SARATOGA INVESTMENT CORP. NEW 2027 Q2 Earnings Call

I would like to welcome everyone to Saratoga Investment Corp's fiscal second quarter 2027 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 2027 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. For everyone new to our story, please note that our fiscal year-end is February 28th, so any reference to Q2 results reflects our August 31st quarter-end period.

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. Before discussing our results, I would like to take a moment to recognize Henri's transition that was recently announced. Henri will be stepping down from his executive roles on October 31st for health reasons. Henri has been an invaluable member of our team, has made significant contributions to Saratoga over his almost 13 years with us. While we are sad to see him step away from his day-to-day roles, we fully support his decision to prioritize his health. We are grateful that he will remain a member of our board and the CFO of the SBICs and continue to support the company in a consulting capacity. On behalf of the board and the entire Saratoga team, I want to thank Henri for his leadership, judgment and dedication to the company and our shareholders.

This quarter had numerous highlights subsequent to the quarter, including net positive originations of $37.1 million, including two new non-software portfolio companies originated in the quarter, and sustained high-quality AUM growth, with AUM growing 2.1% during the quarter and reaching a record level of $1.15 billion. Issuance of the $85 million SAX Baby Bond, which subsequent to quarter end increased to $120.8 million through the exercise of the green shoe and reopening of the issuance. This allowed for the refinancing of the $105.5 million SAT Baby Bond due early 2027 last month, reducing refinancing risk for next year. This baby bond was opportunistically issued prior to Labor Day and subsequent increases in interest rates and competitive offerings. Stable adjusted NII of $0.46 per share, inclusive of the cost of our recently refinanced capital structure.

Repurchasing approximately 444,000 shares at a discount to NAV, which was accretive to NAV by $0.09 per share. Taking advantage of robust refinancing environment to reset our legacy CLO at $350 million at lower rates, resulting in new three-year reinvestment period and ensuring future BDC management fees and significant interest income. Continuation of significant Zollege investment appreciation and the sale of both our Pepper Palace and CLO F-Note investment subsequent to quarter end, resulting in the resolution of our remaining non-accrual investments. Our core BDC portfolio fair value remains within 1.6% of cost, demonstrating solid overall credit quality in a challenging and volatile macroeconomic environment. Our non-accruals are now zero following the above resolutions, significantly lower than the industry's 3.5% of cost average.

Some of the headwinds experienced this quarter included the balance sheet refinancing, resulting in additional interest expense from higher cost debt, while spreads on assets have not yet widened. We see the base rate increases, which will benefit interest income, with every 25 basis points increasing interest income by $0.033 per quarter. Our NAV per share decline, including $0.82 per share, specifically related to company performance in three distinct credits and $0.30 per share related to dividend distributions exceeding net investment income, offset by $0.09 per share appreciation from share repurchases. $13.3 million of $25.9 million NAV decline from accretive share repurchases being 32% of the change, and excess dividend distribution of previously undistributed earnings being 19% of the change, which reduces the company's spillover obligation. We continue our track record of strong dividend distributions.

We recently announced a monthly base dividend of $0.25 per share or $0.75 per share in aggregate for the third quarter of fiscal 2027, which when annualized, represents an 18.1% yield based on the stock price of $16.61 as of October 5th, 2026, offering strong current income. Originations and AUM growth during the quarter contributed to adjusted NII of $0.46 per share compared to $0.47 per share last quarter. The modest sequential decline reflected higher interest income from portfolio growth, including new originations in BB and BBB CLO debt investments, offset by the full period impact of our recent refinancing activity. Investment activity remained healthy during the quarter, supported by the continued expansion of our business development capabilities and sponsor relationships. Market dynamics continued to be very competitive during the quarter.

Despite this, we originated $76.1 million of investments, including investments in two new non-software portfolio companies and nine follow-on investments, compared with $39 million of repayments, resulting in $37.1 million of net originations. Approximately $9.2 million of the quarter's originations consisted of BB and BBB CLO debt investments. Our strong reputation, differentiated market positioning, and the ongoing development of sponsor relationships continue to create attractive investment opportunities from high-quality sponsors. Investment activity continues post-quarter end with $35 million of originations, including one new portfolio company, offset by $2 million of repayments. While the competition remains significant and sentiment across private credit continues to be cautious, we remain highly selective and disciplined in evaluating opportunities given the uncertain operating environment.

Our total $1.15 billion portfolio was marked down $14.4 million during the quarter, including net depreciation of $15.4 million in the non-CLO core portfolio, driven primarily by $13.1 million of markdowns in Madison Logic, Exigo, and Chronus, reflecting company performance adjustments, and the equity conversions of Gen4 and Modis that resulted in a $1.5 million reversal of previously recognized unrealized appreciation. Other marks reflected a combination of lower equity market multiples and changes in market spreads, partially offset by $4.5 million of unrealized appreciation in Zollege. The CLO1's F-Note remained at zero fair value. The JV was written down $1.1 million after paying a $0.8 million dividend to the BDC, and the BB and BBB portfolio was relatively flat. We also recognized $2.1 million of realized gains, primarily from the Gen4 and Modis dental equity conversions.

As of quarter end, our core non-CLO portfolio was 1.6% below cost, with our total portfolio valuation 4.9% below cost. During the second quarter, our core BDC net interest margin increased to $13.6 million from $13.4 million last quarter. This was driven primarily by a 1.2% increase in average core assets and the average SOFR rate used in the portfolio increasing by five basis points from last quarter. This was partially offset by spreads on originations this quarter being 220 basis points lower than the repayments they replaced and increased interest expense on the changes in our capital structure. As always, and particularly in the current uncertain environment, balance sheet strength, liquidity, and NAV preservation remain paramount for us.

At quarter end, we maintained a substantial $211 million of investment capacity to support our portfolio companies with $121 million available through our existing SBIC III license, including the recent SBA approval of a $75 million upsize and $90 million from our two revolving credit facilities. All quarter end cash was used to repay the SAX Baby Bond in September. As we enter the back half of the fiscal year 2027, the operating environment remains uneven as geopolitical uncertainty, persistent inflation, interest rate volatility, and concerns regarding AI-related disruption within the software sector continue to affect borrowers and valuations. These conditions have contributed to higher default activity, declining NAVs across the industry, and dividend reductions by several BDCs.

At Saratoga, however, the NAV decline this quarter, in addition to it being due to the significant share repurchases that were accretive to NAV per share, was concentrated in a limited number of portfolio-specific situations and does not appear to reflect broad-based deterioration across the portfolio. At the same time, strong BDC debt issuance, firmer values for higher quality loans, and slightly improving M&A activity point to a market that appears to be stabilizing and increasingly differentiated among managers. We remain confident that our disciplined senior secured first lien focused underwriting and well-structured balance sheet position Saratoga to navigate this environment. Moving on to Saratoga Investment's fiscal 2027 second quarter key performance indicators as compared to the quarter that ended May 31st, 2026, and August 31st, 2025.

Our quarter end NAV was $376 million, down 6.8% from $378.5 million last quarter and 14.1% from $410.5 million last year, with $8.4 million of the charge being due to share repurchases. Our NAV per share was $22.15, down from $23.23 last quarter and $25.61 last year. Of the $1.08 sequential quarter reduction, $0.30 or 28% was due to the under-earning of the dividend. This excess distribution represents previously undistributed NII profits from prior years. Our adjusted NII was $7.4 million this quarter, down 2.6% from last quarter and down 18.7% from last year. Our adjusted NII per share was $0.46 this quarter, down 2.1% from last quarter and 20.7% from last year. Adjusted NII yield was 8.1% this quarter, up from 7.8% last quarter and down from 9% last year.