Saratoga Investment Corp 2nd Quarter 2027 Earnings Conference Call - QTREX QUANTUM LTD

Financial Performance:

• Record Assets Under Management (AUM) of $1.15 billion, growing 2.1% sequentially; total portfolio value $1.5 billion.
• Adjusted Net Investment Income (NII) was $7.4 million (46 cents per share), a 2.6% decrease from the prior quarter and 18.7% lower year-over-year.
• Adjusted NII yield was 8.1%, while 12-month Return on Equity (ROE) was -1.1%, down from 4% and 9.1% in previous periods.
• NAV per share declined to $22.15 (down $1.08 sequentially); the decline was driven by dividend distribution exceeding NII ($0.30), $0.82 in specific credit mark-to-market adjustments, offset by $0.09 accretion from share repurchases.
• Repurchased 444,000 shares for $8.4 million at a discount, which was accretive to NAV.
• Total portfolio valuation is 4.9% below cost; core non-CLO portfolio is 1.6% below cost.
• Non-accrual investments reduced to zero following the post-quarter-end sale of "Pepper Palace" and resolution of the CLO F-Note; non-accrual rate was 1.3% of cost at quarter end.
• Realized gains of $2.1 million primarily from equity conversions; net unrealized depreciation of $15.4 million in the core portfolio driven by software-specific credits (MadisonLogic, Exego, Cronus).

Guidance and Future Outlook:

• Management maintains a disciplined, long-term focus with confidence in navigating the uneven macro environment; expects portfolio growth to continue.
• Dividend of $0.75 per share (monthly $0.25) declared for the third quarter, annualizing to an 18.1% yield based on recent stock price; no immediate changes anticipated.
• Anticipate narrowing the gap between NII and dividend distributions as market spreads widen and base rates stabilize; currently viewing the asset side as catching up to the liability side rate adjustments.
• Expect increased management fees and interest income from the refinanced CLO ($350 million) with a new reinvestment period through October 2029.
• Pipeline strength is improving, with deal flow increasing significantly from end-of-year 2024 levels due to expanded business development efforts.
• Long-term ROE target remains strong, leveraging a 12-year average of 9.2%, significantly outperforming the BDC industry average.

Business Segments and Product Lines:

• Core BDC operations generated $76.1 million in originations (2 new non-software platforms, 9 follow-ons) and $9.2 million in BBB CLO debt investments.
• Successfully refinanced the $105.5 million SAT baby bond and issued $85 million in SACS baby bonds (reopening increased proceeds to $120.8 million), reducing near-term refinancing risk.
• Resolved remaining non-accruals by selling "Pepper Palace" and the CLO F-Note, leaving the portfolio with zero non-accruals.
• SBIC 3 leverage limit increased by SBA approval to $250 million, adding $75 million in low-cost, 10-year bullet debt capacity.
• CLO refinancing extended the reinvestment period to 2029 and legal maturity to 2037, while establishing a non-call period through April 2028.
• 81.5% of the portfolio is in first-lien debt; 21.2% are first-lien last-out positions.

Market and Competitive Landscape:

• Market remains highly competitive with tight spreads and abundant capital supply, though early signs of spread widening and stabilizing loan values are emerging.
• M&A activity in the lower-middle market remains low, but demand for credit and refinancing needs are increasing, particularly in private equity.
• Software sector faces valuation pressure due to AI disruption concerns and customer churn; management expects a shift away from new software originations.
• Management favors private equity sponsors for added credit support and capital discipline; 88% of term sheets currently favor PE sponsors.
• Lower-middle market offers the best risk-adjusted returns due to conservative capital structures, stronger covenants, and robust management engagement.

Risks and Challenges:

• Higher interest expense resulting from recent debt refinancing has temporarily compressed net investment income until asset yields adjust.
• Persistent inflation, interest rate volatility, and geopolitical uncertainty continue to pressure borrower valuations and create default risks across the industry.
• Specific portfolio headwinds in three software credits (Exego, Kronos, MadisonLogic) drove significant markdowns due to customer retention issues and market softness.
• NAV decline in the quarter was impacted by the release of undistributed earnings (spillover) and the accounting impact of accretive share repurchases.
• Industry-wide defaults and NAV declines are occurring, though Saratoga's exposures are concentrated rather than broad-based.

Management Commentary and Tone:

• CEO Christian Oberbeck and CFO Henry Steenkamp displayed confidence in the balance sheet strength and portfolio quality despite short-term headwinds.
• Henry Steenkamp announced his stepping down from executive roles on October 31st for health reasons but will remain on the board and in a consulting capacity; Christine Ramdahal promoted to CFO of the BDCs.
• Tone was pragmatic and disciplined, emphasizing the importance of credit selection, business development, and balance sheet preservation over short-term NAV fluctuations.
• Management expressed strong alignment with shareholders, citing 11.5% management ownership and a long-term track record of value creation.

Analyst Questions and Answers:

• Spillover & Dividend: Spillover reduced to ~$1/share; management views bridging the NII/dividend gap as a multi-quarter process driven by market normalization.
• Leverage & Share Repurchases: Share repurchases are viewed as accretive when trading at significant discounts to NAV, balancing the slight increase in leverage ratio; debt structure (laddered maturities) mitigates rating agency concerns.
• CLO Fees: Management fees on the CLO will ramp back to full levels (~$450k quarterly) upon refinancing, plus interest income from subordinated notes and E-notes.
• SBIC Eligibility: ~85-90% of deal flow is SBIC-eligible; incremental capacity will be prioritized for SBIC financing due to its low cost and favorable structure.
• AI Impact: No meaningful negative impact from AI identified in the affected software credits (Kronos and MadisonLogic); AI is monitored but currently accretive or neutral for these specific businesses.
• PE Sponsorships: Preference for PE-sponsored deals remains high due to capital support and sophistication, with 88% of current term sheets favoring this channel.

Other Key Points:

• $211 million in liquidity available at quarter-end ($121M SBA, $90M revolving credit, $211M cash/available capacity), allowing for 18% portfolio growth without external financing.
• The company has zero non-accruals as of the end of the quarter, significantly lower than the industry average of 3.4-3.5%.
• Total return for the last 12 months was -16% (vs. BDC index -6%), but 3-year and 5-year returns remain in line with the index.
• Since 2010, the company has achieved a 700% total return, more than 2.5 times the industry average of 270%.