Capital Southwest Corporation

Thank you for joining today's Capital Southwest second fiscal quarter 2020 earnings call. Participating on the call today are Bowen Deal, CEO, Michael Sarner, CFO, and Chris Rehberger, VP Finance. I will now turn the call over to Chris Rehberger.

Thank you. I would like to remind everyone that in the course of this call, we will be making certain forward-looking statements. These statements are based on current conditions, currently available information, and management's expectations, assumptions, and beliefs. They are not guarantees of future results and are subject to numerous risks, uncertainties, and assumptions that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Capital Southwest publicly available filings with the SEC. The company does not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future events, changing circumstances, or any other reason after the date of this press release, except as required by law. I will now hand the call off to our President and Chief Executive Officer, Bowen Deal.

Thanks, Chris, and thank you, everyone, for joining us for our second quarter fiscal year 2020 earnings call. Throughout our remarks, we will refer to various slides in our earnings presentation, which can be found on our website, at www.capitalsouthwest.com. We are pleased to be with you this morning and to announce our quarterly results for the second physical quarter ended September 30, 2019. During the quarter, we continue to advance our credit strategy of prudently building a well-performing credit portfolio utilizing conservative late cycle underwriting principles. We continue to be committed and excited about our core investment strategy of building a predominantly lower middle market portfolio consisting largely of first lien senior secured debt with equity co-investments across the loan portfolio where we believe significant equity upside exists. Executing our investment strategy under our shareholder-friendly, internally managed structure closely aligns the interests of our board and management team with that of our fellow shareholders in generating sustainable long-term value through recurring dividends, capital preservation, NAD per share growth, and operating cost efficiency. During the September 30, 2019 quarter, as summarized on slide 6, we generated 42 cents per share of pre-tax net investment income, representing 17% growth over the 36 cents per share generated in the same quarter a year ago. During the quarter, we incurred $472,000, or 3 cents per share, of a one-time expense for the write-off of the deferred operating costs related to our previous form into registration statement. We paid out a regular dividend during the quarter of 40 cents per share, achieving 105% dividend coverage on pre-tax net investment income per share. Additionally, we distributed 10 cents per share through our supplemental dividend program funded by our sizable undistributed taxable income balance, or UTI, which was generated by excess income and capital gains accumulated from our investment strategy to date. As of September 30, 2019, we had approximately $18.3 million, or $1.02 per share, in UTI, providing visibility to continuing the quarterly supplemental dividend program well into the future. For the September quarter, the $0.50 per share paid out in total dividends generated a total annualized dividend yield of 9.2% based on our September 30, 2019 share prices. We are also pleased to announce our quarterly regular dividend for the December quarter as our board has again declared dividends of 50 cents per share, made up of a 40 cent per share regular dividend and a 10 cent per share supplemental dividend. During the September quarter, we grew our portfolio on a net basis to $539 million from $533 million as of June 30, 2019, originating approximately $30 million in new commitments and receiving one prepayment totaling $14 million in proceeds. Our I-45 Senior Loan Fund provided dividends to Capital Southwest representing a 16% annualized yield at fair value on our capital in the fund for the quarter. During the quarter, we successfully completed a $65 million five-year institutionally placed bond offering priced at 5.38%. Subsequent to quarter end, we raised an additional $10 million under the same debenture Bringing the aggregate principal outstanding to $75 million. In addition, we raised $5 million in gross proceeds through our equity ATM program during the quarter, selling over 231,000 shares at a weighted average price of $21.62 per share, representing a 16% premium to book value. I'm pleased to report that since the initiation of our equity ATM program, Capital Southwest has sold almost 700,000 shares at similar premiums to book value, raising approximately $15 million in gross proceeds. Our equity ATM program continues to provide a steady flow of equity capital raised on a just-in-time basis in lockstep with our ability to thoughtfully put the capital to work. Turning to slide seven and eight, we illustrate our continued track record of producing a strong dividend yield, consistent dividend coverage, and value creation since the launch of our credit strategy. Turning to slide nine, As a reminder, our investment strategy has remained consistent since its launch in January 2015. We continue to focus on a blend of both lower middle market and upper middle market assets, providing us strategic flexibility as we have built the robust capability to seek attractive risk-adjusted returns in both markets. In our core market, the lower middle market, we directly originate opportunities consisting of debt investments and equity co-investments. Building out a highly performing and granular portfolio of equity co-investments is important to driving growth in NAD per share while aiding in the mitigation of future credit losses. At the same time, our capability and presence in the upper middle market provides us the ability to opportunistically invest in a more liquid market when attractive risk-adjusted returns exist. Overall, we believe that maximizing the top end of our deal origination funnel in both markets is critical to generating strong credit investment performance over time as it ensures that we consider a wide array of deals allowing us to employ our conservative underwriting standards in a competitive market and thoughtfully build a portfolio that will perform through the economic cycle. Our on-balance sheet credit portfolio, excluding I-45 as shown on slide 10, Thank you for joining us. Turning to slide 11, during the quarter, we originated $29 million in first lien senior secured debt and $1 million in equity co-investment. The capital committed went to one lower middle market portfolio company and two add-ons to existing portfolio companies. The new portfolio company was a first lien last out senior secured loan with an equity co-investment. One of the add-ons was in the upper middle market while the other was in a lower middle market company in which Capital Southwest is the sole lender and also an equity investor. The weighted average yield and maturity on all originations this quarter was 11.7%. Subsequent to quarter end, we have originated $33 million in new commitments to two new portfolio companies. This included $30 million in first lien senior secured debt Two and a half million in an unfunded revolving credit facility and one million in an equity co-investment. We are pleased with the pipeline as it stands today and expect that two or three additional deals currently in diligence should close by calendar year end. As shown on slide 12, we also had a full prepayment of one credit investment during the quarter for $14 million in total proceeds. Thank you for joining us. generating $214 million in total proceeds and a cumulative IRR of 15.5%. On slide 13, we break out our unbalanced sheet portfolio, again excluding I-45, between the lower middle market and upper middle market. As of the end of the quarter, the total portfolio was weighted approximately 76% to the lower middle market and 24% to the upper middle market on a cost basis. We had 27 lower middle market portfolio companies with an average hold size of $12.2 million, a weighted average EBITDA of $8.2 million, a weighted average yield of 12%, and a leverage ratio measured as debt to EBITDA through our security of 3.5 times. Within our lower middle market portfolio, as of the end of the quarter, we held equity ownership in 70% of our portfolio companies. Our on-balance sheet upper middle market portfolio and many more. With respect to American Addiction, the company continues to have challenges. As in prior quarters, due to it being a public company, we want to be careful not to effectively announce developments prior to the American Addiction management team appropriately communicating to the shareholders. What we will say is that the lender group continues to work with the company on solutions to the capital structure. The company's leading market position in the substance abuse industry, the company's cost-saving and business development initiatives, and its large owned real estate portfolio all provide reasons to remain optimistic on the prospect of a favorable resolution. American Edition was placed on non-accrual this quarter and remains rated a 3 on our internal rating system. As a reminder, all investments upon origination are initially assigned an investment rating of 2 on a 4-point scale. with one being the highest rating and four being the lowest rating. Overall, we are pleased with the performance of the investment portfolio as a whole. As of the end of the quarter, of the 40 loans in the portfolio at fair value, we had three with the highest rating of one, representing 13% of the credit portfolio. We had 32 loans rated at two, representing 80% of the credit portfolio. We had four loans rated at three, representing 5% of the credit portfolio. and we had one loan rated 4 representing 2% of the credit portfolio. As illustrated on slide 14, we have established a portfolio well diversified across industries which we believe is well positioned for late in the economic cycle. Further, our portfolio asset mix should provide strong security for our shareholders' capital. The portfolio remains heavily weighted towards first lien senior secured debt with only 6% in second lien senior secured debt and only 3% in subordinated debt. MRI, which does business under the banner SPOTC, represented 10% of the investment portfolio at fair value as of the end of the quarter, while all other equity co-investments represented 7% of the investment portfolio. The sales process for SPOTC continues to progress, albeit slower than we expected earlier in the year. As we all know, the current global trade environment is complicated with many elements of uncertainty. Spotsy continues to perform very well, despite having over half of its revenue generated by customers outside the United States. These uncertainties have caused the sale process to take longer than we expected at the beginning of the year. All that being said, we continue to expect that the transaction should close in the next few months. is a well-performing company with exciting products that provide its customers with valuable real-time information regarding the condition of their assets, both remote and in transit. To us, timing is much less important than ensuring that we complete a transaction that benefits our shareholders short-term and long-term. Shown on slide 15, as of the end of the quarter, the I-45 portfolio was 95% first lien with diversity among industries, and an average hold size of 2.2% of the portfolio. The I-45 portfolio weighted average EBITDA of approximately 69 million and weighted average leverage through the I-45 security of 4.3 times. We also excluded American Addiction from these ratios for the aforementioned reasons. I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.