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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x  Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended May 31, 2012

 

o  Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Commission File Number: 1-33376

 

SARATOGA INVESTMENT CORP.

(Exact name of registrant as specified in its charter)

 

Maryland

 

20-8700615

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

535 Madison Avenue
New York, New York

 

10022

(Address of principal executive office)

 

(Zip Code)

 

(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 o

 

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 o No o

 

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):

 

Large Accelerated Filer o

 

Accelerated Filer o

 

 

 

Non-Accelerated Filer x

 

Smaller Reporting Company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of July 16, 2012 was 3,876,661.

 

 

 



Table of Contents

 

SARATOGA INVESTMENT CORP.

FORM 10-Q FOR THE QUARTER ENDED MAY 31, 2012

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

PART I

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Statements of Assets and Liabilities as of May 31, 2012 (unaudited) and February 29, 2012

3

 

 

 

 

Consolidated Statements of Operations for the three months ended May 31, 2012 and 2011(unaudited)

4

 

 

 

 

Consolidated Schedules of Investments as of May 31, 2012 (unaudited) and February 29, 2012

5

 

 

 

 

Consolidated Statements of Changes in Net Assets for the three months ended May 31, 2012 and 2011 (unaudited)

9

 

 

 

 

Consolidated Statements of Cash Flows for the three months ended May 31, 2012 and 2011 (unaudited)

10

 

 

 

 

Notes to Consolidated Financial Statements as of May 31, 2012 (unaudited)

11

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

32

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

48

 

 

 

Item 4.

Controls and Procedures

49

 

 

 

PART II

OTHER INFORMATION

49

 

 

 

Item 1.

Legal Proceedings

49

 

 

 

Item 1A.

Risk Factors

49

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

 

Item 3.

Defaults upon Senior Securities

49

 

 

 

Item 4.

Mine Safety Disclosures

49

 

 

 

Item 5.

Other Information

49

 

 

 

Item 6.

Exhibits

50

 

 

 

Signatures

 

51

 

2



Table of Contents

 

Saratoga Investment Corp.

 

Consolidated Statements of Assets and Liabilities

 

 

 

As of

 

 

 

May 31, 2012

 

February 29, 2012

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Investments at fair value

 

 

 

 

 

Non-control/non-affiliate investments (amortized cost of $83,648,205 and $73,161,722, respectively)

 

$

81,495,260

 

$

69,513,434

 

Control investments (cost of $22,684,908 and $23,540,517, respectively)

 

25,234,885

 

25,846,414

 

Total investments at fair value (amortized cost of $106,333,113 and $96,702,239, respectively)

 

106,730,145

 

95,359,848

 

Cash and cash equivalents

 

2,377,041

 

1,325,698

 

Cash and cash equivalents, reserve accounts

 

26,058,523

 

25,534,195

 

Outstanding interest rate cap at fair value (cost of $0 and $131,000, respectively)

 

 

75

 

Interest receivable, (net of reserve of $347,052 and $273,361, respectively)

 

1,290,779

 

1,689,404

 

Deferred credit facility financing costs, net

 

1,098,341

 

1,199,490

 

Management fee receivable

 

227,850

 

227,581

 

Other assets

 

53,215

 

94,823

 

Receivable from unsettled trades

 

 

59,511

 

Total assets

 

$

137,835,894

 

$

125,490,625

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Revolving credit facility

 

$

20,000,000

 

$

20,000,000

 

Payable for unsettled trades

 

13,335,300

 

4,072,500

 

Management and incentive fees payable

 

3,135,987

 

2,885,670

 

Accounts payable and accrued expenses

 

561,711

 

704,949

 

Interest and credit facility fees payable

 

161,979

 

53,262

 

Due to manager

 

70,000

 

394,094

 

Total liabilities

 

$

37,264,977

 

$

28,110,475

 

 

 

 

 

 

 

NET ASSETS

 

 

 

 

 

Common stock, par value $.001, 100,000,000 common shares authorized, 3,876,661 and 3,876,661 common shares issued and outstanding, respectively

 

$

3,877

 

$

3,877

 

Capital in excess of par value

 

161,644,426

 

161,644,426

 

Distribution in excess of net investment income

 

(12,647,278

)

(13,920,068

)

Accumulated net realized loss from investments and derivatives

 

(48,827,137

)

(48,874,767

)

Net unrealized appreciation (depreciation) on investments and derivatives

 

397,029

 

(1,473,318

)

Total Net Assets

 

100,570,917

 

97,380,150

 

 

 

 

 

 

 

Total liabilities and Net Assets

 

$

137,835,894

 

$

125,490,625

 

 

 

 

 

 

 

NET ASSET VALUE PER SHARE

 

$

25.94

 

$

25.12

 

 

See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

Saratoga Investment Corp.

 

Consolidated Statements of Operations

 

 

 

For the three months
ended May 31, 2012

 

For the three months
ended May 31, 2011

 

 

 

(unaudited)

 

(unaudited)

 

 

 

 

 

 

 

INVESTMENT INCOME

 

 

 

 

 

Interest from investments

 

 

 

 

 

Non-control/Non-affiliate investments

 

$

2,064,985

 

$

1,497,889

 

Control investments

 

1,045,785

 

889,577

 

Total interest income

 

3,110,770

 

2,387,466

 

Interest from cash and cash equivalents

 

2,846

 

4,148

 

Management fee income

 

499,840

 

506,368

 

Other income

 

5,726

 

 

Total investment income

 

3,619,182

 

2,897,982

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

Interest and credit facility financing expenses

 

625,703

 

369,910

 

Base management fees

 

458,808

 

398,464

 

Professional fees

 

345,839

 

293,628

 

Administrator expenses

 

250,000

 

240,000

 

Incentive management fees

 

430,271

 

721,725

 

Insurance

 

130,307

 

156,982

 

Directors fees and expenses

 

51,000

 

51,000

 

General & administrative

 

51,341

 

86,354

 

Other expense

 

3,123

 

1,310

 

Total expenses

 

2,346,392

 

2,319,373

 

 

 

 

 

 

 

NET INVESTMENT INCOME

 

1,272,790

 

578,609

 

 

 

 

 

 

 

REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:

 

 

 

 

 

Net realized gain from investments

 

178,630

 

98,008

 

Net realized loss from derivatives

 

(131,000

)

 

Net unrealized appreciation on investments

 

1,739,422

 

5,043,135

 

Net unrealized appreciation (depreciation) on derivatives

 

130,925

 

(10,542

)

Net gain on investments

 

1,917,977

 

5,130,601

 

 

 

 

 

 

 

NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS

 

$

3,190,767

 

$

5,709,210

 

 

 

 

 

 

 

WEIGHTED AVERAGE - BASIC AND DILUTED EARNINGS PER COMMON SHARE

 

$

0.82

 

$

1.74

 

 

 

 

 

 

 

WEIGHTED AVERAGE COMMON STOCK OUTSTANDING - BASIC AND DILUTED

 

3,876,661

 

3,277,077

 

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

Saratoga Investment Corp.

 

Consolidated Schedule of Investments

 

May 31, 2012

(unaudited)

 

Company (a)

 

Industry

 

Investment Interest
Rate/Maturity

 

Principal/
Number of Shares

 

Cost

 

Fair Value (c)

 

% of
Net Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-control/Non-affiliated investments - 81.0% (b)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Coast Plating, Inc. (d)

 

Aerospace

 

First Lien Term Loan
11.75% Cash, 9/13/2014

 

$

2,550,000

 

$

2,550,000

 

$

2,550,000

 

2.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Coast Plating, Inc. (d)

 

Aerospace

 

First Lien Term Loan
13.25% Cash, 9/13/2014

 

$

950,000

 

950,000

 

950,000

 

0.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Aerospace

 

 

 

3,500,000

 

3,500,000

 

3.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Take 5 Oil Change, L.L.C. (d)

 

Automotive

 

First Lien Term Loan
10.00% Cash, 11/28/2016

 

$

7,000,000

 

7,000,000

 

7,000,000

 

7.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Take 5 Oil Change, L.L.C. (d), (h)

 

Automotive

 

Common Stock

 

7,128

 

712,800

 

712,800

 

0.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Automotive

 

 

 

7,712,800

 

7,712,800

 

7.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Legacy Cabinets Holdings (d), (h)

 

Building Products

 

Common Stock Voting A-1

 

2,535

 

220,900

 

 

0.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Legacy Cabinets Holdings (d), (h)

 

Building Products

 

Common Stock Voting B-1

 

1,600

 

139,424

 

 

0.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Legacy Cabinets, Inc. (d)

 

Building Products

 

First Lien Term Loan
7.25% (1.00% Cash/6.25% PIK), 5/3/2014

 

$

317,050

 

317,050

 

212,360

 

0.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Building Products

 

 

 

677,374

 

212,360

 

0.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SourceHOV LLC (d)

 

Business Services

 

Second Lien Term Loan
10.50% Cash, 4/30/2018

 

$

3,000,000

 

2,600,000

 

2,550,300

 

2.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Business Services

 

 

 

2,600,000

 

2,550,300

 

2.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Targus Group International, Inc. (d)

 

Consumer Products

 

First Lien Term Loan
11.00% Cash, 5/24/2016

 

$

3,970,000

 

3,906,049

 

3,970,000

 

3.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Targus Holdings, Inc. (d)

 

Consumer Products

 

Unsecured Notes
10.00% PIK, 6/14/2019

 

$

1,799,479

 

1,799,479

 

985,215

 

1.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Targus Holdings, Inc. (d), (h)

 

Consumer Products

 

Common Stock

 

62,413

 

566,765

 

3,681,119

 

3.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Consumer Products

 

 

 

6,272,293

 

8,636,334

 

8.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CFF Acquisition LLC (d)

 

Consumer Services

 

First Lien Term Loan
7.50% Cash, 7/31/2015

 

$

2,601,266

 

2,397,435

 

2,497,216

 

2.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PrePaid Legal Services, Inc. (d)

 

Consumer Services

 

First Lien Term Loan
11.00% Cash, 12/31/2016

 

$

3,000,000

 

2,924,557

 

2,947,500

 

2.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Consumer Services

 

 

 

5,321,992

 

5,444,716

 

5.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

M/C Acquisition Corp., LLC (d)

 

Education

 

First Lien Term Loan
6.75% (1.00% Cash/5.75% PIK), 12/31/2012

 

$

2,795,497

 

1,641,562

 

559,099

 

0.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

M/C Acquisition Corp., LLC (d), (h)

 

Education

 

Class A Common Stock

 

544,761

 

30,242

 

 

0.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Education

 

 

 

1,671,804

 

559,099

 

0.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Advanced Lighting Technologies, Inc. (d)

 

Electronics

 

Second Lien Term Loan
6.24% Cash, 6/1/2014

 

$

2,000,000

 

1,913,016

 

2,000,000

 

2.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Group Dekko, Inc. (d)

 

Electronics

 

Second Lien Term Loan
10.50% (6.50% Cash/4.00% PIK), 5/1/2013

 

$

7,647,116

 

$

7,647,116

 

7,224,231

 

7.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Electronics

 

 

 

9,560,132

 

9,224,231

 

9.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

USS Parent Holding Corp. (d), (h)

 

Environmental

 

Non Voting Common Stock

 

765

 

133,002

 

103,232

 

0.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

USS Parent Holding Corp. (d), (h)

 

Environmental

 

Voting Common Stock

 

17,396

 

3,025,798

 

2,348,521

 

2.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Environmental

 

 

 

3,158,800

 

2,451,753

 

2.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

DS Waters of America, Inc. (d)

 

Food and Beverage

 

First Lien Term Loan
10.50% Cash, 8/29/2017

 

$

3,000,000

 

3,022,500

 

3,022,500

 

3.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

HOA Restaurant Group, LLC. (d)

 

Food and Beverage

 

Senior Secured Notes
11.25% Cash, 4/1/2017

 

$

4,000,000

 

3,883,530

 

3,800,000

 

3.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Food and Beverage

 

 

 

6,906,030

 

6,822,500

 

6.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maverick Healthcare Group (d)

 

Healthcare Services

 

First Lien Term Loan
10.75% Cash, 12/31/2016

 

$

4,937,500

 

4,859,708

 

4,794,806

 

4.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Healthcare Services

 

 

 

4,859,708

 

4,794,806

 

4.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

McMillin Companies LLC (d), (h)

 

Homebuilding

 

Senior Secured Notes
0% Cash, 12/31/2013

 

$

550,000

 

518,094

 

289,465

 

0.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Homebuilding

 

 

 

518,094

 

289,465

 

0.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capstone Logistics, LLC (d)

 

Logistics

 

First Lien Term Loan
7.50% Cash, 9/16/2016

 

$

994,648

 

981,303

 

994,648

 

1.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capstone Logistics, LLC (d)

 

Logistics

 

First Lien Term Loan
13.50% Cash, 9/16/2016

 

$

4,000,000

 

3,946,332

 

4,000,000

 

4.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Worldwide Express Operations, LLC (d)

 

Logistics

 

First Lien Term Loan
7.50% Cash, 6/30/2013

 

$

6,581,758

 

6,364,599

 

6,417,214

 

6.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Logistics

 

 

 

11,292,234

 

11,411,862

 

11.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sabre Industries, Inc (d)

 

Manufacturing

 

Senior Unsecured Loan
15.00% (12.00% Cash/3.00% PIK), 6/6/2016

 

$

6,044,262

 

5,905,699

 

6,044,262

 

6.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Manufacturing

 

 

 

5,905,699

 

6,044,262

 

6.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Elyria Foundry Company, LLC (d)

 

Metals

 

Senior Secured Notes
17.00% (13.00% Cash/4.00% PIK), 3/1/2013

 

$

7,577,025

 

7,412,143

 

6,788,257

 

6.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Elyria Foundry Company, LLC (d), (h)

 

Metals

 

Warrants to Purchase Limited Liability Company Interests

 

3,000

 

 

 

0.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Metals

 

 

 

7,412,143

 

6,788,257

 

6.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Network Communications, Inc. (d)

 

Publishing

 

Unsecured Notes
8.60% PIK, 1/14/2020

 

$

2,422,095

 

1,946,320

 

978,769

 

0.9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Network Communications, Inc. (d), (h)

 

Publishing

 

Common Stock

 

211,429

 

 

367,886

 

0.4

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Penton Media, Inc. (d)

 

Publishing

 

First Lien Term Loan
5.00% Cash, 8/1/2014

 

$

4,838,570

 

4,332,782

 

3,705,860

 

3.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Publishing

 

 

 

6,279,102

 

5,052,515

 

5.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sub Total Non-control/Non-affiliated investments

 

 

 

 

 

 

 

83,648,205

 

81,495,260

 

81.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Control investments - 25.1% (b)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GSC Partners CDO GP III, LP (g), (h)

 

Financial Services

 

100% General Partnership Interest

 

 

 

 

0.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GSC Investment Corp. CLO 2007 LTD. (d), (e), (g)

 

Structured Finance Securities

 

Other/Structured Finance Securities
18.92%, 1/21/2020

 

$

30,000,000

 

22,684,908

 

25,234,885

 

25.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sub Total Control investments

 

 

 

 

 

 

 

22,684,908

 

25,234,885

 

25.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Affiliate investments - 0.0% (b)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GSC Partners CDO GP III, LP (f), (h)

 

Financial Services

 

6.24% Limited Partnership Interest

 

 

 

 

0.0

%

Sub Total Affiliate investments

 

 

 

 

 

 

 

 

 

0.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TOTAL INVESTMENTS - 106.1% (b)

 

 

 

 

 

 

 

$

106,333,113

 

$

106,730,145

 

106.1

%

 

5



Table of Contents

 


(a)   All of our equity and debt investments are issued by eligible portfolio companies, as defined in the Investment Company Act of 1940, except GSC Investment Corp. CLO 2007 Ltd. and GSC Partners CDO GP III, LP.

(b)  Percentages are based on net assets of $100,570,917 as of May 31, 2012.

(c)   Because there is no readily available market value for these investments, the fair value of these investments is approved in good faith by our board of directors. (see Note 3 to the consolidated financial statements).

(d)  These securities are pledged as collateral under a senior secured revolving credit facility (see Note 6 to the consolidated financial statements).

(e)   18.92% represents the modeled effective interest rate that is expected to be earned over the life of the investment.

(f)   As defined in the Investment Company Act, we are an “Affiliate” of this portfolio company because we own 5% or more of the portfolio company’s outstanding voting securities. Transactions during the period in which the issuer was an Affiliate are as follows:

 

 

 

 

 

 

 

 

 

Interest

 

Management

 

Net Realized

 

Net Unrealized

 

Company

 

Purchases

 

Redemptions

 

Sales (cost)

 

Income

 

fee income

 

gains/(losses)

 

gains/(losses)

 

GSC Partners CDO GP III, LP

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

 

(g)   As defined in the Investment Company Act, we “Control” this portfolio company because we own more than 25% of the portfolio company’s outstanding voting securities. Transactions during the period in which the issuer was both an Affiliate and a portfolio company that we Control are as follows:

 

 

 

 

 

 

 

 

 

Interest

 

Management

 

Net Realized

 

Net Unrealized

 

Company

 

Purchases

 

Redemptions

 

Sales (cost)

 

Income

 

fee income

 

gains/(losses)

 

gains/(losses)

 

GSC Investment Corp. CLO 2007 LTD.

 

$

 

$

 

$

 

$

1,045,785

 

$

499,840

 

$

 

$

244,080

 

GSC Partners CDO GP III, LP

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

 

(h)  Non-income producing at May 31, 2012.

 

6



Table of Contents

 

Saratoga Investment Corp.

 

Consolidated Schedule of Investments

 

February 29, 2012

 

Company(a)

 

Industry

 

Investment Interest Rate/Maturity

 

Principal/
Number of
Shares

 

Cost

 

Fair Value(c)

 

% of
Net
Assets

 

Non-control/Non-affiliated investments—71.4%(b)

 

 

 

 

 

 

 

 

 

 

 

 

 

Coast Plating, Inc.(d)

 

Aerospace

 

First Lien Term Loan 11.77% Cash, 9/13/2014

 

$

2,550,000

 

$

2,550,000

 

$

2,550,000

 

2.6

%

Coast Plating, Inc.(d)

 

Aerospace

 

First Lien Term Loan 12.52% Cash, 9/13/2014

 

$

950,000

 

950,000

 

950,000

 

1.0

%

 

 

 

 

Total Aerospace

 

 

 

3,500,000

 

3,500,000

 

3.6

%

Legacy Cabinets Holdings(d)(h)

 

Building Products

 

Common Stock Voting A-1

 

2,535

 

220,900

 

 

0.0

%

Legacy Cabinets Holdings(d)(h)

 

Building Products

 

Common Stock Voting B-1

 

1,600

 

139,424

 

 

0.0

%

Legacy Cabinets, Inc.(d)

 

Building Products

 

First Lien Term Loan 7.25% (1.00% Cash/6.25% PIK), 5/3/2014

 

$

312,198

 

312,198

 

221,629

 

0.2

%

 

 

 

 

Total Building Products

 

 

 

672,522

 

221,629

 

0.2

%

Targus Group International, Inc.(d)

 

Consumer Products

 

First Lien Term Loan 11.00% Cash, 5/24/2016

 

$

3,980,000

 

3,911,828

 

3,944,976

 

4.1

%

Targus Holdings, Inc.(d)

 

Consumer Products

 

Unsecured Notes 10.00% PIK, 6/14/2019

 

$

1,799,479

 

1,799,479

 

963,621

 

1.0

%

Targus Holdings, Inc.(d)(h)

 

Consumer Products

 

Common Stock

 

62,413

 

566,765

 

2,675,645

 

2.7

%

 

 

 

 

Total Consumer Products

 

 

 

6,278,072

 

7,584,242

 

7.8

%

CFF Acquisition LLC(d)

 

Consumer Services

 

First Lien Term Loan 7.50% Cash, 7/31/2015

 

$

2,684,141

 

2,462,831

 

2,448,205

 

2.5

%

PrePaid Legal Services, Inc.(d)

 

Consumer Services

 

First Lien Term Loan 11.00% Cash, 12/31/2016

 

$

3,000,000

 

2,920,411

 

2,940,000

 

3.0

%

 

 

 

 

Total Consumer Services

 

 

 

5,383,242

 

5,388,205

 

5.5

%

M/C Acquisition Corp., LLC(d)

 

Education

 

First Lien Term Loan 10.00% (4.25% Cash/5.75% PIK), 12/31/2012

 

$

2,944,596

 

1,790,662

 

591,864

 

0.6

%

M/C Acquisition Corp., LLC(d)(h)

 

Education

 

Class A Common Stock

 

544,761

 

30,242

 

 

0.0

%

 

 

 

 

Total Education

 

 

 

1,820,904

 

591,864

 

0.6

%

Advanced Lighting Technologies, Inc.(d)

 

Electronics

 

Second Lien Term Loan 6.25% Cash, 6/1/2014

 

$

2,000,000

 

1,902,053

 

1,910,400

 

2.0

%

Group Dekko, Inc.(d)

 

Electronics

 

Second Lien Term Loan 10.50% (6.50% Cash/4.00% PIK), 5/1/2013

 

$

7,571,152

 

7,571,152

 

7,003,316

 

7.2

%

 

 

 

 

Total Electronics

 

 

 

9,473,205

 

8,913,716

 

9.2

%

USS Parent Holding Corp.(d)(h)

 

Environmental

 

Non Voting Common Stock

 

765

 

133,002

 

97,810

 

0.1

%

USS Parent Holding Corp.(d)(h)

 

Environmental

 

Voting Common Stock

 

17,396

 

3,025,798

 

2,225,180

 

2.3

%

 

 

 

 

Total Environmental

 

 

 

3,158,800

 

2,322,990

 

2.4

%

DCS Business Services, Inc.(d)

 

Financial Services

 

First Lien Term Loan 14.00% Cash, 9/30/2012

 

$

1,600,000

 

1,604,464

 

1,600,000

 

1.6

%

Big Train, Inc.(d)

 

Food and Beverage

 

First Lien Term Loan 7.75% Cash, 3/31/2012

 

$

1,406,768

 

1,389,640

 

1,368,785

 

1.4

%

HOA Restaurant Group, LLC.(d)

 

Food and Beverage

 

Senior Secured Notes 11.25% Cash, 4/1/2017

 

$

4,000,000

 

3,880,000

 

3,880,000

 

4.0

%

 

 

 

 

Total Food and Beverage

 

 

 

5,269,640

 

5,248,785

 

5.4

%

Maverick Healthcare Group(d)

 

Healthcare Services

 

First Lien Term Loan 10.75% Cash, 12/31/2016

 

$

4,950,000

 

4,867,725

 

4,824,270

 

5.0

%

McMillin Companies LLC(d)(h)

 

Homebuilding

 

Senior Secured Notes 0% Cash, 12/31/2013

 

$

550,000

 

511,952

 

288,915

 

0.3

%

Capstone Logistics, LLC(d)

 

Logistics

 

First Lien Term Loan 7.50% Cash, 9/16/2016

 

$

997,118

 

982,954

 

997,118

 

1.0

%

Capstone Logistics, LLC(d)

 

Logistics

 

First Lien Term Loan 13.50% Cash, 9/16/2016

 

$

4,000,000

 

3,943,183

 

4,000,000

 

4.1

%

Worldwide Express Operations, LLC(d)

 

Logistics

 

First Lien Term Loan 7.50% Cash, 6/30/2013

 

$

6,680,276

 

6,412,355

 

6,103,100

 

6.3

%

 

 

 

 

Total Logistics

 

 

 

11,338,492

 

11,100,218

 

11.4

%

Sabre Industries, Inc(d)

 

Manufacturing

 

Senior Unsecured Loan 15.00% (12.00% Cash/3.00% PIK), 6/6/2016

 

$

6,000,000

 

5,852,741

 

6,000,000

 

6.2

%

Elyria Foundry Company, LLC(d)

 

Metals

 

Senior Secured Notes 17.00% (13.00% Cash/4.00% PIK), 3/1/2013

 

$

7,428,456

 

7,224,787

 

6,537,041

 

6.7

%

Elyria Foundry Company, LLC(d)(h)

 

Metals

 

Warrants to Purchase Limited Liability Company Interests

 

3,000

 

 

 

0.0

%

 

 

 

 

Total Metals

 

 

 

7,224,787

 

6,537,041

 

6.7

%

Network Communications, Inc.(d)

 

Publishing

 

Unsecured Notes 8.60% PIK, 1/14/2020

 

$

2,422,095

 

1,924,577

 

1,044,892

 

1.0

%

Network Communications, Inc.(d)(h)

 

Publishing

 

Common Stock

 

211,429

 

 

691,373

 

0.7

%

Penton Media, Inc.(d)

 

Publishing

 

First Lien Term Loan 5.00% (4.00% Cash/ 1.00% PIK), 8/1/2014

 

$

4,839,526

 

4,280,599

 

3,655,294

 

3.8

%

 

 

 

 

Total Publishing

 

 

 

6,205,176

 

5,391,559

 

5.5

%

Sub Total Non-control/Non-affiliated investments

 

 

 

 

 

 

 

73,161,722

 

69,513,434

 

71.4

%

Control investments—26.5%(b)

 

 

 

 

 

 

 

 

 

 

 

 

 

GSC Partners CDO GP III, LP(g)(h)

 

Financial Services

 

100% General Partnership Interest

 

 

 

 

0.0

%

GSC Investment Corp. CLO 2007 LTD.(d)(e)(g)

 

Structured Finance Securities

 

Other/Structured Finance Securities 17.38%, 1/21/2020

 

$

30,000,000

 

23,540,517

 

25,846,414

 

26.5

%

Sub Total Control investments

 

 

 

 

 

 

 

23,540,517

 

25,846,414

 

26.5

%

Affiliate investments—0.0%(b)

 

 

 

 

 

 

 

 

 

 

 

 

 

GSC Partners CDO GP III, LP(f)(h)

 

Financial Services

 

6.24% Limited Partnership Interest

 

 

 

 

0.0

%

Sub Total Affiliate investments

 

 

 

 

 

 

 

 

 

0.0

%

TOTAL INVESTMENTS—97.9%(b)

 

 

 

 

 

 

 

$

96,702,239

 

$

95,359,848

 

97.9

%

 

Outstanding interest rate cap

 

Interest
rate

 

Maturity

 

Notional

 

Cost

 

Fair
Value

 

% of
Net
Assets

 

Interest rate cap

 

8.0

%

2/9/2014

 

$

19,591,837

 

$

87,000

 

$

54

 

0.0

%

Interest rate cap

 

8.0

%

11/30/2013

 

10,332,000

 

44,000

 

21

 

0.0

%

Total Outstanding interest rate cap

 

 

 

 

 

 

 

$

131,000

 

$

75

 

0.0

%

 


*

Amounts to less than 0.05%

 

 

(a)

All of our equity and debt investments are issued by eligible portfolio companies, as defined in the Investment Company Act of 1940, except GSC Investment Corp. CLO 2007 Ltd. and GSC Partners CDO GP III, LP.

 

 

(b)

Percentages are based on net assets of $97,380,150 as of February 29, 2012.

 

7



Table of Contents

 

(c)

Because there is no readily available market value for these investments, the fair value of these investments is approved in good faith by our board of directors. (see Note 3 to the consolidated financial statements).

 

 

(d)

These securities are pledged as collateral under a senior secured revolving credit facility (see Note 6 to the consolidated financial statements).

 

 

(e)

17.38% represents the modeled effective interest rate that is expected to be earned over the life of the investment.

 

 

(f)

As defined in the Investment Company Act, we are an “Affiliate” of this portfolio company because we own 5% or more of the portfolio company’s outstanding voting securities. Transactions during the period in which the issuer was an Affiliate are as follows:

 

 

 

 

Company

 

Purchases

 

Redemptions

 

Sales
(cost)

 

Interest
Income

 

Management
fee income

 

Net Realized
gains/(losses)

 

Net
Unrealized
gains/(losses)

 

 

GSC Partners CDO GP III, LP

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

 

 

 

(g)

As defined in the Investment Company Act, we “Control” this portfolio company because we own more than 25% of the portfolio company’s outstanding voting securities. Transactions during the period in which the issuer was both an Affiliate and a portfolio company that we Control are as follows:

 

 

 

Company

 

Purchases

 

Redemptions

 

Sales
(cost)

 

Interest
Income

 

Management
fee income

 

Net Realized
gains/(losses)

 

Net
Unrealized
gains/(losses)

 

 

GSC Investment Corp. CLO 2007 LTD.

 

$

 

$

 

$

 

$

4,198,007

 

$

2,011,516

 

$

 

$

6,938,209

 

 

GSC Partners CDO GP III, LP

 

$

 

$

 

$

 

$

 

$

 

$

 

$

 

 

 

(h)

Non-income producing at February 29, 2012.

 

8



Table of Contents

 

Saratoga Investment Corp.

 

Consolidated Statements of Changes in Net Assets

 

 

 

For the three months
ended May 31, 2012

 

For the three months
ended May 31, 2011

 

 

 

(unaudited)

 

(unaudited)

 

INCREASE FROM OPERATIONS:

 

 

 

 

 

Net investment income

 

$

1,272,790

 

$

578,609

 

Net realized gain from investments

 

178,630

 

98,008

 

Net realized loss from derivatives

 

(131,000

)

 

Net unrealized appreciation on investments

 

1,739,422

 

5,043,135

 

Net unrealized appreciation (depreciation) on derivatives

 

130,925

 

(10,542

)

Net increase in net assets from operations

 

3,190,767

 

5,709,210

 

 

 

 

 

 

 

Total increase in net assets

 

3,190,767

 

5,709,210

 

Net assets at beginning of period

 

97,380,150

 

86,071,454

 

Net assets at end of period

 

$

100,570,917

 

$

91,780,664

 

 

 

 

 

 

 

Net asset value per common share

 

$

25.94

 

$

28.01

 

Common shares outstanding at end of period

 

3,876,661

 

3,277,077

 

 

 

 

 

 

 

Distribution in excess of net investment income

 

$

(12,647,278

)

$

(8,340,281

)

 

See accompanying notes to consolidated financial statements.

 

9



Table of Contents

 

Saratoga Investment Corp.

 

Consolidated Statements of Cash Flows

 

 

 

For the three months
ended May 31, 2012

 

For the three months
ended May 31, 2011

 

 

 

(unaudited)

 

(unaudited)

 

Operating activities

 

 

 

 

 

NET INCREASE IN NET ASSETS FROM OPERATIONS

 

$

3,190,767

 

$

5,709,210

 

ADJUSTMENTS TO RECONCILE NET INCREASE IN NET ASSETS FROM OPERATIONS TO NET CASH PROVIDED BY OPERATING ACTIVITIES:

 

 

 

 

 

Paid-in-kind interest income

 

(326,462

)

(619,583

)

Net accretion of discount on investments

 

(244,768

)

(158,918

)

Amortization of deferred credit facility financing costs

 

101,149

 

170,744

 

Net realized gain from investments

 

(178,630

)

(98,008

)

Net realized loss from derivatives

 

131,000

 

 

Net unrealized appreciation on investments

 

(1,739,422

)

(5,043,135

)

Net unrealized (appreciation) depreciation on derivatives

 

(130,925

)

10,542

 

Proceeds from sale and redemption of investments

 

4,454,285

 

6,965,659

 

Purchase of investments

 

(13,335,300

)

(14,677,353

)

(Increase) decrease in operating assets:

 

 

 

 

 

Cash and cash equivalents, reserve accounts

 

(524,328

)

922,206

 

Interest receivable

 

398,625

 

344,182

 

Management fee receivable

 

(269

)

2,358

 

Other assets

 

41,608

 

(240,857

)

Receivable from unsettled trades

 

59,511

 

 

Increase (decrease) in operating liabilities:

 

 

 

 

 

Payable for unsettled trades

 

9,262,800

 

9,903,626

 

Management and incentive fees payable

 

250,317

 

171,300

 

Accounts payable and accrued expenses

 

(143,238

)

(95,712

)

Interest and credit facility fees payable

 

108,717

 

(21,969

)

Due to manager

 

(324,094

)

583,972

 

NET CASH PROVIDED BY OPERATING ACTIVITIES

 

1,051,343

 

3,828,264

 

 

 

 

 

 

 

Financing activities

 

 

 

 

 

Paydowns on debt

 

 

(4,500,000

)

NET CASH USED BY FINANCING ACTIVITIES

 

 

(4,500,000

)

 

 

 

 

 

 

NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS

 

1,051,343

 

(671,736

)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

 

1,325,698

 

10,735,755

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

 

$

2,377,041

 

$

10,064,019

 

 

 

 

 

 

 

Supplemental Information:

 

 

 

 

 

Interest paid during the period

 

$

415,837

 

$

221,135

 

 

 

 

 

 

 

Supplemental non-cash information

 

 

 

 

 

Paid-in-kind interest income

 

$

326,462

 

$

619,583

 

Net accretion of discount on investments

 

$

244,768

 

$

158,918

 

Amortization of deferred credit facility financing costs

 

$

101,149

 

$

170,744

 

 

See accompanying notes to consolidated financial statements.

 

10



Table of Contents

 

SARATOGA INVESTMENT CORP.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

May 31, 2012

 

(unaudited)

 

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.” in conjunction with the transaction described in “Note 12. Recapitalization Transaction” below.

 

We are externally managed and advised by our investment adviser, Saratoga Investment Advisors, LLC (the “Manager”), pursuant to an investment advisory and 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 (“GAAP”) and include the accounts of the Company and its wholly-owned subsidiaries, Saratoga Investment Funding, LLC (previously known as GSC Investment Funding LLC) and Saratoga Investment Corp. 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 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. Pursuant to 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:

 

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·                  we were to own more than 3% of the total outstanding voting stock of the money market fund;

 

·                  we were to hold securities in the money market fund having an aggregate value in excess of 5% of the value of our total assets; or

 

·                  we were to hold securities in money market funds and other registered investment companies and BDCs having an aggregate value in excess of 10% of the value of our total assets.

 

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 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% of the voting securities or maintain greater than 50% 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% and 25% 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:

 

·                  Each investment is initially valued by the responsible investment professionals of our Manager and preliminary valuation conclusions are documented and discussed with our senior management of our Manager; and

 

·                  An independent valuation firm engaged by our board of directors reviews approximately one quarter of these preliminary valuations each quarter so that the valuation of each investment for which market quotes are not readily available is reviewed by the independent valuation firm at least annually.

 

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In addition, all our investments are subject to the following valuation process:

 

·                  The audit committee of our board of directors reviews each preliminary valuation and our Manager and independent valuation firm (if applicable) will supplement the preliminary valuation to reflect any comments provided by the audit committee; and

 

·                  Our board of directors discusses the valuations and approves the fair value of each investment, in good faith, based on the input of our Manager, independent valuation firm (to the extent applicable) and the audit committee of our board of directors.

 

Our investment in GSC Investment Corp. CLO 2007, 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.

 

Derivative Financial Instruments

 

We account for derivative financial instruments in accordance with ASC Topic 815, Derivatives and Hedging (“ASC 815”). ASC 815 requires recognizing all derivative instruments as either assets or liabilities on the consolidated statements of assets and liabilities at fair value. The Company values derivative contracts at the closing fair value provided by the counterparty. Changes in the values of derivative contracts are included in the consolidated statements of operations.

 

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, 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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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 Credit Facility Financing Costs

 

Financing costs incurred in connection with our credit facility are deferred and amortized using the straight line method over the life of the facility.

 

Indemnifications

 

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.

 

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 the obligation to pay 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% 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% on undistributed income if it does not distribute at least 98% 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% 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% 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% 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 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 statement of operations. As of May 31, 2012 and February 29, 2012, 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 approved 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.

 

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We have adopted a dividend reinvestment plan 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 our dividend reinvestment plan will have their cash dividends automatically reinvested in additional shares of our common stock, rather than receiving the cash dividends. If our common stock is trading below net asset value at the time of valuation, the plan administrator may receive the dividend or distribution in cash and purchase common stock in the open market, on the New York Stock Exchange or elsewhere, for the account of each participant in our dividend reinvestment plan.

 

Capital Gains Incentive Fee

 

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.

 

New Accounting Pronouncements

 

In December 2011, the FASB issued (“ASU”) No. 2011-11, Disclosures about Offsetting Assets and Liabilities, which requires entities to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The guidance is effective for fiscal years and interim periods beginning on or after January 1, 2013 with retrospective application for all comparative periods presented. The adoption of this guidance, which is related to disclosure only, is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

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.

 

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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:

 

·                  Level 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

 

·                  Level 2—Valuations based on inputs other than quoted prices in active markets, which are either directly or indirectly observable.

 

·                  Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement. The inputs used in the determination of fair value may require significant management judgment or estimation. Such information may be the result of consensus pricing information or broker quotes which include a disclaimer that the broker would not be held to such a price in an actual transaction. The non-binding nature of consensus pricing and/or quotes accompanied by disclaimer would result in classification as a Level 3 asset, assuming no additional corroborating evidence.

 

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.

 

The following table presents fair value measurements of investments, by major class, as of May 31, 2012 (dollars in thousands), according to the fair value hierarchy:

 

 

 

Fair Value Measurements

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

First lien term loans

 

$