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Edited Transcript of SAR earnings conference call or presentation 9-Jul-20 2:00pm GMT

Q1 2021 Saratoga Investment Corp Earnings Call

NEW YORK Aug 19, 2020 (Thomson StreetEvents) -- Edited Transcript of Saratoga Investment Corp earnings conference call or presentation Thursday, July 9, 2020 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christian L. Oberbeck

Saratoga Investment Corp. - Chairman & CEO

* Henri J. Steenkamp

Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO

* Michael J. Grisius

Saratoga Investment Corp. - President & Director

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Conference Call Participants

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* Bryce Wells Rowe

National Securities Corporation, Research Division - MD of Equity Research

* Casey Jay Alexander

Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst

* Mickey Max Schleien

Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst

* Timothy Paul Hayes

B. Riley FBR, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Saratoga Investment Corp.'s Fiscal First Quarter 2021 Financial Results Conference Call. Please note that today's call is being recorded. (Operator Instructions) 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.

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [2]

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Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s Fiscal First Quarter 2021 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 first quarter 2021 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 1:00 p.m. today through July 16. 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.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [3]

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Thank you, Henri, and welcome, everyone. This past quarter, with a full 3 months of the COVID-19 impact, has been challenging for our portfolio companies and Saratoga. Despite the unprecedented impact of COVID-19 across our businesses and the world, we believe Saratoga and our portfolio companies are positioned well at this point in time to weather this calamitous health and economic environment. We look forward to presenting our most recent results and reviewing the solid structure of our capitalization and recently improved liquidity on today's call.

We continue to focus on ensuring the safety of our employees and the employees of our portfolio companies while optimizing the management of all our ongoing business activities. The company is working collaboratively with all our constituents to navigate the significant challenges presented by the COVID-19 pandemic. We want to especially thank our professional staff and employees who have worked so tirelessly through the past months as well as our shareholders who have stood by us in these difficult times.

We believe that our historically conservative approach to investing, leverage utilization, maintenance of solid levels of liquidity, conservative spillover management and some good fortune have put us in a strong position with the balance sheet strength to face these uncertain and challenging times. While no business can anticipate with clarity how long the displacement in the market and global economy will last, we have confidence that our capital structure, liquidity, organization and management experience will enable us to efficiently and effectively navigate this challenging current and uncertain future environment.

To briefly recap the past quarter on Slide 2. First, we continued to strengthen our financial foundation this quarter by maintaining a relatively high level of investment credit quality, with over 90% of our loan investments retaining our highest credit rating after incorporating the impact of changes to market spreads, EBITDA multiples and/or revised portfolio company performance related to COVID-19. These impacts led to a 6.1% unrealized markdown on our overall portfolio. Representing almost 3 months of post-COVID results, we believe our performance exceeds the reported industry average of results that were reported 2 months ago, generating a return on equity of 9.9% on a trailing 12-month basis in Q1, net of the COVID-19 impact to the portfolio. This is the highest ROE of all the BDCs for the past year and significantly exceeds the BDC industry average of a negative 12.2% and registering a gross unlevered IRR of 16.7% on total realizations of $483 million.

Second, our assets under management declined slightly to $483 million this quarter or a 0.6% decrease from $486 million as of last quarter, but an 18% increase from $409 million as of the same time last year. Despite the unprecedented uncertainty and turmoil in the markets, we originated a healthy $39 million of new investments, offset by $9 million of repayments. Importantly, our new originations included 2 new portfolio company investments. Our capital structure, portfolio performance and recently improved liquidity have enabled us to remain open for business, an important differentiator in today's market.

Third, as we look ahead to the numerous challenges that the COVID-19 pandemic presents to the economy and particularly small businesses, balance sheet strength, liquidity and NAV preservation are paramount, both for our portfolio companies and ourselves. Our current capital structure at quarter end was strong with $282 million of mark-to-market equity supporting $60 million of long-term, covenant-free, non-SBIC debt. Our quarter end regulatory leverage of 569% substantially exceeds our 150% requirement.

And in June and including the exercise of the green shoe this week, we further increased our capital and liquidity by raising a new $43.1 million public baby bond, the first BDC issuing public debt since the pandemic began. This substantially increases our quarter-end BDC cash and our available liquidity to support our existing portfolio companies, in addition to the $155 million of available SBIC II facilities, which can be used to finance new opportunities with an all-in cost of approximately 2.5%. We had $9 million of uncommitted undrawn lending commitments as of year-end and $40 million of discretionary funding commitments.

Finally, following substantial efforts by our management team to improve liquidity since our last earnings call at the beginning of May, including our recent baby bond raise and the current resiliency of our portfolio, the Board of Directors has decided to declare a $0.40 per share dividend for the quarter ended May 31, 2020. This dividend has been calibrated at this level relative to the most recent $0.56 per share dividend to reflect, on the one hand, our relatively strong quarterly results and recently improved liquidity profile; and on the other hand, the lack of short- and long-term visibility of portfolio company and the general economy fundamental earnings levels, given the unprecedented and highly effective amounts of liquidity provided by PPP loans, fed interventions and fiscal stimulus. We will continue to reassess the amount of our dividends on at least a quarterly basis as we gain better visibility on the economy and fundamental business performance.

As discussed on our May call, we have historically conservatively managed our RIC compliance obligations such that we have no ordinary income spillover obligations, and therefore, a substantial spillover flexibility and consequent liquidity. Payment of this dividend further preserves our spillover liquidity position.

This quarter saw continued solid performance within our key performance indicators as compared to the quarters ended May 31, 2019, and February 29, 2020. And considering the current economic environment, our adjusted NII is $5.8 million this quarter, up 24% versus $4.6 million last year but down 15% versus $6.8 million last quarter. Our adjusted NII per share is $0.51 this quarter, down $0.09 from $0.60 last year and down $0.10 from $0.61 last quarter. Latest 12 months return on equity is 9.9%, currently the highest in the BDC industry. And our NAV per share is $25.11, up 4% from $24.06 last year and down 7% from $27.13 last quarter, significantly exceeding industry performance. Henri will provide more detail later.

As in the past, we remain committed to further advancing the overall long-term size and quality of our asset base. As you can see on Slide 3, our assets under management have steadily risen since we took over the BDC and the quality of our credits remains high. While we had a slight 0.6% decrease this quarter as compared to last based on fair value and reflecting the unrealized change in fair value for the quarter, our cost basis increased to $516 million, which is a 27% increase from last year and a 6% increase from last quarter.

With that, I would like to now turn the call back over to Henri to review our financial results as well as the composition and performance of our portfolio.

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [4]

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Thank you, Chris. Slide 4 highlights our key performance metrics for the quarter ended May 31, 2020. When adjusting for the incentive fee accrual related to net capital gains in the second incentive fee calculation, adjusted NII of $5.8 million was down 15.3% from $6.8 million last quarter and up 24.5% from $4.6 million as compared to last year's Q1. Adjusted NII per share was $0.51, down $0.09 from $0.60 per share last year and down $0.10 from $0.61 per share last quarter. The increase in adjusted NII from last year primarily reflects the higher level of investments and resultant higher interest income, with AUM at cost up 27% from last year. The decreased NII from last quarter is primarily due to the nonrecurring one-off impact from last quarter's sale of Easy Ice.

The decrease in adjusted NII per share from last year was primarily due to the higher number of shares outstanding this year. Weighted average common shares outstanding increased by 44.8% from 7.7 million shares last year Q1 to 11.2 million shares for the past 3 months ended February 29, 2020, and May 31, 2020, respectively. Adjusted NII yield was 7.9%. This yield is down 220 basis points from 10.1% last year and 140 basis points from 9.3% last quarter, reflecting primarily the impact of our growing NAV, the reduced LIBOR over this period and the effect of our currently undeployed capital.

For this first quarter, we experienced a net loss on investments of $31.7 million or $2.82 per weighted average share, resulting in a total decrease in net assets resulting from operations of $22.7 million or $2.02 per share. The $31.7 million net loss on investments was comprised of $32.0 million in net unrealized depreciation on investments, offset by $0.3 million of net deferred tax benefit on unrealized depreciation in our blocker subsidiaries. The $32 million unrealized depreciation reflects a 6.1% reduction in the total value of the portfolio, primarily related to the impact of COVID-19 that resulted in changes to market spreads, EBITDA multiples and/or revised portfolio company performance following the events since March of this year.

The most significant fair value reductions are summarized in the MD&A in our Form 10-Q that was also filed last night. But in summary, there was no single investment with unrealized depreciation in excess of $4 million and the 3 largest Q1 reductions were Nolan Group with $3.8 million, C2 Education Services with $3.1 million and our CLO equity investment, also with $3.1 million. There were also 5 more investments with fair value reductions between $1 million and $2 million each.

Return on equity remains an important performance indicator for us, which includes both realized and unrealized gains. Our return on equity was 9.9% for the last 12 months, which places us at the top of the industry for this period and well above the industry average of negative 12.2%. Total expenses, excluding interest and debt financing expenses, base management fees and incentive management fees, increased from $1.3 million for the quarter ended May 31, 2019, to $1.4 million for this quarter, but remained unchanged at 1.1% of average total assets.

We have also again added the KPI slides, starting from Slides 25 through 28 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past 11 quarters and the upward trends we have maintained. Of particular note is Slide 28, highlighting how our net interest margin run rate has almost quadrupled since Saratoga took over management of the BDC and has continued to increase in Q1.

Moving on to Slide 5, NAV was $281.6 million as of this quarter end, a $22.7 million decrease from NAV of $304.3 million at year-end and a $94.8 million increase from NAV of $186.8 million as of the same quarter last year. NAV per share was $25.11 as of quarter end, down from $27.13 as of year-end and up 4.4% from $24.06 as of 12 months ago. For the 3 months ended May 31, 2020, $9.0 million of net investment income and $0.3 million of deferred tax benefit on net unrealized gains in Saratoga blocker subsidiaries were earned, offset by $32 million of net unrealized depreciation. Our net asset value has steadily increased since 2011 and is up 51% in just the past year alone, and this growth has been accretive as demonstrated by the increase in NAV per share. We continue to benefit from our history of consistent realized and unrealized gains.

On Slide 6, you will see a simple reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. Starting at the top, NII per share decreased from $0.61 per share last quarter to $0.51 per share in Q1. Most of the decrease was due to the nonrecurring net $0.14 decrease in other income and deferred tax expense from the Easy Ice sale last year. This was offset by a $0.05 increase in non-CLO interest income. Moving on to the lower half of the slide, this reconciles the $2.02 NAV per share decrease for the quarter. The $0.80 generated by our NII this quarter was offset by the $2.82 unrealized depreciation on investments.

Slide 7 outlines the dry powder available to us as of May 31, 2020, which totaled $225.8 million. This was spread between our available cash, undrawn SBA debentures, undrawn Madison facility and publicly traded notes. This quarter end level of available liquidity allows us to grow our assets by an additional 47% without the need for external financing, with $26 million of it being cash, and that's fully accretive to NII when deployed. And since quarter end, we increased our available BDC liquidity by raising $43.1 million in a 7.25% 5-year maturity, 2-year non-core baby bond trading under the ticker SAK, becoming the first BDC to raise a public baby bond since COVID-19 began. We remain pleased with our liquidity position, especially taking into account the overall conservative nature of our balance sheet and the fact that all our debt is long term in nature, actually all 3 years plus.

Now we'd like to move on to Slides 8 through 10 and review the composition and yield of our investment portfolio. Slide 8 shows that our composition and weighted average current yields have changed slightly as compared to the past. We now have $483 million of AUM at fair value or $516 million at cost, invested in 39 portfolio companies and 1 CLO fund. Our first lien percentage has increased to 73% of our total investments, of which 14% is in first lien last-out positions.

On Slide 9, you can see how the yield on our core BDC assets, excluding our CLO and syndicated loans, as well as our total asset yield has dropped below 10%, yet remains healthy. This quarter, our overall yield increased slightly to 9.6%, with fair value decreasing, but core asset yields decreased from 9.8% to 9.5% based on cost as LIBOR decreased to well below 100 basis points during Q1. 100 basis points is our lowest floor, so we do not expect to see further decreases in LIBOR really impact our interest income. The weighted average fair value yield on the CLO remained relatively unchanged, and the CLO is currently performing and current.

Turning to Slide 10, during the first fiscal quarter, we made investments of $39.0 million in 2 new portfolio companies and 10 follow-ons and had $9.4 million in 1 exit plus amortizations, resulting in a net increase in investments of $29.6 million for the quarter. Our investments remain highly diversified by type as well as in terms of geography and industry, spread over 9 distinct industries with a large focus on business, health care and education services. Business services remain our largest classification and represents investments in companies that provide specific services to other businesses across a wide variety of industries. As of quarter end, the business services classification currently includes investments in 23 different companies whose services range broadly from education to financial advisory, IT management to restaurant supply, human resources and many other services, 16 in total. This breakdown is provided in our featured presentation on our website. Of our total investment portfolio, 5.4% consists of equity interests, which remain an important part of our overall investment strategy.

As you can see on Slide 11, for the past 8 fiscal years, including Q1, we had a combined $59.6 million of net realized gains from the sale of equity interest or sale or early redemption of other investments. About 2/3 of these gains were fully accretive to NAV due to the unused capital loss carryforwards that were carried over from when Saratoga took over management of the BDC. This consistent performance highlights our portfolio credit quality, has helped grow our NAV and is reflected in our healthy long-term ROE. In fact, our 6-year ROE average is now above 10%, including Q1, with not 1 year below 9%. That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our President and Chief Investment Officer, for an overview of the investment market.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [5]

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Thank you, Henri. I'll take a couple of minutes to describe the current state of the market as we see it and then comment on our current portfolio performance and investment strategy in light of the continued impact of COVID-19. While the first couple of months of 2020 were very similar to the market environment that has persisted over the last couple of years, the impact of the pandemic has altered market dynamics considerably.

When we last spoke, new platform originations in our market had nearly come to a halt. Most M&A processes have been suspended while buyers and sellers waited to better understand the impact of the pandemic. While most M&A processes are naturally still on hold, we are now beginning to see some new loan inquiries. The deals that are getting done in the current market are less frequently with new platforms and more often with existing portfolio companies that are either pursuing growth initiatives or seeking liquidity.

The new capital that is being deployed in this market is generally at lower leverage thresholds and marginally higher spreads. In addition, the underwriting bar is much higher than usual, reflecting the current economic uncertainty. Now, all of that said, we think it is an excellent time to invest in new portfolio companies and we are actively seeking such opportunities. We believe that compelling risk-adjusted returns can be achieved by deploying capital in support of those highly select businesses that have demonstrated strength and durability in the midst of this difficult environment. We have invested in 3 new platform investments since the onset of the pandemic, including 1 just this week.

From a competitive standpoint, lenders seem to be generally open for business, although some institutions appear to be practically out of the market for new capital deployment altogether. This has shifted market dynamics more favorably to lenders, but there is still competition for capital deployment.

We continue to be very actively engaged with our portfolio companies. We have found that our portfolio companies are generally taking the right steps to help mitigate both the near- and long-term effect of COVID-19 on their businesses. Many of them were also able to avail themselves of the Paycheck Protection Program, or PPP, loan relief. All of our loans in our portfolio are paying according to their payment terms, except for Roscoe. Taco Mac, My Alarm and Roscoe investments have experienced challenges for some time now and remain on nonaccrual.

The impact of COVID-19 on our portfolio remains uncertain. While virtually every business has had some level of impact in the near term, the ultimate impact of the coronavirus on any individual portfolio company remains unknown as the uncertainties with the virus and the possible long-term economic impacts persist. Our Q1 valuations reflect a 6.1% reduction in the total value of the portfolio, primarily related to the impact of COVID-19 that resulted in changes to market spreads, EBITDA multiples and/or revised portfolio company performance following the events since March 2020. We believe this strong performance reflects certain attributes of our portfolio that we expect will help us as we navigate through this economic environment, and we remain confident thus far in the overall durability of our portfolio.

73% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that we have -- that have historically performed well in stress situations. We have no direct energy exposure. In addition, the majority of our portfolio is comprised of businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. However, there are still plenty of uncertainties, and therefore potential future adverse effects of COVID-19 on market conditions and the overall economy, including but not limited to, the related declines in market multiples, increases in underlying market credit spreads and company-specific negative impacts on operating performance could lead to unrealized and potentially realized depreciation being recognized in our portfolio in the future.

While no business can anticipate with clarity how the long-term displacement in the market and global economy will last, we continue to believe that our well-constructed capital structure and liquidity will help us navigate the challenges presented by the coronavirus. We believe sticking to our strategy has and will continue to serve us best, especially in the market we currently face. Our approach has always been to focus on the quality of our underwriting. And as you can see on Slide 12, this approach has resulted in our portfolio performance being at the top of the BDC space, with net realized gains of $59.6 million since taking over management of the portfolio in 2010.

A strong underwriting culture remains paramount at Saratoga. We approach each investment working directly with management and ownership to thoroughly assess the long-term strength of the company and its business model. We endeavor to peer as deeply as possible into a business in order to understand accurately its underlying strengths and characteristics. We always have sought durable businesses and invested capital with the objective of producing the best risk-adjusted accretive returns for our shareholders over the long term.

Our internal credit quality rating reflecting the impact of COVID-19 shows 90% of our portfolio at our highest credit rating as of quarter end. We believe our underwriting approach has contributed to our overall strong portfolio performance and successful returns and has also positioned us well for this current economic downturn. We believe these results reflect the current strength of our underwriting approach, team and portfolio and the quality of opportunities that typically exist in our markets.

Now looking at leverage on Slide 13, you can see that industry debt multiples decreased somewhat in calendar Q1, with 57% of multiples above 5x versus 80% of deals last year. Total leverage for our portfolio was 4.46x, increasing slightly from last quarter. As we frequently highlight, rather than just considering leverage, our focus remains on investing in credits with attractive risk return profiles and exceptionally strong business models where we are confident that the enterprise value of the businesses will sustainably exceed the last dollar of our investment.

In addition, this slide illustrates our consistent ability to generate new investments over the long term despite difficult market dynamics. During the last 2 quarters, we added 4 new portfolio companies and made 15 follow-on investments as well as 1 more platform investment thus far in July. There are a number of factors that give us measured confidence that, despite the current precipitous decline in deal activity, we can continue to grow our AUM steadily in this environment as well as over the long term.

First, we continue to grow our reach into the marketplace as is evidenced by several investments we have recently made with newly formed relationships. Second, we have developed numerous deep long-term relationships with active and established firms that look to us as their preferred source of financing. Third, competition has become marginally less aggressive in this environment. And last, we expect the pace of payoffs to diminish significantly until financing markets recover and the impact of COVID-19 is more fully known.

Moving on to Slide 14, our team's skill set, experience and relationships continue to mature and our significant focus on business development has led to new strategic relationships that have become sources for new deals. The number of new business opportunities has been greatly impacted by COVID-19. However, we are beginning to see some rebound in inquiries and the deal pipeline is more active this past month. Notably, over the past 12 months, almost 1/4 of term sheets issued and 4 of our new portfolio companies are from newly formed relationships, reflecting solid progress as we expand our business development efforts.

The continued activity in our deal funnel evidences the strength of our origination platform, while the count of our new portfolio companies, which has largely been steady, underscores how we continue to maintain our investment discipline. Passing on a deal that is in front of you is hard, but maintaining discipline is ingrained in our culture, and we will continue to say no if opportunities do not fit our credit profile.

As you can see on Slide 15, our overall portfolio credit quality remains solid. On the chart on the right, you can see total gross unlevered IRR on our $487 million of combined weighted SBIC and BDC unrealized investments is 9.9% since Saratoga took over management, reflecting the impact of COVID-19 fair value reductions this quarter. As Henri mentioned earlier and reflected in our Form 10-Q, these markdowns are across a wide variety of companies and does not change our view of their fundamental long-term performance. As expected, other than our CLO, the 2 largest unrealized depreciations are in our Nolan Group and C2 Education investments, both of which are more dependent on in-person human interaction.

Our investment approach has yielded exceptional realized returns. The gross unleveraged IRR on realized investments made by the Saratoga Investment management team is 16.7% on approximately $483 million of realizations. The single repayment in Q1 had an IRR of 13.1%.

Now moving on to Slide 16, you can see our first SBIC license is fully funded, with $227.8 million invested as of year-end. Our second SBIC license has already been funded with $50 million of equity, of which $70.1 million of equity and SBA debentures have been deployed. There is still $1.4 million of cash and $80 million of debentures currently available against that equity. In looking back at Q1, the way the portfolio has proven itself to be well constructed and resilient against the impact of COVID-19 demonstrate the strength of our team, platform and portfolio and our overall underwriting and due diligence procedures. Credit quality remains our primary focus.

And while the world has changed significantly over the past 3-plus months, we remain intensely focused on preserving asset value and remain confident in our team and the future for Saratoga. This concludes my review of the market, and I'd like to turn the call back over to Chris.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [6]

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Thank you, Mike. As outlined on Slide 17, following Saratoga Investment's recent baby bond raise and the current performance of its portfolio, the Board of Directors has decided to declare a $0.40 per share dividend for the quarter ended May 31, 2020. This dividend has been calibrated at this level relative to the prior $0.56 per share dividend to reflect, on the one hand, our relatively strong quarterly results and recently improved liquidity profile, and on the other hand, the lack of short- and long-term visibility in the context of how the massive recent liquidity infusions domestically from PPP loans, Fed interventions and fiscal stimulus, will ultimately play out in the economy and business operations. The Board of Directors will continue to reassess this on at least a quarterly basis.

Moving to Slide 18, our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of minus 26%, below the BDC index at minus 22%. Latest 12 months' total return was impacted by COVID-19, which has caused volatility, severe market dislocations and liquidity constraints in many markets, particularly impacting the smaller BDCs, with latest 12-month returns for BDCs with NAV below $300 million between negative 23% and negative 62%.

Our longer-term performance is outlined on our next slide, 19. Over 3- and 5-year returns -- our 3- and 5-year returns place us in the top 10 and 15, respectively, of all BDCs for both time horizons. Over the past 3 years, our 0% return actually exceeded the negative 15% return of the index. While over the past 5 years, our 50% return exceeded the index's negative 4% return.

On Slide 20, you can further see our outperformance placed in the context of the broader industry and specific to certain key performance metrics. We remain above the industry average across diverse categories, including interest yield on the portfolio, latest 12 months' NII yield, latest 12 months' return on equity and latest 12 months' NAV per share growth. We continue to focus on our latest 12 months' return on equity and NAV per share outperformance, which are both at the top of the industry and reflects the growing value our shareholders are receiving. Not only are we one of the few BDCs to have grown NAV, we have done it accretively by also growing NAV per share.

Moving on to Slide 21, all of our initiatives discussed in this call are designed to make Saratoga Investment a highly competitive BDC that is attractive to the capital markets community. We believe that our differentiated characteristics outlined on this slide will help drive the size and quality of our investor base, including adding more institutions.

Our differentiating characteristics include maintaining one of the highest levels of management ownership in the industry, at 11%, which has decreased percentage-wise as a result of recent equity issuances and not by shares sold by management other than transfers among managers for compensation-related purposes; access to low-cost and long-term liquidity with which to support our portfolio and make accretive investments; receipt of our second SBIC license providing sub-2.5% cost liquidity; a BBB investment-grade rating and a new public baby bond issuance in June; solid historic earnings per share and NII yield; strong historic return on equity accompanied by growing NAV and NAV per share, putting us at the top of the industry for both; high-quality expansion of AUM; and an attractive risk profile.

In addition, our historically high credit quality portfolio contains minimal exposure to conventionally cyclical industries, including the oil and gas industry. We remain confident that our experienced management team, historically strong underwriting standards and tested investment strategy will serve us well in battling through the substantial changes in the current and future environment. And that our balance sheet, capital structure and liquidity will benefit Saratoga's shareholders in the near and long term. In closing, I would like again to thank all of our shareholders for their ongoing support. And I would like to now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Tim Hayes with B. Riley FBR.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [2]

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Hope you're all doing well. My first question here, do you have an estimate of just how much of the unrealized depreciation was due to credit spread widening versus fundamental performance?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [3]

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I would tell you that about -- this is a rough estimate, about 2/3 of the write-downs in our portfolio were attributed to spread widening, and about 1/3 can be attributed to either a reduction in performance or expected reduction in performance at this point.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [4]

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Okay, got it. That's helpful. And of that, the third bucket that's related to fundamental performance, are there any common threads here? Whether it's performance of companies at the CLO versus the BDC level or if it's sponsored versus nonsponsored companies or just the types of industries that are more exposed to kind of what's going on right now.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [5]

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I would say it's the latter. It's such unprecedented times, as you I'm sure can appreciate. When we were evaluating companies, we certainly weren't saying, "Oh, let's run a scenario where the world shuts down." But I would say that the businesses that are being most affected in our experience are those that require a fair amount of human interaction. So I think we referenced, for instance, C2 and Nolan, those are businesses that we feel really good about their fundamentals. Nothing has changed. And really across the portfolio, this experience hasn't caused us to change our view of the fundamental strong credit characteristics of our portfolio.

But in those specific cases, they do require -- in Nolan's case, that's a company that provides a really excellent value proposition to a customer base that's in the lodging sector and that's certainly being impacted right now. In C2's case, it's tutoring services. And I think can tell people have more visibility on school attendance and in sync with that, high school kids attending tutoring in person, they'll still be working through that. But we feel fundamentally that both of those businesses are very strong, and we're going to wait to see how and what the COVID impact will be over time.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [6]

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That's helpful. I appreciate that, Michael. Were these credits -- were Nolan or C2, were they of that 10% bucket or roughly 10% bucket that was downgraded on your internal metrics? Or can you maybe touch on what other companies, if not those, that you had downgraded internally? And if it's more again just a function of near-term headwinds, given that the human interaction needed for these businesses? Or if it's reflecting longer-term outlook for some of these companies?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [7]

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The downgrades that changed from last quarter are reflecting the current environment. Not necessarily reflecting any fundamental change in the long-term outlook for the business, really just reflecting the particular businesses that are experiencing a bit more difficulty in this environment. I don't know if that -- does that address your question?

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [8]

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Yes. No, that is helpful. And I know the culprits you kind of alluded to earlier, the ones that have been on nonaccrual for a while, Roscoe and Taco Mac and My Alarm. But are there any others that are now more on your watch list, given kind of the longer-term outlook for these businesses rather than the near-term disruptions that you can point to?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [9]

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There's no specific business beyond the couple that we mentioned that we would put into that category necessarily. But I would caution you that as we think about the world right now, there's so much uncertainty. I think we've done a really good job assembling a portfolio that has a superstrong recurring revenue characteristics. But having said that, you look at certain end markets in the economy; education would be one. We're all looking to see how the education market is going to deal with COVID come the fall. We think our business models that are serving that end market should hold up really well, but there's just uncertainty around that. We're not pointing to any specific one, but we're all kind of watching and managing that very actively.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [10]

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Got it, got it. Okay. I appreciate the comments there. And then this might be a better one for Chris. But -- and I know it's a Board decision and I appreciate the prepared remarks on the dividend. Good to see it kind of reestablished. But can you just give us a little bit more context around the $0.40 level here? And obviously, based on adjusted NII this quarter, very strong dividend coverage at this point. Is it at a level that reflects certain credit scenarios where you see earnings power kind of dropping and $0.40 can be sustained in most of the scenarios? Or is this just kind of almost an arbitrary number where you think you can maybe even grow it, barring a material degradation in kind of the economic outlook?

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [11]

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Okay. Well, look, I think that's a very good question. As you can imagine, as a team and with the Board, we spend a lot of time deliberating as to exactly where to set it, sort of coming back from our conversation. Really, when you think about it just 2 months ago, the amount of change that's occurred both in the environment and within our grasp of our portfolio, I think as Mike touched on, the team has been very close with all of our portfolio companies and really gone through budgets and current performance and all that type of thing.

And so while there was a tremendous amount of mystery just 2 months ago, I think now we have a lot more clarity as to how the companies are actually weathering and performing this. And again, as Mike touched on, the PPP loans and Fed stimulus and all that type of thing, has been enormously helpful to bridging what could have been a very calamitous decline. There's also substantial unemployment payments out there and everything. So we're, right now, riding kind of a liquidity wave that was brought about by the government to help bridge our way through this. And so as businesses are adjusting in this environment, things look pretty good.

I think the concern we have, what we're trying to be conservative about going forward, is how -- the excess unemployment compensation is going to run out July 31. The Fed has -- I don't know how unlimited their balance sheet is to do the things they've been doing. The PPP loan has been extended, but it has a finite amount of capital allocated to it at this point in time. So it's not clear when these initial liquidity initiatives play out or are consumed, what's next? And does the real economy come back to pick up the slack? It may, and we have great faith in the U.S. economy. And we -- our management teams, the teams out there and -- the ability to adjust is one of the great things about U.S., America and our system of companies. So we've great faith in that. However, we just do not know what kind of actual economic environment will occur.

And so we didn't want to set the dividend right up at 100% payout of our earnings this past quarter because there may be declines coming forward. We also just issued a baby bond issue, so we have more cash on our balance sheet. So as we said earlier about, liquidity is critically important, balance sheet strength is very important. And so we have substantially more cash and substantially more liquid cash. In other words it's at the holding company, so we have lots of flexibility as to what to do with that cash. However, that cash is expensive. We have to pay interest on the unused portion. And so that creates a level of drag on the -- on our earnings until that capital is deployed. I think again, as Mike alluded to, we're having some good origination activity. Hopefully, that will continue and absorb this capital in a productive way at a measured pace. But we could get significant redemptions and -- or deals could dry up or something. So we could be carrying that load. And so we didn't -- we wanted to allow for that kind of drag on our earnings.

And then we have our CLO, and our CLO has performed in quite a resilient way. And for anyone who studies CLOs, there's a very complex animal with all kinds of tests for what type of payouts you get. We, for the last 2 quarters, inside this last 2 payments inside post COVID, we have gotten our full management fee and our full equity distribution. And so that is a meaningful consideration. But should there be a decline or a -- some kind of adverse events which cause the broadly syndicated market to retreat, somehow get in a position where our distributions from the CLO are blocked partially or completely, we wanted to take that into account as well. And so we kind of had a range into the low $0.30s all the way up to $0.50 or something. And we felt that $0.40 was kind of solidly in sort of the middle of the range of outcomes. And we also felt that it was a number that we could sustain if things go status quo. And then if things decline through new investments and the like, we would be able to carry that dividend.

So that's a lot of the thinking. I think at the end of the day, there's a little bit more art than science in the exact number just because we're still dealing with such substantial uncertainty. I think as Henri mentioned in his, we sort of had 2 things. One is how certain are we -- well, 3 things. One, how certain are we about our portfolio? How certain are we about the economy? And what's our liquidity position? So since our last call, our liquidity position has improved dramatically. We've worked very hard on that, and we feel good about our liquidity position as of right now. We still have a lot of uncertainty in the future. So putting all of that together is how we arrived at $0.40.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [12]

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Got it. I appreciate the color on that, Chris. It's very helpful, and certainly can appreciate the uncertainty as well, factoring into that decision. Appreciate it.

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Operator [13]

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Our next question comes from Casey Alexander with Compass Point.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [14]

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My first question is for Mike. Mike, can you tell us -- I think investors would really like to know, the new investments that you made in this environment, what was particular about those investments under such uncertain conditions that gave you the confidence to put that money out to those quarters? And if you can kind of discuss the industries that they were in, sort of the multiples for new investments. And what drove your thinking that this was -- that the company could confidently put that money out?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [15]

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Good question. The underwriting that we applied for those new portfolio companies is the same that we've applied historically as we've assembled this portfolio. What's changed, as everyone knows in this environment, is that many companies are facing a lot of uncertainty in their revenue stream, and as a result, many new deals are just not happening. The deals that are happening and the ones that we did in this case were in businesses that have proven themselves to be performing -- continuing to perform very well in this environment. And their outlook for continued growth is still very strong.

In addition, in all 3 cases, the capital structure is, we think, exceedingly strong. And so the risk-adjusted returns that I think our shareholders will benefit from here are really outsized. In all 3 cases, they are businesses that have -- are delivering their service through a software platform. And I think we and our shareholders are benefiting from our expertise in that area. One of the things that we've seen, not 100% of the time, but by and large throughout our portfolio, is that most of our SaaS businesses or software-related businesses aren't being affected as greatly as other businesses, as I referred to earlier, that require a lot of human interaction. And in fact, in this environment, some of them are getting an additional boost because companies that were in a prior environment evaluating efficiency tools and ways to introduce more productivity tools to their business models are now seeing the value of that in an even greater way.

So in all 3 cases, without getting into lots of details about each one, common elements are continued strong performance, outlook for that as well and really strong capital structures. And we're in a -- as a consequence, in a position in the balance sheet that we think offers a terrific risk-adjusted return.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [16]

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Okay. Secondly, it would seem to me that in highly uncertain economic times with little visibility such as Chris discussed, this would be a time where you would be sticking with kind of your go-to relationships as opposed to striking up new relationships where these new relationships, you -- there's some uncertainty as to how they may react if things start to go sideways. Can you explain what gives you the confidence to develop new relationships in a period of time like this?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [17]

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Great question. The thing that hopefully you can recognize is that the business development efforts in our space are very detailed, and the diligence that we do on relationships is quite exhaustive. So most of the deals and relationships that we develop have a very long gestation period. It would be great if we could go to visit a company that has a terrific reputation. We've seen the deals that they've done. They've performed exceedingly well. You know how they've reacted in tough times. You show up in their office and then they start giving you deals. It tends not to work that way. Most of those firms want to get to know you as a lender as well. And that period of time is fairly lengthy.

So the new relationships that we're referring to are ones that we have been spending a lot of time getting to know and have done quite exhaustive due diligence on those relationships. I would add to that, and this is an important point because we certainly compete with people that don't look at the world the same way, we turn deals down with our best relationships all the time. And it goes back to what I've referenced about discipline. We do not just follow sponsors or private equity firms that we have good relationships with and whatever they want us to do, we do. We're careful to develop that relationship in a way where, if we see a business that is a really strong one, we want to be the go-to provider there and get the last look and support them there very actively. But we also want to develop those relationships where, if we look at the fundamentals of the business and we're not comfortable with the financing opportunity, the relationship is strong enough that we can say no and continue to have a very healthy relationship.

So I give you that because it is important for you to understand that we're certainly not underwriting deals with an expectation that a sponsor or the ownership group is going to come in and bail us out. First and foremost, we are looking at the fundamentals of the business and always asking ourselves, look, is our -- under almost all reasonable circumstances that we can diligence and thoroughly understand, is our last dollar of capital, it's safe. Is it in a safe space where we feel like we can recover that capital? Not necessarily because the sponsor or the ownership group is going to rescue us, but that there's fundamental value there that we can recoup, if necessary, relative to where we are on the balance sheet.

Now in addition, and certainly one of the things that we factor in is who is that relationship and what's their reputation, et cetera. So it does come into play. And in this environment, certainly, the relationships that we have, have been very supportive of the portfolio companies and that's helpful. But that doesn't prevent us from actively trying to strengthen the relationships that we've been seeking to develop over time. In fact, we think in this environment, there is a great opportunity to really distinguish yourself by being there with capital and supporting businesses that are being underwritten, as I mentioned before, with a higher bar but actually are evidencing really strong characteristics.

I would tell you this, we've turned down -- in this environment, we have seen opportunities that people have presented to us. And even in some of those cases, the fundamental metrics of the businesses have, on the face of them, looked pretty solid. But as we dug deeper, we didn't get comfortable with the longer-term prospects for those businesses, so we've turned down many deal opportunities in this environment as well.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [18]

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Okay. It's really good color and I certainly appreciate. My last question is for Chris. And Chris, I apologize if this sounds contentious, but this is a question that I've been asked by several institutions and I simply do not have the answer for it, which is, at the last quarterly conference call, you went to great lengths to express the lack of visibility in the environment and the uncertainty of the environment. And then beginning 1 day after the call, yourself and several other insiders began making insider purchases of the stock, which seems like contradictory behavior. And I would appreciate if you could give us some color on your thoughts on the insider purchases so that we can put this within the context of your comments.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [19]

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Sure. Thank you for that question, Casey. And I would just like to add one thing to what Mike said just to complete maybe some of the firm's thinking on that. I think Mike articulated very well that we all, across our management team, this environment and performing, as Mike said, in this environment is one of the best opportunities to create new long-lasting relationships and deepen our relationships with our -- deepen the quality of the relationship with our existing partners in this field. And so we are very encouraged by the developments there, and we're very encouraged by the quality and the nature of how all these investments are being discussed, where it's not so much a bidding exercise, much more collaborative and the like. And so we're setting a foundation here now today which will be with us for many, many years and pay many, many long-term dividends by being in a position to play ball, if you will, right now.

As to the insider purchases, I'm not going to speak for Henri. Henri is on the call, you can ask Henri. A couple of things. As you can see from the Form -- the Form 4 filings, I basically -- a chunk of my ownership was transferred to certain members of our management team. 35,000 shares were transferred to another -- to a group of our managers to further empower their compensation and their incentives and alignment with shareholders. And so what I did -- what I wanted to do, sort of at a minimum, was maintain my ownership levels in this period of time. And so I went up buying, I forget the exact number, I think it was around 20,000 shares or something. So -- and I'm still a little short of the full 35,000 to stay sort of net even for me personally. So that part of the decision was for me to be able to issue shares to our management team and then maintain a similar level of investment in the company, which I think is important and we, as a management team, think is important.

Further, despite going to the great lengths of the uncertainty, there's also price and value. And never, I don't think -- I hope I didn't give the impression, but never did we say, we don't think we're going to make it through this environment and come out strong, okay? I mean, we have enormous faith in our company and our balance sheet. I think at the moment that we said that, right, we had -- we were early in the COVID experience. We hadn't had time to harvest the information from our portfolio companies. Analysts were predicting 10% to 40% declines in NAVs across the board and things like that. And so yes, there was a lot of that type of uncertainty. But the levels that we were trading at are -- were so far below what we felt was our intrinsic value and still substantially below our intrinsic value, that we thought this was a very clear opportunity to invest.

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Operator [20]

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Our next question comes from Bryce Rowe with National Securities.

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Bryce Wells Rowe, National Securities Corporation, Research Division - MD of Equity Research [21]

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I wanted to ask about, I guess, Slide #7 that references $7 million of net repayments so far since the end of May. And just was curious if that net $7 million included the new platform company that you all spoke to that was added this week.

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [22]

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Yes, that's right, Bryce. So what we've done last quarter, and we concluded to do it again this quarter was just to give some color on sort of where our portfolio is, especially in the context of the increased liquidity that we have. And so yes, you're right, that number includes a new portfolio company that we've been closing this week.

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Bryce Wells Rowe, National Securities Corporation, Research Division - MD of Equity Research [23]

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Okay. And if maybe Henri or Mike, could you kind of reconcile that with some of the comments you made in your prepared remarks about this environment expecting lower levels of repayments? Just curious, what's driving the repayments in an environment like this to get you to a net repayment position at this point in the quarter?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [24]

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I think it's just one deal that paid off and consistent with what we've been expressing, that one portfolio company is one that was performing very well in this environment. And so there was a sale process that had stalled at one point. But because the company's performance continued to be very strong, that sale process was reenergized and there was just a change of control that resulted in us getting paid off through that change of control. So I think if there's a theme there, it's, as I've expressed, for those companies that are distinguishing themselves in this environment, there are still transactions being done. The percentage of those businesses that are out there in this environment is much lower than what we all would have been looking at 4 months ago. But that's the dynamics that's at play.

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Bryce Wells Rowe, National Securities Corporation, Research Division - MD of Equity Research [25]

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Got it, okay. And Mike, maybe you could kind of take this one, too. The 2 new portfolio companies that you added in the May quarter, one looks to be priced at about a 6% type of coupon, and that was done in the first half or in the middle of March, whereas the second portfolio company has a 10% yield and that was done in April. So I'm kind of curious if that's where you're seeing pricing today, in that 10% level, or is there just something at play with respect to each of those companies that would have allowed for a relatively low 6% rate versus what is now going to be a higher rate versus the weighted average portfolio yield.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [26]

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That's a good question. I mean, the first one with a 6% rate, we think, still offers a terrific risk-adjusted return with a sponsor group that we've been courting for some time, one of the premier software investment firms in the country. I think if that deal were priced today, the pricing would be wider than that. And our hope is that there'll be an opportunity for a repricing event in the future. That's a deal that we had, was kind of an unusual timing because we had COVID really starting to accelerate at the point that we were closing it, and, for a variety of reasons, felt like proceeding with the closing was the right thing for us to do and for the long-term relationship and so forth. But we're excited to be in that investment.

Certainly, the other deal that closed subsequent to that is more reflective of the pricing that we're seeing in this environment. I think, as I mentioned, one thing that we've seen is that the attachment points, the leverage level that people are requesting and we have an opportunity to invest in, in this environment is much improved relative to 4 months ago, pre-COVID. But we haven't seen as much widening in pricing. Certainly, there's some of that but there is capital on the sidelines waiting for those opportunities. And so I think the way we think about it is that the risk-adjusted return opportunities for those very select circumstances where we can put capital to work in a new portfolio company is much greater. But the spreads, we have not seen widen to a really high degree. They certainly have widened but not as much as we would have hoped.

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Bryce Wells Rowe, National Securities Corporation, Research Division - MD of Equity Research [27]

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Okay, that's helpful. And just one more for me. I think that portfolio -- you had a comment in the press release, Mike, that referred to portfolio management. And so I was -- kind of maybe just broadly, how have you gone about the process of managing the portfolio as a team? And then what kind of trends have you seen, whether it be week-to-week or month-to-month from your portfolio companies as we've progressed through this COVID period? I assume that you've gathered some pretty good intelligence along the way.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [28]

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Well, I would -- just to give you some context, I would say in the ordinary course, and this obviously fluctuates depending on particular portfolio companies, et cetera, but in the ordinary course, we probably spend about 2/3 of our time combing through new deal opportunities, trying to find new investments to grow our shareholder value and about 1/3 of our time actively managing our portfolio. With the onset of COVID, that switched to 95%. One could argue 110% of our time, just getting really close to ongoing events with our portfolio.

We shifted to the point where we had weekly portfolio management meetings, where we literally, as a team, went through each and every portfolio company that we have, looking at things like what is their liquidity position? What's their updated outlook on their performance? How are they being affected? And we've been doing that ever since the onset of COVID and continue to do that. Now how has that changed? Initially, as you can imagine, people were, as I referenced, availing themselves the PPP loans. We were helping a lot of the portfolio companies make sure that they were getting that done timely to the extent that we had to make modifications to our loan documents to accommodate that. We are doing things of that nature as well.

I should point out, too, it's important to note, where we play in the marketplace, we're typically on a first name basis with our management teams. So managing our portfolio companies at that level is something that's natural for us and natural for the management teams to expect. So we have an open dialogue with the management team and the ownership groups as well. That shifted. Clearly, things have settled down. We've got much more visibility on the portfolio and the portfolio performance. And we're continuing to monitor extremely carefully and actively, just given all the uncertainty out there. But I think at this point, we're probably still spending more than half our time, just making sure that we're on top of things. We don't want to be surprised by anything. And -- but at the same time, we are starting to see new loan inquiries and we're spending some more time on that. Does that address -- hopefully, that addressed your question.

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Bryce Wells Rowe, National Securities Corporation, Research Division - MD of Equity Research [29]

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No, that does. And I mean, in those -- I guess, that active management period, I was just curious what you've seen from an EBITDA or cash flow perspective from your portfolio companies. I mean I get that the PPP funds have helped in a lot of ways, but kind of was curious what you've seen from a fundamental revenue perspective at those portfolio companies, where it fits.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [30]

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Right. I mean -- and it's going to vary. The impact of COVID will vary depending on the company. And I think as I've referenced, companies that are more greatly affected are ones where there's human interaction or something of that nature that's going to affect their revenue stream. We are and our shareholders are benefiting from our underwriting approach, which is, if there's a common theme in our portfolio, it's we really gravitate to businesses that have really strong recurring revenue dynamics. So we haven't seen as much impact.

I think the reference I made to 2/3 of the valuation being -- decrease in value in the portfolio being driven by just widening spreads and about 1/3 of that 6% devalue -- devaluation being driven by either performance or expected reduction in performance is generally indicative of what we're seeing.

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Operator [31]

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Our next question comes from Mickey Schleien of Ladenburg.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [32]

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Glad to hear everyone's doing well. Kind of tough to go this late into the call but I still have a handful of questions I'd like to ask. Mike, I think you alluded to this, but I'll ask the question a little bit differently. Where would you say spreads are today in your market, the lower, middle market today versus May 31, in general?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [33]

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I would -- if I had to pick a -- I'll give you a range, 50 to 100 basis points wider. But it's not completely apples-to-apples because at the same time, we're finding opportunities to put ourselves in a lower leverage point in the balance sheet. So 4 deals -- yes.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [34]

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Okay. But that conceivably, that could continue to pressure net asset value then if you were to close the books today, correct?

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [35]

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I think Mike is talking versus really March, the beginning of COVID, right, Mike?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [36]

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Right. No, no. So that's a good thing to clarify...

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [37]

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Mickey is thinking from May.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [38]

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Right, right. So we're not seeing further widening -- if -- yes. So the valuations are reflecting a mark-to-market relative to spread -- prevailing spreads in the marketplace. We haven't seen any shift or significant shift in spreads from that valuation. I was referencing -- what I meant to reference was for our end of the market, if we were to deploy new capital in a new deal, we would find ourselves generally in a more conservative spot in the balance sheet. And that all else equal, the pricing would likely be 50 to 100 basis points wider.

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [39]

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Yes. From pre-COVID.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [40]

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From pre-COVID, not from the valuation point. That's right.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [41]

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Okay. And going back to the LogicMonitor question. I understand it may have an attractive business profile, and that's hard to find in this kind of market. But at a 6% rate, the math doesn't work very well for Saratoga. If I'm not mistaken, that's the lowest yielding investment in the portfolio. So could you just expand on your comments as to why do that deal at all, given the yield characteristic?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [42]

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Well, the vast majority of the capital that was deployed in that deal was through our new SBIC license. And the position that we're in the balance sheet, the strength of the company, to us, made us conclude that the risk-adjusted return was quite nice and still accretive to our shareholders. And as importantly, the relationship opportunity, we think, is very important for us, one, for us as a firm. And so the combination of those things, at the time that was priced pre-COVID, we felt like made a lot of sense. I also indicated to you that it's -- there's some likelihood, not certain, but there's some likelihood that there's a chance that, that pricing could be revisited.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [43]

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Right, right. Okay. That makes sense. And on Sceptre Hospitality, I think you've also referred to that. But that adds to your hospitality allocation on top of Knowland and I would probably group Village Realty into that. And everybody knows that, that's a highly challenged industry right now. What specifically about Sceptre gave you the comfort to go ahead in what is, maybe besides airlines, the industry that's suffering the most?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [44]

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Well, I would say this, and we have to -- hopefully, you can appreciate, as it relates to Sceptre, we can't get into all the details because it's private business, and we'll just put it at that. But I would say that there is very significant credit support associated with that deal. So the combination of the business's performance as well as the credit dynamics associated with it made us very comfortable that the risk-adjusted returns there were really strong.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [45]

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And in terms of credit dynamics, you're talking about the deal structure and the support by the sponsor or something else?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [46]

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Both.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [47]

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Okay. Mike, you mentioned a third new investment. I think that's the one subsequent to the quarter, correct?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [48]

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That's right.

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [49]

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Correct.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [50]

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Did you -- can you tell us what industry that's in?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [51]

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Yes, I think our preference would be not to get into -- I mean, it's a business that is delivering its services in a SaaS model, and it's a business that's holding up very well in this environment. But given the recency of it, it's not something that we've disclosed publicly yet. I'd rather not get into too many of the details. I don't think the ownership would be pleased with that. I don't think it's been announced in the marketplace yet.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [52]

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That's fine. As long -- a SaaS business, which is your -- sort of your sweet spot, I understand. And touching on the education segment, I think you said C2 was performing well. But you have others like EMS LINQ and GoReact. Another industry where frankly, I don't -- I have a hard time forming a thesis on what's going to happen with K-12 or universities for that matter, given the spike in the curve. What is your thesis on those businesses? And how are you -- what are you assuming in terms of the valuations of those businesses for the potential for the schools to reopen in the fall?

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [53]

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Okay. So let me clarify one thing. So C2 is one that we wrote down in a fairly material way, and that is experiencing some challenges because of what we referenced, that it's a tutoring model and so there's some human interaction that's involved. We're optimistic that, that will work out really well, and the business model has demonstrated strength over the years and it has terrific ownership sponsorship as well.

As it relates to the other education-related businesses, the vast majority of those, not all of them, but the vast majority of those are also software-related businesses. And the products that are being offered there are ones that are still fundamental to the efficiency or they're typically bringing greater efficiency to the school system in a lot of ways when you look at the use case of the software. And the long-term prospects for those businesses, we continue to feel really, really good. Near term, there's some uncertainty but our -- just in terms of how schools will reopen and how they're managing that, none of us really know. You can see that changing weekly. But it has been our broader experience, and we're seeing this right now, that typically people don't decide if there's some uncertainty about reopening, et cetera, that they're going to shut off all of their software. It just is -- it becomes fundamental to how they operate as institutions. So we haven't really seen -- have that experience or seen that in this environment. Our expectation or certainly our hope is that there won't be a material impact on that sector, but it's something that we're watching very carefully.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [54]

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Okay, I understand. A couple of questions on the CLO. So my understanding is that the bulk of CLOs make their distributions quarterly and it's typically the first month of the quarter, which would have been April. I'm not sure if that's the case for your CLO. But obviously, based on your comments that the CLO was passing all its tests, if I'm not mistaken, how does it look in terms of its tests going into the next distribution? And do you expect to reduce the estimated yield, given the level of loans that are rated B minus in the market with more downgrades and higher defaults expected?

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [55]

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Yes. Yes. That's right, Mickey. You're absolutely right. It's a -- the measurement date is once every 3 months. And actually, April was a measurement date but also yesterday was a measurement date. So July 8 is a measurement date, and that determines whether you -- whether it passes all of its tests, which our CLO did. So as of yesterday, it met all of the tests, and so there's no issue for the next 3 months and specifically to Q2. Obviously, there'll be a new measurement date and it's a single-day test then in 3 months' time.

With regards to the effective interest rates, that's an output from the actual valuation, the weighted average effective interest rate. And so obviously, there were pretty conservative assumptions, as you saw with regards to our valuation as of May 31. From a downgrade perspective, not too much has changed since we did the valuation through today. But obviously, we need to keep monitoring it over the next couple of months until we get to that, firstly, the next valuation date at -- on August 31, which will drive the interest rate, and then the measurement date in October that will drive the payment for Q3.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [56]

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Okay. So Henri, based on those -- on what you just said, it seems that at least in the very near term, the CLO does not need another additional equity injected into it?

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [57]

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Yes, correct. As of today, yes.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [58]

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Okay. And going back to the cash drag question, I certainly appreciate tapping into liquidity when it's available. But you do have a very low level of discretionary unfunded commitments. I think I look -- I think I saw it was $8 million or $9 million. So that's not really an overwhelming amount for you. You've now declared a dividend, so the DRIP will start again. And I would imagine smart shareholders are going to take advantage of the share price. It would seem to me, and maybe this is a question for Chris, the best use of the cash, at least some of it, is to buy back the stock, not only to offset the DRIP dilution but just to reinvest in the portfolio, given the level of confidence that you have in it? Or am I missing something?

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [59]

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Well, Mickey, I think that's a very good question. I think as we're trading at a very substantial discount to NAV, I think you heard Mike mention earlier that a lot of the markdowns in our portfolio are mark-to-market, more spread-based. 2/3 of the markdown roughly is based on spread marks as opposed to fundamental credit quality marks. So we have a lot of confidence in our NAV and the new investments we're making. So yes, we do feel our stock is substantially undervalued, and we do have the ability to repurchase stock as you've noted.

The questions, obviously, that one needs to consider is how much of this liquidity is needed for what purposes. I think as we talked about in our last call, we have our SBIC I, which is largely fully invested. And to the extent companies in that portfolio have incremental needs for capital, we need to supply that from outside that entity with an essentially holding company capital. So we need to keep our -- some powder dry to support those investments.

And we did have one repayment in there, which gave us a little extra room and helped our liquidity, so that we do have some incremental capital available inside that, in that SBIC I, which is helpful. And then SBIC II, we still have another -- we've invested $50 million and there's another $37.5 million of equity to go in, which gets levered 2:1 at sub-2% rate. So the return on equity investment in the SBIC II is -- can be extremely high. And so we have to gauge when and how we put more equity into that entity. We still have borrowing capacity there.

And then we also have a lot of opportunities that we're looking at that are outside the SBIC criteria, the different types of investments. And those are very important for our franchise in the near and long term and type of relationships we're building, sort of our non-SBIC businesses that we finance. And so -- and there are less -- they don't have the same level of return at this point in time with cost of capital today necessarily, but they might have higher spreads. And so developing those markets is also strategically very important for us, and while strategically today will translate into economics, as we put some of that money to work in some of those newer relationships outside the SBIC criteria world. So we have a lot to balance.

We also -- I think as we said on the last call and in this call, the whole system is riding on a huge wave of liquidity. And will that continue? And how will it continue? And at what rate does the real economy pick up the slack, if you will, to get back to normal? And that's still an open question. And so we just need to be careful because we were the first, and I guess, Henri, correct me if I'm wrong, the only baby bond issuance in our industry. We -- we were ready -- we got to market as soon as we could get to market, and we raised the capital, and that was, we think, very fortuitous.

As you know, when things decline, all capital markets, public markets tend to disappear. And so we have to be very careful not to get in a position where we feel like we, all of a sudden, need to raise capital in a period of time where you can't raise capital. So we have a lot of competing interests and a lot of uncertainty ahead. And so number one, let's get our liquidity into a position where we feel very comfortable we can support our portfolio and do new deals. I think buying in equity does have value, and it's absolutely something of consideration. And so that will be factored in on all of these. But again, we've just had a massive improvement in our liquidity from just 2 months ago, and we think that's very important for the near and long term.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [60]

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No, I agree with that, Chris. I guess my last question, my follow-up to that would be, at a minimum, wouldn't it make sense to at least try to buy back shares in the open market to offset the likely dilution from the DRIP, given you've got a lot of experience with your shareholders. You know more or less the ratio of shareholders that are going to elect for cash versus stock and at this price, it could be meaningfully dilutive to NAV and it would seem to make sense to at least try to offset that.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [61]

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That's clearly a consideration. In terms of how much of a DRIP there is, I mean, that has varied fairly substantially over the different quarters for different reasons. And -- but we do understand that concern, and I understand that, that dilution again to NAV and then to NAV per share or to earnings per share issues and all that does have consequence. So that's absolutely something that we're aware of and watching.

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Mickey Max Schleien, Ladenburg Thalmann & Co. Inc., Research Division - MD of Equity Research & Supervisory Analyst [62]

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Okay. That's it for me. I appreciate your patience on what's probably one of the longest earnings call for you, but very, very helpful.

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Operator [63]

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I'm not showing any further questions at this time. I would now like to turn the call back over to Christian Oberbeck for closing remarks.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [64]

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

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Operator [65]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.