Capital Southwest Corporation

Thank you for joining today's Capital Southwest fourth quarter fiscal year 2025 earnings call. Participating on the call today are Michael Sarner, Chief Executive Officer, Chris Rehberger, Chief Financial Officer, Josh Weinstein, Chief Investment Officer, and Amy Baker, Executive Vice President, Accounting. I will now turn the call over to Amy Baker.

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 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, Michael Sarner.

Thanks, Amy. Thank you, everyone, for joining us for our fourth quarter fiscal year 2025 earnings call. We're pleased to be with you today to discuss our fourth fiscal quarter, the 2025 fiscal year as a whole, as well as share our observations on the market in a rapidly changing environment. Overall, 2025 was a very productive year for Capital Southwest, as we were able to make significant strides in strengthening both sides of our balance sheet. On the left side of the balance sheet, during the year we grew our investment portfolio by approximately $300 million, or 21%, from $1.5 billion to $1.8 billion. The quality of our debt portfolio continued to improve as we further reduced our weighted average leverage in the investment portfolio to 3.5 times, maintained a solid 94% cash income as a percentage of total investment income, while decreasing our non-accruals at fair value from 2.3% to 1.7%. Additionally, our equity portfolio performed exceptionally well this year as we grew unrealized appreciation from $38.5 million or 85 cents per share at the end of fiscal year 2024 to $53.2 million or $1 per share as of the end of fiscal year 2025. This is an important metric as we anticipate that a portion of this appreciation will be harvested as realized gains in fiscal year 2026, and thus will be available in our UTI bucket to support future dividend distributions. In fact, subsequent to quarter end, we have harvested realized gains of approximately $20 million on our equity investments in two portfolio companies, which will further grow our UTI balance. On the right side of the balance sheet, we were extremely active during the year in diversifying our sources of capital. we raised over $300 million in new debt capital commitments this year in the form of a $230 million fixed 5.125% convertible bond issuance and an additional $75 million in new secure debt commitments on our two credit facilities. We utilized $140 million of the proceeds received from the convertible issuance to retire our January 2026 bond, which we felt was prudent at the time to stay well ahead of our 2026 unsecured debt maturities. in an uncertain economic environment. Post-quarter end, we received approval from the SBA for our second SDIC license, which allows for an additional $175 million in debt capital to support our direct lower middle market platform. Additionally, we raised over $180 million in gross equity proceeds on our ATM program during the year. Having continual access to the public equity market through the ATM program is a tremendous tool which we can use in all market environments. Finally, we recently had our BBB- corporate ratings from both Moody's and Fitch affirmed, as well as our secure debt rating from Fitch upgraded from BBB- to BBB-. This year, we continued our long track record of producing steady dividend growth, consistent dividend coverage, and solid value creation. Despite a year in which our base rate, SOFR, shrunk by over 1%, we grew our regular dividend from $2.24 per share in fiscal year 2024 to $2.31 per share in fiscal year 2025, while paying an additional $0.23 per share in supplemental dividends. Since the launch of our credit strategy, we have increased our quarterly regular dividend 29 times and have never cut the regular dividend, all while maintaining strong coverage for our regular dividend with pre-tax and other investment income. In addition, Over the same period, we have paid or declared 28 special or supplemental dividends totaling $4.18 per share, all generated from excess earnings and realized gains from our investment portfolio. Dividend sustainability, strong credit performance, and continued access to capital from multiple capital sources are all core to our overall business strategy. Our track record in all these areas demonstrates consistent performance as well as the absolute alignment of all of our decisions with the interest of our fellow shareholders. Turning to the quarterly results, during the fourth fiscal quarter, we generated pre-tax net investment income of 56 cents per share. However, our adjusted pre-tax net investment income was 61 cents per share after excluding one-time expenses related to the departure of our former chief executive officer. Additionally, as a result of gains realized in two equity investments during the quarter, we're able to increase our undistributed taxable income balance to 79 cents per share from 68 cents per share as of the end of the prior quarter. As mentioned earlier, this balance will grow meaningfully in the June quarter with our most recent exits. Deal flow in the low rental market was solid this quarter with 150 million in total new commitments to four new portfolio companies and 15 existing portfolio companies. Add-on financings continue to be an important source of originations as approximately 22 percent of total capital commitments during the quarter were follow-on financings in performing portfolio companies. Over the last 12 months, add-ons as a percentage of total new commitments has been 38 percent, so clearly a strong source of origination volume in deals we know well and have experience with the management team and sponsor. As previously announced, our Board of Directors has declared a regular dividend of 58 cents per share for the quarter ending June 30, 2025. Additionally, our board has declared supplemental dividends of $0.06 per share, bringing total dividends declared for the June quarter to $0.64 per share. From a market perspective, it is impossible to ignore what has transpired in the broader geopolitical arena over the past month and a half. The recent trade policy changes, as well as government cost reductions, have created uncertainty, which has impacted the lower middle market in the short term. This uncertainty has temporarily impacted the volume of underwritable opportunities. Industries such as manufacturing, building products, and consumer discretionary products all are experiencing increased costs for parts and products from China, Mexico, and Canada, as well as other countries impacted by the trade war. Recent budget cuts within the government sector have created uncertainty in the healthcare space in terms of Medicare and Medicaid reimbursement, as well as medical research. The net result of this uncertainty is the potential for slower M&A, and thus lower deal volume, offset by lower prepayments in 2025. Additionally, if these conditions persist, we may experience continued spread compression in the lower middle market as lenders will compete harder for deals which fall outside the directly impacted industries. The recent announcement of a 90-day agreement between China and the United States, whereby tariffs on Chinese goods will come down to 30%, and China's tariff on American goods will likewise decline to 10%, has created some optimism that we'll see a soft landing relative to the previous rhetoric. However, the announced agreement is temporary, and thus we will remain vigilant in our underwriting standards until such time as we have a more permanent solution in place. In terms of potential direct impacts to our existing portfolio, we have undertaken an in-depth review of our portfolio and the risks associated with these policy uncertainties. we have identified 7% of the debt portfolio at fair value, which we would characterize as moderate risk, which means there's some exposure to tariffs, such as sourcing of components or inventory, generally from China, or customers of the portfolio company have some level of exposure to these same risks. However, only 1% of the debt portfolio at fair value has both moderate risk tariff exposure and a current loan to value above 50%. In summary, our portfolio has limited direct exposure to tariffs, and those companies where the exposure is greatest are well positioned from a capital structure perspective. As a company, we will continually monitor any current or prospective policy changes as they develop, and on a real-time basis, analyze any impact on both our existing portfolio as well as the lower middle market in general. Overall, as a predominantly first-lane portfolio with a weighted average debt to EBITDA of 3.5 times, and a balance sheet levered at 0.89 to 1 with significant liquidity and no maturities until October 2026, we feel confident that our balance sheet is well positioned to endure this market volatility. Further proof of our market positioning, since the onset of the tariff-related volatility in the public equity markets, we are one of only five BDCs which has continued to trade above book at all times. From a historical perspective, Capital Southwest has only traded below book once since 2018, and that was for a few weeks during the COVID outbreak. Consistently trading above book allows us to continue to raise equity capital in uncertain times to deleverage the balance sheet, invest in new platform companies, and provide financing for add-on acquisitions for our existing portfolio companies. Our investment strategy and performance have earned us this flexibility, which we believe is a key differentiator for many other BDCs. I will now hand the call over to Josh to review more specifics of our investment activity in the market environment.