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Edited Transcript of SAR earnings conference call or presentation 9-Jan-20 3:00pm GMT

Q3 2020 Saratoga Investment Corp Earnings Call

NEW YORK Jan 13, 2020 (Thomson StreetEvents) -- Edited Transcript of Saratoga Investment Corp earnings conference call or presentation Thursday, January 9, 2020 at 3:00:00pm 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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* Benjamin Ira Zucker

Aegis Capital Corporation, Research Division - Analyst

* Casey Jay Alexander

Compass Point Research & Trading, LLC, Research Division - Senior VP & Research 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, and thank you for standing by. Welcome to Saratoga Investment Corp.'s Fiscal Third Quarter 2020 Fiscal -- 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. Chief Financial and Compliance Officer, Mr. Henri Steenkamp. 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 Third Quarter 2020 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 third quarter 2020 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 January 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 fiscal quarter has continued our financial outperformance and furthered our ongoing progress in growing the capital base of Saratoga. Despite a challenging and competitive investment environment, our origination efforts, combined with our flexible capital solutions and diversified sources of cost-effective liquidity, continued to support our robust pipeline of available deal sources, driving greater scale. The quality of our underwriting, reaffirmed further this quarter, has propelled us to the top ranks of our BDC competitors over the long term.

As we complete the first decade of this BDC under the management of Saratoga, our accomplishments this fiscal year, including the receipt of our second SBIC license, a return on equity of 17.6% and a 63% increase in NAV and a 9% increase in NAV per share, further our momentum and provide a strong foundation for future growth.

To briefly recap the past quarter's highlights on Slide 2. First, we continued to strengthen our financial foundation this quarter by maintaining a high level of investment credit quality with 99% of our loan investments having our highest rating, generating a return on equity of 17.6% on a trailing 12-month basis, 21.7% annualized in Q3, both significantly ahead of the BDC industry mean of 7.6%; and increasing NAV by a net $9.1 million realized and unrealized gains this quarter or $0.91 per share. This includes a realized gain of $10.7 million on our Censis investment in Q3 for a total Censis realized gain of $11.2 million. And as of the end of Q3, we have registered a gross unlevered IRR of 14.1% on our total unrealized portfolio and a gross unlevered IRR of 14.8% on total realizations to date of $435 million.

Subsequent to quarter end, our Easy Ice $28 million second lien investment and $11 million preferred equity investment was repaid at par, including all accrued interest, plus we received approximately $35 million of additional proceeds, interest and fees. This realization in and of itself will add more than $17 million or $1.51 per share to NAV in Q4.

Second, our assets under management remain steady this quarter at $487 million, no net increase since last quarter but a 21% increase from $402 million as of year-end. Even though we had $40 million of repayments this quarter excluding the gains, we again demonstrated the ability of our origination platform to keep pace with quarterly redemptions, which can often be lumpy and unexpected.

Third, our Board of Directors has declared a quarterly dividend of $0.56 per share for the fiscal quarter ended November 30, 2019, unchanged from the prior quarter and payable on February 6, 2020, to all stockholders of record at the close of business on January 24, 2020. Our operating performance has enabled us to increase our dividends for the last 5 years, currently at a level of $2.24 per share on an annualized basis. We are 1 of only 8 BDCs to have increased dividends over the past year.

And finally, looking forward, our capital structure and base of liquidity provides us a strong foundation for future earnings growth. We sold nearly 2 million common shares, raising gross proceeds of $49 million through our ATM equity offering during the quarter. These shares were sold at a gross premium of 3.3%, resulting in a $0.02 accretion to NAV per share. In total, $85 million of equity was raised this fiscal year, essentially fully funding the equity requirement for our second SBIC license that we received in August. This license provides a significant long-term benefits of 2:1 leverage and approximately 3% all-in cost of debt with the opportunity for potentially accretive long-term future returns.

Subsequent to quarter end, we also utilized available excess liquidity to redeem $50 million of our existing 6.75% SAB baby bonds. In addition, we note that subsequent to quarter end, we have called the remaining $25.5 million of SAB bonds with a repayment date of February 7, 2020. We have now significantly increased dry powder to address future investment opportunities in a changing credit and pricing environment. Our existing pro forma available quarter end liquidity of $251 million post baby bond redemption allows us to grow our current assets under management by 52% without any new external financing.

Saratoga delivered strong return on equity performance this quarter and year-to-date, as noted above, and continued solid performance within our key performance indicators as compared to the quarters ended November 30, 2018 and August 31, 2019. Our adjusted NII is $6.1 million this quarter, up 27% versus $4.8 million last year and up 9% versus $5.6 million last quarter. Our adjusted NII per share is $0.61 this quarter, down from $0.65 last year and $0.68 last quarter, primarily reflecting the increased share count and substantial cash on hand.

Latest 12 months return on equity is 17.6% this quarter, up from 10.1% last year and 14.3% last quarter. And our net asset value per share is $25.30, up 9% from $23.13 last year and up 3% from $24.47 last quarter. And we will provide more detail later.

Originations for the most part offset repayments this quarter. But as you can see on Slide 3, AUM has steadily risen since we took over management of the BDC more than 9 years ago, and the quality of our credits remain high. We are working diligently to continue this positive trend as we deploy our increased available capital.

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 November 30, 2019. When adjusting for the incentive fee accrual related to net capital gains in the second incentive fee calculation, adjusted NII of $6.1 million was up 9% from $5.6 million last quarter and up 27% from $4.8 million as compared to last year's Q3. Adjusted NII per share was $0.61, down $0.04 from $0.65 per share last year and down $0.07 from $0.68 last quarter.

The increase in adjusted NII from last year and last quarter primarily reflects the higher level of investments and results in higher interest income, with AUM steady from last quarter but reflecting the full quarter impact of last quarter's significant originations and AUM up 10% from last year.

Despite having adjusted NII increase, the decrease in adjusted NII per share from last year was primarily due to a steady increase in the number of shares outstanding. Weighted average common shares outstanding increased from 7.5 million shares for the 3 months ended November 30, 2018, to 8.3 million shares and 10.0 million shares for the 3 months ended [August 31, 2019] and November 30, 2019, respectively.

Adjusted NII yield was 9.7% when adjusted for the second incentive fee accrual. This yield is down from 11.0% last quarter and 11.2% last year, again reflecting the impact of our growing NAV but also the effect of our substantial cash on hand.

For this third quarter, we experienced a net gain on investments of $9.1 million or $0.91 per weighted average share, resulting in a total increase in net assets resulting from operations of $13.7 million or $1.37 per share. The $9.1 million net gain on investments was comprised of $10.7 million in net realized gain offset by $0.5 million in net unrealized depreciation and $1.1 million of net deferred tax expense on unrealized gains in Saratoga Investment's blocker subsidiaries. The $10.7 million net realized gain reflects the impact of the realization of the company's Censis technology investment during the quarter. The $0.5 million net unrealized depreciation primarily reflects the $4.3 million reversal of previously recognized depreciation following the realization of the Censis investment offset by $3.7 million unrealized appreciation on the company's Easy Ice investment recognized in Q3.

Return on equity remains an important performance indicator for us, which includes both realized and unrealized gains. Our return on equity was 17.6% for the last 12 months and 21.7% annualized for the quarter, well above the BDC industry average of 7.6%. This is up from an LTM ROE of 10.1% last year.

Quickly touching on expenses. Total expenses, excluding interest and debt financing expenses, base management fees and incentive management fees, decreased to $0.5 million this quarter from $1.3 million in the same period last year, representing a decrease from 1.2% to 0.8% of average total assets. The decrease was primarily due to the deferred tax benefit of $1 million recognized in the quarter related to the Easy Ice blocker subsidiary. This tax benefit is nonrecurring. And excluding this benefit from both quarters, operating expenses increased 6.6% from $1.4 million to $1.5 million.

We have also added the historical KPIs in Slides 26 through 29 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past 10 quarters and the upward trends we have maintained. Of particular note is Slide 29, highlighting how our net interest margin run rate has more than tripled since Saratoga took over management of the BDC, with our current year run rate ahead of last year.

Moving on to Slide 5. NAV was $282.2 million as of this quarter end, a $101.3 million increase from $180.9 million at year-end and a $108.9 million increase from $173.3 million as of the same quarter last year. NAV per share was $25.30 at quarter end, up from $24.47 as of last quarter, up from $23.62 as of year-end and up from $23.13 as of the same period last year or a 9.4% increase in 12 months. So NAV has not only increased in total dollars, we have now had 4 sequential quarters of NAV per share increases and growth in 8 of the last 9 quarters. You can see this on the previously referenced Slide 26.

For this past quarter, $4.6 million of net investment income and $10.2 million of net realized and unrealized appreciation were earned partially offset by $5.3 million of dividends declared and $1.1 million of deferred tax expense on net unrealized gains in Saratoga's blocker subsidiaries. In addition, $0.8 million of stock dividend distributions were made through the company's DRIP plan, and just under 2 million shares were sold or a net $48.6 million raised through the company's ATM equity offering during the quarter. Accretion on our stock issuances during this quarter added $0.02 to our NAV per share.

Our net asset value has steadily increased since 2011, reflecting our strong credit performance, our accretive stock issuances and the benefit of our history of consistent realized and unrealized gains and growing earnings.

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 $0.68 per share last quarter to $0.61 per share in Q3. The significant increases were a $0.10 increase in non-CLO interest income from higher AUM and a $0.04 increase in deferred tax benefit that is nonrecurring. These increases were offset by a $0.01 increase in base management fees, a $0.01 decrease in CLO interest income, a $0.07 decrease in other income and a $0.12 dilution from increased shares from the ATM and DRIP programs.

Moving on to the lower half of the slide. This reconciles the $0.83 NAV per share increase for the quarter. The $0.46 generated by our NII in Q3, $0.91 net realized and unrealized gains on investments and $0.02 accretive net impact of our ATM and DRIP programs in Q3 were partially offset by the $0.56 dividend declared for Q2 with a Q3 record date.

Slide 7 outlines the dry powder available to us as of November 30, 2019, which totaled $301.1 million. This consists of our available cash, undrawn SBA debentures and undrawn Madison facility. Our recently approved second SBIC license has added $175 million to our dry powder in the form of undrawn SBA debentures. In addition, subsequent to quarter end, we used some of our available cash to partially redeem $50 million of our 6.75% SAB baby bonds.

On a pro forma basis, reflecting this redemption, our remaining available dry powder allows us to grow our assets by an additional 52% without the need for external financing. The composition of this capacity is also more accretive to NII when deployed, with $31 million of it being cash with no additional expense attached and $175 million undrawn SBA debentures with a low 3% total cost of capital based on current pricings.

We remain extremely 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 4 years plus.

Now I would like to move on to Slides 8 through 10 and review the composition and yield of our investment portfolio. Starting with Slide 8. Our $487 million of assets are invested in 38 portfolio companies and 1 CLO fund; and 62% of our investments are in first lien, of which 11% is in first lien last out positions.

On Slide 9, you can see how the yield on our core BDC assets, excluding our CLO as well as our total asset yield, is around 10% as LIBOR continues to decline and the buyer-friendly market continues to place downward pressure on yields. Our overall yield decreased to 9.8% from 10.1% last quarter due to core asset yields decreasing from 10.4% to 10.1%, although our CLO yield increased slightly from 14.7% to 14.9%. The change in the core asset yield primarily reflects the 23 basis points reduction in LIBOR during Q3.

Turning to Slide 10. During Q3, we made investments of $40.8 million in 2 new portfolio companies and 2 follow-on investments and had $51.2 million in 1 exit and refinancing plus amortization, including the realized gain, resulting in a net decrease in investments of $10.4 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.

We are often asked about the business services classification as this category 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 20 different companies whose services range broadly from education, to financial advisory, to IT management, to restaurant supply, to human resources and to many other services, 15 in total. This breakdown is provided in our featured presentation on our website.

Of our total investment portfolio, 9.6% consists of equity interest, which remain an important part of our overall investment strategy. We had net realized gains during Q3 of $10.7 million, as previously described. For the past 7 fiscal years and as demonstrated on Slide 11, including the first 9 months of fiscal 2020, we had a combined $29.3 million of net realized gains from the sale of equity interest or sale or early redemption of other investments.

As a reminder, for tax purposes, we continue to have unused capital loss carryforwards that were carried over from when Saratoga took over management of the BDC, resulting in these gains being fully accretive to NAV. As we have disclosed, we have another significant gain in Q4 from the Easy Ice sale and expect this transaction to increase our realized gains further while also fully utilizing our unused capital loss carryforwards. This consistent performance over time highlights our portfolio credit quality, has helped grow our NAV and is reflected in our healthy long-term ROE.

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 a couple of minutes to describe the current market as we see it and then comment on our current portfolio performance and investment strategy.

We have not seen a significant change in the market since last quarter. The landscape remains competitive. Conditions continue to be borrower-friendly, and these all generally lead to tightened prices and expanded leverage tolerances. Fortunately, for us, deal activity is still healthy and our pipeline continues to be robust.

We continue to see no spread expansion. And in fact, absolute yields continue to decline due to the impact of decreasing LIBOR with another 23 basis point reduction experienced this quarter, adding up to about 60 basis points since June. We have been reasonably successful in obtaining floors that reflect current market conditions on most of our new deals, which helps reduce the long-term impact of a decreasing rate environment. Overall, we have not sacrificed quality, but these dynamics have served to put downward pressure on yields generally.

In the market we face, we believe sticking to our strategy has and will continue to serve us best. Our approach has always been to focus on the quality of our underwriting, and as you can see on Slide 12, this is in part reflected by our history of producing net realized gains. A strong underwriting culture remains paramount at Saratoga Investment. 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. With the possibility of a market downturn always in our minds, we seek durable businesses. We invest capital with the objective of producing the best risk-adjusted accretive returns for our shareholders over the long term. Our internal credit quality rating remained at 99% despite the market forces we face.

We believe this approach has contributed to our successful returns and has also positioned us well for any future market downturns. With net portfolio appreciation of $10.2 million in Q3 and $17.5 million year-to-date, we are also pleased with how our overall portfolio is performing. And this excludes the Easy Ice exit that just occurred that will greatly increase these numbers. This transaction will be reflected in our financials in Q4, and I will discuss that further below. We believe these results reflect the strength of our underwriting approach, team and portfolio and the quality of the opportunities that exist in our markets.

Looking at leverage on Slide 13. Total leverage for the overall portfolio was 4.86x, basically unchanged from the previous quarter and below average year-to-date market leverage multiples, which are all well above 5x across our industry. We have been able to maintain a relatively modest risk profile, and the new portfolio company investments this quarter have generally been in line with our -- or below our historical average leverage. 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 investments.

In addition, this slide illustrates our consistent ability to generate new investments over the long term despite difficult market dynamics. With 22 originations through the 2019 calendar quarter, including 1 new portfolio company and 2 follow-ons this quarter, we have established an origination level that is on par with last year's record pace while applying consistent investment criteria. We always emphasize that quarterly portfolio growth can be lumpy from 1 quarter to the next and is dependent on various factors, including a robust pipeline, credit quality within that pipeline and the pace of repayments. This past quarter was an example where healthy originations were roughly offset by repayments, and the AUM remained unchanged.

We continue to focus on the longer term and remain confident that we can continue to grow our AUM steadily over time as we expand our presence in our part of the market and invest in and develop our ranks of business development and execution professionals.

Our teams' 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 of new deals. As demonstrated on Slide 14, our number of deals sourced continues to increase despite a market that is competitive and frothy. The 77 term sheets issued in 2019 is up from last year. And notably, 25% of the term sheets issued and 3 of our new portfolio companies over the past 12 months are from newly formed relationships. We have generally seen more deals from a greater variety of sources, reflecting solid progress as we expand our business development efforts.

The breadth of our deal funnel also evidences how we continue to maintain our investment discipline. We say no to a lot of deals, but maintaining discipline is ingrained in our culture, and we will continue to say no if opportunities do not fit our credit profile. We know this is how we will preserve and grow the enterprise value of Saratoga for our shareholders.

Our overall portfolio of credit quality remains strong, with Q3 again demonstrating this on Slide 15. This quarter, we saw our Censis investment realized, resulting in a 12x return on our $1 million equity investment and an $11.2 million total gain. The gross unlevered IRR on realized investments made by the Saratoga Investment management team is 14.8% on approximately $435 million of realizations. On the chart to the right, you can see the total gross unlevered IRR on our $455 million of combined weighted SBIC I, II and the BDC unrealized investments is 14.1% since Saratoga took over management.

We previously highlighted that our Roscoe Medical second lien investment was on nonaccrual. There is no significant update since we last reported, with a $4.2 million second lien still marked at a fair value of $1.9 million this quarter and the equity investment remaining at 0. These marks continue to reflect both fundamental weakened performance as well as operational issues. We continue to work with the senior lenders and sponsor to pursue strategic alternatives in the near to medium term.

Subsequent to quarter end, our second lien term loans in Easy Ice and Easy Ice Masters were repaid at par and a preferred equity sold in a change-of-control transaction. In addition to the second lien term loans of $28 million and the preferred equity of $11 million being repaid in full, including all accrued interest, Saratoga Investment also received approximately $36 million of additional proceeds, interest and fees. This is a wonderful result for Saratoga and results in significant realized gains and NAV growth for the BDC, which by itself will result in an NAV per share increase in Q4 from this investment of at least $1.51 per share. This quarter is a great example of how a solid, high-quality portfolio interacts as a whole.

Now moving on to Slide 16. You can see our first SBIC license is close to fully funded, with $216 million invested as of quarter end following the Censis repayment. Our second SBIC license has already been funded with $50 million of equity, of which $44 million has been deployed with $6 million of cash and $100 million of debentures available against that equity.

Overall, we feel the operating results of this quarter and especially the realizations of Censis and Easy Ice demonstrate the strength of our team, platform and portfolio, while we remain extremely diligent in our overall underwriting and due diligence procedures. This culminates in high-quality asset selection and strong equity returns within a tough market. Credit quality remains our top focus, and we remain committed to this approach.

This concludes my review of the market, and I'd like to turn the call back over to Chris, our CEO.

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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, we last night announced a dividend for the third quarter ended November 30, 2019, of $0.56 per share, which is the same level as the prior quarter. We note that this is the first time in the past 20 quarters that we have not increased our dividend, although we are the industry leaders in dividend growth on an annual basis during the past 5 years. Consideration for the pause in quarterly dividend increases include the recent substantial share issuances and the more than $55 million of recently received equity proceeds and fees from Censis and Easy Ice, which have substantially increased Saratoga's liquidity and NAV, establishing a solid foundation for future growth.

In this highly competitive industry environment, we want to be prudent with our dividend commitment and consistent with our past performance and measured AUM growth, not creating undue pressure to put assets to work. Saratoga has now had 5 years of dividend growth.

Slide 18 shows that the 5.7% year-over-year dividend growth easily places us near the very top of our peers and 1 of the -- of only 8 BDCs who have grown dividends this past year. With most BDCs having either no increases or decreasing the size of their dividend payments, our continually increasing dividend which we have over-earned in each quarter, has differentiated us within the marketplace.

Moving to Slide 19. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of 31%, beating the BDC index of 27%. Our longer-term performance is outlined on our next slide, 20.

Over the 3- and 5-year returns -- our 3- and 5-year returns place us in the top 2 or 3, respectively, of all BDCs for both time horizons. Over the past 3 years, our 78% return exceeded the 21% return of the index. And over the past 5 years, our 203% return exceeded the index's 48% return.

On Slide 21, you can further see our outperformance placed in the context of the broader industry and specific to key -- certain key performance metrics. We continue to achieve high marks and outperform the industry across diverse categories, including interest yield on the portfolio, latest 12-month NII yield, latest 12 months return on equity, year-over-year dividend growth and latest 12 months net asset value per share growth. Of note is that our -- as our assets continue to grow over the long term and we're increasingly achieving scale, our expense ratio is moving closer towards the industry averages. Notably, our latest 12 months return on equity and NAV per share outperformance reflects the growing value our shareholders are receiving.

Moving on to Slide 22. All of our initiatives and achievements discussed today on 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. Differentiating characteristics include maintaining one of the highest levels of management ownership in the industry at 14%, which has decreased percentage-wise as a result of the recent equity issuances with no shares sold by management; access to low-cost and long-term liquidity with which to grow our current asset base by more than 52%; receipt of our second SBIC license; a BBB investment-grade rating; solid earnings per share and NII yield with substantial growth potential; strong return on equity with growing NAV and NAV per share; high-quality expansion of assets under management; and an attractive risk profile. In addition, our high-quality credit portfolio contains minimal exposure to cyclical industries, including the oil and gas industry.

Looking at Slide 23. We'd like to focus for a moment on our recent substantial investment returns on Censis and Easy Ice, both of which were large outsized positions in our portfolio and discussed extensively in quarterly conference calls. Looking at value, we turned a combined $9 million of equity investments into more than $55 million of total proceeds received. Easy Ice, which began as a $5 million loan more than 5 years ago and resulted in more than $35 million in proceeds in addition to ongoing interest income and repayment of invested capital, represents the kind of opportunity available in the smaller middle market to our kind of creative capital solutions. Partnering with company management in an unsponsored situation, Saratoga supported the company's more than tenfold EBITDA growth during our involvement.

Censis, too, started out as a $12 million loan more than 5 years ago in a sponsored transaction where Saratoga partnered with and supported the sponsor, and substantial growth resulted in a more than 10x return on equity invested. Partnering with company management and sponsors and making equity investments along with our extension of credit is a core feature of Saratoga's investment strategy.

Finally, we continue to progress on our long-term goal to expand our asset base without sacrificing credit quality while benefiting from scale. We also continue to increase our capacity to source, analyze, close and manage our investments by adding to our management team and capabilities, enabling us to execute on our simple and consistent objectives.

In closing, I would like to thank all of our shareholders for their ongoing support. We're excited for the growth and profitability that lies ahead for Saratoga Investment Corp. I would now like to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first 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 [2]

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Certainly, congratulations on the realization of the 2 investments. Certainly, I had been as direct about the accumulation of concentrated risk as anybody, and I think that's just a fantastic outcome for shareholders. Would you anticipate that you would kind of -- given the fact that you have so much liquidity from the sale of the investments that you funded SBIC II, would you anticipate tapping the brakes on the ATM at this point in time and allowing earnings to start to catch back up?

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

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Well, thank you, Casey, for your congratulations. We appreciate that. And we appreciate your focus on our portfolio concentration issues. And thankfully, very good resolution, as you mentioned.

In terms of our ATM issuance, I think that -- as you mentioned in your question, one of the key objectives of our equity issuance was to fully fund our SBIC license equity requirement, which is approximately at $87.5 million. So in essence, we've done that. And so we have issued a very substantial amount of equity accretively, as we've mentioned. And we feel we are very well capitalized. We have tremendous liquidity on hand, as you note. And so there's no straightforward obvious need for incremental capital at this time. So without committing ourselves to anything in the future, I think -- we think we're -- at this point in time today, we feel we're very well capitalized.

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Casey Jay Alexander, Compass Point Research & Trading, LLC, Research Division - Senior VP & Research Analyst [4]

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Okay. Great. Secondly, for Mike. Obviously, the balance of first lien and second lien is going to shift more towards first lien once the Easy Ice investments pay off in the next quarter. But do you see -- given that the scale of the BDC is changing, do you kind of see your deal size evolving? And given where we are in the credit cycle, would you tend to press a little closer towards first lien than second lien at this point in time in the credit cycle?

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

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Good question, Casey, and good observation just in terms of the mix of securities in our portfolio. Let me address the 2 parts of your question. In terms of deal size, we like being at the lower end of the middle market. We've highlighted that. There are thousands and thousands of really good businesses out there. We think it's a much better place to play in the marketplace than sort of the upper end of the middle market where many of the BDCs spend most of their time deploying capital. I think the 2 businesses that we exited very successfully most recently give evidence to the opportunity set that exists at that end of the market.

So the playbook for us is to stay at that end of the market, and that's going to result in us making some smaller investments. And you'll see as some of the recent investments we've made have been on the small side, and you'll see as we do future investments, we're going to continue to find opportunities that are maybe $5 million, $10 million initial check sizes.

But what the expanded balance sheet allows us to do, and you've seen this in many cases in the past, not just in the 2 most recent exits but many other examples where as those companies have grown, we've been able to support their growth with additional capital, and our balance sheet is sizable enough to do that. What most often happens in the marketplace is that companies of that profile go to a smaller firm. They get a capital partner. They get to a certain size, and then they need to go find another partner to continue to grow as the business develops. And from our perspective, we want to stay at the lower end of the middle market, do that the same way we have historically, find really good businesses to support. And then we'll likely, hopefully, have an opportunity to deploy more capital as those businesses grow. And the check sizes will increase at that point.

Now you've also talked about concentration. One of the reasons that we were comfortable with the check sizes that we had in those most 2 recent exits, as we've mentioned, is these are businesses that we knew incredibly well. One of them, I think, was a 2013 investment originally and the other was 2014. So we came to know the management teams. We came to understand the strength of those businesses. And we're very confident in the performance as well as, most importantly, the enterprise value protection that we had. So continuing to support those businesses with more capital was, as I said, part of that playbook.

Now as it relates to the mix of securities, we have -- unlike some other folks in the marketplace, we've never adopted the strategy of sort of the BDC 1.0 or 2.0 or whatever terminology you want to put around that. We've always said that we're going to look for the best risk-adjusted return opportunities that we can find in the marketplace. It just so happens that right now, we're finding a lot more first lien opportunities. And I think that's reflective of the fact that it's a very competitive market. The bar is always much higher, has always been, will always be much higher for junior securities for us. Doesn't mean we won't continue to do those when we find really good opportunities. But that investment approach that we've had historically has remained constant. It's just that the opportunities in the marketplace have changed as we've seen people get increasingly aggressive. And as a result, the opportunities we're seeing tend to lean more towards first lien investments. And if that marketplace doesn't change, then you're likely to see us do a higher percentage of first lien investments.

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Operator [6]

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And our next question comes from Tim Hayes with B. Riley FBR.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [7]

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Congrats on the strong results. My first one, I just want to circle back on the dividend. And Chris, I appreciate your comments there. But adjusted EPS -- excuse me, NII, $0.61 this quarter. Based on that level of earnings power, there's clearly some room to bring up the dividend from where it's at. You highlighted pressure on asset yields, but I would expect that putting the Easy Ice and Censis proceeds to work and drawing down on the SBIC facility should be very accretive to earnings over the intermediate term. So are you just waiting to see how earnings power shakes out over the next couple of quarters before continuing to potentially raise the dividend? Or is it your view that the asset yield pressures and maybe some other factors should offset those benefits I just mentioned? Any color around that would be helpful.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [8]

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Sure. Well, I think as we mentioned in our prepared remarks, we have had a significant share issuance. And we do have substantial liquidity on hand, and so that's what informed us to pause on our dividend increase. I mean we have had 5 years of increases, so we are believers and drivers in trying to continue on that trend. But I think as Mike mentioned in his part here, it's about the pace of net asset growth that we have to watch. And so we make our dividend decisions on a quarterly basis. And so we've made one for this quarter, we have not yet made them for the future quarters. And our decisions will be informed.

The biggest driver of our decision-making is going to be asset deployment. And so if we get more redemptions than assets deployed, that's one set of facts. If we put a lot of money to work, that's another set of facts. And so it's very difficult for us to lay out a projection of any increase from here. But the dynamic of our company, the dynamic of our high-level equitization relative to where we've been in the past would indicate that if we get more asset growth, that would be something that we should follow. But it's really going to be driven by how much capital we can put to work relative to redemptions.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [9]

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Got it. Okay. Yes, that makes sense, and appreciate the additional commentary there. And then were there any onetime exit fees received from the Easy Ice change of control?

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [10]

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Yes. I mean there -- I think, as we say, again, in our prepared remarks, and we also need to be thoughtful here because this is a post quarter end and we have an audited 10-Q -- not audited, but I mean we've got an E&Y reviewed 10-Q that we have released. We have a subsequent event paragraph, and the specific information that we can release at this time is included in that characterization. So we really don't have a lot more specifics from there.

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Timothy Paul Hayes, B. Riley FBR, Inc., Research Division - Analyst [11]

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Okay. Yes, I guess I was just -- I'll look for, I guess, maybe a breakdown when -- with the next release. But then on -- and then on -- just on the $1.51 per share expected increase in NAV from the Easy Ice exit, how much of that do you expect to be sheltered by the capital loss carryforward?

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [12]

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Well, a few things. I think our tax analysis is not complete, as to exactly how this will all work through. And so obviously, we have a certain amount of our NOLS -- capital loss carryforwards remaining, and those will be consumed and we will go through that amount. The exact treatment beyond that amount is something that's still under consideration and also will be affected by their performance over the next quarter. So it's not something that we can go into in great detail on this call.

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Operator [13]

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And our next question comes from Ben Zucker with Aegis Capital.

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Benjamin Ira Zucker, Aegis Capital Corporation, Research Division - Analyst [14]

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I'd echo the congratulations on those 2 big gains that you guys have mentioned. I want to kind of flip the script on that ATM question you guys got. Pro forma for the subsequent Easy Ice gain and notwithstanding the other investment activity in fiscal 4Q that we haven't seen yet, the stock now appears or might be trading at a discount to your forward NAV per share. So I mean with this in mind, is it possible that you kind of flip the lever and look at potential share buybacks? I do believe you have an authorization with some capacity, and obviously, it's always a balancing act between new investment opportunities. But is there a general kind of price to NAV multiple where you think that could look like an attractive use of your capital?

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [15]

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Well, I think that's a good question. I think historically, there have been periods of time where we have repurchased shares at a discount. We didn't have a specific described percentage of NAV that we would target. And then we've also sold our ATM at a premium. So we have worked on both sides of that equation in the past. I think we have both programs available to the company to utilize as we and the Board determine is in the best interest of shareholders. So yes, those 2 programs are alive and able to be activated.

I think going through our earnings release today, there's a lot of moving parts. Fortunately, they are positive moving parts. So exactly where our share price settles out, the investors decide to put it based -- as a result of all this is to be determined. So it's not something that we can really get into in significant detail or talk about how we will perceive it. And we also -- on the other side, we also have our investment pipeline to focus on. So all those things will be taken into consideration as they always are both at quarter end and as we go through each quarter.

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Benjamin Ira Zucker, Aegis Capital Corporation, Research Division - Analyst [16]

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Okay. That's helpful. And kind of just going about that Easy Ice gain in a different way and I know there's only so much you can say, but is it my understanding that at least the $1.50 that we're calling out is based off of the $17 million gain over the quarter end share count? So like there might be -- that's a gross NAV increased figure that could be offset by some incentive fee triggers and stuff like that as well that could also not eat up as much of the NOLS? Am I thinking about that properly?

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [17]

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I think that -- what we try to do there, and again, we're trying to do this in a proper disclosure fashion, right? We have our full quarter end, and we have the subsequent event. So what we try to do is to provide some basic information on the way the gain might be characterized, but recognize that's an estimate. It's not a final determined number. And that $17 million gross number is intended to be a net number. So there's -- so that would be the net addition. And the idea was that if you could add it to the prior quarter's NAV to give you a sense directionally of where we think NAV will probably be, however, we still have 2 months to go in this quarter. There's lots of dynamics going on. And so the final NAV might be different to that depending on other things in the portfolio. So we don't want to hang too much on that. We just wanted to make sure that shareholders had the benefit of understanding that material realization.

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [18]

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Ben, it's the old-fashioned Article 11 pro forma calc of treating the Easy Ice transaction as a totally discrete item.

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Benjamin Ira Zucker, Aegis Capital Corporation, Research Division - Analyst [19]

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Stand-alone item. Sure. I understand, Henri. On the 6.75% notes, these weren't coming due for a few more years. So what was the motivation to redeem these baby bonds so early? Is it kind of just a dual function of having so much cash on hand that you might -- and your share count going up that you might as well reduce some of this immediate interest expense burden and also improve your all-in debt cost as a firm?

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [20]

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I think that's very well said. I think that is part of the consideration. Also, when we issued these baby bonds at 6.75%, that was a very different time and place for us as a company. If we were to reissue baby bonds today in the same amount, the interest rate would be substantially lower. So that is a high cost of funds for us as a general corporate financial matter. We have in the past been able to readily access the baby bond market so that if we did want to reissue that, it does -- it's not -- again, all things being equal, no crisis in the world, but in these types of circumstances, we could reissue that capital should we desire to. And then as you point out, we do have a lot of liquidity. And rather than having it sit in short-term accounts, by redeeming this, in effect, we're getting a 6.75% yield on the use of that cash.

And then a further consideration is having gotten our SBIC license this summer, and we haven't drawn on it. Many of our deals are going to be -- many of our investments are going to be in the SBIC fund. And so we're going to -- when we relever and as we grow our portfolio and relever our -- most probably, again, for those investments that fit the SBIC criteria, we'll be using SBIC debentures, which are about a 3% all-in costs. So the forward releveraging should be a substantially improved rate. And then the like-kind, if we were to like-kind issue, it'd also be substantially lower. So all in, it was sort of a corporate financial decision.

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Benjamin Ira Zucker, Aegis Capital Corporation, Research Division - Analyst [21]

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Yes. I hear you there, and I think that people who are thinking about your all-in weighted cost of capital with the removal of these notes and then looking down the line to where you have the fully funded SBIC at, call it, whatever 3.75%, it's really going to do some nice things for the earnings power of the vehicle.

I guess lastly, just I can pick on Mike, I might have missed your comments on this, but the increased competition and challenging operating environment that you mentioned, how much downward pressure, if any, do you think that you might see with your portfolio yield? I mean obviously, LIBOR has seemed to kind of bottom out and settle over the last few weeks, which is one component of the all-in yield, but curious about where you're seeing your spreads over LIBOR go from here.

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Michael J. Grisius, Saratoga Investment Corp. - President & Director [22]

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I think the rates at which we're deploying capital most recently are reflective of what's market today. One of the things to give consideration to is even though there's some downward pressure on yields for assets, we are the beneficiary of lower cost of capital as well. So as we referenced earlier, that SBIC cost of capital has come down. It's lower than I think it's been since we've been associated with the program.

And so what's really nice about what we see in the marketplace is we can deploy capital in a -- I'll just give you an example, a first lien investment at the lower end of the middle market, one that we've done extensive due diligence on, we like, et cetera. And we might get a 9% to 10% return on that investment, which is lower than where the portfolio has achieved on average historically. But if you're -- can then get 2:1 leverage on that at all-in about 3%, I don't need to do the rest of the math for you, but that's highly accretive for -- to shareholders.

So we feel good about our ability to deploy capital in a way that's very accretive for shareholders. The thing that I would add, because we've seen this mistake happen so often, it's just human nature, is that when you're sitting on a bunch of capital, people race sometimes too fast to deploy capital and they let their guard down on diligence. We're focused on making sure that the additional capital that we put to work and additional portfolio of companies that we invest in are every bit as good as they have been historically. Fortunately, for us, over time, our presence in the marketplace has grown, the investment in people that we have made over the years is paying off, and we're continuing to actively look for additional business development talent as well so that we can kind of ramp up that pace of investment without sacrificing any credit quality.

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Benjamin Ira Zucker, Aegis Capital Corporation, Research Division - Analyst [23]

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Yes. I hear you there, and I think that goes back to the prudent decision to maybe take a little wait-and-see approach with the dividend as you work through the higher share counts and kind of watch where the portfolio shakes out. So that's it for me guys. Appreciate you taking my questions, and again, congratulations on a strong quarter.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [24]

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Thank you.

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Henri J. Steenkamp, Saratoga Investment Corp. - Chief Compliance Officer, Secretary, Treasurer & CFO [25]

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Thanks for the questions, Ben.

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Operator [26]

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Thank you. There are no other questions in the queue. I'd like to turn the call back to Christian Oberbeck for closing remarks.

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Christian L. Oberbeck, Saratoga Investment Corp. - Chairman & CEO [27]

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

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Operator [28]

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Ladies and gentlemen, this concludes the conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.