Good morning, ladies and gentlemen, thank you for standing by. Welcome to Saratoga Investment Corp’s 2024 Fiscal Second Quarter 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 your questions. At this time, I would like to turn the call over to Saratoga Investment Corp's Chief Financial and Chief Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead.

Thank you. I would like to welcome everyone to Saratoga Investment Corp’s 2024 fiscal second quarter earnings conference call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal second quarter 2024 shareholder presentation in the Events and Presentation 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.

(Audit Start) Thank you, Henri, and welcome, everyone. Saratoga's adjusted net investment income per share increased 86% as compared to last year and remained unchanged as compared to last quarter. This performance outpaced our recent and significant dividend increases and reflected growth in AUM and margin improvement from rising rates on our largely floating rate assets in contrast to largely fixed interest rates paid on financing liabilities. Higher and rising interest rates and a general contraction of available credit are producing higher margins on our portfolio and importantly an abundant flow of attractive investment opportunities from high-quality sponsors at increasingly improving pricing, terms, and absolute rates. We believe Saratoga continues to be well positioned for potential future economic opportunities and challenges. Saratoga's credit structure, with largely interest-only, covenant free, long duration debt, incorporating maturities primarily two to 10 years out, positions us particularly well for the rising and potentially higher-for-longer interest rate environment, coupled with market volatility. Most importantly, at the foundation of our performance is the high-quality nature and resilience of our approximately $1.1 billion portfolio, which has been marked down 1.4% overall versus cost in this challenging environment. Our core BDC portfolio, excluding our CLO and JV, is up 0.2% versus cost, reflecting the strength of our underwriting in our solid growing portfolio of companies and sponsors in well-selected industry segments. This quarter's unrealized appreciation of $5.7 million reflects $15.4 million net unrealized appreciation related to our Pepper Palace investment, significantly offset by a broad appreciation across the rest of our core and broadly syndicated portfolios. Consistent with Q2 and since quarter-end, we continue to see improvements in pricing in the broadly syndicated loan market that would increase that portfolio fair value if marked as of today. Importantly, we raised $34 million of equity since last quarter-end, increasing…

Thank you, Chris. Slide 4 highlights our key performance metrics for the fiscal second quarter ended August 31, 2023, most of which Chris already touched on. Of note, the weighted average common shares outstanding of 12.2 million shares in Q2 increased from 12.0 million last year and 11.9 million last quarter. Adjusted NII increased this quarter, up 89.0% from last year and up 2.4% from last quarter, primarily from, first, the impact of higher interest rates, both base rates and spreads, with a weighted average current coupon on non-CLO BDC investments increasing from 9.9% to 12.6% year-over-year, but down from 12.7% last quarter. Second, average non-CLO BDC assets increased by 16.4% year-over-year and by 2.2% since last quarter. And third, other income included a $1.6 million dividend received from the Saratoga Investment joint venture. Adjusted NII yield was 15.0%. This yield is unchanged from last quarter but up from 8.2% last year. Total expenses for this Q2 excluding interest and debt financing expenses, base management fees and incentive fees, and income and excise taxes decreased from $2.3 million to $2.1 million as compared to last quarter and increased from $1.6 million from last year. This represented 0.7% of average total assets on an annualized basis, down from 0.8% at both Q2 last year and last quarter. Also, we have again added the KPI slides 27 through 30 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past nine quarters and the upward trends we have maintained, including a 66% increase in net interest margin over the past year. Moving on to Slide 5. NAV was $362.1 million as of this quarter-end, a $24.6 million increase from last quarter, and a $24.9 million increase from the same quarter last year.…

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. The overall deal market has remained relatively unchanged since our last update, as it seems to be in a bit of a holding pattern to see what happens in the broader macro environment. While liquidity among private equity firms remains abundant, an opaque economic outlook, high financing costs, and elevated levels of inflation continue to constrain the private equity deal market, which drives much of the demand for new credits. Lenders, especially banks, remain more risk sensitive, backing off historically volatile sectors and taking a harder stance on the use of capital, which creates a lending vacuum for borrowers. Overall, lenders are requiring greater equity capitalizations regardless of the enterprise multiple and in some cases, have reduced their pace of deployment as well as their hold positions. All of these factors are positive for us as we have been seeing more attractive opportunities come our way as we build gaps that have arisen in the market and we have a very actionable deal pipeline. Leverage levels appear to have come down at the margin but remain full for strong credits. Absolute yields continue to grow with absolute SOFR increasing another 11 basis points during our fiscal second quarter and have remained there. The widening spread we had been experiencing in recent quarters appears to have stabilized. With fears of an economic slowdown dampening among some market participants, we have seen some lenders offer tighter spreads to win mandates. The Saratoga management team has successfully managed through a number of credit cycles, and that experience has made us particularly aware of the importance of, first, being disciplined when making investment decisions,…

Thank you, Mike. As outlined on Slide 19, our latest dividend of $0.71 per share for the quarter ended August 31, 2023, was paid on September 28, 2023. This is the largest quarterly dividend in our history and reflects a 37% and 31% increase over the past two years and latest 12 months, respectively. The Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both the company and general economic factors, including the near-term impact of rising base rates and increased spreads on our earnings. Recognizing the divergence of opinions on the future direction of interest rate levels and overall economic performance, Saratoga's Q2 overearning of its dividend by 52% or $1.08 versus $0.71 per share this quarter provides substantial cushion in any circumstance should economic conditions deteriorate or base rates decline. Moving to Slide 20. Our total return for the last 12 months, which includes both capital appreciation and dividends has generated total returns of 16%, outperforming the BDC index of 12% for the same period. Our longer-term performance is outlined on our next Slide 21. 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 102% return exceeded the average index return of 70%, while over the past five years, our 66% return exceeded the index's average of 34%. Since Saratoga took over the management of the BDC in 2010, our total return has been 688%, versus the industry's 224%. 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 our long-term metrics such as return on equity, NAV per share, NII yield and dividend growth, all of…

(Audit Start) Thank you. [Operator Instructions] And our first question coming from the line of Bryce Rowe with B. Riley. Your line is open.

Hi, thanks. Good morning. I wanted to maybe ask about the use of the equity ATM since the end of the last quarter. Can you speak to maybe the decision to go ahead and use that equity ATM, especially with the stock still trading slightly below NAV? And then I wanted to kind of get a sense for, I guess, the level at which the manager will continue to subsidize those equity raises at NAV. Thanks.

Sure. Well, thank you for that question. I think, in our view, looking at our overall business, we are really turning away a lot of tremendous opportunities given what we see out there. And so the key to -- for the growth is -- one of the keys is more equity. And so we thought it was a very good investment from the point of view of our shareholders to issue such equity to help support, I think, what we've described as a very robust new issuance opportunity set for the company. And so we saw the opportunity. We saw the opportunity in significant size, $34 million in a quarter is a very substantial amount. And with that opportunity, we -- our judgment was that it was a good idea. And from the manager’s standpoint, we were happy to support and subsidize what was a slight discount to NAV and which we covered from the managers’ pocket, if you will. Whether those opportunities arise and how often they rise in the future is something we can't predict, but we saw some interesting interest in demand, and we decided to meet it.

That's helpful, Chris. And maybe a follow-up there. It sounds like there's clearly a healthy pipeline and a discerning eye at Saratoga, you've seen -- you saw balance sheet leverage kind of come down here in the quarter with the ATM usage. Is there a particular target? Do you think we'll see leverage kind of creep back up again as you put money to work? Or do you feel more comfortable operating with, I guess, a lower level of leverage than we saw maybe the last -- over the last couple of quarters?

Well, I think that, that is kind of a dynamic situation. I think as we've said in past quarters, we have to balance a lot of things, and we have balanced our opportunities. And as you correctly pointed out, our leverage did increase a fair amount over the past year really and to address what we saw is some greater opportunities. Clearly, over time, we want to balance the magnitude of our leverage with our opportunity set. And when we have opportunities to raise equity, we do. And we really haven't had many opportunities in the last period of time. And just recently, we did, and so we decided to take advantage of that. And we, obviously, remain balanced in terms of how much leverage we're going to absolutely put on versus how much equity we're able to raise. And again, it's a dynamic situation that we can't -- there are two different markets, right? The market for our equity is one thing and the market for our new originations is something else and we're not necessarily able to precisely match them in time. But over time, we want to keep ourselves in a very solid balance sheet position.

Got it. Appreciate that. Appreciate you taking the time.

Thanks, Bryce.

Thank you.

Thank you. And our next question coming from the line of Casey Alexander with Compass Point Research. Your line is open.

Yeah. I mean, your gross leverage is still around 2 times. Your net leverage is around 1.5 times. So to a certain extent, we could argue that at least right now, without repayments, you're sort of loaned to the limit. What is the outlook for repayments for the balance of the year because we're going into a period that traditionally -- the end of the year is generally a fairly robust period of time for originations. So are you going to be able to participate in that? What is the outlook for repayments? And also, what is the remaining capacity in the JV for you to be able to originate investments and put investments there as well?

Maybe I'll start with that. Again, I think as I just mentioned to Bryce's question, we don't 100% determine the flow of origination opportunities. And we have a group of sponsors that we've been working with, sponsors that we want to work with. And the exact flows that come off of those opportunities are things that we want to manage to keep growing and keep supporting as we have been, our base. So that's not necessarily something we can predict in this fourth quarter precisely. In terms of leverage, we do have a -- what we feel is a significant improvement in our leverage position given the equity issuances. And in terms of repayments, Mike, do you want to...

Yeah. Casey, let me try to take that. The rule of thumb I always apply, I think you've heard me say this before, is that the portfolio of our type should generally turn over about a third a year roughly. But then it never really turns over at that level. That's kind of just a rule of thumb. And in really dynamic markets where everybody is feeling super bullish, it can turn over a lot faster than that. In this market, our shareholders are getting the benefit of us not experiencing as much turnover. And so we've got a really healthy portfolio where the owners are continuing to pay us interest and the companies are performing well, but they're deciding now is not the best time to sell because there's a disconnect between generally in the market where sellers feel there's value and where it was historically and where buyers are willing to pay for things. And so we are getting the benefit of fewer payoffs. Now having said that, we're bound to have payoffs. We certainly are aware of some that are on the horizon that are meaningful. I think the important thing, though, to also recognize, and I think Chris mentioned this as well, is that we have very significant availability under our SBIC license, and we don't feel that as being a constraint for us at all. If we see a really good opportunity to invest capital through that vehicle and it's a business that's really strong, we're going to take advantage of that. I think when you get outside of the SBIC license, we're sort of balancing, as Chris mentioned, capital availability, leverage, how much we like the deal, some of those factors. And certainly, the amount of payoffs that we get will be part of that equation as well. (Audit End)

Yeah. And Casey, you probably noticed we repaid $27 million of our SBIC I debentures. And although that doesn't obviously impact the net leverage, that did free up capacity there just from a gross leverage perspective as one sort of thinks about the SBIC III deployment. And you also asked about the joint venture. We have no need or requirement to put additional capital into the joint venture at this point in time. So there's not going to -- necessarily going to be a drain of liquidity on the joint venture in the near term. It's sort of operating at a steady state now. And obviously, it's subject to the volatility of the broadly syndicated loan market, but you see the dividend income that it's generating at the moment now, two quarters in a row, and that's becoming more of a steady-state return, if you will, at this point in time than unusual or non-recurring.

And just picking up a little bit on what Mike said about the absence of sort of normalized repayments. I mean in effect, what's happening is that the percentage of prior investments or seasoned credits in our portfolio is growing. And so these are credits that we know, we have a lot of experience with. And so those are very solid credits that we're involved with and are producing what we feel is pretty tremendous earnings. Our earnings yield at 17% is very substantial earnings yield across our portfolio. And while we do have some...

But which is accompanied with a high level of leverage, Chris, I mean...

Correct. Correct.

I mean -- it’s -- you're not in a business that investors are necessarily going to be comfortable with an unlimited amount of leverage. I mean, whether the gross leverage is the same as your regulatory leverage, that number can't go to a number that makes investors uncomfortable or it will be counterproductive, right, no matter what your earnings are. So…

We understand that.

You have to keep that in mind.

Yeah. We absolutely do keep it in mind. And I think as you've heard us on many of our conference calls in these discussions, gross leverage for one BDC is not the same as gross leverage for another. And our gross leverage, given the term structure of our leverage, the duration of our leverage, the absence of covenants, the absence of amortization rates and things like that, we believe makes our leverage quite manageable in the context of our portfolio.

Yeah. Okay. Secondly, for Mike, you said that you're looking forward to some type of broad restructuring of Pepper Palace. Do you think you guys are going to end up with the keys here? Or are you just going to be a -- continue to be in a supportive role? And should we expect where your mark is at to likely turn into some form of equity here?

Casey, obviously, it's a private company, so I can't get into all the details. But certainly, we are working with the sponsor right now trying to improve performance. Recently brought some additional resources to bear to that end. Is it possible that we could end up with the keys? I mean it's uncertain because it's a challenging situation. I've certainly been -- we've been in this business for a long time. There are a lot of lenders who are perhaps overly fearful of taking ownership position when maybe that's the best thing to do. And so that's certainly something that we would consider under the right circumstances. For now, we're working with the sponsor, and we're working to improve the performance. I think the thing that's really important to note is that its challenges are unique to it and are not connected to anything that we're seeing in the broader portfolio. And that -- I'd add additionally that the vast majority of our portfolio is experienced performance that's up -- at or up prior quarters. So we're feeling very, very good about our portfolio. This is a unique circumstance that we're working on hard.

Yeah. Okay. Thank you for that. And then lastly, are you guys afraid that investors will misunderstand the ATM equity sales, seeing as that where you're actually executing them is below NAV, you're adding back the difference. And are these investors ought to want to know whether or not these are being bled out into the market or these are single point institutional trades that are not impacting the day-to-day trading of the stock?

I think that's obviously a very astute question and interesting. It's not precisely something I think we can comment on. I think there will be more evidence of what exactly happened when the 13Fs are filed shortly. But it's something that we don't have 100% visibility on and we will be reporting and have been reporting on according to the SEC standards on what's happened. But we have different periods of time, we have as of quarter-end and what's happened since and then some of the confidentialities of who's doing it. So it's difficult for us to give you a precise read on exactly what happened in terms of the trading volumes. But I mean, I think as you can see, there's quite a few big blocks. And then some of the volume responses after trades were quite good. After the main trades were done, I think the stock price rallied pretty well. Perhaps you can tell us why people aren't valuing our stock at a higher rate than they are right now because you have a better perspective on it. But given all things, improving leverage and 70% earnings yield, dividend yield, portfolio stability and all those type of things, we would think that there would be maybe more interest in the stock than there has been apparently.

Well, I'll reserve my answer to that question for my report. I'm not here to educate the other analysts on the call, but thank you for taking my questions.

Thanks, Casey.

Thank you. And our next question coming from the line of Mickey Schleien with Ladenburg Thalmann. Your line is now open.

Yes, good morning, everyone. Mike, I appreciate your comments on Pepper Palace. I just want to understand if the issues that are -- that, that portfolio company is confronting in terms of its exposure to the consumer is also being manifested anywhere else in your portfolio with respect to companies that are retail oriented?

That's a good question, Mickey. As I said, the vast majority of our portfolio is performing exceptionally well and is up -- is certainly at or up in prior periods. We don't really have that many companies in our portfolio that are direct to consumers. I'm scratching my head to even think of one. Almost all of our portfolio is B2B generally. So -- and to answer your question directly, no, we're not seeing any evidence of that.

Okay. That's helpful. How about in the healthcare sector, Mike, are there further issues developing there at all? Or is that -- are your investments relatively insulated from the wage inflation and reimbursement risk that we've been seeing developing over the last several quarters?

We have not experienced that. I think the areas that we focus on and one of the reasons that we've been attracted to the healthcare market is that it's been our experience that the persistency of demand for those services is quite strong. So not as affected by any larger macro trends, if you will. We also tend to steer clear of generally healthcare deals where they're directly dependent on reimbursement rates. Those are generally not the businesses that we focus on if you look at some of the areas that we're investing in healthcare. So that's not an experience that we've had as well either. I would say it is a broad challenge that almost any middle market, really any business is experiencing now, which is that the labor markets are difficult. And so labor rates are high, and that certainly is constraining margins to some degree. For our portfolio companies, thankfully, these are high value-add businesses. It's one of the things that we look at very hard in underwriting. So they tend to have a lot of pricing power and they usually can manage through that in a way where they can preserve their margins. And that's certainly what we've seen in the performance of our portfolio.

That's helpful and actually is sort of a segue into my next question, which is interest coverage. Can you give us a sense of where the portfolio's average interest coverage ratio is? And do you have a meaningful amount of portfolio companies with an interest coverage ratio below 1?

No, no. And we look at that in underwriting. I can't give you the total portfolio number. That's certainly something that we can look at. But we feel very comfortable that the interest coverage across the portfolio is quite strong.

Yeah. Mickey, and just sort of looking at some -- just very high level, I mean the impact of the interest rate change has probably resulted in like a half a turn of interest rate coverage change. It's not as significant, I think, as one -- as some people perhaps think it might be because of the change in rates over the last year or in our portfolio.

Okay. That's interesting. And just lastly, sort of a housekeeping question. There was a modest decline in portfolio [way] (ph) on average. And I suspect it's due to Pepper Palace, but I just want to confirm if that's the case?

Yeah, that's right. Yeah, that's why I highlighted in my comments as well, Mickey. You had a slight decrease from the rate change, but obviously, a lot of the change happened really in Q1-ish. But that was all seen by Pepper Palace, is the impact of putting that on 0%, obviously, which drives the overall yield down like 20 bps or so.

Okay. Those are all my questions this morning. Thank you for your time.

Thank you, Mickey.

Thank you. And our next question coming from the line of Sean-Paul Adams with Raymond James. Your line is open.

Hi, guys. Good morning. One quick question back to Pepper Palace. It looks like it's been a troubled asset for a while, but was the major markdown at all the result of any sponsor support relationship deteriorating? Or was it just a continued company-specific problem?

There's been no change in the relationship with the sponsor. We're working together to try to improve the performance. What did happen though is that the performance declined significantly enough that the sponsor stopped paying our interest in August. And so it needed to go on non-accrual as a result. But the write-down in valuation was reflective of the continued challenges that the business is having.

Okay. Thank you. And regarding the spillover, do you guys have any idea of a special dividend or declaration sometime in 2024, because it is going to be quite high by the end of this year?

Yeah. I mean I think the spillover is increasing. I think as we've mentioned in prior calls, we've been conservative in our spillover management. And so we don't have any spillover owed this November. And the next time to reconcile spillover will be by November of 2024. And we haven't fully determined our plans relative to managing that. But clearly, there's BDC and RIC rules determining what one does with one's earnings and spillover.

Got it. Thank you. I appreciate it.

Thank you. And our next question coming from the line of Erik Zwick with Hovde Group. Your line is open.

Good morning. I wanted to just start with the commentary that the origination volume in 2Q was kind of slower than it had been in prior quarters, primarily due to a number of the opportunities you've reviewed, not meeting credit standards. So maybe kind of two questions there. One, were there any commonalities between kind of the shortcomings versus your criteria and what you're viewing? Or was it kind of diverse across the company? And two, has that improved so far this quarter? Are you seeing more opportunities that would potentially meet your criteria to add to the portfolio?

I would say that, that was the experience with one new platform company was more reflective of just the nature of the business that we're in, where it's not something where you can look at trends in one quarter and assign too much to that. I think we overall feel very good about the quality of the pipeline that we have. and expect that we'll continue to deploy capital in new portfolio companies kind of at a consistent pace with what we've done in the past. While deal flow in general is down in the market for all the reasons that we've outlined, we're certainly benefiting from the fact that banks have retreated in a pretty significant way. And so we have people even reaching out to us unsolicited trying to form a relationship with us, and that certainly increased our pipeline in a meaningful way. And so that plus all of the efforts that we've made on the business development side have kept our pipeline pretty full. So there's not really anything that I could point to that would say, oh, thematically, we're seeing X in the marketplace, and we're not comfortable with that. We're taking the same approach to underwriting that we have historically.

Thanks. That's helpful. And then the only other question I had, a little bit kind of going back to the debt service coverage ratio discussion from a couple of questions ago. Curious kind of looking at it from the other perspective or kind of other side of the coin. Curious if you could just give any color or characteristics in terms of recent EBITDA growth for your portfolio companies or average or other kind of KPIs that you look at that have helped these companies maybe offset higher interest burden as well as inflationary pressures?

If there's one theme I would say that is common across our portfolio is that we look for businesses that have differentiated business models and often benefit from secular growth trends, i.e., they have a better mousetrap and they're performing well. And therefore, even if the macro environment is a bit challenged, now this isn't 100% the case across every portfolio of the company, but thematically, in general, those businesses that we gravitate toward are ones that are going to perform pretty well even in a challenging environment, and that's what we're seeing in our portfolio.

And so safe to assume that you are seeing kind of growth across the portfolio in terms of EBITDA and other metrics?

Yeah. I think as I've said, the vast majority of our portfolio is up at or above where they were in prior periods.

Okay. Great. Thanks for taking my questions today.

Thank you.

Thank you. And I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Oberbeck for any closing remarks.

Well, we want to thank everyone for joining us today, and we look forward to speaking with you next quarter. Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.