25% of the Fee Basis Amount at the beginning of the Collection Period, paid quarterly to the extent of available proceeds. We are also entitled to an incentive management fee equal to 20.0% of the remaining interest proceeds and principal proceeds, if any, after the subordinated notes have realized the incentive management fee target return of 12.0%, in accordance with the Priority of Payments after making the prior distributions on the relevant payment date. For the three months ended November 30, 2014 and November 30, 2013, we accrued $0.4 million and $0.4 million in management fee income, respectively, and $0.7 million and $0.6 million in interest income, respectively, from Saratoga CLO. For the nine months ended November 30, 2014 and November 30, 2013, we accrued $1.2 million and $1.4 million in management fee income, respectively, and $2.0 million and $2.8 million in interest income, respectively, from Saratoga CLO. We did not accrue any amounts related to the incentive management fee as the 12.0% hurdle rate has not yet been achieved.
At November 30, 2014, the Company determined that the fair value of its investment in the subordinated notes of Saratoga CLO was $19.4 million. The Company determines the fair value of its investment in the subordinated notes of Saratoga CLO based on the present value of the projected future cash flows of the subordinated notes over the life of Saratoga CLO. At November 30, 2014, Saratoga CLO had investments with a principal balance of $302.6 million and a weighted average spread over LIBOR of 4.2%, and had debt with a principal balance of $282.4 million with a weighted average spread over LIBOR of 1.8%. As a result, Saratoga CLO earns a “spread” between the interest income it receives on its investments and the interest expense it pays on its debt and other operating expenses, which is distributed quarterly to the Company as the holder of its subordinated notes. At November 30, 2014, the total “spread”, or projected future cash flows of the subordinated notes, over the life of Saratoga CLO was $23.7 million, which had a present value of approximately $19.8 million, using a 10.0% discount rate.
Below is certain financial information from the separate unaudited financial statements of Saratoga CLO as of November 30, 2014 and February 28, 2014, pursuant to Rule 3-09 of SEC rules Regulation S-X, and for the three and nine months ended November 30, 2014 and November 30, 2013.
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Statements of Assets and Liabilities
Investments
Fair value loans (amortized cost of $300,731,616 and $299,137,566, respectively)
Total investments at fair value (amortized cost of $300,731,616 and $299,137,566, respectively)
Receivable from open trades
Interest payable
Payable from open trades
Accrued base management fee
Accrued subordinated management fee
Class X Notes - SIC CLO 2013-1, Ltd.
Class A-1 Notes - SIC CLO 2013-1, Ltd.
Discount on Class A-1 Notes - SIC CLO 2013-1, Ltd.
Class A-2 Notes - SIC CLO 2013-1, Ltd.
Discount on Class A-2 Notes - SIC CLO 2013-1, Ltd.
Class B Notes - SIC CLO 2013-1, Ltd.
Discount on Class B Notes - SIC CLO 2013-1, Ltd.
Class C Notes - SIC CLO 2013-1, Ltd.
Discount on Class C Notes - SIC CLO 2013-1, Ltd.
Class D Notes - SIC CLO 2013-1, Ltd.
Discount on Class D Notes - SIC CLO 2013-1, Ltd.
Class E Notes - SIC CLO 2013-1, Ltd.
Discount on Class E Notes - SIC CLO 2013-1, Ltd.
Class F Notes - SIC CLO 2013-1, Ltd.
Discount on Class F Notes - SIC CLO 2013-1, Ltd.
Subordinated Notes
Commitments and contingencies
Ordinary equity, par value $1.00, 250 ordinary shares authorized, 250 and 250 issued and outstanding, respectively
Accumulated gain/(loss)
Net loss
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Statements of Operations
Interest expense
Miscellaneous fee expense
Base management fee
Subordinated management fee
Trustee expenses
Amortization expense
NET INVESTMENT INCOME (LOSS)
Net realized gain/(loss) on investments
Net unrealized appreciation/(depreciation) on investments
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS
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Saratoga Investment Corp. CLO 2013-1 Ltd.
Schedule of Investments
Issuer Name
Industry
Asset Name
Asset Type
24 Hour Holdings III LLC
Acosta Holdco Inc.
Aderant North America, Inc.
Advantage Sales & Marketing Inc.
AECOM Technology Corporation
Aegis Toxicology Science Corporation
Akorn, Inc.
Albertson’s LLC
Alere Inc. (fka IM US Holdings, LLC)
American Tire Distributors Inc
Anchor Glass
Applied Systems, Inc.
Aramark Corporation
ARG IH Corp
Asurion, LLC (fka Asurion Corporation)
Auction.Com, LLC
Avantor Performance Materials Holdings, Inc.
Avast Software
AZ Chem US Inc.
Bass Pro Group, LLC
Bayonne Energy Center
Belmond Hotels
Berry Plastics Corporation
Big Heart Pet Brands (fka Del Monte Corporation)
Biomet, Inc.
BJ’s Wholesale Club, Inc.
Bombardier Recreational Products Inc.
Brickman Group Holdings, Inc.
Brock Holdings III, Inc.
Burlington Coat Factory Warehouse Corporation
BWAY
Caesars Entertainment Corp.
Camp International Holding Company
Capital Automotive L.P.
Catalent Pharma Solutions, Inc
Celanese US Holdings LLC
Cengage Learning
Charter Communications Operating, LLC
CHS/Community Health Systems, Inc.
Cinedigm Digital Funding I, LLC
CITGO Petroleum
ClubCorp Club Operations, Inc.
Covanta Energy Corporation
CPI International Acquisition, Inc. (f/k/a Catalyst Holdings, Inc.)
Crosby US Acquisition Corp.
Crown Castle Operating Company
CT Technologies Intermediate Hldgs, Inc
Culligan International Company
Cumulus Media Holdings Inc.
Custom Sensors
DaVita HealthCare Partners Inc. (fka DaVita Inc.)
DCS Business Services, Inc.
Dealertrack Technologies, Inc.
Dell International LLC
Delos Finance SARL
Delta 2 (Lux) S.a.r.l.
Deluxe Entertainment Service Group, Inc.
Devix US, Inc.
Diamond Resorts International
DPX Holdings B.V.
Drew Marine Group Inc.
Dunkin’ Brands, Inc.
Education Management LLC
EIG Investors Corp.
Emerald Performance Materials, LLC
EnergySolutions, LLC
Enviromental Resources Management
Evergreen Acqco 1 LP
EWT Holdings III Corp. (fka WTG Holdings III Corp.)
Federal-Mogul Corporation
First Data Corporation
Fitness International, LLC
FMG Resources (August 2006) Pty LTD (FMG America Finance, Inc.)
Four Seasons Holdings Inc.
Garda World Security Corporation
Gardner Denver, Inc.
Gates Global LLC
Generac Power Systems, Inc.
General Nutrition Centers, Inc.
Global Tel*Link Corporation
Goodyear Tire & Rubber Company, The
Grosvenor Capital Management Holdings, LP
GTCR Valor Companies, Inc.
Harland Clarke Holdings Corp. (fka Clarke American Corp.)
HCA Inc.
Hertz Corporation, The
Hoffmaster Group, Inc.
Hologic, Inc.
Huntsman International LLC
Husky Injection
Ikaria, Inc.
Infor (US), Inc. (fka Lawson Software Inc.)
J. Crew Group, Inc.
Jazz Acquisition, Inc
Kinetic Concepts, Inc.
Koosharem, LLC
La Quinta Holdings, Inc.
Level 3 Financing, Inc.
Mauser Holdings, Inc.
Michaels Stores, Inc.
Microsemi Corporation
Midas Intermediate Holdco II, LLC
Millenium Laboratories, LLC
Mitel US Holdings, Inc.
MPH Acquisition Holdings LLC
MSC Software Corp.
National CineMedia, LLC
National Veterinary Associates, Inc
National Vision, Inc.
Newsday, LLC
Nortek, Inc.
Novelis, Inc.
NPC International, Inc.
NRG Energy, Inc.
NuSil Technology LLC.
OEP Pearl Dutch Acquisition B.V.
Ollie’s Bargain Outlet, Inc
On Assignment, Inc.
Onex Carestream Finance LP
OnexYork Acquisition Co
OpenLink International LLC
Orbitz Worldwide, Inc.
P.F. Chang’s China Bistro, Inc. (Wok Acquisition Corp.)
P2 Upstream Acquisition Co. (P2 Upstream Canada BC ULC)
Paragon Offshore Finance
PetCo Animal Supplies Stores, Inc.
PGX Holdings, Inc.
Pharmaceutical Product Development, Inc. (Jaguar Holdings, LLC)
Phillips-Medisize Corporation
Pinnacle Foods Finance LLC
Planet Fitness Holdings LLC
Polymer Group, Inc.
Prestige Brands, Inc.
Progressive Waste Solutions Ltd.
QoL Meds, LLC
Quintiles Transnational Corp.
Ranpak Holdings, Inc.
Redtop Acquisitions Limited
Rexnord LLC/RBS Global, Inc.
Reynolds Group Holdings Inc.
Rocket Software, Inc.
Rovi Solutions Corporation / Rovi Guides, Inc.
RPI Finance Trust
SBP Holdings LP
Scientific Games International, Inc.
Scitor Corporation
Seadrill
Sensata Technologies B.V./Sensata Technology Finance Company, LLC
Sensus USA Inc. (fka Sensus Metering Systems)
ServiceMaster Company, The
Shearers Foods LLC
Sonneborn, LLC
Sophia, L.P.
SourceHOV LLC
Southwire Company, LLC (f.k.a Southwire Company)
SRAM, LLC
SS&C Technologies Holdings Europe S.A.R.L.
SS&C Technologies, Inc., /Sunshine Acquisition II, Inc.
Steak ‘n Shake Operations, Inc.
STHI Holding
SunGard Data Systems Inc. (Solar Capital Corp.)
SuperMedia Inc. (fka Idearc Inc.)
Syniverse Holdings, Inc.
Taminco Global Chemical Corporation
TGI Friday’s
TPF II Power LLC and TPF II Covert Midco LLC
TransDigm, Inc.
TransFirst
TransUnion
Tricorbraun, Inc. (fka Kranson Industries, Inc.)
Truven Health Analytics Inc. (fka Thomson Reuters (Healthcare) Inc.)
Twin River Management Group, Inc.
U.S. Security Associates Holdings, Inc.
United Surgical Partners International, Inc.
Univar Inc.
Univision Communications Inc.
Valeant Pharmaceuticals International, Inc.
Verint Systems Inc.
Vertafore, Inc.
Vouvray US Finance
Washington Inventory Service
Wendy’s International, Inc
West Corporation
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Academy, LTD.
Acosta, Inc.
Aegis Toxicology Sciences Corporation
Aeroflex Incorporated
Ardagh Holdings USA Inc. (Ardagh Packaging Finance S.A.)
ARG IH Corporation
Autotrader.com, Inc.
Brickman Group Ltd. LLC, The
C.H.I. Overhead Doors, Inc.
Capstone Logistics, LLC
Capsugel Holdings US, Inc.
DealerTrack Technologies, Inc.
Delos Finance
Deluxe Entertainment Services Group Inc.
Digitalglobe, Inc.
DynCorp International Inc.
Energy Transfer Equity, L.P.
Hunter Defense Technologies, Inc.
Inventiv Health, Inc. (fka Ventive Health, Inc)
JFB Firth Rixson Inc.
La Quinta Intermediate Holdings L.L.C
OpenLink International, Inc.
Patheon Inc.
PetCo Animal Supplies, Inc.
Pro Mach, Inc.
SI Organization, Inc., The
SRA International Inc.
SunCoke Energy, Inc.
SunGard Data Systems Inc (Solar Capital Corp.)
Team Health, Inc.
TECTUM HOLDINGS INC
Tomkins, LLC / Tomkins, Inc. (f/k/a Pinafore, LLC / Pinafore, Inc.)
TransDigm Inc.
Tricorbraun Inc. (fka Kranson Industries, Inc.)
U.S. Silica Company
U.S. Xpress Enterprises, Inc.
UPC Financing Partnership
Visant Corporation (fka Jostens)
W.R. Grace & Co.-CONN
Wesco Aircraft Hardware Corp.
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Note 5. Agreements and Related Party Transactions
On July 30, 2010, the Company entered into the Management Agreement with our Manager. The initial term of the Management Agreement is two years, with automatic, one-year renewals at the end of each year subject to certain approvals by our board of directors and/or our stockholders. On July 10, 2014, our board of directors approved the renewal of the Management Agreement for an additional one-year term. Pursuant to the Management Agreement, our Manager implements our business strategy on a day-to-day basis and performs certain services for us, subject to oversight by our board of directors. Our Manager is responsible for, among other duties, determining investment criteria, sourcing, analyzing and executing investments transactions, asset sales, financings and performing asset management duties. Under the Management Agreement, we have agreed to pay our Manager a management fee for investment advisory and management services consisting of a base management fee and an incentive fee.
The base management fee of 1.75% is calculated based on the average value of our gross assets (other than cash or cash equivalents, but including assets purchased with borrowed funds) at the end of the two most recently completed fiscal quarters, and appropriately adjusted for any share issuances or repurchases during the applicable fiscal quarter.
The incentive fee consists of the following two parts:
The first, payable quarterly in arrears, equals 20.0% of our pre-incentive fee net investment income, expressed as a rate of return on the value of our net assets at the end of the immediately preceding quarter, that exceeds a 1.875% quarterly (7.5% annualized) hurdle rate measured as of the end of each fiscal quarter, subject to a “catch-up” provision. Under this provision, in any fiscal quarter, our Manager receives no incentive fee unless our pre-incentive fee net investment income exceeds the hurdle rate of 1.875%. Our Manager will receive 100.0% of pre-incentive fee net investment income, if any, that exceeds the hurdle rate but is less than or equal to 2.344% in any fiscal quarter (9.376% annualized); and 20.0% of the amount of the our pre-incentive fee net investment income, if any, that exceeds 2.344% in any fiscal quarter (9.376% annualized).
The second part of the incentive fee is determined and payable in arrears as of the end of each fiscal year (or upon termination of the Management Agreement) and equals 20.0% of our “incentive fee capital gains,” which equals our realized capital gains on a cumulative basis from May 31, 2010 through the end of the year, if any, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid capital gain incentive fee. Importantly, the capital gains portion of the incentive fee is based on realized gains and realized and unrealized losses from May 31, 2010. Therefore, realized and unrealized losses incurred prior to such time will not be taken into account when calculating the capital gains portion of the incentive fee, and our Manager will be entitled to 20.0% of incentive fee capital gains that arise after May 31, 2010. In addition, for the purpose of the “incentive fee capital gains” calculations, the cost basis for computing realized gains and losses on investments held by us as of May 31, 2010 will equal the fair value of such investments as of such date.
For the three months ended November 30, 2014 and 2013, we incurred $1.1 million and $0.9 million in base management fees, respectively. For the three months ended November 30, 2014 and 2013, we accrued $0.7 million and $0.2 million in incentive fees related to pre-incentive fee net investment income. For the three months ended November 30, 2014, we accrued $0.1 million in incentive fees related to capital gains. For the three months ended November 30, 2013, there was a reduction of $0.8 million in incentive management fees related to capital gains. For the nine months ended November 30, 2014 and 2013, we incurred $3.1 million and $2.4 million in base management fees, respectively. For the nine months ended November 30, 2014 and 2013, we accrued $1.6 million and $1.0 million in incentive fees related to pre-incentive fee net investment income. For the nine months ended November 30, 2014, we accrued $0.4 million in incentive management fees related to capital gains. For the nine months ended November 30, 2013, there was a reduction of $0.8 million in incentive management fees related to capital gains. The accrual is calculated using both realized and unrealized capital gains for the period. The actual incentive fee related to capital gains will be determined and payable in arrears at the end of the fiscal year and will include only realized capital gains for the period. As of November 30, 2014, the base management fees accrual was $1.1 million, and the incentive fees accrual was $3.5 million and is included in management and incentive fees payable in the accompanying consolidated statements of assets and liabilities. As of February 28, 2014, the base management fees accrual was $0.9 million and the incentive fees accrual was $3.0 million and is included in management and incentive fees payable in the accompanying consolidated statements of assets and liabilities.
On July 30, 2010, the Company entered into a separate administration agreement (the “Administration Agreement”) with our Manager, pursuant to which our Manager, as our administrator, has agreed to furnish us with the facilities and administrative services necessary to conduct our day-to-day operations and provide managerial assistance on our behalf to those portfolio companies to which we are required to provide such assistance. The initial term of the Administration Agreement is two years, with automatic, one-year renewals at the end of each year subject to certain approvals by our board of directors and/or our stockholders. The amount of expenses payable or reimbursable thereunder by the Company is capped at $1.0 million for the initial two year term of the administration agreement. On July 10, 2014, our board of directors approved the renewal of the Administration Agreement for an additional one-year term and determined to maintain the cap on the payment or reimbursement of expenses by the Company thereunder to $1.0 million for the additional one-year term.
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For the three months ended November 30, 2014 and 2013, we recognized $0.3 million and $0.3 million in administrator expenses for the periods, pertaining to bookkeeping, record keeping and other administrative services provided to us in addition to our allocable portion of rent and other overhead related expenses, respectively. For the nine months ended November 30, 2014 and 2013, we recognized $0.8 million and $0.8 million in administrator expenses for the periods, pertaining to bookkeeping, record keeping and other administrative services provided to us in addition to our allocable portion of rent and other overhead related expenses, respectively. As of November 30, 2014 and February 28, 2014, $0.3 million and $0.4 million, respectively, of administrator expenses were accrued and included in due to manager in the accompanying consolidated statements of assets and liabilities.
Note 6. Borrowings
Credit Facility
As a BDC, we are only allowed to employ leverage to the extent that our asset coverage, as defined in the 1940 Act, equals at least 200.0% after giving effect to such leverage. The amount of leverage that we employ at any time depends on our assessment of the market and other factors at the time of any proposed borrowing.
On April 11, 2007, we entered into a $100.0 million revolving securitized credit facility (the “Revolving Facility”). On May 1, 2007, we entered into a $25.7 million term securitized credit facility (the “Term Facility” and, together with the Revolving Facility, the “Facilities”), which was fully drawn at closing. In December 2007, we consolidated the Facilities by using a draw under the Revolving Facility to repay the Term Facility. In response to the market wide decline in financial asset prices, which negatively affected the value of our portfolio, we terminated the revolving period of the Revolving Facility effective January 14, 2009 and commenced a two-year amortization period during which all principal proceeds from the collateral was used to repay outstanding borrowings. A significant percentage of our total assets had been pledged under the Revolving Facility to secure our obligations thereunder. Under the Revolving Facility, funds were borrowed from or through certain lenders and interest was payable monthly at the greater of the commercial paper rate and our lender’s prime rate plus 4.00% plus a default rate of 2.00% or, if the commercial paper market was unavailable, the greater of the prevailing LIBOR rates and our lender’s prime rate plus 6.00% plus a default rate of 3.00%.
In March 2009, we amended the Revolving Facility to increase the portion of the portfolio that could be invested in “CCC” rated investments in return for an increased interest rate and expedited amortization. As a result of these transactions, we expected to have additional cushion under our borrowing base under the Revolving Facility that would allow us to better manage our capital in times of declining asset prices and market dislocation.
On July 30, 2009, we exceeded the permissible borrowing limit under the Revolving Facility for 30 consecutive days, resulting in an event of default under the Revolving Facility. As a result of this event of default, our lender had the right to accelerate repayment of the outstanding indebtedness under the Revolving Facility and to foreclose and liquidate the collateral pledged thereunder. Acceleration of the outstanding indebtedness and/or liquidation of the collateral could have had a material adverse effect on our liquidity, financial condition and operations.
On July 30, 2010, we used the net proceeds from (i) the stock purchase transaction and (ii) a portion of the funds available to us under the $45.0 million senior secured revolving credit facility (the “Credit Facility”) with Madison Capital Funding LLC to pay the full amount of principal and accrued interest, including default interest, outstanding under the Revolving Facility. As a result, the Revolving Facility was terminated in connection therewith. Substantially all of our total assets, other than those held by SBIC LP, have been pledged under the Credit Facility to secure our obligations thereunder.
On February 24, 2012, we amended our senior secured revolving credit facility with Madison Capital Funding LLC to, among other things:
On September 17, 2014, we entered into a second amendment to the Revolving Facility with Madison Capital Funding LLC to, among other things:
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As of November 30, 2014 and February 28, 2014, there was $4.9 million and $0.0 million outstanding under the Credit Facility, respectively, and the Company was in compliance with all of the limitations and requirements of the Credit Facility. The carrying amount of the amount outstanding under the Credit Facility approximates its fair value. $2.7 million of financing costs related to the Credit Facility have been capitalized and are being amortized over the term of the facility. For the three months ended November 30, 2014 and 2013, we recorded $0.2 million and $0.1 million of interest expense related to the Credit Facility, respectively. For the three months ended November 30, 2014 and 2013, we recorded $0.03 million and $0.1 million of amortization of deferred financing costs related to the Credit Facility, respectively. The interest rates during the three and nine months ended November 30, 2014 on the outstanding borrowings under the Credit Facility were 7.50% and 7.50%, respectively. The interest rates during the three and nine months ended November 30, 2013 on the outstanding borrowings under the Credit Facility were 7.50% and 7.50%, respectively. For the nine months ended November 30, 2014 and 2013, we recorded $0.6 million and $0.8 million of interest expense related to the Credit Facility, respectively. For the nine months ended November 30, 2014 and 2013, we recorded $0.2 million and $0.3 million of amortization of deferred financing costs related to the Credit Facility, respectively.
The Credit Facility contains limitations as to how borrowed funds may be used, such as restrictions on industry concentrations, asset size, weighted average life, currency denomination and collateral interests. The Credit Facility also includes certain requirements relating to portfolio performance, the violation of which could result in the limit of further advances and, in some cases, result in an event of default, allowing the lenders to accelerate repayment of amounts owed thereunder. The Credit Facility has an eight year term, consisting of a three year period (the “Revolving Period”), under which the Company may make and repay borrowings, and a final maturity five years from the end of the Revolving Period. Availability on the Credit Facility will be subject to a borrowing base calculation, based on, among other things, applicable advance rates (which vary from 50.0% to 75.0% of par or fair value depending on the type of loan asset) and the value of certain “eligible” loan assets included as part of the Borrowing Base. Funds may be borrowed at the greater of the prevailing LIBOR rate and 1.25%, plus an applicable margin of 4.75%. At the Company’s option, funds may be borrowed based on an alternative base rate, which in no event will be less than 2.25%, and the applicable margin over such alternative base rate is 3.75%. In addition, the Company will pay the lenders a commitment fee of 0.75% per year on the unused amount of the Credit Facility for the duration of the Revolving Period.
Our borrowing base under the Credit Facility was $37.1 million subject to the Credit Facility cap of $45.0 million at November 30, 2014 For purposes of determining the borrowing base, most assets are assigned the values set forth in our most recent Annual Report on Form 10-K or Quarterly Report on Form 10-Q filed with the SEC. Accordingly, the November 30, 2014 borrowing base relies upon the valuations set forth in the Annual Report on Form 10-K for the year ended February 28, 2014. The valuations presented in this Quarterly Report on Form 10-Q will not be incorporated into the borrowing base until after this Quarterly Report on Form 10-Q is filed with the SEC.
SBA Debentures
SBIC LP is able to borrow funds from the SBA against regulatory capital (which approximates equity capital) that is paid in and is subject to customary regulatory requirements including but not limited to an examination by the SBA. As of November 30, 2014, we have funded SBIC LP with $59.3 million of equity capital, and have $79.0 million of SBA-guaranteed debentures outstanding. SBA debentures are non-recourse to us, have a 10-year maturity, and may be prepaid at any time without penalty. The interest rate of SBA debentures is fixed at the time of issuance, often referred to as pooling, at a market-driven spread over 10-year U.S. Treasury Notes. SBA current regulations limit the amount that SBIC LP may borrow to a maximum of $150.0 million, which is up to twice its potential regulatory capital.
SBICs are designed to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses. Under present SBA regulations, eligible small businesses include businesses that have a tangible net worth not exceeding $19.5 million and have average annual fully taxed net income not exceeding $6.5 million for the two most recent fiscal years. In addition, an SBIC must devote 25.0% of its investment activity to ‘‘smaller’’ concerns as defined by the SBA. A smaller concern is one that has a tangible net worth not exceeding $6.0 million and has average annual fully taxed net income not exceeding $2.0 million for the two most recent fiscal years. SBA regulations also provide alternative size standard criteria to determine eligibility, which depend on the industry in which the business is engaged and are based on such factors as the number of employees and gross sales. According to SBA regulations, SBICs may make long-term loans to small businesses, invest in the equity securities of such businesses and provide them with consulting and advisory services.
28
SBIC LP is subject to regulation and oversight by the SBA, including requirements with respect to maintaining certain minimum financial ratios and other covenants. Receipt of an SBIC license does not assure that SBIC LP will receive SBA guaranteed debenture funding, which is dependent upon SBIC LP continuing to be in compliance with SBA regulations and policies. The SBA, as a creditor, will have a superior claim to SBIC LP’s assets over our stockholders and debtholders in the event we liquidate SBIC LP or the SBA exercises its remedies under the SBA-guaranteed debentures issued by SBIC LP upon an event of default.
The Company received exemptive relief from the Securities and Exchange Commission to permit it to exclude the debt of SBIC LP guaranteed by the SBA from the definition of senior securities in the 200.0% asset coverage test under the 1940 Act. This allows the Company increased flexibility under the 200.0% asset coverage test by permitting it to borrow up to $150.0 million more than it would otherwise be able to absent the receipt of this exemptive relief.
As of November 30, 2014 and February 28, 2014, there was $79.0 million and $50.0 million outstanding of SBA debentures, respectively. The carrying amount of the amount outstanding of SBA debentures approximates its fair value. $2.7 million of financing costs related to the SBA debentures have been capitalized and are being amortized over the term of the commitment and drawdown. For the three months ended November 30, 2014 and 2013, the Company recorded $0.6 million and $0.3 million, respectively, of interest expense related to the SBA debentures. For the nine months ended November 30, 2014 and 2013, the Company recorded $1.4 million and $0.9 million, respectively, of interest expense related to the SBA debentures. For the three months ended November 30, 2014 and 2013, the Company recorded $0.1 million and $0.05 million, respectively, of amortization of deferred financing costs related to the SBA debentures. For the nine months ended November 30, 2014 and 2013, the Company recorded $0.2 million and $0.2 million, respectively, of amortization of deferred financing costs related to the SBA debentures. The weighted average interest rate during the nine months ended November 30, 2014 and 2013 on the outstanding borrowings of the SBA debentures was 3.16% and 2.99%, respectively.
Notes
On May 10, 2013, the Company issued $42.0 million in aggregate principal amount of 7.50% fixed-rate notes due 2020 (the “Notes”). The Notes will mature on May 31, 2020, and may be redeemed in whole or in part at any time or from time to time at the Company’s option on or after May 31, 2016. Interest will be payable quarterly beginning August 15, 2013.
On May 17, 2013, the Company closed an additional $6.3 million in aggregate principal amount of the Notes, pursuant to the full exercise of the underwriters’ option to purchase additional Notes.
As of November 30, 2014, the carrying amount and fair value of the Notes was $48.3 million and $49.5 million, respectively. The fair value of the Notes, which are publicly traded, is based upon closing market quotes as of the measurement date and would be classified as a level 1 liability within the fair value hierarchy. As of November 30, 2014, $2.5 million of financing costs related to the Notes have been capitalized and are being amortized over the term of the Notes. For the three months ended November 30, 2014 and 2013, we recorded $0.9 million and $0.9 million, respectively, of interest expense and $0.1 million and $0.09 million, respectively, of amortization of deferred financing costs related to the Notes. For the nine months ended November 30, 2014 and 2013, we recorded $2.7 million and $2.0 million, respectively, of interest expense and $0.3 million and $0.2 million, respectively, of amortization of deferred financing costs related to the Notes.
Note 7. Commitments and Contingencies
Contractual obligations
The following table shows our payment obligations for repayment of debt and other contractual obligations at November 30, 2014:
Long-Term Debt Obligations
Off-balance sheet arrangements
The Company’s off-balance sheet arrangements consisted of $12.8 million and $12.2 million of unfunded commitments to provide debt financing to its portfolio companies or to fund limited partnership interests as of November 30, 2014 and February 28, 2014, respectively. Such commitments are generally up to the Company’s discretion to approve, or the satisfaction of certain financial and nonfinancial covenants and involve, to varying degrees, elements of credit risk in excess of the amount recognized in the Company’s Consolidated Statement of Assets and Liabilities and are not reflected in the Company’s Consolidated Statements of Assets and Liabilities.
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Note 8. Directors Fees
The independent directors receive an annual fee of $40,000. They also receive $2,500 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each board meeting and receive $1,000 plus reimbursement of reasonable out-of-pocket expenses incurred in connection with attending each committee meeting. In addition, the chairman of the Audit Committee receives an annual fee of $5,000 and the chairman of each other committee receives an annual fee of $2,000 for their additional services in these capacities. In addition, we have purchased directors’ and officers’ liability insurance on behalf of our directors and officers. Independent directors have the option to receive their directors’ fees in the form of our common stock issued at a price per share equal to the greater of net asset value or the market price at the time of payment. No compensation is paid to directors who are “interested persons” of the Company (as such term is defined in the 1940 Act). For the three months ended November 30, 2014 and 2013, we accrued $0.05 million and $0.04 million for directors’ fees expense, respectively. For the nine months ended November 30, 2014 and 2013, we accrued $0.2 million and $0.1 million for directors’ fees expense, respectively. As of November 30, 2014 and February 28, 2014, $0.04 million and $0.05 million in directors’ fees expense were unpaid and included in accounts payable and accrued expenses in the consolidated statements of assets and liabilities. As of November 30, 2014, we had not issued any common stock to our directors as compensation for their services.
Note 9. Stockholders’ Equity
On May 16, 2006, GSC Group, Inc. capitalized the LLC, by contributing $1,000 in exchange for 67 shares, constituting all of the issued and outstanding shares of the LLC.
On March 20, 2007, the Company issued 95,995.5 and 8,136.2 shares of common stock, priced at $150.00 per share, to GSC Group and certain individual employees of GSC Group, respectively, in exchange for the general partnership interest and a limited partnership interest in GSC Partners CDO III GP, LP, collectively valued at $15.6 million. At this time, the 6.7 shares owned by GSC Group in the LLC were exchanged for 6.7 shares of the Company.
On March 28, 2007, the Company completed its IPO of 725,000 shares of common stock, priced at $150.00 per share, before underwriting discounts and commissions. Total proceeds received from the IPO, net of $7.1 million in underwriter’s discount and commissions, and $1.0 million in offering costs, were $100.7 million.
On November 13, 2009, we declared a dividend of $18.25 per share payable on December 31, 2009. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to $2.1 million or $2.50 per share. Based on shareholder elections, the dividend consisted of $2.1 million in cash and 864,872.5 of newly issued shares of common stock.
On July 30, 2010, our Manager and its affiliates purchased 986,842 shares of common stock at $15.20 per share. Total proceeds received from this sale were $15.0 million.
On August 12, 2010, we effected a one-for-ten reverse stock split of our outstanding common stock. As a result of the reverse stock split, every ten shares of our common stock were converted into one share of our common stock. Any fractional shares received as a result of the reverse stock split were redeemed for cash. The total cash payment in lieu of shares was $230. Immediately after the reverse stock split, we had 2,680,842 shares of our common stock outstanding.
On November 12, 2010, we declared a dividend of $4.40 per share payable on December 29, 2010. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to approximately $1.2 million or $0.44 per share. Based on shareholder elections, the dividend consisted of approximately $1.2 million in cash and 596,235 shares of common stock.
On November 15, 2011, we declared a dividend of $3.00 per share payable on December 30, 2011. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to approximately $2.0 million or $0.60 per share. Based on shareholder elections, the dividend consisted of approximately $2.0 million in cash and 599,584 shares of common stock.
On November 9, 2012, the Company declared a dividend of $4.25 per share payable on December 31, 2012. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to approximately $3.3 million or $0.85 per share. Based on shareholder elections, the dividend consisted of approximately $3.3 million in cash and 853,455 shares of common stock.
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On October 30, 2013, the Company declared a dividend of $2.65 per share payable on December 27, 2013. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to approximately $2.5 million or $0.53 per share. Based on shareholder elections, the dividend consisted of approximately $2.5 million in cash and 649,500 shares of common stock.
On September 24, 2014, the Company declared a dividend of $0.18 per share payable on November 28, 2014. Shareholders had the option to receive payment of the dividend in cash, or receive shares of common stock pursuant to the Company’s DRIP. Based on shareholder elections, the dividend consisted of approximately $0.6 million in cash and 22,283 newly issued shares of common stock.
On September 24, 2014, the Company announced the approval of an open market share repurchase plan that allows it to repurchase up to 200,000 shares of its common stock at prices below its NAV as reported in its then most recently published financial statements. As of November 30, 2014, the Company had not purchased any shares of common stock pursuant to this repurchase plan.
Note 10. Earnings Per Share
In accordance with the provisions of FASB ASC 260, “Earnings per Share” (“ASC 260”), basic earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis.
The following information sets forth the computation of the weighted average basic and diluted net increase in net assets per share from operations for the three and nine months ended November 30, 2014 and 2013 (dollars in thousands except share and per share amounts):
Basic and diluted
Weighted average common shares outstanding
Earnings per common share-basic and diluted
Note 11. Dividend
On September 24, 2014, the Company declared a dividend of $0.22 per share payable on February 27, 2015. Shareholders have the option to receive payment of the dividend in cash, or receive shares of common stock pursuant to the Company’s DRIP.
On September 24, 2014, the Company declared a dividend of $0.18 per share payable on November 28, 2014. Shareholders had the option to receive payment of the dividend in cash, or receive shares of common stock pursuant to the Company’s DRIP. Based on shareholder elections, the dividend consisted of approximately $0.6 million in cash and 22,283 newly issued shares of common stock, or 0.4% of our outstanding common stock prior to the dividend payment. The number of shares of common stock comprising the stock portion was calculated based on a price of $14.37 per share, which equaled the volume weighted average trading price per share of the common stock on November 14, 17, 18, 19, 20, 21, 24, 25, 26 and 28, 2014.
On October 30, 2013, the Company declared a dividend of $2.65 per share payable on December 27, 2013. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to approximately $2.5 million or $0.53 per share. This dividend was declared in reliance on certain private letter rulings issued by the IRS concluding that a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20.0% of the aggregate declared distribution.
Based on shareholder elections, the dividend consisted of approximately $2.5 million in cash and 649,500 shares of common stock, or 13.7% of our outstanding common stock prior to the dividend payment. The number of shares of common stock comprising the stock portion was calculated based on a price of $15.439 per share, which equaled the volume weighted average trading price per share of the common stock on December 11, 13, and 16, 2013.
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Note 12. Financial Highlights
The following is a schedule of financial highlights for the nine months ended November 30, 2014 and 2013:
Per share data:
Net asset value at beginning of period
Net investment income(1)
Net realized and unrealized gains and (losses) on investments and derivatives
Distributions declared from net investment income
Other (2)
Net asset value at end of period
Shares outstanding at end of period
Per share market value at end of period
Total return based on market value(3)
Total return based on net asset value(4)
Ratio/Supplemental data:
Ratio of net investment income to average, net assets(5)
Ratio of operating expenses to average net assets(5)
Ratio of incentive management fees to average net assets(5)
Ratio of debt related expenses to average net assets(5)
Ratio of total expenses to average net assets(5)
Portfolio turnover rate(6)
Note 13. Subsequent Events
Management has evaluated subsequent events through the date of issuance of the consolidated financial statements included herein. There have been no further subsequent events that occurred during such period that would require disclosure in this
Form 10-Q or would be required to be recognized in the consolidated financial statements as of and for the quarter ended November 30, 2014.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our financial statements and related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. In addition to historical information, the following discussion and other parts of this Quarterly Report contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to the factors discussed under Part I, Item 1A in our Annual Report on Form 10-K for the fiscal year ended February 28, 2014.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us or are within our control. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements.
The forward-looking statements contained in this Quarterly Report on Form 10-Q involve risks and uncertainties, including statements as to:
You should not place undue reliance on these forward-looking statements. The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.
OVERVIEW
We are a Maryland corporation that has elected to be treated as a business development company (“BDC”) under the Investment Company Act of 1940 (the “1940 Act”). Our investment objective is to generate current income and, to a lesser extent, capital appreciation from our investments. We invest primarily in leveraged loans and mezzanine debt issued by private U.S. middle market companies, which we define as companies having EBITDA of between $5 million and $50 million, both through direct lending and through participation in loan syndicates. We may also invest up to 30.0% of the portfolio in opportunistic investments in order to seek to enhance returns to stockholders. Such investments may include investments in distressed debt, which may include securities of companies in bankruptcy, foreign debt, private equity, securities of public companies that are not thinly traded and structured finance vehicles such as collateralized loan obligation funds. We have elected and qualified to be treated as a regulated investment company (“RIC”) under Subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”).
Corporate History
We commenced operations, at the time known as GSC Investment Corp., on March 23, 2007 and completed an initial public offering of shares of common stock on March 28, 2007. Prior to July 30, 2010, we were externally managed and advised by GSCP (NJ), L.P., an entity affiliated with GSC Group, Inc. In connection with the consummation of a recapitalization transaction on July 30, 2010, as described below we engaged Saratoga Investment Advisors (“SIA”) to replace GSCP (NJ), L.P. as our investment adviser and changed our name to Saratoga Investment Corp.
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As a result of the event of default under a revolving securitized credit facility with Deutsche Bank we previously had in place, in December 2008 we engaged the investment banking firm of Stifel, Nicolaus & Company to evaluate strategic transaction opportunities and consider alternatives for us. On April 14, 2010, GSC Investment Corp. entered into a stock purchase agreement with Saratoga Investment Advisors and certain of its affiliates and an assignment, assumption and novation agreement with Saratoga Investment Advisors, pursuant to which GSC Investment Corp. assumed certain rights and obligations of Saratoga Investment Advisors under a debt commitment letter Saratoga Investment Advisors received from Madison Capital Funding LLC, which indicated Madison Capital Funding’s willingness to provide GSC Investment Corp. with a $40.0 million senior secured revolving credit facility, subject to the satisfaction of certain terms and conditions. In addition, GSC Investment Corp. and GSCP (NJ), L.P. entered into a termination and release agreement, to be effective as of the closing of the transaction contemplated by the stock purchase agreement, pursuant to which GSCP (NJ), L.P., among other things, agreed to waive any and all accrued and unpaid deferred incentive management fees up to and as of the closing of the transaction contemplated by the stock purchase agreement but continued to be entitled to receive the base management fees earned through the date of the closing of the transaction contemplated by the stock purchase agreement.
On July 30, 2010, the transactions contemplated by the stock purchase agreement with Saratoga Investment Advisors and certain of its affiliates were completed, the private sale of 986,842 shares of our common stock for $15.0 million in aggregate purchase price to Saratoga Investment Advisors and certain of its affiliates closed, the Company entered into the Credit Facility, and the Company began doing business as Saratoga Investment Corp.
We used the net proceeds from the private sale transaction and a portion of the funds available to us under the Credit Facility to pay the full amount of principal and accrued interest, including default interest, outstanding under our revolving securitized credit facility with Deutsche Bank. The revolving securitized credit facility with Deutsche Bank was terminated in connection with our payment of all amounts outstanding thereunder on July 30, 2010.
In January 2011, we registered for public resale the 982,842 shares of our common stock issued to Saratoga Investment Advisors and certain of its affiliates.
In May 2013, we issued $48.3 million in aggregate principal amount of our 7.50% unsecured notes due 2020 for net proceeds of $46.1 million after deducting underwriting commissions of $1.9 million and offering costs of $0.3 million. The proceeds included the underwriters’ full exercise of their overallotment option. Interest on these notes is paid quarterly in arrears on February 15, May 15, August 15 and November 15, at a rate of 7.50% per year, beginning August 15, 2013. The notes mature on May 31, 2020 and may be redeemed in whole or in part at any time or from time to time at our option on or after May 31, 2016. The notes are listed on the NYSE under the trading symbol “SAQ” with a par value of $25.00 per share.
Critical Accounting Policies
Basis of Presentation
The preparation of financial statements in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) requires management to make certain estimates and assumptions affecting amounts reported in the Company’s consolidated financial statements. We have identified investment valuation, revenue recognition and the recognition of capital gains incentive fee expense as our most critical accounting estimates. We continuously evaluate our estimates, including those related to the matters described below. These estimates are based on the information that is currently available to us and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates under different assumptions or conditions. A discussion of our critical accounting policies follows.
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Investments for which market quotations are readily available are fair valued at such market quotations obtained from independent third party pricing services and market makers subject to any decision by our board of directors to approve a fair value determination to reflect significant events affecting the value of these investments. We value investments for which market quotations are not readily available at fair value as approved, in good faith, by our board of directors based on input from Saratoga Investment Advisers, the audit committee of our board of directors and a third party independent valuation firm. Determinations of fair value may involve subjective judgments and estimates. The types of factors that may be considered in determining the fair value of our investments include the nature and realizable value of any collateral, the portfolio company’s ability to make payments, market yield trend analysis, the markets in which the portfolio company does business, comparison to publicly traded companies, discounted cash flow and other relevant factors. We undertake a multi-step valuation process each quarter when valuing investments for which market quotations are not readily available, as described below:
Our investment in Saratoga Investment Corp. CLO 2013-1, Ltd. (“Saratoga CLO”) is carried at fair value, which is based on a discounted cash flow model that utilizes prepayment, re-investment and loss assumptions based on historical experience and projected performance, economic factors, the characteristics of the underlying cash flow, and comparable yields for equity interests in collateralized loan obligation funds similar to Saratoga CLO, when available, as determined by SIA and recommended to our board of directors. Specifically, we use Intex cash flow models, or an appropriate substitute, to form the basis for the valuation of our investment in Saratoga CLO. The models use a set of assumptions including projected default rates, recovery rates, reinvestment rate and prepayment rates in order to arrive at estimated valuations. The assumptions are based on available market data and projections provided by third parties as well as management estimates. We use the output from the Intex models (i.e., the estimated cash flows) to perform a discounted cash flows analysis on expected future cash flows to determine a valuation for our investment in Saratoga CLO.
Revenue Recognition
Income Recognition
Interest income, adjusted for amortization of premium and accretion of discount, is recorded on an accrual basis to the extent that such amounts are expected to be collected. The Company stops accruing interest on its investments when it is determined that interest is no longer collectible. Discounts and premiums on investments purchased are accreted/amortized over the life of the respective investment using the effective yield method. The amortized cost of investments represents the original cost adjusted for the accretion of discounts and amortizations of premium on investments.
Interest income on our investment in Saratoga CLO is recorded using the effective interest method in accordance with the provisions of ASC Topic 325-40, Investments-Other, Beneficial Interests in Securitized Financial Assets, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the investment from the date the estimated yield was changed.
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The Company records an expense accrual relating to the capital gains incentive fee payable by the Company to its investment adviser when the unrealized gains on its investments exceed all realized capital losses on its investments given the fact that a capital gains incentive fee would be owed to the investment adviser if the Company were to liquidate its investment portfolio at such time. The actual incentive fee payable to the Company’s investment adviser related to capital gains will be determined and payable in arrears at the end of each fiscal year and will include only realized capital gains for the period.
Revenues
We generate revenue in the form of interest income and capital gains on the debt investments that we hold and capital gains, if any, on equity interests that we may acquire. We expect our debt investments, whether in the form of leveraged loans or mezzanine debt, to have terms of up to ten years, and to bear interest at either a fixed or floating rate. Interest on debt will be payable generally either quarterly or semi-annually. In some cases, our debt investments may provide for a portion of the interest to be PIK. To the extent interest is paid-in-kind, it will be payable through the increase of the principal amount of the obligation by the amount of interest due on the then-outstanding aggregate principal amount of such obligation. The principal amount of the debt and any accrued but unpaid interest will generally become due at the maturity date. In addition, we may generate revenue in the form of commitment, origination, structuring or diligence fees, fees for providing managerial assistance or investment management services and possibly consulting fees. Any such fees will be generated in connection with our investments and recognized as earned. We may also invest in preferred equity securities that pay dividends on a current basis.
On January 22, 2008, we entered into a collateral management agreement with Saratoga CLO, pursuant to which we act as its collateral manager. The Saratoga CLO was refinanced in October 2013 and its reinvestment period ends in October 2016. The Saratoga CLO remains 100% owned and managed by Saratoga Investment Corp. We receive a senior collateral management fee of 0.25% and a subordinate collateral management fee of 0.25% of the outstanding principal amount of Saratoga CLO’s assets, paid quarterly to the extent of available proceeds. We are also entitled to an incentive management fee equal to 20.0% of excess cash flow to the extent the Saratoga CLO subordinated notes receive an internal rate of return equal to or greater than 12.0%.
We recognize interest income on our investment in the subordinated notes of Saratoga CLO using the effective interest method, based on the anticipated yield and the estimated cash flows over the projected life of the investment. Yields are revised when there are changes in actual or estimated cash flows due to changes in prepayments and/or re-investments, credit losses or asset pricing. Changes in estimated yield are recognized as an adjustment to the estimated yield over the remaining life of the investment from the date the estimated yield was changed.
Expenses
Our primary operating expenses include the payment of investment advisory and management fees, professional fees, directors and officers insurance, fees paid to independent directors and administrator expenses, including our allocable portion of our administrator’s overhead. Our investment advisory and management fees compensate our investment adviser for its work in identifying, evaluating, negotiating, closing and monitoring our investments. We bear all other costs and expenses of our operations and transactions, including those relating to:
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Pursuant to the investment advisory and management agreement that we had with GSCP (NJ), L.P., our former investment adviser and administrator, we had agreed to pay GSCP (NJ), L.P. as investment adviser a quarterly base management fee of 1.75% of the average value of our total assets (other than cash or cash equivalents but including assets purchased with borrowed funds) at the end of the two most recently completed fiscal quarters, and appropriately adjusted for any share issuances or repurchases during the applicable fiscal quarter, and an incentive fee.
The incentive fee had two parts:
We deferred cash payment of any incentive fee otherwise earned by our former investment adviser if, during the then most recent four full fiscal quarters ending on or prior to the date such payment was to be made, the sum of (a) our aggregate distributions to our stockholders and (b) our change in net assets (defined as total assets less liabilities) (before taking into account any incentive fees payable during that period) was less than 7.5% of our net assets at the beginning of such period. These calculations were appropriately pro-rated for the first three fiscal quarters of operation and adjusted for any share issuances or repurchases during the applicable period. Such incentive fee would become payable on the next date on which such test had been satisfied for the most recent four full fiscal quarters or upon certain terminations of the investment advisory and management agreement. We commenced deferring cash payment of incentive fees during the quarterly period ended August 31, 2007, and continued to defer such payments through the quarterly period ended May 31, 2010. As of July 30, 2010, the date on which GSCP (NJ), L.P. ceased to be our investment adviser and administrator, we owed GSCP (NJ), L.P. $2.9 million in fees for services previously provided to us; of which $0.3 million has been paid by us. GSCP (NJ), L.P. agreed to waive payment by us of the remaining $2.6 million in connection with the consummation of the stock purchase transaction with Saratoga Investment Advisors and certain of its affiliates described elsewhere in this Annual Report.
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The terms of the investment advisory and management agreement with Saratoga Investment Advisors, our current investment adviser, are substantially similar to the terms of the investment advisory and management agreement we had entered into with GSCP (NJ), L.P., our former investment adviser, except for the following material distinctions in the fee terms:
To the extent that any of our leveraged loans are denominated in a currency other than U.S. dollars, we may enter into currency hedging contracts to reduce our exposure to fluctuations in currency exchange rates. We may also enter into interest rate hedging agreements. Such hedging activities, which will be subject to compliance with applicable legal requirements, may include the use of interest rate caps, futures, options and forward contracts. Costs incurred in entering into or settling such contracts will be borne by us.
Portfolio and investment activity
Corporate Debt Portfolio Overview
Number of investments(1)
Number of portfolio companies(1)
Average investment size(1)
Weighted average maturity(1)
Number of industries(1)
Average investment per portfolio company(1)
Non-performing or delinquent investments(1)
Fixed rate debt (% of interest bearing portfolio)(2)
Weighted average current coupon(2)
Floating rate debt (% of interest bearing portfolio)(2)
Weighted average current spread over LIBOR(2)
During the three months ended November 30, 2014, we made $30.6 million investments in new or existing portfolio companies and had $26.8 million in aggregate amount of exits and repayments resulting in net investments of $3.8 million for the period. During the three months ended November 30, 2013, we made $22.3 million investments in the new or existing portfolio companies and had $9.9 million in aggregate amount of exits and repayments resulting in net investments of $12.4 million for the period.
During the nine months ended November 30, 2014, we made $84.0 million investments in new or existing portfolio companies and had $51.2 million in aggregate amount of exits and repayments resulting in net investments of $32.8 million for the period. During the nine months ended November 30, 2013, we made $110.1 million investments in new or existing portfolio companies and had $65.0 million in aggregate amount of exits and repayments resulting in net investments of $45.1 million for the period.
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Our portfolio composition based on fair value at November 30, 2014 and February 28, 2014 was as follows:
Portfolio composition
Saratoga CLO subordinated notes
Our investment in the subordinated notes of Saratoga CLO represents a first loss position in a portfolio that, at November 30, 2014 and February 28, 2014, was composed of $302.6 million and $301.3 million, respectively, in aggregate principal amount of predominantly senior secured first lien term loans. This investment is subject to unique risks. (See “Risk Factors—Our investment in Saratoga CLO 2013-1 Ltd. constitutes a leveraged investment in a portfolio of predominantly senior secured first lien term loans and is subject to additional risks and volatility” in our Annual Report on Form 10-K for the fiscal year ended February 28, 2014.). We do not consolidate the Saratoga CLO portfolio in our financial statements. Accordingly, the metrics below do not include the underlying Saratoga CLO portfolio investments. However, at November 30, 2014, $289.3 million or 97.4% of the Saratoga CLO portfolio investments in terms of market value had a CMR (as defined below) color rating of green or yellow and one Saratoga CLO portfolio investment was in default. At February 28, 2014, $298.9 million or 99.5% of the Saratoga CLO portfolio investments in terms of market value had a CMR color rating of green or yellow and no Saratoga CLO portfolio investments were in default.
Saratoga Investment Advisors normally grades all of our investments using a credit and monitoring rating system (“CMR”). The CMR consists of a single component: a color rating. The color rating is based on several criteria, including financial and operating strength, probability of default, and restructuring risk. The color ratings are characterized as follows: (Green)—strong credit; (Yellow)—satisfactory credit; (Red)—payment default risk, in payment default and/or significant restructuring activity.
The CMR distribution of our investments at November 30, 2014 and February 28, 2014 was as follows:
Portfolio CMR distribution
Color
Score
Green
Yellow
Red
N/A(1)
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The CMR distribution of Saratoga CLO investments at November 30, 2014 and February 28, 2014 was as follows:
Portfolio composition by industry grouping at fair value
The following table shows the portfolio composition by industry grouping at fair value at November 30, 2014 and February 28, 2014:
Software
Business Services
Healthcare Services
Consumer Services
Structured Finance Securities(1)
Automotive Aftermarket
Food and Beverage
Media
Electronics
Utilities
Metals
Manufacturing
Consumer Products
Building Products
Publishing
Education
Environmental
Homebuilding
Aerospace
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The following table shows the portfolio composition by industry grouping of Saratoga CLO at fair value at November 30, 2014 and February 28, 2014:
Business Equipment and Services
Healthcare
Chemicals/Plastics
Conglomerate
Industrial Equipment
Electronics/Electric
Leisure Goods/Activities/Movies
Financial Intermediaries
Drugs
Food Services
Aerospace and Defense
Oil and Gas
Telecommunications
Automotive
Containers/Glass Products
Lodging and Casinos
Food Products
Food/Drug Retailers
Brokers/Dealers/Investment Houses
Cable and Satellite Television
Telecommunications/Cellular
Nonferrous Metals/Minerals
Ecological Services and Equipment
Building and Development
Broadcast Radio and Television
Health Insurance
Computers and Electronics
Gaming and Hotels
Leasing
Portfolio composition by geographic location at fair value
The following table shows the portfolio composition by geographic location at fair value at November 30, 2014 and February 28, 2014. The geographic composition is determined by the location of the corporate headquarters of the portfolio company.
Southeast
Midwest
Northeast
West
Other(1)
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Results of operations
Operating results for the three and nine months ended November 30, 2014 and 2013 are as follows:
Total expenses, net
Net realized gains
Net unrealized losses
Net increase in net assets resulting from operations
Investment income
The composition of our investment income for the three and nine months ended November 30, 2014 and 2013 was as follows:
Management fee income from Saratoga CLO
Interest from cash and cash equivalents and other income
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For the three months ended November 30, 2014, total investment income increased $1.5 million, or 25.9% compared to the three months ended November 30, 2013. Interest income from investments increased $1.1 million, or 21.2%, to $6.1 million for the three months ended November 30, 2014, from $5.0 million for the three months ended November 30, 2013. This reflects an increase of 21.3% in total investments to $241.2 million at November 30, 2014 from $198.8 million at November 30, 2013, with the weighted average yield also increasing to 11.9% from 10.8%. In addition, other income increased $0.5 million, or 127.4% from $0.4 million for the three months ended November 30, 2013 to $0.9 million for the three months ended November 30, 2014, reflecting the receipt of an increased number of dividends during those three months.
For the nine months ended November 30, 2014, total investment income increased $2.7 million, or 15.8%, compared to the nine months ended November 30, 2013. Interest income from investments increased $2.7 million, or 18.3%, to $17.7 million for the nine months ended November 30, 2014, from $15.0 million for the nine months ended November 30, 2013. This reflects an increase of 21.3% in total investments to $241.2 million at November 30, 2014 from $198.8 million at November 30, 2013, with the weighted average yield also increasing to 11.9% from 10.8%.
For the three and nine months ended November 30, 2014 and 2013, total PIK income was $0.3 million and $0.9 million, and $0.2 million and $0.6 million, respectively.
The Saratoga CLO was refinanced in October 2013. As a result, proceeds from principal payments in the loan portfolio of Saratoga CLO must now be used to paydown its outstanding notes. Thus, the management fee income and investment income that we receive from Saratoga CLO has declined from historical periods decreasing $0.04 million, or 9.0%, to $0.4 million and $0.2 million, or 17.9%, to $1.2 million, respectively, for the three and nine months ended November 30, 2014 from $0.4 million and $1.4 million for the three and nine months ended November 30, 2013, respectively.
Operating expenses
The composition of our expenses for the three and nine months ended November 30, 2014 and 2013 was as follows:
Operating Expenses
General and administrative and other expenses
For the three months ended November 30, 2014, total operating expenses increased $1.7 million, or 58.3% compared to the three months ended November 30, 2013. For the nine months ended November 30, 2014, total operating expenses increased $3.5 million or 36.7% compared to the nine months ended November 30, 2013.
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For the three months ended November 30, 2014 and 2013, the increase in interest and credit facility expense is primarily attributable to an increase in the amount of outstanding debt as compared to the prior periods, with higher levels of both the SBA debentures and the revolving credit facility outstanding. For the three months ended November 30, 2014, the weighted average interest rate on our outstanding indebtedness was 4.97% compared to 5.55% for the three months ended November 30, 2013. This decrease was primarily driven by an increase in SBA debentures that carry a lower interest rate but now make up a higher proportion of our overall debt, increasing from 43.3% of overall debt as of November 30, 2013 to 59.8% as of November 30, 2014.
For the nine months ended November 30, 2014 and 2013, the increase in interest and credit facility expense is primarily attributable to an increase in the amount of outstanding debt as compared to the prior periods, with increased levels of both the SBA debentures and the revolving credit facility outstanding. For the nine months ended November 30, 2014, the weighted average interest rate on our outstanding indebtedness was 5.13% for both the nine months ended November 30, 2013 and 2014.
For the three months ended November 30, 2014, base management fees increased $0.2 million, or 24.2% compared to the three months ended November 30, 2013. For the nine months ended November 30, 2014, base management fees increased $0.7 million, or 27.6% compared to the nine months ended November 30, 2013. The increase in base management fees results from the increase in the average value of our total assets, less cash and cash equivalents, from $200.9 million to $246.6 million as of November 30, 2013 and 2014, respectively.
For the three and nine months ended November 30, 2014, professional fees decreased $0.1 million or 27.8%, and increased $0.1 million, or 6.6%, respectively, compared to the three and nine months ended November 30, 2013.
For the three months ended November 30, 2014, incentive management fees increased $1.4 million compared to the three months ended November 30, 2013. For the three months ended November 30, 2014 incentive management fees were $0.9 million. For the three months ended November 30, 2013 there was a reduction of $0.5 million in incentive management fees which was related to capital losses, thereby offsetting incentive fees expense related to investment income. For the nine months ended November 30, 2014, incentive management fees increased $1.8 million or 819.1% compared to the nine months ended November 30, 2013. The increase in incentive management fees is primarily attributable to an increase in accrued incentive fees related to higher net investment income and incentive fee capital gains, offset by incentive management fee credits for the three months ended November 30, 2013, driven by net unrealized losses in that period.
As discussed above, the increase in interest and credit facility expense for the three and nine months ended November 30, 2014 and 2013 is primarily attributable to an increase in the amount of outstanding debt as compared to the prior periods. For the nine months ended November 30, 2014, the weighted average interest rate on the outstanding borrowings under the Credit Facility and notes payable was 7.50%, however the notes were only issued and outstanding from May 10, 2013, while they were outstanding for the full nine months ended November 30, 2014. For the three months ended November 30, 2014 and 2013, the weighted average interest rate on the outstanding borrowings of the SBA debentures was 3.16% and 3.16%, respectively. For the nine months ended November 30, 2014 and 2013, the weighted average interest rate on the outstanding borrowings of the SBA debentures was 3.16% and 2.99%, respectively.
Net realized gains/losses on sales of investments
For the three months ended November 30, 2014, the Company had $26.8 million of sales, repayments, exits or restructurings resulting in $2.8 million of net realized gains.
For the nine months ended November 30, 2014, the Company had $51.2 million of sales, repayments, exits or restructurings resulting in $3.2 million of net realized gains.
For the three months ended November 30, 2013, the Company had $9.9 million of sales, repayments, exits or restructurings resulting in $0.1 million of net realized gains.
For the nine months ended November 30, 2013, the Company had $65.0 million of sales, repayments, exits or restructurings resulting in $1.2 million of net realized gains.
Net unrealized appreciation/depreciation on investments
For the three months ended November 30, 2014, our investments had net unrealized depreciation of $2.0 million versus net unrealized depreciation of $1.7 million for the three months ended November 30, 2013. For the nine months ended November 30, 2014, our investments had net unrealized depreciation of $1.7 million versus net unrealized depreciation of $3.8 million for the nine months ended November 30, 2013. The most significant cumulative changes in unrealized appreciation and depreciation for the nine months ended November 30, 2014, were the following:
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Nine Months ended November 30, 2014
Issuer
Elyria Foundry Company, L.L.C.
Legacy Cabinets Holdings
Targus Holdings, Inc.
The $0.6 million of unrealized depreciation in our investment in Elyria Foundry Company, LLC was due to a decline in the company’s performance as a result of volume declines from key energy customers.
The $0.9 million of unrealized appreciation in our investment in Legacy Cabinets, Inc. was driven by significant fundamental growth, which increased the fair market value of the equity.
The $0.7 million of unrealized depreciation in our investment in Targus Holdings, Inc. was due to a decline in earnings resulting from weakened demand in the company’s end markets.
The most significant cumulative changes in unrealized appreciation and depreciation for the nine months ended November 30, 2013, were the following:
Nine months ended November 30, 2013
Saratoga CLO
USS Parent Holding Corp.
The $2.2 million of unrealized depreciation in our investment in Elyria Foundry Company, LLC was due to a weakened demand in oil and gas end-markets.
The $4.1 million of unrealized depreciation in our investment in the Saratoga CLO subordinated notes was due to lower net present value of projected future cash flows due to a smaller total portfolio and higher financing costs.
The $1.5 million of unrealized appreciation in our investment in the common stock of USS Parent Holding Corp. was due to improved operating performance.
Changes in net assets resulting from operations
For the three months ended November 30, 2014, we recorded a net increase in net assets resulting from operations of $3.5 million versus a net increase in net assets resulting from operations of $1.3 million for the three months ended November 30, 2013. Based on 5,379,616 and 4,851,451 weighted average common shares outstanding for the three months ended November 30, 2014 and November 30, 2013, respectively, our per share net increase in net assets resulting from operations was $0.64 for the three months ended November 30, 2014 versus a per share net increase in net assets from operations of $0.26 for the three months ended November 30, 2013.
For the nine months ended November 30, 2014, we recorded a net increase in net assets resulting from operations of $8.4 million versus a net increase in net assets resulting from operations of $5.0 million for the nine months ended November 30, 2013. Based on 5,379,616 and 4,770,267 weighted average common shares outstanding for the nine months ended November 30, 2014 and November 30, 2013, respectively, our per share net increase in net assets resulting from operations was $1.55 for the nine months ended November 30, 2014 versus a per share net increase in net assets from operations of $1.05 for the nine months ended November 30, 2013.
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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
We intend to continue to generate cash primarily from cash flows from operations, including interest earned from our investments in debt in middle market companies, interest earned from the temporary investment of cash in U.S. government securities and other high-quality debt investments that mature in one year or less, future borrowings and future offerings of securities.
Although we expect to fund the growth of our investment portfolio through the net proceeds from SBA debenture drawdowns and future equity offerings, including our dividend reinvestment plan, and issuances of senior securities or future borrowings, to the extent permitted by the 1940 Act, we cannot assure you that our plans to raise capital will be successful. In this regard, because our common stock has historically traded at a price below our current net asset value per share and we are limited in our ability to sell our common stock at a price below net asset value per share, we have been and may continue to be limited in our ability to raise equity capital. Our stockholders approved a proposal at our annual meeting of stockholders held on September 30, 2014 that authorizes us to sell shares of our common stock at an offering price per share to investors that is not less than 85% of our then current net asset value per share in one or more offerings for a period ending on the earlier of September 30, 2015 or the date of our next annual meeting of stockholders. We would need stockholder approval of a similar proposal to issue shares below net asset value per share at any time after the earlier of September 30, 2015 or our next annual meeting of stockholders.
In addition, we intend to distribute to our stockholders substantially all of our taxable income in order to satisfy the distribution requirement applicable to RICs under Subchapter M of the Code. In satisfying this distribution requirement, we have in the past relied on IRS issued private letter rulings concluding that a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20% of the aggregate declared distribution. We may rely on these IRS private letter rulings in future periods to satisfy our RIC distribution requirement.
Also, as a BDC, we generally are required to meet a coverage ratio of total assets, less liabilities and indebtedness not represented by senior securities, to total senior securities, which include all of our borrowings and any outstanding preferred stock, of at least 200%. This requirement limits the amount that we may borrow. Our asset coverage ratio, as defined in the 1940 Act, was 329.9% as of November 30, 2014 and 337.9% as of February 28, 2014. To fund growth in our investment portfolio in the future, we anticipate needing to raise additional capital from various sources, including the equity markets and other debt-related markets, which may or may not be available on favorable terms, if at all.
Consequently, we may not have the funds or the ability to fund new investments, to make additional investments in our portfolio companies, to fund our unfunded commitments to portfolio companies or to repay borrowings. Also, the illiquidity of our portfolio investments may make it difficult for us to sell these investments when desired and, if we are required to sell these investments, we may realize significantly less than their recorded value.
Madison revolving credit facility
Below is a summary of the terms of the senior secured revolving credit facility we entered into with Madison Capital Funding (the “Credit Facility”) on June 30, 2010.
Availability. The Company can draw up to the lesser of (i) $40.0 million (the “Facility Amount”) and (ii) the product of the applicable advance rate (which varies from 50.0% to 75.0% depending on the type of loan asset) and the value, determined in accordance with the Credit Facility (the “Adjusted Borrowing Value”), of certain “eligible” loan assets pledged as security for the loan (the “Borrowing Base”), in each case less (a) the amount of any undrawn funding commitments the Company has under any loan asset and which are not covered by amounts in the Unfunded Exposure Account referred to below (the “Unfunded Exposure Amount”) and (b) outstanding borrowings. Each loan asset held by the Company as of the date on which the Credit Facility was closed was valued as of that date and each loan asset that the Company acquires after such date will be valued at the lowest of its fair value, its face value (excluding accrued interest) and the purchase price paid for such loan asset. Adjustments to the value of a loan asset will be made to reflect, among other things, changes in its fair value, a default by the obligor on the loan asset, insolvency of the obligor, acceleration of the loan asset, and certain modifications to the terms of the loan asset.
The Credit Facility contains limitations on the type of loan assets that are “eligible” to be included in the Borrowing Base and as to the concentration level of certain categories of loan assets in the Borrowing Base such as restrictions on geographic and industry concentrations, asset size and quality, payment frequency, status and terms, average life, and collateral interests. In addition, if an asset is to remain an “eligible” loan asset, the Company may not make changes to the payment, amortization, collateral and certain other terms of the loan assets without the consent of the administrative agent that will either result in subordination of the loan asset or be materially adverse to the lenders.
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Collateral. The Credit Facility is secured by substantially all of the assets of the Company (other than assets held by our SBIC subsidiary) and includes the subordinated notes (“CLO Notes”) issued by Saratoga CLO and the Company’s rights under the CLO Management Agreement (as defined below).
Interest Rate and Fees. Under the Credit Facility, funds are borrowed from or through certain lenders at the greater of the prevailing LIBOR rate and 2.00%, plus an applicable margin of 5.50%. At the Company’s option, funds may be borrowed based on an alternative base rate, which in no event will be less than 3.00%, and the applicable margin over such alternative base rate is 4.50%. In addition, the Company pays the lenders a commitment fee of 0.75% per year on the unused amount of the Credit Facility for the duration of the Revolving Period (defined below). Accrued interest and commitment fees are payable monthly. The Company was also obligated to pay certain other fees to the lenders in connection with the closing of the Credit Facility.
Revolving Period and Maturity Date. The Company may make and repay borrowings under the Credit Facility for a period of three years following the closing of the Credit Facility (the “Revolving Period”). The Revolving Period may be terminated at an earlier time by the Company or, upon the occurrence of an event of default, by action of the lenders or automatically. All borrowings and other amounts payable under the Credit Facility are due and payable in full five years after the end of the Revolving Period.
Collateral Tests. It is a condition precedent to any borrowing under the Credit Facility that the principal amount outstanding under the Credit Facility, after giving effect to the proposed borrowings, not exceed the lesser of the Borrowing Base or the Facility Amount (the “Borrowing Base Test”). In addition to satisfying the Borrowing Base Test, the following tests must also be satisfied (together with Borrowing Base Test, the “Collateral Tests”):
The Credit Facility also requires payment of outstanding borrowings or replacement of pledged loan assets upon the Company’s breach of its representation and warranty that pledged loan assets included in the Borrowing Base are “eligible” loan assets. Such payments or replacements must equal the lower of the amount by which the Borrowing Base is overstated as a result of such breach or any deficiency under the Collateral Tests at the time of repayment or replacement. Compliance with the Collateral Tests is also a condition to the discretionary sale of pledged loan assets by the Company.
Priority of Payments. During the Revolving Period, the priority of payments provisions of the Credit Facility require, after payment of specified fees and expenses and any necessary funding of the Unfunded Exposure Account, that collections of principal from the loan assets and, to the extent that these are insufficient, collections of interest from the loan assets, be applied on each payment date to payment of outstanding borrowings if the Borrowing Base Test, the Overcollateralization Ratio and the Interest Coverage Ratio would not otherwise be met. Similarly, following termination of the Revolving Period, collections of interest are required to be applied, after payment of certain fees and expenses, to cure any deficiencies in the Borrowing Base Test, the Interest Coverage Ratio and the Overcollateralization Ratio as of the relevant payment date.
Reserve Account. The Credit Facility requires the Company to set aside an amount equal to the sum of accrued interest, commitment fees and administrative agent fees due and payable on the next succeeding three payment dates (or corresponding to three payment periods). If for any monthly period during which fees and other payments accrue, the aggregate Adjusted Borrowing Value of “eligible” pledged loan assets which do not pay cash interest at least quarterly exceeds 15.0% of the aggregate Adjusted Borrowing Value of “eligible” pledged loan assets, the Company is required to set aside such interest and fees due and payable on the next succeeding six payment dates. Amounts in the reserve account can be applied solely to the payment of administrative agent fees, commitment fees, accrued and unpaid interest and any breakage costs payable to the lenders.
Unfunded Exposure Account. With respect to revolver or delayed draw loan assets, the Company is required to set aside in a designated account (the “Unfunded Exposure Account”) 100.0% of its outstanding and undrawn funding commitments with respect to such loan assets. The Unfunded Exposure Account is funded at the time the Company acquires a revolver or delayed draw loan asset and requests a related borrowing under the Credit Facility. The Unfunded Exposure Account is funded through a combination of proceeds of the requested borrowing and other Company funds, and if for any reason such amounts are insufficient, through application of the priority of payment provisions described above.
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Operating Expenses. The priority of payments provision of the Credit Facility provides for the payment of certain operating expenses of the Company out of collections on principal and interest during the Revolving Period and out of collections on interest following the termination of the Revolving Period in accordance with the priority established in such provision. The operating expenses payable pursuant to the priority of payment provisions is limited to $350,000 for each monthly payment date or $2.5 million for the immediately preceding period of twelve consecutive monthly payment dates. This ceiling can be increased by the lesser of 5.0% or the percentage increase in the fair market value of all the Company’s assets only on the first monthly payment date to occur after each one-year anniversary following the closing of the Credit Facility. Upon the occurrence of a Manager Event (described below), the consent of the administrative agent is required in order to pay operating expenses through the priority of payments provision.
Events of Default. The Credit Facility contains certain negative covenants, customary representations and warranties and affirmative covenants and events of default. The Credit Facility does not contain grace periods for breach by the Company of certain covenants, including, without limitation, preservation of existence, negative pledge, change of name or jurisdiction and separate legal entity status of the Company covenants and certain other customary covenants. Other events of default under the Credit Facility include, among other things, the following:
Conditions to Acquisitions and Pledges of Loan Assets. The Credit Facility imposes certain additional conditions to the acquisition and pledge of additional loan assets. Among other things, the Company may not acquire additional loan assets without the prior written consent of the administrative agent until such time that the administrative agent indicates in writing its satisfaction with Saratoga Investment Advisors’ policies, personnel and processes relating to the loan assets.
Fees and Expenses. The Company paid certain fees and reimbursed Madison Capital Funding for the aggregate amount of all documented, out-of-pocket costs and expenses, including the reasonable fees and expenses of lawyers, incurred by Madison Capital Funding in connection with the Credit Facility and the carrying out of any and all acts contemplated thereunder up to and as of the date of closing of the stock purchase transaction with Saratoga Investment Advisors and certain of its affiliates. These amounts totaled $2.0 million.
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As of November 30, 2014, we had $4.9 million outstanding under the Credit Facility and $79.0 million SBA-guaranteed debentures outstanding (which are discussed below). As of February 28, 2014, we had no outstanding balance under the Credit Facility and $50.0 million SBA-guaranteed debentures outstanding. Our borrowing base under the Credit Facility at November 30, 2014 and February 28, 2014 was $37.1 million, and $44.6 million, respectively.
Our asset coverage ratio, as defined in the 1940 Act, was 329.9% as of November 30, 2014 and 337.9% as of February 28, 2014.
SBA-guaranteed debentures
In addition, we, through a wholly-owned subsidiary, sought and obtained a license from the SBA to operate an SBIC. In this regard, on March 28, 2012, our wholly-owned subsidiary, Saratoga Investment Corp. SBIC, LP, received a license from the SBA to operate as an SBIC under Section 301(c) of the Small Business Investment Act of 1958. SBICs are designated to stimulate the flow of private equity capital to eligible small businesses. Under SBA regulations, SBICs may make loans to eligible small businesses and invest in the equity securities of small businesses.
The SBIC license allows our SBIC subsidiary to obtain leverage by issuing SBA-guaranteed debentures. SBA-guaranteed debentures are non-recourse, interest only debentures with interest payable semi-annually and have a ten year maturity. The principal amount of SBA-guaranteed debentures is not required to be paid prior to maturity but may be prepaid at any time without penalty. The interest rate of SBA-guaranteed debentures is fixed on a semi-annual basis at a market-driven spread over U.S. Treasury Notes with 10-year maturities.
SBA regulations currently limit the amount that our SBIC subsidiary may borrow to a maximum of $150 million when it has at least $75 million in regulatory capital, receives a capital commitment from the SBA and has been through an examination by the SBA subsequent to licensing. As of November 30, 2014, our SBIC subsidiary had $59.3 million in regulatory capital and $79.0 million SBA-guaranteed debentures outstanding.
We received exemptive relief from the Securities and Exchange Commission to permit us to exclude the debt of our SBIC subsidiary guaranteed by the SBA from the definition of senior securities in the 200% asset coverage test under the 1940 Act. This allows us increased flexibility under the 200% asset coverage test by permitting us to borrow up to $150 million more than we would otherwise be able to absent the receipt of this exemptive relief.
In May 2013, we issued $48.3 million in aggregate principal amount of our 7.50% unsecured notes due 2020 for net proceeds of $46.1 million after deducting underwriting commissions of $1.9 million and offering costs of $0.3 million. The proceeds included the underwriters’ full exercise of their overallotment option. Interest on these notes is paid quarterly in arrears on February 15, May 15, August 15 and November 15, at a rate of 7.50% per year, beginning August 15, 2013. The notes mature on May 31, 2020 and may be redeemed in whole or in part at any time or from time to time at our option on or after May 31, 2016. In connection with the issuance of the notes, we agreed to the following covenants for the period of time during which the notes are outstanding:
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The Notes are listed on the NYSE under the trading symbol “SAQ” with a par value of $25.00 per share.
At November 30, 2014 and February 28, 2014, the fair value of investments, cash and cash equivalents and cash and cash equivalents, securitization accounts were as follows:
Cash and cash equivalents, securitization accounts
Equity Interest
On September 24, 2014, the Company declared a dividend of $0.22 per share payable on February 27, 2015. Shareholders have the option to receive payment of the dividend in cash, or receive shares of common stock, pursuant our DRIP.
On September 24, 2014, the Company declared a dividend of $0.18 per share payable on November 28, 2014. Shareholders had the option to receive payment of the dividend in cash, or receive shares of common stock pursuant to our DRIP. Based on shareholder elections, the dividend consisted of approximately $0.6 million in cash and 22,283 newly issued shares of common stock, or 0.4% of our outstanding common stock prior to the dividend payment. The number of shares of common stock comprising the stock portion was calculated based on a price of $14.37 per share, which equaled the volume weighted average trading price per share of the common stock on November 14, 17, 18, 19, 20, 21, 24, 25, 26 and 28, 2014.
On October 30, 2013, our board of directors declared a dividend of $2.65 per share payable on December 27, 2013, to common stockholders of record on November 13, 2013. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to approximately $2.5 million or $0.53 per share. This dividend was declared in reliance on certain private letter rulings issued by the IRS concluding that a RIC may treat a distribution of its own stock as fulfilling its RIC distribution requirements if each stockholder may elect to receive his or her entire distribution in either cash or stock of the RIC subject to a limitation on the aggregate amount of cash to be distributed to all stockholders, which limitation must be at least 20.0% of the aggregate declared distribution.
Based on shareholder elections, the dividend consisted of approximately $2.5 million in cash and 649,500 shares of common stock, or 13.7% of our outstanding common stock prior to the dividend payment. The amount of cash elected to be received was greater than the cash limit of 20.0% of the aggregate dividend amount, thus resulting in the payment of a combination of cash and stock to shareholders who elected to receive cash. The number of shares of common stock comprising the stock portion was calculated based on a price of $15.439 per share, which equaled the volume weighted average trading price per share of the common stock on December 11, 13 and 16, 2013.
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On November 9, 2012, our board of directors declared a dividend of $4.25 per share payable on December 31, 2012, to common stockholders of record on November 20, 2012. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to approximately $3.3 million or $0.85 per share.
Based on shareholder elections, the dividend consisted of $3.3 million in cash and 853,455 shares of common stock, or 22.0% of our outstanding common stock prior to the dividend payment. The amount of cash elected to be received was greater than the cash limit of 20.0% of the aggregate dividend amount, thus resulting in the payment of a combination of cash and stock to shareholders who elected to receive cash. The number of shares of common stock comprising the stock portion was calculated based on a price of $15.444 per share, which equaled the volume weighted average trading price per share of the common stock on December 14, 17 and 19, 2012.
On November 15, 2011, our board of directors declared a dividend of $3.00 per share payable on December 30, 2011, to common stockholders of record on November 25, 2011. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to $2.0 million or $0.60 per share.
Based on shareholder elections, the dividend consisted of $2.0 million in cash and 599,584 shares of common stock, or 18.0% of our outstanding common stock prior to the dividend payment. The amount of cash elected to be received was greater than the cash limit of 20.0% of the aggregate dividend amount, thus resulting in the payment of a combination of cash and stock to shareholders who elected to receive cash. The number of shares of common stock comprising the stock portion was calculated based on a price of $13.117067 per share, which equaled the volume weighted average trading price per share of the common stock on December 20, 21 and 22, 2011.
On November 12, 2010, our board of directors declared a dividend of $4.40 per share to shareholders payable in cash or shares of our common stock, in accordance with the provisions of the IRS Revenue Procedure 2010-12, which allows a publicly-traded regulated investment company to satisfy its distribution requirements with a distribution paid partly in common stock provided that at least 10.0% of the distribution is payable in cash. The dividend was paid on December 29, 2010 to common shareholders of record on November 19, 2010.
Based on shareholder elections, the dividend consisted of $1.2 million in cash and 596,235 shares of common stock, or 22.0% of our outstanding common stock prior to the dividend payment. The amount of cash elected to be received was greater than the cash limit of 10.0% of the aggregate dividend amount, thus resulting in the payment of a combination of cash and stock to shareholders who elected to receive cash. The number of shares of common stock comprising the stock portion was calculated based on a price of $17.8049 per share, which equaled the volume weighted average trading price per share of the common stock on December 20, 21 and 22, 2010.
On November 13, 2009, our board of directors declared a dividend of $18.25 per share payable on December 31, 2009, to common stockholders of record on November 25, 2009. Shareholders had the option to receive payment of the dividend in cash, shares of common stock, or a combination of cash and shares of common stock, provided that the aggregate cash payable to all shareholders was limited to $2.1 million or $0.25 per share.
Based on shareholder elections, the dividend consisted of $2.1 million in cash and 8,648,725 shares of common stock, or 104.0% of our outstanding common stock prior to the dividend payment. The amount of cash elected to be received was greater than the cash limit of 13.7% of the aggregate dividend amount, thus resulting in the payment of a combination of cash and stock to shareholders who elected to receive cash. The number of shares of common stock comprising the stock portion was calculated based on a price of $1.5099 per share, which equaled the volume weighted average trading price per share of the common stock on December 24 and 28, 2009.
We cannot provide any assurance that these measures will provide sufficient sources of liquidity to support our operations and growth.
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On July 10, 2014, our board of directors appointed Henri J. Steenkamp to serve as our Chief Financial Officer and Chief Compliance Officer. As previously disclosed, Mr. Steenkamp was previously appointed to serve as our Interim Chief Financial Officer and Interim Chief Compliance Officer on March 4, 2014.
On July 10, 2014, our board of directors, including a majority of the independent directors, approved the annual continuation of our investment advisory and management agreement with Saratoga Investment Advisors, LLC. Our board of directors also approved the renewal of the administration agreement with Saratoga Investment Advisors, LLC for an additional one-year term and determined to maintain the cap on the payment or reimbursement of expenses by us thereunder to $1.0 million for the additional one-year term.
Recent Developments
None.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our market risks have not changed materially from the risks reported in our Form 10-K for the year ended February 28, 2014.
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On August 31, 2012, a complaint was filed in the United States Bankruptcy Court for the Southern District of New York by GSC Acquisition Holdings, LLC against us to recover, among other things, approximately $2.6 million for the benefit of the estates and the general unsecured creditors of GSC Group, Inc. and its affiliates, including the Company’s former investment adviser, GSCP
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(NJ), L.P. The complaint alleges that the former investment adviser made a constructively fraudulent transfer of $2.6 million in deferred incentive fees by waiving them in connection with the termination of the Management Agreement with us, and that the termination of the Management Agreement was itself a fraudulent transfer. These transfers, the complaint alleges, were made without receipt of reasonably equivalent value and while the former investment adviser was insolvent. The complaint has not yet been served, and the plaintiff’s motion for authority to prosecute the case on behalf of the estates was taken under advisement by the court on October 1, 2012. We opposed that motion. We believe that the claims in this lawsuit are without merit and, if the plaintiff is authorized to proceed, intend to vigorously defend against this action.
Except as discussed above, neither we nor our wholly-owned subsidiaries, Saratoga Investment Funding LLC and Saratoga Investment Corp. SBIC LP, are currently subject to any material legal proceedings.
Item 1A. Risk Factors
Other than as set forth below, there have been no material changes from the risk factors set forth in our annual report on Form 10-K for the year ended February 28, 2014.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3. Defaults upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Listed below are the exhibits which are filed as part of this report (according to the number assigned to them in Item 601 of Regulation S-K):
Exhibit
Number
Description of Document
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
/s/ CHRISTIAN L. OBERBECK
/s/ HENRI J. STEENKAMP
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