Capital Southwest Corporation

Thank you for joining today's Capital Southwest fourth quarter and fiscal year 2021 earnings call. Participating on the call today are Bowen Deal, CEO, Michael Sonner, 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 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 over to our President and Chief Executive Officer, Bo.

Thanks, Chris, and thank you, everyone, for joining us for our fourth quarter and 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 the fourth quarter and fiscal year ended March 31, 2021. I want to first say I hope everyone, their families and their employees continue to be safe and well. We are hopeful that the economy will continue to take steps forward as businesses and communities continue to return to pre-pandemic levels. While the aftermath of the pandemic continues to impact certain parts of the U.S. and world economies, we are grateful for all the work done by our employees as well as the sponsors, owners, and employees of our portfolio companies. I'm pleased to report that this year was another stellar year for Capital Southwest as we continued to steadily grow all aspects of our company, including investment assets, capital availability and flexibility, and investment income. As we reflect on the year and the unprecedented storm that hit the economy vis-a-vis the COVID pandemic, We noted some fundamental decisions made in prior years reflective of our full economic cycle management philosophy that allowed us to perform well during the unprecedented black swan event that we all experienced in 2020. First, we have been intent to always have ample liquidity, which in our case means ample revolver availability and a prudent amount of outstanding unfunded portfolio company commitments. Second, we maintained a flexible leverage structure on our balance sheet with over 50% of our liability structure in the unsecured covenant-like bonds going into the pandemic. And third, and perhaps most importantly, we have maintained our discipline in building a high-quality, almost exclusively first lien credit portfolio with diversity in industries and a granularity of hold sizes. As a result of these decisions, we were able to do three important things in this fiscal year. First, we had more than ample liquidity to support portfolio companies that needed it, while also continuing to fund new deals that were able to be underwritten in the pandemic environment. Second, we were able to more than cover dividends to our shareholders. And third, when the inevitable stock market volatility presented itself, we were able to repurchase a material amount of our stock. Beginning on slide six of the presentation, we summarized some of the key performance highlights for the fiscal year. Total return to shareholders for the fiscal year was 119%, which consisted of share price appreciation of 94%, and total dividends paid during the year of $2.05. Our NAV per share grew 6% to $16.01 versus $15.13 in the prior year period, driven primarily by $20.2 million in net unrealized and realized gains on the portfolio. I think it is also important to note that our NAV per share of 1601 as of March 31, 2021, represented a retracement to 99% of its pre-pandemic level of 1674 per share as of December 31, 2019, when adjusted for the 50 cents per share in supplemental dividends we paid out to shareholders during this 15-month time period. Considering the unprecedented events of the last 15 months, we are extremely proud of the team and what they have accomplished. During the fiscal year, we grew our total portfolio at fair value by 24% year-over-year to $688 million versus $553 million in the prior year and increased our pre-tax net investment income by 7% to $1.79 per share from $1.68 per share in the prior year. Furthermore, we strengthened our balance sheet during the year through the issuance of $190 million of unsecured notes, $51.4 million in equity proceeds through our equity ATM program, and $15 million in additional commitments obtained on our ING-led revolving credit facility. Additionally, we announced in April that we have been formally approved into the SBIC program and have officially received our SBIC license. Michael will provide further detail on this later in the prepared remarks. As a well-capitalized first lien lender with ample liquidity, Capital Southwest continues to be in a favorable position to seek attractive financing opportunities, grow our asset base, and continue to grow earnings and increase dividends for our shareholders. 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 seven 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 44 cents per share, which exceeded our regular dividend paid for the quarter of 42 cents per share. Including our supplemental dividend of 10 cents per share, total dividends for the quarter were 52 cents per share, which represented an annualized dividend yield on the quarter end stock price, of 9.4% 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 53 cents per share for the coming quarter ending June 30, 2021, consisting of a regular dividend increase from 42 cents per share to 43 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 portfolio growth, continued reductions in our cost of capital, and our ability to improve our operating leverage efficiency by actively managing operating costs while growing the asset base. During the quarter, we grew our investment portfolio on a net basis by 6% to $688 million as of March 31, 2021. Portfolio growth during the quarter was driven primarily by a total of 77.3 million in new commitments to six new portfolio companies and one existing portfolio company, offset by 23 million in total proceeds from two exits. The portfolio generated net realized and unrealized gains of $2.6 million during the quarter, and we currently have no investments on non-accrual. On the capitalization front, we were quite busy during the quarter, we successfully raised over $89 million in investable capital, consisting of $65 million in aggregate principal of unsecured notes and $24.1 million in gross proceeds through our equity ATM program. Turning to slides 8 and 9, 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. We believe the strength of our investment and capitalization management strategies was demonstrated by the solid performance of our company and our portfolio throughout this unprecedented period. Maintenance and growth of NAV per share and shareholder dividends remain as core tenants of our long-term investment objective of creating long-term value for our shareholders. Turning to slide 10 as a refresher, our investment strategy has remained consistent since its launch in January 2015. We continue to focus on our core lower middle market lending strategy 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. We believe that 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 equity investments in 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. Today, our equity co-investment portfolio consists of 29 investments totaling $58.7 million, or 9% of our portfolio at fair value. Though the equity portfolio currently has performed extremely well with $10.1 million in cumulative appreciation, some lingering effects of the pandemic aftermath still persist, leaving us very excited about the potential upside of this equity portfolio moving forward. As illustrated on slide 11, our on-balance sheet credit portfolio is at the end of the quarter, excluding our I-45 joint venture. grew 8% to $573 million as compared to $531 million as of the end of the prior quarter. Our credit portfolio is currently weighted 88% to lower middle market loans, up from 86% last quarter. For the quarter, 100% of the debt originations were first lien senior secured, and as of the quarter end, 92% of the credit portfolio was first lien senior secured. On slide 12, we lay out the $77.3 million of capital invested in and committed to portfolio companies during the quarter. This included $74.5 million in first lien senior secured debt committed to six new portfolio companies, along with $2.5 million invested in equity co-investments alongside two of the new portfolio loans. Turning to slide 13, we continued our track record of successful exits with two this quarter. a first lien senior secured loan to Environmental Pest Service, and the remainder of our expected proceeds from the sale of AG Kings to Acme Markets. To date, we have generated a cumulative weighted average IRR of 15.5% on 38 portfolio exits, representing approximately $384 million in proceeds. On slide 14, we break out our on-balance 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 88% to the lower middle market and 12% to the upper middle market on a fair value basis. Our portfolio of 44 lower middle market companies has a weighted average leverage ratio measured as debt to EBITDA through our security of 4.2 times. Within our lower middle market portfolio, as of the end of the quarter, we held equity ownership in approximately 60% of our portfolio companies. Our unbalanced sheet upper middle market portfolio, excluding our I-45 joint venture, consisted of 10 companies with an average leverage ratio through our security of four times. Turning to slide 15, we have laid out the rating migration within our portfolio again this quarter. During the quarter, we had one loan upgraded from a two to a one, while having one loan downgraded from a two to a three. 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. As of the end of the quarter, we had 56 loans representing 91% of our investment portfolio at fair value, rated in one of the top two categories, a one or a two. We had seven loans representing 9.2% of the portfolio at fair value rated a three, and we had no loans 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 5% 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 $1.5 million. Leverage at the I-45 fund level is now 1.27 debt to equity at fair value. The increase in leverage at I-45 was mainly driven by an equity distribution to the JV partners during the quarter, which represented most of the capital contributed to the JV during the height of the COVID-related market disruptions. Michael will talk more specifically about this in a moment. As of the end of the quarter, 95% of the I-45 portfolio is invested in first lien senior secured debt with diversity among industries and an average hold size of 2.8% of the portfolio. I will now hand the call over to Michael to review the specifics of our financial performance for the quarter.