Capital Southwest Corporation

Thank you for joining today's Capital Southwest third quarter fiscal year 2021 earnings call. Participating on the call today are Bowen Deal, CEO, Michael Sarner, CFO, and Chris Reberger, VP Finance. I will now turn the call over to Chris Reberger.

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 more information concerning these risks and uncertainties, see Capital Southwest's 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 Deal.

Thanks, Chris. And thank you to everyone for joining us for our third quarter fiscal year 2021 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 results for our third physical quarter ended December 31, 2020. I want to first say that I hope everyone, their families, and their employees continue to be safe and well. In summary, this quarter was exceptional in virtually all areas. Strong originations, strong capital raises, and strong portfolio performance. As we reflect back on 2020, we were very impressed by how the vast majority of our portfolio management teams and financial sponsors managed our portfolio companies, prioritizing the health and safety of their employees, realizing cost efficiencies were needed, and now recovering nicely from the worst effects of the pandemic. While the pandemic is not yet completely behind us, as we look back to where we were in March of 2020, with so much economic uncertainty and market volatility, we are very grateful for all the work done by the team here at Capital Southwest, and the teams at both our portfolio companies and financial sponsor clients. The pandemic has impacted so many people and companies in a variety of ways, and we are humbled by how well the portfolio has held up through this difficult time. The way our deal team has been able to continue to source, diligence, and originate high-quality assets while continuing to actively monitor our existing portfolio over the past year has corroborated my confidence in them and also in the strength and quality of the assets. During the quarter, our portfolio continued to improve, as evidenced by $7.1 million of net appreciation across the portfolio. For the quarter, we had two loans which had investment rating upgrades. We had no investment rating downgrades, and we had no new loans placed on non-accrual. Overall, as of the end of the quarter, we had only one loan on non-accrual, the junior most tranche of our loan to AG Kings, which had a fair value of $739,000. Substance to quarter end, the sale of AG Kings to Albertson's Ackley Markets has closed. Now we're resolving this last non-accrual asset for Capital Southwest. As a well-capitalized first lien lender with ample liquidity, Capital Southwest continues to be in a favorable position to seek attractive financing opportunities and to provide financial support for the growth of our portfolio companies. Executing our investment strategy under our shareholder-friendly, internally managed structure closely aligns the interest of our board and management team with that of our fellow shareholders in generating sustainable long-term value through recurring dividends, capital preservation, and operating cost efficiency. On slide six of the earnings presentation, we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pre-tax net investment income of 52 cents per share, which more than earned both our regular dividend paid for the quarter of 41 cents per share and our supplemental dividend for the quarter of an additional 10 cents per share. Total dividends for the quarter of 51 cents per share represented an annualized dividend yield on the quarter end stock price of 11.5%, and an annualized yield on net asset value per share of 13%. I'm also pleased to announce that our board has increased our total dividends to 52 cents per share for the coming quarter ending March 31, 2021, consisting of a regular dividend increase from 41 cents per share up to 42 cents per share and a supplemental dividend of 10 cents per share. Our decision to increase the dividend emanates from our confidence in the current earnings power of our portfolio as a result of the reduction in our cost of capital and our ability to continue to improve our operating leverage as we grow the portfolio. During the quarter, we grew our investment portfolio on a net basis by 3% to $649 million as of December 31, 2020. Portfolio growth during the quarter was driven primarily by $57.5 million in total new commitments to three new portfolio companies and three existing portfolio companies, offset by $28 million in total proceeds from three exits. Subsequent quarter end, we added additional investment activity, which spilled over into the new year, closing an additional $33.5 million in commitments. I will review our investment activity in a bit more detail in a moment. On the capitalization front, we were quite busy during the quarter. We successfully raised over $96 million in investable capital during the quarter, consisting of $75 million in aggregate principal in a new 4.5% institutionally placed unsecured bond and $21.1 million in gross proceeds through our equity ATM program. During the quarter, we also received $15 million of additional commitments to our revolving credit facility, which now stands at a total of $340 million in total commitments from 11 banks. In addition, subsequent to quarter end, we paid off the remaining balance on our 5.95% December 22 baby bonds. Turning to slides 7 and 8, 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. In fact, specific to slide eight, as of December 31, 2020, we hit a new all-time high in total value creation for our shareholders. We believe the strength of our investment and capitalization management strategies have been demonstrated through the pandemic based on the solid performance of our company and our portfolio. And now we are pleased to announce an increase in our regular dividend this quarter. We believe that the maintenance and growth of both net asset value and dividends per share are paramount to creating long-term value for our shareholders. Turning to slide nine as a refresher, our investment strategy has remained consistent since its launch in January of 2015. We continue to focus on our core lower middle market while also maintaining the ability to opportunistically invest in the upper middle market when attractive risk-adjusted returns exist. In the lower middle market, we directly originate and lead opportunities consisting primarily of first lien senior secured loans with smaller equity co-investments made alongside our loans. This combination is powerful for a BDC as it provides strong security for the vast majority of our invested capital while also providing NAV upside from these growing businesses. Building out a well-performing and granular portfolio of equity co-investments is important to driving growth in NAV per share, while aiding in the mitigation of any credit losses over time. As illustrated on slide 10, our on-balance sheet credit portfolio as of the end of the quarter, excluding our I-45 joint venture, grew 2% to $531 million, as compared to $521 million as of the end of the prior quarter. Our credit portfolio is currently weighted 86% to lower middle market loans, up from 82% last quarter, as a result of one loan prepayment in the upper middle market and six loan originations in the lower middle market during the quarter. Ninety-nine percent of the debt originations for the quarter were first lien seniors secured, and as of quarter end, 91 percent of the credit portfolio was first lien seniors secured. On slide 11, we lay out the $57.5 million of capital invested in and committed to portfolio companies during the quarter. This included $45.4 million in first-ling senior secured debt committed to three new portfolio companies, along with $2 million invested in equity co-investments alongside two of the new portfolio loans. We committed an additional $9.8 million in first-ling senior secured debt to two existing portfolio companies, which in both cases was utilized to fund strategic acquisitions. Turning to slide 12, as I noted earlier, Substance to quarter end, we have thus far invested $33.5 million of capital in two new portfolio companies. We believe our ability to cultivate strong sponsor relationships in the market and be a long-term dependable partner to our sponsors and portfolio companies has translated to enhanced deal activity and the ability to win more deals that fit our investment strategy. These relationships are also key to putting us in a position to make small equity co-investments in growing lower middle market companies alongside many of these sponsors. Turning to slide 13, we had two lower middle market exits this quarter, our equity investment in Tenuity and our first lien senior secured loan to Coastal Television. In the upper middle market, we exited our first lien senior secured loan to iEnergizer The exit of our equity investment in tenuity was especially notable as it generated a realized gain of $8.1 million on an initial capital outlay of $1.4 million. This resulted in an IRR of 73.2% and a multiple on invested capital of 6.8 times. Mountain Gate Capital, tenuity sponsored during our hold, and the tenuity management team did an exceptional job growing this business both organically and through acquisitions. and positioning it for a sale that generated an outstanding result for all parties involved. We are grateful to have had the opportunity to support the growth strategy for this company and its sponsor over the past four years. This continues our track record of successful exits. To date, we have generated a cumulative weighted average IRR of 16.8% on 35 portfolio exits, representing approximately $336 million in proceeds. On slide 14, we break out our unbalanced sheet portfolio as of the end of the quarter between the lower middle market and the upper middle market, again, excluding our I-45 joint venture. As of the end of the quarter, the total portfolio, including equity co-investments, was weighted approximately 86% to the lower middle market and 14% to the upper middle market on a fair value basis. Our portfolio of 39 lower middle market portfolio companies has a weighted average leverage ratio measured as debt to EBITDA through our security of 3.8 times. Leverage in EBITDA improved across a solid majority of the lower middle market portfolio for the quarter. Within our lower middle market portfolio, as of the end of the quarter, we held equity ownership in approximately two-thirds of our portfolio companies. Our on-balance sheet upper middle market portfolio, excluding our I-45 joint venture, consisted of 11 companies with an average leverage ratio through our security of 3.6 times. We were also pleased with the leverage and EBITDA improvement across the upper middle market portfolio. Turning to slide 15, we have laid out the rating migration within our portfolio for the quarter. During the quarter, we had two loans upgraded while having no loans downgraded. As a reminder, All loans 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. The upgrades consisted of loans to two portfolio companies, one previously rated a three and one previously rated a two, which were upgraded to a two and to a one rating respectively, both based on improved EBITDA performance and deleveraging. I'll also note that the number of loans in each category, as of December 31, 2020, included new portfolio company originations during the quarter, each rated a 2, while removing portfolio companies exited during the quarter. Specifically, one of the portfolio companies exited during the quarter was rated a 1, and one exit was rated a 2. As of the end of the quarter, over 90% of our investment portfolio at fair value was rated in one of the top two categories, either a 1 or a 2. We had six loans representing 9.6 percent of the portfolio at fair value, rated a three, and only one loan, our junior-most loan tranche to AG Kings, representing 0.1 percent of the portfolio at fair value, rated a four. As illustrated on slide 16, our total investment portfolio continues to be well diversified across industries with an asset mix which provides strong security for our shareholders' capital The portfolio remains heavily weighted towards first lien senior secured debt, with only 6% of the portfolio in second lien senior secured debt and only 2% of the portfolio in one subordinated debt investment. Turning to slide 17, the I-45 portfolio also continued to show improvement during the quarter, as our investment in the I-45 joint venture appreciated by $2.2 million. Leverage at the I-45 fund level is now 1.07 times debt-to-equity at fair value, which is substantially improved from the peak leverage of 2.51 times debt-to-equity at March 31, 2020. As of the end of the quarter, 94% of the I-45 portfolio was invested in first-lane senior security debt with a diversity among industries and an average hold size of 2.6% of the portfolio. I'll now hand the call over to Michael to review the specifics of our financial performance for the quarter.