Thank you for joining today's Capital Southwest Fourth Quarter and Fiscal Year 2023 Earnings Call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; and Chris Rehberger, Vice President of 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 Diehl.

Thanks, Chris. And thank you to everyone for joining us for our fourth quarter and fiscal year 2023 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 to 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 page on our website at www.capitalsouthwest.com. You'll also find our quarterly earnings press release issued last evening on our website. Now turning to Slide 6 of the earnings presentation. We will begin with a summary of the key performance highlights for the 2023 fiscal year. During the fiscal year, we grew our total portfolio at fair value by 29% year-over-year to over $1.2 billion from $937 million in the prior year. While increasing our pretax investment income by 21% to $2.30 per share from $1.90 per share in the prior year. We increased our regular dividends paid to $2.03 per share for the fiscal year representing an increase of 12% compared to the $1.82 per share of regular dividends paid in the prior year. We continued our track record of covering our regular dividend with pretax NII, and with over 113% coverage for the year. In addition to our regular dividend growth, we began a supplemental dividend program in the December 2022 quarter paying $0.05 per share in each of the December and March quarters. Our Board has again declared a $0.05 per share supplemental dividend for the June 2023 quarter. In addition, during the year, we strengthened our balance sheet through a variety of capital markets activities. First, we raised a total of $207 million in…

Thanks, Bowen. Specific to our performance for the quarter, as summarized on Slide 18, we increased pretax net investment income 22% quarter-over-quarter to $22.8 million compared to $18.7 million in the prior quarter. Pretax NII was $0.65 per share for the quarter. During the quarter, we paid a $0.53 per share regular dividend and a $0.05 per share supplemental dividend. As mentioned earlier, our Board has approved an increase to the regular dividend for the June quarter to $0.54 per share and declared another $0.05 per share supplemental dividend for the quarter. Maintaining a consistent track record of meaningfully covering our dividend with pretax NII, is important to our investment strategy. We continue our strong track record of regular dividend coverage with 113% coverage for the last 12 months ended March 31, 2023, and 108% cumulative coverage since the launch of our credit strategy in January of 2015. Given the floating rate nature of our credit portfolio, elevated interest rates continue to be a significant tailwind to our net investment income. The base rate index used to calculate interest on the majority of our loans reset in early April to approximately 5.1%, up from its early January reset at 4.75%. This increase quarter-over-quarter will provide another immediate step-up in portfolio income in the June quarter. As such, we expect to thoughtfully increase our regular dividend to a level which can be sustained, should base rates return to a neutral level. In addition, while base rates remain elevated, our intent is to distribute a portion of excess pretax NII to our shareholders each quarter through supplemental dividends. Based upon our current UTI balance of $0.45 per share, the ability to grow UTI each quarter organically by over earning our total dividend and the expectation that we will harvest gains over time…

Thanks, Michael. And again, thank you, everyone, for joining us today. We appreciate the opportunity to provide you with an update on our business, our portfolio and the market environment. Our company and portfolio continue to perform well, and I continue to be impressed by the job our team has done in building a robust asset-based deal origination capability as well as a flexible capital structure. As to the uncertainty in the economy, again, we have been underwriting with a full economic cycle mentality since day 1, which we believe has positioned us well for any economic environment presented to us in the future. In summary, we have a floating rate credit portfolio heavily weighted to first lien senior secured debt allocated across a broad array of companies and industries, 90% of which is backed by private equity firms. We have a well-capitalized balance sheet with diverse capital sources, strong liquidity and flexible capital, much of which is fixed rate and covenant [ length ]. We believe our first lien senior secured investment focus and our capital raising strategy provide us complete confidence in the health and positioning of our company and our portfolio as we look ahead. This concludes our prepared remarks. Operator, we are ready to open the lines up for Q&A.

[Operator Instructions] Our first question comes from Mickey Schleien with Ladenburg Thalmann.

Bowen, I wanted to ask you about the portfolio activity during the quarter. What were the catalysts that allowed you to be so active in what is usually a seasonally slow quarter? And with overall M&A volumes down pretty meaningfully?

Interesting question. I mean if I look down the originations, I mean, they were just sponsor relationships that were active in the market. The lower middle market, I mean, activity was $60 million or so for the quarter is an okay quarter from an origination perspective. So obviously, as we referenced on the prepared remarks, we've done over $80 million in this quarter. So the activity in our world with the sponsors that we have relationships with across the country because it just continues to be nicely active. So we also -- the levels are down, spreads are up, loan-to-value percentages are down from [ what ] a year ago. So it's -- I don't know that we were doing anything as a firm differently other than just continuing to underwrite to a coming recession. So it just -- our sponsors have been reasonably active.

Yes. And I'd also add, as we've grown our balance sheet, you'll see our add-on investments with our existing portfolio has grown as well. I mean there's obviously a lot of these companies are doing well. They're doing M&A transactions themselves. And so that supplements new platforms as well.

I'd say one thing as I looked down the originations, given some of these leverage levels, asset coverage on some of these deals. I would say that the banks have been less aggressive in the market. As I look at that, I see lower leverage levels and a couple of situations have nice asset coverage a year ago, that would be bank deals, that we've been able to compete for. That's one thing. And that has to be probably due to the bank's mentality looking at the market pulling back as we all know, that's kind of going on in the economy. And then we see less competition from bank [ mezz ] alternative. [ Mezz guys ] usually attached to a bank loan. And we're seeing -- my sense is we're seeing less competition from that, probably driven by, again, the banks -- the bank's level of aggressiveness in the market. So I think those 2 things in our world, in our lower middle world, would be a positive uplift all else equal to our activity.

And the activity earlier, Mickey, in terms of early originations in the June quarter, a lot of those were deals that we've been working on for the last 2 to 4 months. So they're not just coming on our plate today, so longer too.

I understand. Yes, I was actually going to ask about the bank competition. So I'm glad you addressed that. A couple more questions for me. Clearly, the market is concerned about the outlook for credit, that's no secret. But you noted that the portfolio is performing well, which is really good to hear. But I do see that the portfolio's average EBITDA decline. So could you just walk us through how much of that decline was due to any portfolio company performance issues versus just movements in the portfolio due to the size of the new investments that you made?

Yes. I mean like we looked across our whole portfolio this quarter, as we do each quarter. It's kind of on a weighted average basis come flat revenues, flat EBITDA on the whole portfolio is basically flat. So definitely, I would say that the trajectory of the EBITDA and revenue is not really negative, but it's not -- it's slowing. So from a portfolio comment, the trajectory is flattening out, I guess, is the best way to say it. Are you just looking at the average EBITDA on the portfolio?

Yes, I think it's because some of the new originations we put in place actually had lower EBITDA. And so to Bowen's point, the existing portfolio is flat, but the new originations were less than that EBITDA, and therefore, that's why you saw the reduction. So it's not about...

Yes, right. My comment is more on the portfolio static basis. But yes, that's right. The new deals are slightly smaller EBITDA for sure.

Okay. That's what I suspected. So is that because you see the lower middle market is offering a better risk-adjusted return? Or is it just idiosyncratic to the deal pipeline and the pace at which deals are closing? I'm asking because certain other BDCs have indicated that they're seeing better terms in the -- further up into the middle market or in the upper middle market. But historically, that's not the case.

Yes. We're seeing attractive terms in the lower middle market. I think also the other thing that's going on is we do a new origination, it's got a less EBITDA, a smaller company. And we back a lot of buy-and-bills So we're doing add-ons with our sponsors. And so -- the EBITDA of the portfolio of the company grows through acquisitions. And so you can see -- new originations are going to have most of the time less EBITDA than a portfolio would because we're just getting started. That's the first platform, we'll do several acquisitions and 3 or 4 quarters from now, that EBITDA in that particular company could be much larger.

I understand. Just one housekeeping question. You mentioned, and I think in the press release, it says you got $16.8 million from Amware fulfillment. But I looked at the previous SOI and a short of principal outstanding from them at $17.1 million. So I'm just trying to reconcile that to the IRR that you mentioned. Did you actually take a loss on that investment apart from the interest that you collected over time?

No, we definitely didn't take a loss. There was a principal prepayment that happened. So that exit is the actual -- is the proceeds on the exit. So we had gotten a principal prepayment prior to the exit. So we got full [ power ] back.

[Operator Instructions] Our next question comes from Erik Zwick with Hovde Group.

I wanted to first just start as I looked at the trend in the income statement noticed that -- the dollar amount and the percentage contribution from PIK interest has increased. Wondering if you could just talk about that trend a little bit what's driving that?

Yes. So from the previous quarter to this quarter, that's actually one company that had around $300,000 in PIK. That company had a PIK toggle through a previous amendment that ended at the end of March 31 when we had another amendment where there was an equity infusion in cash. So that company is delevered in performing and back on cash. So we would expect that to come back down in the subsequent quarter.

Okay. That's helpful. And then I noted that for the I-45 SLF that credit facility was amended to reduce the available total commitment from $150 million to $100 million. Curious kind of maybe the tenor of that discussion? Or what kind of drove that reduction?

Yes. We probably tell you over the last 2 and 3 years, our investments in the syndicated space has been opportunistic at best. So what we've seen are -- the credit facility come down from probably $135 million drawn to $80 million drawn today. And so we were incurring significant unused fees at the $150 million in commitment side. So it made sense without us seeing a runway where we'd be relevering that facility, it makes a lot of sense to [indiscernible] permanently production to the level that's more appropriate for our current utilization.

And just to be clear, 100% driven by us.

Okay. Great. No, that's -- I appreciate the commentary there. And I guess maybe a quick follow-up on that one. Does that mean, as you mentioned, you don't have any ability to -- or don't have any desire at this point to kind of utilize that and lever that facility back up? Is that just what you choose to hold on your balance sheet outside of that the opportunities are more attractive today in terms of spread and what you're seeing?

I mean I would tell you, yes. And if you look at levered return, our leverage on our balance sheet is about commensurate with the leverage in the credit facility for I-45, and the yields tend to be wider on the lower middle market than they do in the upper middle market. So the all-in return is more attractive. We also have more control as a first lien lender with covenants than you might see on the syndicated space. So.

Yes. As we've kind of said in the last several quarters, I mean and from what I've heard from other earnings calls, I think it's probably similar across the industry. I mean, the syndicated markets hasn't been that interesting with SandBox, especially for us, given how robust our lower middle market, asset class and platform has been and that senior loan fund is really designed around a syndicated market kind of product. And so the decrease in the facility reflects kind of the less investing in that asset class and we will see where it goes going forward. We could always grow it and expand it in the future if we saw the opportunity to, but we don't really -- we're very focused on the direct lending to the lower middle market where we lead the deals.

And to Bowen's point earlier, I mean, there was -- there's plenty of appetite from [ DB ] who leads that facility to grow as well as some of the lenders underneath it in the syndicate.

Got it. That's helpful. One last one for me and then I'll step aside. And I appreciate the interest rate sensitivity table included on Page 26. And I guess I'm just curious if the Fed has done hike in here? I guess there's still some debate on whether they do one more in June. But if we start to see LIBOR and so forth kind of level out, maybe hold at this level for a little while. Is there still a little bit of lag benefit that you would see in terms of your portfolio yields and NII as it kind of catches up to the final Fed or increase in kind of the base rates and so forth in LIBOR? Or -- and then as we move forward, would you still potentially feel a little bit of creep as you put on new investments, which seem to be coming on maybe with higher spread? Just trying to get a sense of the direction of NII from here.

Sure. Yes. We would tell you that if rates do flatten out at [ 5.25% ] or thereabouts for a period of time, I mean, we would expect that our NII would be somewhere in the $0.65 to $0.70 range for a period of time. It's hard to see. We -- I think we put our balance sheet in a pretty strong position. We've got inexpensive fixed rate debt. We've got the SBIC, which is low rate that we're funding off of a floating rate assets. So certainly, we can see expansion in NII in the near term.

[Operator Instructions] Our next question comes from Robert Dodd with Raymond James.

On the leverage obviously, it's come down at slightly below, I think, the historic target range now. Can you give us any -- is that you see the pipeline building, obviously, $80 million since the end of the quarter, and so you took the leverage down to rebuild it our way? Or is there any connection to -- was there any feedback from Moody's for [indiscernible] sort of a different target in mind?

Well, I would tell you from Moody's it's actually part of their analysis and providing us an investment grade was our strategy to delever going into what could be a cycle and being at the low level to the lower end of our range, certainly within [indiscernible] I mean that -- it just happened to dovetail -- it is their view to dovetail with our strategy, so that's positive. Going forward, I mean, I think we would tell you, Bowen and I would tell you that if we think we're going into a tumultuous time or even they're going kind of sideways, we think we should start out at a lower leverage. And so being at 0.88%, 0.9% is where we'd like to be. We still see the ability to raise equity off the ATM, which we started off this quarter with some -- with the ability to do that as well. So we don't -- we feel like staying at that bottom end is not going to be an issue for us in the short term, and it's certainly where we are. If and when there's sort of an all clear in the market, you could see us picking up, maybe raising slightly less equity and trending closer to 1x regulatory leverage, but that's where we are now.

Got it. Got it. I appreciate that. Now one more question if I can. Maybe I've meaning too much into this. Okay. So on Page 15 of your presentation, obviously, there were 3 investments that were downgraded but small, right? This quarter -- but last quarter, you had 9 category 3, category 4. This quarter, you've still got 9. So 3 downgrades, presumably, 3 others that were already rated at the low end we exited. If I look at footnote 5 on Page 14, right, last quarter, you're excluding 6 portfolio companies because of, I guess, negative EBITDA, in this quarter, you're excluding 9, right? So that -- so is it -- are they really portfolio companies that are showing meaningful EBITDA deterioration? Or is there -- I mean, obviously, you talked about the average, like the average portfolio revenue EBITDA is kind of flat. But is -- at the margin, are there are 3 that are showing material weakness at the moment? Or am I reading too much into a couple of [ private ] details?

Yes. Let me break that apart in a couple of pieces. On the new downgrade to a 4 was the last small loan in one of the prior not 4 [indiscernible] companies. So it's not -- it's further deterioration in an already very tough situation we've been writing it -- it was written down for a while. So that's not a new portfolio company story. The 2 that was the 2 downgraded to a 3, both underperforming, one of them underperforming very temporarily because of some inventory adjustments with it's customers, the other ones underperforming and so sort of going down to that [ 3 ] and so that's -- I mean, [indiscernible] Michael. That's the yes. And then the color behind those [indiscernible] downgrades.

And then if you turn on Slide 14, the increase from 3.6x to 4.0x was actually we included a company back in these metrics because it now has positive EBITDA where it had negative EBITDA in the previous quarter. And therefore, the metric shifted up just by its inclusion because it is a highly leveraged business. I think if you excluded that company, the weighted average leverage would actually been pretty consistent with the previous quarter.

And I'm not showing any further questions at this time. I'd like to turn the call back over to Bowen.

Great. Thank you, operator. Thanks, everybody, for joining us. And we always love for giving you an update on our company and how we're performing, and we look forward to speaking to you next quarter. Thank you.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.