Capital Southwest Corporation

Thank you for joining today's Capital Southwest second quarter fiscal year 2024 earnings call. Participating on today's call are Bowen Diehl, 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'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, everyone, for joining us for our second quarter fiscal 2024 earnings call. We are pleased to be with you this morning and look forward to giving you an update on the performance of our company and our portfolio as we continue to diligently execute our investment strategy as stewards of your capital. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found in the investor relations section of our website at www.capitalsouthwest.com. You will also find our quarterly earnings press release issued last evening on our website. We'll begin on slide six of the earnings presentation, where we have summarized some of the key performance highlights for the quarter. During the quarter, we generated pre-tax net investment income of 67 cents per share, which represented 24% growth over the $0.54 per share generated a year ago in the September quarter. The $0.67 per share more than covered both our regular dividends and our supplemental dividends paid during the quarter of $0.56 and $0.06 per share, respectively. We'll follow our earnings continue to be strong, and as of the end of the quarter, we estimate that our undistributed taxable income was $0.42 per share. We're also pleased to announce today that our Board of Directors has declared a $0.01 per share increase in our regular dividend to $0.57 per share for the quarter ending December 31, 2023. This represents an increase of 1.8% compared to the $0.56 per share regular dividend paid during the September quarter and 9.6% over the 52% per share paid a year ago in the December quarter. These increases in our regular dividend are a result of the increased fundamental earnings power of our portfolio, given its growth and performance, as well as further improvements in our operating leverage. In addition, due to the excess earnings being generated by our floating rate debt investment portfolio in this high-interest rate environment, our board has again declared a supplemental dividend of six cents per share for the December 23 quarter, bringing total dividends declared for the December 23 quarter to 63 cents per share, which in total represent 11% growth over total dividends paid out a year ago quarter. While future dividend declarations are at the discretion of our board of directors, it is our intent and expectation that Capital Southwest will continue to distribute quarterly supplemental dividends for the foreseeable future while base rates are above historical averages and we have a meaningful UTI, which is generated by earnings in excess of our dividends and realized gains from our equity investment portfolio. During the quarter, deal quality and activity in the lower middle market continued at a healthy pace, and we continued to be able to find attractive investment opportunities. Deal flow continued to be weighted more towards acquisitions rather than refinancing, and the environment continued to be a favorable one for non-bank first lien lenders like Capital Southwest. Private equity firms and business owners continued to transact, while non-bank lenders continued to provide more certainty to closing than traditional bank financing structures. Loan pricing spreads remained attractive but moderated somewhat, retracting 25 to 50 basis points versus the most recent couple of quarters, as competition in the lower middle market among non-bank lenders migrated slightly towards more normal levels. That said, we are still seeing very attractive loan pricing spreads on new portfolio loans that are 25 to 50 basis points higher than 12 to 18 months ago. Leverage levels on the new portfolio company loans remain generally lower by half to a full turn of EBITDA. We also continue to see loan-to-value levels on new loans calculated as our first lien loan divided by the enterprise value being paid for an acquisition. down meaningfully from 12 to 18 months ago, as private equity firms remained willing to pay relatively full multiples for quality companies. Portfolio growth during the quarter was driven by $110 million in new commitments, consisting of $81.7 million in commitments to five new portfolio companies and $28.3 million in commitments to six existing portfolio companies. On the capitalization front, we are pleased to announce that during the quarter, we successfully amended, extended, and upsized our corporate revolving credit facility, while also raising $22.8 million in gross equity proceeds at a weighted average price of $20.77 per share, or 127% of the prevailing NAD per share. We have remained diligent to ensuring we have strong balance sheet liquidity while also funding a meaningful portion of our investment activity with accretive equity issuances, as we believe it is important to maintain a conservative mindset to both balance sheet liquidity and BDC leverage. We continue to manage our BDC with a full economic cycle mentality. This starts with our underwriting of new opportunities, but it also applies to how we manage the BDC's capitalization. Managing leverage to the lower end of our target range positions us to invest throughout a potential recession when risk-adjusted returns can be particularly attractive. It also allows us to support our portfolio companies while also opportunistically repurchasing our stock if it were to trade meaningfully below NAV. Finally, subsequent to quarter ends, we received shareholder approval to increase authorized shares of our common stock to 75 million shares up from 40 million shares. These new shares will allow us to continue our track record of growing our asset base while maintaining conservative balance sheet leverage by raising accretive equity primarily through our ATM program. On slide seven and eight, we illustrate our continued track record of producing strong dividend growth, consistent dividend coverage, and solid value creation since the launch of our credit strategy back in January of 2015. Since that time, we have increased our regular dividend pay to shareholders 28 times and have never cut the regular dividend, all while maintaining strong coverage of our regular dividend with pre-tax NII. Additionally, over the same time period, we have paid or declared 22 special or supplemental dividends totaling $3.83 per share, including the 6 cents per share the Board has declared for the December 2023 quarter. all generated from excess earnings and realized gains from our investment portfolio. We believe our track record of thoughtfully growing our dividends, the solid performance of our portfolio, as well as our company's sustained access to multiple capital sources, has demonstrated the strength of our investment and capitalization management strategies, as well as the absolute alignment of all our decisions with the interest of our shareholders. Turning to slide nine, we lay out the core tenets of our investment strategy. Our core strategy is lending and investing in the lower middle market, the vast majority of which is in first lien senior secured loans to companies backed by private equity firms. In fact, approximately 91% of our credit portfolio is backed by private equity firms, which provide important guidance and leadership to the portfolio companies, as well as the potential for new junior capital support if needed. We have been pleased with the leadership and support that our private equity firm partners have provided our portfolio companies, both in the few instances where capital has been required to maintain the operating and growth strategies of the portfolio companies, and in realizing operational efficiencies in an environment where business input costs have been rising. In the lower middle market, we often have the opportunity to invest on a minority basis in the equity Perry pursued with the private equity firm, when we believe the equity thesis is compelling. As of the end of the quarter, our equity co-investment portfolio consists of 59 investments with a total fair value of $121.1 million, which was marked at 147% of cost, representing $38.9 million in embedded unrealized appreciation, or $0.97 per share. Our equity portfolio, which represented approximately 9% of our total portfolio fair values at the end of the quarter, continues to provide our shareholders participation in the attractive upside potential of these growing lower middle market businesses, which will come in the form of NAB per share growth and supplemental dividends over time. Our lower middle market strategy is complemented by club participations in first lien loans to larger companies led by like-minded lenders with whom we have relationships and have gained confidence in their post-closing loan management from working together across multiple deals. Virtually all of these club deals are first lien senior secured and backed by private equity firms. As illustrated on slide 10, our on balance sheet credit portfolio as of the end of the quarter grew 6% quarter over quarter to 1.2 billion, compared to 1.1 billion as of the end of the prior quarter. Year over year, the portfolio has grown 31% from 903 million as of the September 22 quarter end. For the current quarter, 100% of our new portfolio company debt originations were first lien senior security. And as of the end of the quarter, 97% of the credit portfolio was first lien senior security. The weighted average credit exposure per company in our portfolio was 1.1%. We believe our portfolio granularity speaks to our continued investment discipline of maintaining a conservative posture to overall risk management as we grow our balance sheet. On slide 11, we detailed the $110 million of capital invested in and committed to portfolio companies during the quarter. Capital committed this quarter included $79.7 million in first lien senior secured debt committed to five new portfolio companies, including two in which we also invested a total of $2 million in equities. We also committed a total of $27.8 million in first lien senior secured debt and $550,000 in equity to six existing portfolio companies. We are pleased with the strong market position that our team has established in the lower middle market as a premier debt and equity capital provider, as evidenced by the broad array of relationships across the country from which our team is sourcing quality opportunities. Deal activity over the past quarter continued at a healthy pace, and we continue to expect solid net portfolio growth in the coming quarters. Slide 12, we detail key stats for our on-balance sheet portfolio as of the end of the quarter, excluding our I-45 joint venture. As of the end of the quarter, the total portfolio fair value was weighted at 87.8% to first-line senior secured debt, 2.8% to second lien senior security debt, 0.1% to sub-debt, and 9.3% to equity co-investments. The credit portfolio had a weighted average yield of 13.5% and weighted average leverage through our security of 3.6 times EBITDA. As seen on slide 13, our total investment portfolio, including our I-45JV, continues to be well diversified across industries, with an asset mix which provides strong security for our shareholders' capital. The portfolio remains predominantly weighted towards first lien senior secured debt with less than 3% of the total portfolio in second lien senior secured debt. Turning to slide 14, we have laid out the rating migration within our portfolio during the quarter. As a reminder, all loans upon origination are initially assigned an investment rating of two on a four-point scale with 1% being the highest rating and 4% being the lowest rate. We feel very good about the performance of our portfolio, with 96.9% of the portfolio at fair value rated in one of the top two categories, a one or a two. I will now hand the call over to Michael to review more specifics of our financial performance for the quarter.