Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corporation Fiscal Second Quarter 2018 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 the management’s prepared remark, we will open the line for questions. At this time, I would like to turn the call over to Saratoga Investment Corporation'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 second quarter 2018 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 2018 shareholder presentation in the Events & 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 from 1 P.M. today through October 19. 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. As we consider our achievements during this most recent fiscal quarter and since we last spoke in July, I'm pleased to note the continued achievement of our core objectives of credit quality, growth, and earnings. Our flexible capital structure and liquidity supports our robust pipeline of available deal sources, increased assets, and greater scale. While the competitive environment remains challenging, our originations and credit quality continue to be strong. Within this environment, Saratoga Investment has risen to and remains at the top of the industry in terms of key performance indicators and in many categories far outpacing our competitors. We continue to progress towards our long-term objective of increasing the quality and size of our asset base, effectively utilizing our diversified sources of cost effective, long-term, and flexible liquidity and continuing to build a robust pipeline of available deal sources with the ultimate purpose of building Saratoga Investment Corp. into a best-in-class BDC generating meaningful and consistent returns for our shareholders. To briefly recap the past quarter on slide two. First, we continue to strengthen our financial foundation this quarter by maintaining a high level of investment credit quality with 97.3% of our loan investments having our highest rating up from 96.3% last quarter, generating a return on equity of 8.3% on a trailing 12-month basis. This latest 12 month's return on equity is net of a $7.7 million realized loss on our My Alarm Center investment, which we'll discuss later on the call. Total realized losses on the whole portfolio for quarter two were $5.8 million and were net of $1.9 million of other realized gains in the quarter, primarily representing the $1.8 million gain on the sale of our Mercury Network equity investment and maintaining a gross unlevered IRR of 12.5% on…

Thank you, Chris. Slide four highlights our key performance metrics for the quarter ended August 31, 2017 in our usual format. Across all these metrics, you can see the positive impact of increased assets and greater scale to our results. When adjusting for the incentive fee accrual related to net unrealized capital gains in the second incentive fee calculation, adjusted NII of $3.7 million was up 25% from last quarter and up 20.7% from last year's Q2. Adjusted NII per share was $0.62, up $0.09 from $0.53 per share last year and up $0.12 from $0.50 per share last quarter. The increase from last quarter and last year primarily reflects our higher level of investments and results in higher interest income with AUM up 22% from last year and 1% from last quarter. Q2 positively reflects the full impact of many new originations executed during the last month in Q1, but conversely also includes the full benefit of the Easy Ice investment that was recapitalized and reduced by $10.2 million at the end of August. These impacts resulted in adjusted NII yield of 11.3% when adjusted for the incentive fee accrual. This adjusted NII yield is up 180 basis points from 9.5% last year and up 210 basis points from 9.2% last quarter. For the second quarter, we experienced a net gain on investments of $4.0 million or $0.67 per weighted average share, resulting in a total increase in net assets resulting from operations of $6.9 million or $1.15 per share. The $4 million net gain on investment was comprised of $5.8 million in net realized losses and $9.8 million in net unrealized appreciation. The net realized loss was primarily due to the recognition of a $7.7 million realized loss on our My Alarm Center investments as a result of…

Thank you, Henri. I'll take a couple of minutes to describe the current market as we see it, then I'll comment on our portfolio performance and investment strategy. The market's extremely competitive conditions have worsened since we last spoke in July. Slide 13 indicates continued downward trend in the number of transactions per deal sizes in the U.S. below $25 million. The number of transactions in the last eight months ended August 31, 2017 is already down significantly as compared to the same period last year. And it is not just volume, total transaction value for the same period is significantly lower than it was last year as well and significantly [Technical Difficulty] run rate. Although certain published data suggest that spreads in the broader middle market have not tightened further, we are seeing a narrowing of spreads starting to impact the lower middle market, driven by a supply/demand imbalance and aggressive leverage and competition for high-quality credits. Thankfully, LIBOR has continued to increase and has provided some counterbalance to spread compression. An extended benign credit cycle and overall expectation for continued economic growth and investor appetite for yield have continued to attract new spread senior and junior capital entrants into the market. This dynamic has created excess liquidity that is giving new receptivity to story paper, higher leverage profiles, and sectors exposed to secular changes. Nevertheless, we really like where we are in the lower middle market because the sheer number of companies at this end of the marketplace allows us to sit through and find transactions that we believe are most likely to deliver the best risk-adjusted returns to our shareholders. On slide 14, you can see that debt multiples in the industry have increased markedly as lenders become more aggressive in their pursuit of higher quality credits.…

Thank you, Mike. As outlined on slide 19, our quarterly cash dividend payment program has grown by 167% since the program launched. During fiscal year 2017, we declared and paid dividends of $1.93 per share, gradually raising the dividend through the year. In addition, we've continued to pay increasing quarterly dividends regularly throughout fiscal year 2018, including $0.46 per share for Q4 last year, $0.47 per share for Q1, and most recently, in September, $0.48 per share for Q2. Total dividends declared and paid during fiscal year 2018 thus far is $1.41 per share. We're also still overearning our dividend by 11.5%, giving us one of the higher dividend coverages in the BDC industry. As you can see on slide 20, we have had 9.3% year-over-year dividend growth, which easily places us first -- in first place among our BDC competition and one of only three BDCs have grown dividends in the past year. We have now had 12 sequential quarters of dividend increases, while most BDCs have either had no increases or decreased the size of their dividend payments. We believe our continually increasing dividend has truly differentiated us within the marketplace. We're also pleased to see a relative standing in the industry consistently improve over time. Moving to slide 21 and reflecting our strong key performance indicators we have discussed earlier, our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 30%, significantly beating the BDC index of 9%. And when viewed over a longer seven year time horizon, as you can see on slide 22, which is when we took over the management of the BDC, our three and seven year return places us in the top two of all BDCs. On slide 23, you can see…

Thank you. [Operator Instructions] And our first question comes from Casey Alexander from Compass Point Research. Your line is now open.

Hi good morning. I have a few questions. Nothing I don't think too difficult. First of all, looking at the schedule of investments, it looks like PIK income will have grown in the coming quarter to around 8% of investment income. Is that a level you're comfortable with? Or is that a level at which you'd like to work PIK income back down? I mean I realize some of it comes from the reset of the Easy Ice investments, but what's your feeling there?

Let me take a stab at that, Casey. Two-thirds of that PIK income roughly is from the Easy Ice transaction. And the way we think about Easy Ice is, of course, given our history and the investment that we've recently made in the business, we obviously like the business quite a bit. It's performing exceedingly well. We, along with management, control the business. The way we've structured is that if we were to not pursue growth, we could pay basically all of that PIK interest in the form of cash and I suppose could bring that number down, which might make you feel good as it relates to our PIK ratio. Instead, given the equity ownership that we have there, we think the best thing for our shareholders is to take that excess cash flow that's being generated internally by the business and invest it in growth. And as you can see from the appreciation that was realized this last quarter, we think that reinvesting that excess cash flow in growth of the business is highly accretive and a better way to deploy capital for our shareholders. So, that's an election that we've made. If you take Easy Ice out, we think that PIK ratio is much more comfortable one obviously. So, it's certainly a fair observation, but I think it's mostly a function of what we're doing with Easy Ice, which we're very excited about.

Go ahead, Chris.

Just one further thing. I want to put to a perspective on it is we actually have a very interesting financial structure at Easy Ice, where that PIK rate can change. And by having it be PIK, we were able to get a much more favorably priced senior loan on the facility. So, we figure that, in addition to the growth objectives that Mike mentioned, the -- having -- instead of having a full cash pay subordinated piece of paper in there, having this partial PIK allowed us to get a much more investor-friendly senior loan that has much more flexibility built into it and is much less expensive than some of the alternatives.

Yes. And I recognize Easy Ice has been a terrific investment. You guys have worked it six ways from Sunday and put yourself into a really favorable position. But I would ask, looking at the level of PIK income over the entire portfolio, of which Easy Ice is a part of, does that impact your flexibility in terms of new investments that you might want to make, that you might want to have some portion of the investment to be PIK income, but maybe less comfortable because of the amount of PIK income over the entire portfolio?

Two questions. Two points on that, Casey. I guess, first of all, if you look at our history, we really have had very little PIK investment and our general strategy has been a heavy weighting in first-lien investments. And we have really not -- I mean, we're not sought some of that high PIK component mezzanine-type investing. We've tried to be more secured investing up the capital structure historically. But in theory, yes, I mean, we obviously don't want to have too much PIK investment income. We think as we've all discussed and you have acknowledged that we think Easy Ice is a special situation that maybe doesn't really speak to the rest of the portfolio because of the nature of our ownership and involvement. So, we are open to other PIK investments, but traditionally, that has not been what we've done in our general portfolio.

Okay. Well, that's a great answer. Thank you very much for that. Secondly, I'm obliged to ask, 40% of the portfolio is listed geographically as Southeast. Any business interruptions from portfolio companies because of the hurricanes that we should know about?

Not anything material.

Okay.

There certainly are some businesses that are in the Southeast that are in the path of the hurricane, but not anything that's affected any of our portfolio companies in a meaningful way.

We only get one chance every three months to ask that question? So, it's kind of a necessary maintenance question to ask. Any update on where you are moving in terms of the second SBIC license since you're a little -- even though the SBIC portfolio came down a little bit this quarter, you're a little deeper into it than you were when you had to extend the period for licensing for the second license. Any update there?

I would just say that we continue to engage with the SBA on an additional license. I think you can see from our performance, we outlined our performance in the -- in our SBIC. As far as we know, we're among the very best SBIC performers down there. And so hopefully, we will get through the system. But it's not something that we can control or drive. And so we need to be responsive to the questions they have and continue to perform as well as we can in our portfolio, which we think we have. And so we really can't give you a hard target date on that.

Sure, okay. Mike, according to one of your slides, 60% of the new deals -- this is not Saratoga's deals, but 60% of the new deals done within your strata of deals that you look at in the quarter were done at attachment points of greater than six times. Does it -- how much does this concern you cyclically? And where were Saratoga's originations for the quarter in comparison to that?

That's a great question Casey. I think it's fair to say that it does concern us to see and that's why we referenced that the marketplace seems to be getting even increasingly competitive, not only from a spread standpoint, but just in terms of the leverage attachment points. So, it does concern us. As you know, though, we've been exceedingly cautious and careful. We're going to grow at a pace that is consistent with the good opportunities that present themselves versus just growing at some predetermined pace. So, asset preservation and making good investments is going to be what really drives our investment pace. And I think as it relates to, let's see, to the attachment points on this most recent quarter, I think I've got that here, but--

Yes. And you in the past explained how sometimes a better deal has a higher attachment point if it's a better company. So, I'm not going to let this color anything. I just want to get a feel for where it is compared to what you showed across the industry.

And I think -- I'm not sure if we have the attachment point per investment here Casey, but you would have noticed that last quarter, our overall portfolio point was 4.3 times and it has come down to four, which I think was a combination of both the Easy Ice downsizing slightly and then also just the relatively moderate levels of attachment on the new investments during the quarter.

Okay.

We're also first lien investments. It's the new ones that were made this quarter.

Yes, that's right.

All right. I have two more very quick questions. So, My Alarm Center, if I understand the realized loss and the remaining investment, as I -- it appears as though -- am I calculating this right? Did you put a little bit more capital into the investment as you did the restructuring? And if that's right, what drove that decision?

That was part of the transaction. So, in order to end up in a position we were in, the current control owner required that the second-lien -- to get the right mix of securities, they require that the second-lien investors step-up for an additional investment as well.

Okay. And lastly, just from a timing perspective, was -- when was Easy Ice recapitalized? Was that right at the end of the quarter?

Yes. August -- actually, I think the last day of the quarter, yes.

Okay. That's very helpful. All right. Great. Thank you for taking my questions. I really appreciate it.

You're welcome. Thank you.

Thanks Casey.

Thank you. And our next question comes from Christopher Testa from National Securities. Your line is now open.

Hey good morning guys. Thank you for taking my questions. Just touching a little bit more on Easy Ice. Obviously, you concluded the recapitalization and sell-down. Are you comfortable with the level that you're at now in terms of the composition of Easy Ice in the portfolio? Or are you looking to potentially sell-down some more of that in the future?

I think the short answer is that we're comfortable with the investment and our current position in the investment and we're very bullish on the company. So, we're not looking to sell-down presently.

Okay. Now, obviously, as you guys just alluded to, you're using the PIK investment there, using the PIK component rather, to get them a cheaper credit, one from Madison Capital. The company completed a very good acquisition of a competitor. Is this something where you're looking to basically continue to do things like this to continue to grow the investment and then potentially be able to sell it at a much larger gain down the road? Is that kind of a right way to look at how you're viewing that?

Well, I don't think we have an exit timeframe in mind, but we are looking at and intentionally structured the transaction in a way that would enable us to have dry powder with our financing partner to not only reinvest internally generated cash flow in the business for growth in an accretive manner, but also be able to draw on that senior facility to help fuel growth. And we think that there's a really nice runway ahead of us for that business and are excited about what the opportunity may be in terms of the growth in the equity value and the enterprise value. Don't really have an exit in mind. We sort of take a little bit more of the Warren Buffett philosophy that if you find a really good business and it's got great dynamics, why sell it? So, those circumstances could change down the road, but at this point, we're just looking at a business that we like an awful lot and an opportunity to grow the enterprise value.

Got it.

And one more comment, Chris, is as we look at the underlying business of Easy Ice, it's a highly diversified revenue source business. It's got a really diverse group of customers and no customer is substantially sized or anything. So, we think having maybe a relatively larger position in a business with these basic fundamentals is fine because of the fundamental diversification of the underlying Easy Ice business.

Kind of excited about the fact that we can control our destiny along with management, of course, they're an important part of the equation. One of the things that we are is -- are challenged with is that we'll deploy debt capital and the deals that go really, really well often have a short lifecycle and you get repaid. Here, we've had -- found a business that we -- as we've said, like an awful lot and have formed a partnership with management. And we can elect when we exit this one and we're not planning to do that anytime soon.

Got it. That's good color. Thank you. And just with the remaining non-accrual TM Restaurant, it was marked up roughly 4% quarter-over-quarter. Just wondering the reason for the markup and any positive trends that you're seeing there.

Well, for Taco Mac, I think, as we said, we're engaged in discussions with ownership and management and are pursuing various options out there. The company continues facing some challenges in the marketplace. I think it actually was -- we've wrote it down slightly this quarter.

Yes, marked down about $300,000, actually.

Yes. Okay. Got that, yes.

And that's just reflecting continued heavy competition in that market. But again, we are in a first-lien position there and I think working actively to improve that situation.

Got it. And as you guys have mentioned your CLO incentive fee was earned more in the quarter. And the weighted average yield on the structured credit securities was pretty significantly despite further spread tightening. Is this indicative of just -- have you guys refinanced a bunch of the CLOs? Just curious what's going on there in light of all the spread compression in the market?

No, there wasn't a refinance -- an additional refinance of the CLO. I think what you saw was just the weighted average effective interest rate, which was then used to calculate the interest income, is an output of all of the other variables and assumptions that go into the valuation.

Right.

And you saw perform really well this quarter and that resulted in a weighted average effective interest rate being slightly higher than it has been in prior quarters and probably at the higher end of what you'd expect. If anything I think you'd expect that rate to sort of come down a little in future quarters rather than keep growing.

Got it. And no I understand that there's a whole plethora of assumptions that go into the level of yield accounting on that. I'm just curious what assumptions specifically were tackled to make the yield go up. Are you expecting lower credit losses? I'm assuming you're not expecting lower reinvestment prices in today's market. So, I'm just curious what specifically drove that up?

I think, Chris, it was very much driven by the performance in the quarter. Because we saw -- if you look at what also impacted the valuation, the biggest driver was the increase in collection, which was a combination of higher -- a higher average interest rate earned as well as the portfolio benefiting from a slightly lower number of assets that were trading under 70 and that, in the model, it's assumed to be immediately defaulted. So, the combination of those [Technical Difficulty] drive increase in collections, increase in value and a higher weighted average interest rate.

Okay, got it. And just looking at the dividend, obviously, congrats on that. You guys are able to increase that again, which is great. I'm just curious, how are you looking at the dividend level going forward? Obviously, it's going to top out at some point. How are you looking at it philosophically, whether you're looking at it sort of the always earned by cash, backing out any potential PIK, backing out anything that you consider non-recurring fees? I'm just curious if you could just kind of give us an idea of how you're looking at it in terms of that?

Well, a few things on that. I think we generally address our dividend on a quarterly basis. And we factor in our cash earnings and obviously as you well know -- everyone knows we've got a tax obligation to pay out a certain amount of our dividends. We also have the benefit of having a net operating loss carryforwards that shelter our capital gain. So, when we have some of our income that covers our dividends, we can shelter. So, we don't -- that doesn't enter the tax equation. That doesn't drive what we need to pay out. I think we consistently had sort of double-digit coverage of our dividend by our earnings and our cash earnings. I think, as you know from my discussion earlier, this whole subject of PIK has really -- is a new -- is sort of new for us because it's really coming up as a result of the Easy Ice investment. And beyond Easy Ice investment, we don't have an intention to do a lot more PIK. And so we don't really think so much about our PIK cash levels and the type of thing. So, I think our view on our dividend is really to comply with our RIC requirements and basically pay out what's comfortable, but leaving a cushion. So, in case of -- in case things are slightly adverse going forward. But we've kind of really addressed in the quarter-by-quarter basis of that based on our cash earnings is principally how we are looking at it.

Okay, great. And you guys have mentioned that the past year or so, about half of your investments are follow-ons, which obviously the other half would be new money. Just curious, what were the primary uses of capital for the new money demand for the loans? And just kind of segueing from that, the LBO showed deals is up and M&A for this calendar year is up pretty significantly from last quarter. Are you seeing more demand for stretch senior relative to just straight first-lien loans as well?

A few things, Chris. Most of the capital that we deploy in new opportunities, new portfolio companies, is usually in conjunction with a change of control transaction. It's not always the case. I mean, I sort of looked at the last quarter, just looking at that, one of them was -- the guy who was taking out as passive partners who wanted to buy them out because he had a lot of faith in the business and wanted a capital partner and help them to growth. So, it really depends. But most of that capital is in conjunction with change of control transactions. I think as we pointed out in one of the slides, one of the challenges that we're facing in the current market, though, is that in the lower end of middle market, we're seeing a lot less transaction volume and there's more and more capital coming in. So to your point, we are seeing more of these stretch senior lenders arriving. We're seeing some of the larger junior capital providers. They're starting to look at some deals that are smaller than we would expect them to look. And so that's making it more difficult environment to deploy capital. And in that environment, we're going to be really cautious, really careful. Fortunately for us, there's couple of things that are helping us. A little bit of bump in LIBOR has been helpful just in terms of how we can price deals to make them accretive. The other thing is that our business development reach and our name in the marketplace has grown quite considerably over the last few years. And so the sheer number of deals that we see is so great that we have confidence that even in this tough environment, that we can find our share of opportunities to deploy capital where the risk-adjusted returns are really nice ones for our shareholders.

Okay, great. That's all for me. Thank you for taking my questions.

Thank you.

Thank you. At this time, I am showing no further questions. I would like to turn the call back over to Christian Oberbeck, CEO for closing remarks.

Well, again, I would like to thank everyone for joining us today. We appreciate your support, and we look forward to speaking with you next quarter.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.