Good morning, ladies and gentlemen, thank you for standing by. Welcome to Saratoga Investment Corp.'s Fiscal Third Quarter 2023 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation, all parties will be in a listen-only mode. Following management's prepared remarks, we will open the line for questions. At this time, I would like to turn the call over to Saratoga Investment Corp.'s Chief Financial and Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s fiscal third quarter 2023 earnings conference call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal third quarter 2023 shareholder presentation in the Events and Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available. Please refer to our earnings press release for details. I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks.

Thank you, Henri, and welcome everyone. Saratoga's 33% sequential quarterly increase in adjusted net investment income per share substantially outpaced its recent record 26% dividend increase, as rising interest rates positively impact the company's largely floating rate assets and drive increasing spread margin due to Saratoga's largely fixed rate liabilities. Saratoga's credit structure with interest-only covenant-free long-duration debt incorporating maturities two to 10 years out, positions us well for rising and "higher for longer" interest-rate environment. Importantly, overall portfolio quality continues to remain high as demonstrated by NAV per share remaining essentially flat over the prior quarter. In this challenging capital markets environment, access to capital for growth is critical and we successfully recently raised more than $100 million in two baby bond offerings, maintaining our BBB+ investment-grade rating and received an important third SBIC license. In addition to providing liquidity for continued growth, these debt offerings further improve Saratoga's credit structure by extending its maturities five to 10 years out. Our existing portfolio companies are generally performing well with our overall fair value close to cost and our current business development pipeline strong. Our AUM continue to grow this quarter to $982 million as we originated $88 million of new follow-on investments offset by $57 million of repayments. We continue to be highly discerning in terms of new commitments in the current environment. Our pipeline remains robust with many actionable opportunities and we executed 18 follow-on investments exclusively in existing portfolio companies with strong business models and balance sheets which are well known to us. Our NAV per share this quarter was essentially flat with a 0.1% decrease from Q2 to $28.25, with headwinds from our CLO exposure in the broadly syndicated loan market almost completely offset by the positive financial performance of our core BDC portfolio and the…

Thank you, Chris. Slide 4 highlights our key performance metrics for the fiscal third quarter ended November 30, 2022. When adjusting for the incentive fee accrual related to net capital gains, adjusted NII of $9.1 million was up 31.1% from last quarter and up 49.8% from last year's Q3. Adjusted NII per share was $0.77, up $0.19 from $0.58 per share last quarter and up $0.24 from $0.53 per share last year. Across the three quarters, weighted average common shares outstanding were 11.9 million for this year's Q3, 12.0 million for last quarter and 11.5 million for last year's Q3. There was zero accretion or dilution due to share repurchases and DRIP plans this quarter. Adjusted NII increased significantly as compared with last year with a 59.1% increase in investment income resulting primarily from a 48.4% increase in AUM and the increase in the current coupon on non-CLO BDC investments from 9.9% to 11.7%, partially offset by increased base management fees and interest expense resulting from the various new Notes Payable and SBA debentures issued during the past year and quarter. The full benefit of higher rates on AUM is not yet fully reflected in interest income. Sequential quarter changes reflect the same factors as year-over-year. However, the increase in current coupon is greater being from 8.8% to 11.7%. Adjusted NII yield was 10.8%, this yield is up from 8.2% last quarter and 7.3% last year. For the third quarter, we experienced a net loss on investments of $3.9 million or $0.32 per weighted average share, resulting in a total increase in net assets from operations of $6.0 million or $0.51 per share. The $3.9 million net loss on investments was comprised of $0.7 million in net realized loss on investments, $3.2 million in net unrealized depreciation on investments, and…

Thank you, Henri. I'll take a few minutes to describe our perspective on the current state of the market and then comment on our current portfolio performance and investment strategy. Since our last update in October, we've observed the persistence of aggressive market conditions for premium credits with lenders remaining open for business and competing heavily for these high-quality opportunities. Liquidity remains abundant after the large-scale fundraisings of last year, but lenders are being more risk-sensitive backing off historically volatile sectors and taking a harder stance on the use of capital. Leverage levels remain elevated but where we are seeing movement is on the rate side, as Henri mentioned a couple of slides ago. Absolute yields are growing significantly as LIBOR and SOFR increased almost 170 basis points this past fiscal quarter, although they have moderated slightly in December. In addition, spreads are continuing to widen the lower middle market, where up until recently, it had mainly been happening in the broader syndicated loan and capital markets. In the first half of calendar year 2022, we saw high transaction volumes and M&A activity, albeit slightly lower than in 2021. In the second half of the calendar year 2022, deal volumes remained reasonably healthy in our market despite lower macro volumes. As a result, we continue to enjoy an actionable deal pipeline. In a competitive market, investors continue to differentiate themselves in other ways, such as accelerated timing to close and looser covenant restriction. That said, lenders in our market remain wary of thinly capitalized deals and for the most part, are staying disciplined in terms of minimum aggregate base levels of equity and requiring reasonable covenants, particularly given the concerns around a potential economic recession forecasted for some time in 2023. The Saratoga management team has successfully managed through a…

Thank you, Mike. Turning to Slide 19. As outlined, our latest dividend of $0.68 per share for the quarter ended November 30, 2022, was paid on January 4, 2023. A 26% increase, this is the largest quarterly dividend increase in our history. The Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both company and general economic factors, including the near-term impact of rising base rates and increased spreads on our earnings. Moving to Slide 20. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of negative 2%, outperforming the BDC index of negative 6% for the same period. This performance reflects the current market volatility impacting both us and the industry. Our longer-term performance is outlined on our next slide. Our three and five year returns place us in the top quartile of all BDCs for both time horizons. Over the past three years, our 27% return exceeded the index average of return of 12%. Over the past five years, our 71% turn more than double the index average of 35%. When Saratoga took over the management of the BDC in 2010, our total return has been 626%, versus the industries of 171%. On Slide 22, you can further see our performance placed in the context of the broader industry and specific to certain key performance metrics. We continue to focus on our long-term metrics such as return on equity, net asset value per share, NII yield and dividend growth, which reflects the growing value our shareholders are receiving. Notwithstanding the slight decline of 0.1% in NAV this quarter, we continue to be one of the few BDCs to have grown NAV over the long term, and we have done it…

Thank you. [Operator Instructions] Our first question will come from Bryce Rowe of B. Riley. Your line is open.

Thank you very much. Good morning. I appreciate you taking the question here. I wanted to kind of ask about the dividend. Obviously, great to see the increased dividend and certainly good to see that it followed a nice increase in earnings. Maybe Chris and Henri, Mike, can you speak to how you're thinking about the dividend constructs we've seen other BDCs take an approach, a variable approach where you're paying a base and then a supplemental on top of the base based on kind of excess earnings. So -- and that with the context of the rate environment and the potential for rates to eventually go back down at some point. So just trying to understand how you all are thinking about that dividend and the dividend construct and giving any consideration to a base plus supplemental construct? Thanks.

Sure. Well, I mean, that's a very good question and something that we have thought a lot about. I think if you look at our earnings level in this recent quarter, while substantially up, the base rate of LIBOR that they're based on is actually substantially lower than the market rate is at this time. And then if you look at the forward curves and who knows, how right the market is, but the rates go up next year and then they're projected to come back down in 2024. But they're projected to come back down in 2024 kind of not that far off of where our average rate is in this most recent quarter. So we feel at this point in time that we are well positioned with our core dividend rate that we can sustain this over certainly the long run. With that said, rates -- I don't know exactly how much higher they may go from where they are now, we are currently over-earning our dividend by a substantial amount. We may continue to do that. We're in a very good position relative to our spillover. So we have room, too over-earned should that be something that made sense for the shareholders. And so we've got to kind of see how this plays out. If it looks like the interest rates are going to stay up for quite a while, then we can move, obviously, our core dividend. If we think it's going to be relatively more temporary, we could consider that sort of bifurcated mode that some of our others have done. So -- but all of this is sort of to be seen and to be determined because this rate environment, there's just a tremendous amount of uncertainty as to exactly how it plays out. But I think the most important consideration is that we feel that the current level we're at is sustainable for the long run. And we will look to build upon that as our earnings increase and as the rate environment becomes more clear.

Great. That's good color, Chris. Maybe a follow-up question around rates and the impact on your borrowers. Can you speak to how borrowers are reacting to the higher rates. Obviously, it's the same for all borrowers expecting with the floating rate debt, but just kind of curious how borrowers are reacting to the higher debt service. And it looks like from a fair value mark perspective, most are performing really well. But any color around borrowers and reaction to debt service would be great. Thanks.

Bryce, this is Mike. That's a really good question. We feel good about our portfolio construction in terms of interest rate coverage. While most of these deals are reasonably leveraged, we spent a lot of time looking at and trying to seek out businesses that have not only really solid dependable cash flow but really strong cash flow margins. So they're generally businesses that can withstand some increase in rates and still produce plenty of excess cash flow with which to comfortably service our debt. So when we look at the interest coverage that we have across our portfolio, there's healthy room there to support the interest coverage in terms of how people react to it. Yes, they don't like to see rates up, but it's kind of the market environment. So anybody else that they're talking to about borrowing money, it's kind of they're facing the same thing. So it's a little bit of it is what it is, but the important thing, I think, is that our portfolio companies are demonstrating that they continue to perform well and are producing sufficient excess cash flow to handle the increase in rates that we've experienced.

Great. I appreciate that.

If I could just add in terms of the new deals, which are kind of -- everybody who's got what they have, they have what they have. But we're looking at a lot of new opportunities, and we're pricing in the new level of debt and companies and sponsors are happy to have it, happy to -- I think we're seeing quite a robust pipeline that it seems like the -- if there's a balance of power, if you will, between borrowers and lenders, I think for the last few years, the borrowers seem to have relatively more leverage in negotiations. And I think that balance is moving the other way, how far it is, it depends on the market, depends on the deal, depends on the sponsor. But we are seeing improvement in overall competitive dynamic and negotiating leverage. And as part of that, the rate structure that we're seeing is being accepted for new deals.

No, it's a good point, Chris. I mean I should have emphasized that. So one development that certainly we're seeing, especially in this last quarter and in the environment that we're in now is Bryce, is that spreads are widening as well. So just in terms of receptivity to a higher rate environment, not only are new borrowers seeing higher indexes but we're able to get wider pricing now than we were even a few months ago. So we're finally starting to see that in our market as well. So if there's an indication of sort of the reaction to rates. Now I do think the higher rate environment is affecting M&A activity in general. So there may be in the broader market fewer deals just in general because of kind of the macro environment. But for the deals that we are seeing, which are high-quality deals and kind of the micro market that we occupy at the lower end of the middle market, we're seeing plenty of activity. And for those deals that we're seeing, they're expecting higher rates, and we're getting them.

That's great. Appreciate the commentary guys.

Thank you. [Operator Instructions] Our next question will come from Casey Alexander of Compass Point Research & Trading. Your line is open.

Hi, good morning. I think this quarter really highlights the underappreciated power - earnings power that you guys have many BDCs are exhibiting right now, and I don't think the market is really appreciating it. And if it weren't for spread widening, your NAV actually would have been up $0.40 a share. So I think it's a very good, and I appreciate the commentary around the dividend because I think holding on to those excess earnings right now to allow NAV to build or to hold against potential credit issues is a great idea. With all those positives, I'm going to do my job and trying to find a couple of places to pick out here. One is looking at the new baby bond deal that you did in December, the absolute and regulatory leverage ratio is really quite high. Can you speak to those leverage ratios and to the extent to which you're comfortable -- I mean, I calculate a regulatory leverage ratio close to 1.5x when you factor in the new baby bond deal. Can you speak to those leverage ratios and why you can comfortably carry a leverage ratio that high?

Sure. Maybe I'll start and then and Henri, you can fill in. Well, first of all, Casey, there's several components to anyone's leverage, right? And the character of the leverage is very, very important. And I think one of the things that we've always carried and the market sort of come around to make our structure work very well right now. And what we have in our leverage is we've got a long-term fixed rate, interest-only covenant-free debt, and our maturity schedule is two to 10 years out. So it's a long time from now before we have to repay any of our leverage. And the spreads off of the marketplace to our leverage are widening, both absolutely with the base rates and with spreads and in terms of our new deals coming on. So our profit margins are expanding, and our leverage structure is very solid. And then on the other side of it, of course, is portfolio. And so when we look at our portfolio and the character and the stability of our portfolio, we look at all that together, and we think we're very well positioned for really substantial earnings. And I think we've just demonstrated this past quarter. I think the earlier quarters in the year, there was a lot of things working through the system and LIBOR lags and adjustments and where our liabilities might have gone up a little higher -- the CLO might have gone up earlier than our asset base rates and all those types of things, but we're kind of through that period now. And so the incremental improvements are kind of flowing directly through to our bottom line. So we have a tremendous amount of earnings that we're generating against this leverage and the structure is extremely favorable. A further…

All right. Thank you. My next question is for Mike. Mike, looking at the fact that all of your new issuance in this quarter was follow-ons. I'm curious, do you have what you would call a higher bar for new investments than you have for follow-ons? And is it more important in this environment with what you see coming at you economically to make sure that you're more supportive of existing portfolio companies as opposed to new companies, which you don't have that history with?

Really good question. And the answer, very succinctly is yes. We certainly, first and foremost, want to make sure that we've got capital available to support our existing portfolio companies. There's not a better call you can get in our industry than a call from a borrower who is performing really well. You know them really well. You like the ownership group, and they've got an opportunity to continue to grow their platform and they're looking for additional capital to put to work. So we did that very successfully this past quarter. It's a big part of what we do just institutionally, if you sort of look at the playbook that we operate under very often, we're making a bit smaller investment as we're getting to know a portfolio company. And then most of our deals and certainly almost all of our best deals have been ones that have started off small and have become much more sizable. Now having said that, we still are seeing good actionable opportunities. And it so happens that just this past quarter, we didn't get any that really -- or didn't find any that really met our underwriting bar. Some of that was due to the fact that we just have a really high standard to begin with. Are we thinking even harder now about businesses that -- what the outlook for a business could be if we were to go through an even a difficult economic time, yes, we are. And certainly, that's probably affecting our bar at the margin. But generally, we have a high bar to begin with. And I think most of the fact that we have fewer portfolio companies this past quarter is sort of reflective of just M&A activity being down. Now having said that, our business doesn't…

All right, thank you. Appreciate you taking my questions. Thanks Mike.

Thanks Casey.

Thank you. [Operator Instructions] Our next question will come from Robert Dodd of Raymond James. Your line is open.

Hi, guys. And congratulations on the quarter. One sort of a follow-up to Casey actually. On follow-on investments being a greater portion of the mix. I mean all the credit and knowing the borrower I understand. So the other question though is when doing a follow-on, do you get the opportunity to put incremental equity into an investment where you've already got an equity investment? Or is it the equity goes in day 1, the follow-ons are debt only? I mean, just trying to get a feel of so much of your performance historically has been generating realized gains on equity, et cetera. If you shift on to follow-ons, are you at the margin losing a little bit of opportunity to keep equity at some portion of the portfolio that you want to target?

Yes, it's an interesting question. So here's how we think about it. And the answer is that it depends. So in some cases when an existing borrower is looking for more capital to grow, the capital that they need requires both debt and equity. There's a portion that makes sense to fund with debt, but also we need to step up with additional equity. In those cases, we have co-investment rights for our equity, and we typically almost always participate and co-invest alongside the control owner. So when that happens, we're co-investing along the way. Now in other cases, they're looking for follow-on capital and the business is performing so well that when you look at the capital structure pro forma for whatever the growth initiative is, it may be an acquisition, it may just be growth to fuel growth in EBITDA. When you look at the capital structure, it may not need equity. But if you're already an existing equity investor, it's very accretive to the existing equity that you have. So that's still good news as well. So to the extent that we have an equity investment in an existing portfolio company, whether we're co-investing along the way or sitting on our current position or our initial position of equity, it typically benefits our initial equity investment very significantly and that's proven out well over time.

Got it. Got it. Yes. I appreciate that color, and I appreciate the classic opening of it depends, which is always the case. On the dividend, I mean, I understand your comment on the earnings power is going to go up materially from here as we get into the middle of the year based on where the forward curve is, I understand retaining some to grow NAV, et cetera, but the BDC rules are what they are, right? So you can't just keep by the distribution requirements. And given an increased dividend but potential earnings power that -- not putting words in your mouth, but could get to like $1 per share kind of per quarter in future quarters. You're going to generate a lot of spillover income in a hurry. So what are your thoughts on how you would handle that if rates do stay higher for longer, that at some point, it's a good problem to have, but it becomes a problem if you build up too large a bucket on spillover, if there's a big earnings dividend missed. So can you give us your thoughts there?

Sure. I think as you point out, I mean, I think these are the type of problems we like to work on. Absolutely, you're right. I mean there are hard rules. You have to -- you've got kind of a two-year period to pay all the -- pay out your high percentage of income from, and we have a certain spillover equation right now, which is fortunately not -- we've got a lot of room in it. And -- but ultimately, if our earnings do increase, as you outlined, that amount of spillover will increase. And then ultimately, all this has to be paid out to shareholders. So in the meantime, right, it would build NAV and so the shareholders are going to get it one way or the other, right? They're going to get either through NAV or through dividends along the way. I think the biggest issue, right, is what's going to happen next in our economy. I mean everybody knows we're in an inflection point to sort of an unprecedented environment, right? We're kind of in a higher for longer rising rate environment, inflation, all these type of things. No one has seen that for 40 years, experienced that systematically, consistently, you've got a very hawkish position from the Fed, which is more aggressive than the market. So there's just a lot of questions to what's this all going to look like. If we have sort of this rising rate environment, followed by massive cuts back down to a hyper stimulative environment, which is -- that's one scenario. I don't know what the odds of that scenario are. We have to be prepared for that. We don't want to get too far out on that and then you could have a difficult economy. And so all those…

Yes, Robert. And I think just the nice thing about the RIC rules and you know how they constructed is, it allows you to plan really well sort of looking ahead more longer term and to manage the payment and to manage the spillover. So as you mentioned, yes, as rates go up, our earnings, i.e., our taxable income that we need to distribute will increase quickly. But that doesn't mean that we will have to pay it out quickly based on the payment rules of the rig structure. So that allows us to sort of -- if you manage your spillover well, which we think we have. It allows you to really plan more long term how you want to pay it out, especially in an economic environment. As Chris was talking about, that is more uncertain. So although the accretion maybe happens quickly, the payment doesn't necessarily happen quickly, which is the nice thing about the sort of the planning mechanism of the RIC rules.

One for the point -- I'm sorry, just one further point on this. And I think that we have been very careful. And I think as you may recall from our very, very long conference call in April of 2020, we've been very careful with our spillover. And we've used our spillover as sort of like a rainy day fund, if you will, or something like that. And some other BDCs are kind of max on their spillover. They view it as a source of capital, perhaps. And so they don't really have a lot of room. And if they have an increase, they kind of have to pay it out immediately. But we've created this flexibility for ourselves utilizable in this environment to give us the time to consider an optimal approach to sort of permanent dividends versus temporary dividends. And as we said before, we're trying to come up with a sustainable, dependable dividend rate and that our shareholders can expect and then look behind all this question and our thinking, right, is what levels of dividend increase are we going to have next quarter and the quarters and the quarters after that? And obviously, I think the balance of consideration is that's going to be relatively more available than in sequential quarters, certainly in the very near term than there has been in the past.

Understood. I really appreciate the color and to your point you've managed spillover such that it's not going to force your hand by being near a cap. So that's a good spot to be in as well. So, thank you for the color.

Thank you. [Operator Instructions] Our next question will come from Erik Zwick of Hovde Group. Your line is open.

Thanks. Good morning. Most of my questions have been asked and answered at this point. And I guess the one I still have is a bit of a follow-up in some terms. So I guess thinking about the health of the borrowers in your current portfolio? And what could impact them certainly based on the outlook for the Fed funds curve, there's another 50 basis points, maybe 75 that would happened here at the beginning of the year in LIBOR would likely follow suit higher to a similar magnitude. There's also a concern about the trajectory of the economy and whether we dip into a mild recession or something more moderate or severe. As you think about the potential for credit and the health of your borrowers. At this point, what would be a larger risk if the Fed had to continue hiking further beyond current expectations, which would put a higher debt burden on your companies or material slowdown in the economy that would materially impact EBITDA and the cash flow of those companies. Just curious how you think about that and weigh those risk factors today?

Well, let me try and answer it first from a high level, and then Mike can speak very specifically to our portfolio. So at a high level, we have the good fortune of investing in the smaller middle market. And so each of our companies has its own destiny, its own marketplace, its own universe. And a lot of these macro considerations, they kind of affect the broader economy in sort of broader ways and there's a lot of cyclicality in the economy. I mean we were just -- in our last investment meetings, we have one of our portfolio companies, we're actually talking about decreasing their rate because they're earning so much money, they want to pay us back, like no, don't do that. I mean they're having surging increase in revenues. And so -- the U.S. market is such a huge, huge place, and there's so many opportunities and efficiencies and all of the Software as a Service companies that we invest in they're creating efficiencies to their products. And so there's a growth dynamic that's going to persist even in a negative -- in a recession. I mean if we have a mild recession, it may not affect a lot of our companies really much at all. And if we have a severe recession, there's a bunch of our companies that will still continue to do well, can continue to do well. So I don't mean to paint an overly rosy picture of everything for everybody. But what I would say is that each of our companies is not necessarily as affected by these macro trends on a current basis and then it partly has to do with the nature of our portfolio and also they're the smaller companies. I mean if you're Walmart, if you're McDonald's, if you're Procter & Gamble, I mean they're much more exposed to the very broad gauge what's going on in the big economy. But our companies have very specific niches in very specific markets and market opportunities. When you add them all up, they aren't necessarily as correlated to the broader economy.

Yes. Let me add to that a little bit, Chris, because it's a good question and an interesting observation you make. We spend a lot of time thinking about that at the front end when we're underwriting deals, and there's so many things that we think about. But first and foremost, at the end of the day, all of the work that we're doing is centered around trying to get a comfort level that the business that we're lending to is at a minimum going to be in a position where under almost all reasonable circumstances we feel comfortable they're going to sustain their cash flow level. And we do that by looking at the end markets that they're in. We look at the value proposition that they offer their customers. We try to think about all the vulnerabilities they may have in the future and reach an assessment as to whether they're going to be able to continue to offer that value proposition to the customer in a way that's very profitable for them. And that underwriting is the most important component to what we do. It makes us -- it draws us to certain industries. It draws us to industries that are less cyclical. It draws us to companies that have wide margins that produce lots of cash flow, why do they have wide margins because they can price their products at a level that allows them to have strong margins because people want their products, they see our services. They see the value in them. And the most important thing in the underwriting and the capital structure, therefore, tends to be the persistency of the cash flow. Now when we underwrite, and I should say before I move into the interest rate part of your question, when…

That's great color. I appreciate the commentary from both of you. Thanks so much. That's all I had today.

Thank you.

Thank you, Erik.

Thank you. I see no further questions in the queue. I would now like to turn the conference back to Mr. Christian Oberbeck for closing remarks.

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

This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a pleasant day.