Capital Southwest Corporation

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

Thank you. I'd 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 statements, 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 Diehl.

Thanks, Chris, and thank you to everyone for joining us for our third quarter fiscal year 2020 earnings call. Throughout our prepared 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 to announce our quarterly results for the third fiscal quarter ended December 31st, 2019. During the quarter, we continued to advance our credit strategy, achieving the final step in transitioning the BDC to solely a middle market lender with a successful sale of media recovery, which as a reminder, does business under the banner SPOTC. The sale was a great outcome for Capital Southwest as we realized a significant capital gain Thank you for joining us. We are excited to have achieved this final step and look forward to continuing the pursuit of 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 opportunities exist. Executing this strategy under our shareholder friendly internally managed structure closely aligns the interest of our board and manager team with that of our fellow shareholders. Thank you for joining us. which was generated by excess income and capital gains accumulated from our investment strategy to date. The realized gain on sale of media recovery allowed us to add approximately 50 cents per share to our UTI balance, bringing the total balance to approximately 27.6 million or $1.48 per share as of December 31st, 2019. We believe this provides visibility to the continuation of the quarterly supplemental dividend program well into the future. Thank you for joining us. Our board also declared another quarterly supplemental dividend of 10 cents per share, bringing our total dividends paid to shareholders to 51 cents per share for the March quarter. During the December quarter, we grew our portfolio on a net basis to $559 million from $539 million as of the end of the September quarter, originating approximately $92 million in investments for the quarter, the vast majority of which were deployed in the lower middle market. From a capitalization perspective, We continue to de-risk the balance sheet by diversifying capital sources and maintaining liquidity. During the quarter, we raised an additional $10 million on our existing five-year 5.38% institutionally placed bond due 2024. The aggregate principal amount for this adventure is now $75 million. In addition, we raised $13.8 million in gross proceeds through our equity ATM program during the quarter. selling over 623,000 shares at a weighted average price of $22.07 per share, representing a 21% premium to the September 2019 net asset value per share. We are pleased to report that since the initiation of our equity ATM program, Capital Southwest has sold over 1.3 million shares at attractive premiums to book value, raising approximately $29 million in gross proceeds. Our equity ATM program continues to provide a steady flow of equity equity capital raised on a just-in-time basis in lockstep with our ability to thoughtfully put the capital to work. Including cash and undrawn commitments on our balance sheet credit facility, we had dry powder of $190 million at quarter end available to deploy in future investments. This dry powder, when invested, represents a 34% increase in our portfolio investment assets. Turning to slides 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 our core lower middle market while also maintaining the ability to invest in the upper middle market when attractive risk-adjusted returns exist. In the lower middle market, we directly originate opportunities consisting of debt investments and equity co-investments Building out a well-performing and granular portfolio of equity co-investments is important to driving NAD per share growth and aiding in the mitigation of any future credit losses. Overall, we believe that maximizing the top end of our deal origination funnel in both markets is critical to generating strong credit 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. We continue to find superior risk-adjusted return opportunities in the lower middle market where we can lend at lower leverage and loan-to-value levels while maintaining tighter covenants and other terms in the loan documents. Over the past several quarters, this has been especially true as the upper middle market has been the primary source of NAD volatility in our portfolio. Turning to slide 10, Our on-balance sheet credit portfolio, excluding I-45, grew 18% during the quarter to $456 million as compared to $387 million as of the end of the prior quarter. We continue to heavily emphasize first lien senior secured debt lending, and again this quarter, the vast majority of our originations were in the lower middle market. As of the end of the quarter, we had 81% of our on-balance sheet credit portfolio invested in the lower middle market companies, while having 90% of the credit portfolio in first lien senior secured debt. On slide 11, we lay out the capital invested in and committed to new lower middle market portfolio companies during the quarter. This included 86 million in first lien senior secured debt invested in five companies and almost 4 million in equity co-investments invested in three of them. We also committed 3.3 million of additional capital to four existing portfolio companies during the quarter bring in our total capital deployed for the quarter to over $92 million. All of the new portfolio company loans were first lien senior secured, with one being a loan in which a bank lender participated in a first out position. The weighted average yield of maturity on new debt and originations funded this quarter was 9.9%. We are pleased with the pipeline as it stands today and expect that several additional deals currently in diligence should close during the March quarter. Again, the vast majority of this prospective investment activity is in the lower middle market. On slide 12, we show a summary of the exits during the quarter. The sale of media recovery, generating $51 million in net proceeds, realizing a gain of $44.3 million and an IRR of 11.8%, measured back to the original acquisition in 1997. During the quarter, we also realized a full prepayment of our subordinated debt investment in Chandler Signs, Chandler is performing well, and we remain invested in an equity co-investment position that is appreciated in value since closing. The subordinated debt exit generated an IRR of 14%. This continues our strong track record of successful exits, as we have now had 29 portfolio exits since launching our credit strategy back in January 2015, generating $267 million in proceeds and a cumulative IRR of 15.4%. On slide 13, we break out our on-balance sheet portfolio excluding I-45 between the lower middle market and the upper middle market. As of the end of the quarter, the total portfolio, including equity co-investments, was weighted approximately 83% to the lower middle market and 17% to the upper middle market on a fair value basis. We had 32 lower middle market portfolio companies with an average hold size of $12.6 million, a weighted average EBITDA of $7.9 million, Weighted average yield of 11.6% and a leverage ratio measured as debt to EBITDA through our security of 3.6 times. Within our lower middle market portfolio, as of the end of the quarter, we held equity ownership in approximately 69% of our portfolio companies. Our on-balance sheet upper middle market portfolio consisted of 11 companies with an average hold size of 9.2 million, a weighted average EBITDA of 65.2 million, A weighted average yield of 7.4% and a leverage ratio through our security of 4.6 times. As in the past couple of quarters, we should note that our on-balance sheet upper middle market metrics are shown excluding our investment in American Addiction as EBITDA, while improving on a run rate basis, remains at a level that would skew the aggregate portfolio leverage ratios to a degree that would obscure the ratios of the remainder of the upper middle market portfolio. American Addiction remains a three on our internal rating system and remains on non-accrual having been placed on non-accrual during the September 2019 quarter. As a reminder, all investments upon origination are initially assigned an investment rating of two on a four-point scale with one being the highest rating and four being the lowest rating. At the end of the quarter, of the 44 loans in the portfolio, we had three with a highest rating of one representing 11% of the credit portfolio at fair value. We had 36 loans rated at two representing 84% of the credit portfolio at fair value. We had four loans rated at three representing 4% of the credit portfolio at fair value. And we had one loan rated at four which represented 1% of the portfolio at fair value. The loans rated at three in the portfolio all in the upper middle market include American Addiction, American Teleconferencing, which does business as Premier Global, and Delphi Intermediate, which does business as Delphi Behavioral Health. Delphi was downgraded from a 2 to a 3 during the September quarter and joined American Addiction on non-accrual status during the December quarter. Both American Addiction and Delphi are in the business of providing addiction treatment services to patients across the country. While it would be inappropriate to discuss in detail the status of each company on a That said, we believe that both situations are rapidly moving to balance sheet restructurings and in both cases we believe that the restructurings will benefit each company in their respective missions to provide the highest quality care to their patients. We also believe that these restructurings will provide the respective lender groups the opportunity to realize appreciation and recovery of their investments as the businesses complete the transitions and grow their respective patient bases. We continue to believe that the challenges facing both companies are addressable and our unrealized appreciation in each is recoverable. As a result of these restructurings, if and when they occur, we would expect that a portion of Capital Southwest's first lien loans currently held in each company would be reinstated as first lien debt on each business with the resulting interest in that portion coming back on accruals. The remainder of Capital Southwest's position in each company would then be equity, which we anticipate will be the source of recovery of the unrealized depreciation that exists today. Our loan rated a 4, also in the upper middle market portfolio, is H.E. Keynes. The loan has remained on non-accrual for the past several quarters. Not much has changed with respect to this position, but the lender group continues to work with the company on strategic alternatives for the business. We will attempt to update you on future calls to the extent we can comment on the company's status. As illustrated on slide 14, we have established a portfolio well diversified across industries. Despite the few idiosyncratic issues we are dealing with in the upper middle market portfolio today, we believe the portfolio is well positioned for late in the economic cycle. Further, our portfolio asset mix should provide strong security for our shareholders' capital. The I-45 portfolio had weighted average EBITDA of approximately $65 million. a weighted average coupon of LIBOR plus 6.3%, and weighted average leverage through the I-45 security of 4.5 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.