Thank you for joining today's Capital Southwest Second Quarter Fiscal Year 2025 Earnings Call. Participating on the call today are Bowen Diehl, Chief Executive Officer; Michael Sarner, Chief Financial Officer; Josh Weinstein, Chief Investment Officer, and Chris Rehberger, Executive 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 Chief Executive Officer, Bowen Diehl.

Thanks, Chris. And thank you, everyone, for joining us for our second quarter fiscal year 2025 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 release issued last evening on our website. We'll now begin on Slide 6 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 $0.64 per share, which fully covered our regular dividend of $0.58 per share and our supplemental dividend of $0.06 per share paid during the quarter. Portfolio earnings continue to be strong, and as of the end of the quarter, we estimate that our undistributed taxable income was $0.64 per share. As we look forward to the December quarter, we are pleased to announce that our board of directors has declared a regular dividend of $0.58 per share for the quarter ended December 31, 2024. Our board has also declared a supplemental dividend of $0.05 per share, bringing total dividends declared for the December quarter to $0.63 per share. Deal flow in the lower middle market continues at a healthy pace this quarter, while competition in the market for both bank and non-bank lenders for quality deals continues to be fierce. This has resulted in tighter spreads on quality new deals, as well as slower net portfolio growth over the last two quarters for Capital Southwest as we…

Thanks, Bowen. On Slide 11, we detailed $89.8 million of capital invested in and committed to portfolio companies during the quarter. Capital committed during the quarter included $72 million in first lien senior secured debt across four new portfolio companies, in which we also invested a total of $975,000 in equity. In addition, we closed add-on financing for 11 existing portfolio of companies consisting of $16 million in first lien senior secured debt in $815,000 in equity. We are pleased with the strong market position that our team has established as a premier lender to the lower middle market. This is evidenced by the broad array of relationships across the countries from which our team is sourcing quality opportunities. As a point of reference, currently, there are more than 70 different private equity firms represented across our investment portfolio. Additionally, in the last year, we closed 10 new platforms with financial sponsors, which we had not previously closed the deal, showing our continued penetration in the market. Since the loss of our credit strategy back in January 2015, we have completed transactions with over 100 different private equity firms across the country, including over 20%, which we have completed multiple transactions. As Bowen mentioned, competition in the lower middle market over the last six months has been quite strong. This has resulted in tight loan pricing for high-quality opportunities. We in the depth and strength of the relationships, our team has cultivated over the years. We continue to source and gain opportunities with attractive risk return profiles, and we are very pleased with the current back auto transactions that should close between now and the end of the year. Turning to Slide 12. We continued our track record of strong returns on our exits, is for debt prepayments during the…

Thanks, Josh. Specific to our performance for the quarter, as summarized on Slide 16, pretax net investment income was $30 million or $0.64 per share as compared to $31.3 million or $0.69 per share in the prior quarter. Net investment income after tax was $31.2 million or $0.66 per share for the quarter. The main driver of the tax benefit this quarter was $1.5 million in deferred taxes related to our taxable subsidiary, CSCI, which holds the majority of our equity investments. For the quarter, total investment income decreased to $48.7 million from $51.4 million in the prior quarter. The decrease was driven primarily by a $1.8 million reduction in onetime cash dividends from equity investments in the prior quarter as well as a decrease of approximately $800,000 in fee revenue quarter-over-quarter. The decrease in cash dividend income was the result of three non-recurring dividend recap transactions which occurred in the prior quarter. As of the end of the quarter, our loans on nonaccrual represented 3.5% of our investment portfolio at fair value and the weighted average yield in the portfolio on all investments was 12.7%. During the quarter, we paid out a $0.58 per share regular dividend and a $0.06 per share supplemental dividend. As mentioned earlier, our board has declared a regular dividend of $0.58 per share in the supplemental dividend of $0.05 per share for the December quarter. Management and the board has spent significant time contemplating the impact of a lower interest rate environment on future earnings. We have consistently maintained the setting a regular dividend at a level that we believe will never be cut in any foreseeable interest rate environment is key to generating stable, attractive shareholder returns over the long-term. We continued our strong track record of regular dividend coverage with 119% coverage…

Thank you, Michael, and thank you, Josh. And again, thank you, everyone, for joining us today. As always, 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 demonstrate strong performance, and we continue to be impressed by the job our team is doing in building a robust asset base, deal origination and portfolio management capability as well as a flexible capital structure. We believe we have prepared our company well for future growth and performance. The overall health and security of our portfolio is strong. Our credit portfolio is predominantly made up of first lien senior secured loans allocated across a broad array of companies and industries with weighted average exposure per company of only 1%. The vast majority of our portfolio is backed by private equity firms. Interest coverage and the debt obligations across our portfolio was a strong 3.4 times with strong equity cushion and support below our debt investments. Additionally, our equity co-investment portfolio gives our shareholders participation in the equity upside of many of these growing lower middle market businesses, providing further enhancement to our long-term shareholder returns. Last but not least, we have a very well-capitalized balance sheet with multiple capital sources and significant balance sheet liquidity, all of which provides our company an exciting runway to continue to grow and generate strong shareholder returns for years to come. This concludes our prepared remarks. Operator, we are ready to open the lines for Q&A.

Certainly. [Operator Instructions]. Our first question will be coming from Brian McKenna of Citizens JMP. Your line is open.

Okay. Great. Thanks good morning, everyone. So I heard the commentary around some deals that got pushed into calendar 4Q. Is there any way to quantify this? And then it's great to hear that the pipeline is also robust. So how should we think about the magnitude of net portfolio growth into year-end and then also into calendar year 2025 as well?

Yeah. So I mean, generally speaking, I mean, we had deals pushed into the fourth quarter and we -- as I said in the commentary, if you look at the deals that we've either signed up, so they're in heavy diligence or we've been told that we're going to win likely so the deal has to close, right? But those two things, I mean, it will be very significant net portfolio growth in the quarter.

Yeah. So it's also relative to the 9/30 quarter, our originations were mostly late stage. This quarter, if we were going to quantify, we'd probably see -- I mean, on the services side, we probably expect to see $150 million to $200 million of net portfolio growth for the quarter. And so say half of the originations are -- either have closed or will close shortly. So we expected a pretty strong portfolio growth, ultra-income as well as the balance sheet.

Yeah. Okay. Got it. That's helpful. And then maybe just a bigger picture question. What are you seeing just within kind of the lower middle markets and then really just the markets more broadly in terms of new deal activity. I think deal flows remain largely stable, the last several years and kind of the lower middle markets and broader sponsor M&A has been pretty muted. So I think we've seen some larger players moving down market. So thinking about sponsor M&A, specifically in the larger end of the market, that should be picking up here. So I guess, what does that mean for transactions and yields in your space? And then are you seeing any early signs of some of these larger firms moving back up market a bit?

Yeah. So it's a really interesting question. And when we think about and ask other firms about quite often. I think -- over the last several years, we've seen an enormous amount of capital being raised initially in the private equity market and then in the private credit market. When you read about the quantity of capital raised, obviously, just that's tends to lean more towards the large market, probably for no other reason to me just a lot more capital. I think we've also heard and you've read in the papers, et cetera, that deal flow, as you just referenced, has been muted in the last year and half years say. And so what we've heard is there's two things going on. And it doesn't take a whole lot of change in the competitive balance, if you will, between supply and demand and capital in the lower middle market to disrupt pricing. So the deal flow in the lower or middle market, as we've -- as you know, is not private equity firms selling businesses to each other, but it's private equity firms buying controlling interest in founder family-owned businesses that are aging and want to diversify their holdings. And so the deal flow has been relatively flat. And so when you have decreased deal flow in the upper market and relatively flat deal flow in the lower middle market, we have seen certainly the private equity parties that I've talked to have seen some of the increased competition from larger market, private equity firms. It's a cascading effect, right? So large market private equity firms starting to justify deals a little bit smaller and then mid-market justifying deals a little bit smaller and kind of cascades down. And then as you just referenced, Brian, I mean that when deal flow picks back up, that should cascade back. Now there's an enormous amount of liquidity in the market. So the speed at which that cascades back is the question mark, but I think it would tend to cascade back up. The other effect is in our market is we're seeing more competition recently from banks. As we all know, banks come and go. They're here now, and they were here year and half ago in many -- and it's a certain handful of regional banks. So that's somewhat disrupts the market from a pricing perspective. We haven't seen a lot of deterioration in credit, like leverage up covenants worse, a little bit around the edges, but not as much as pricing has changed. And so I think those two factors, again, it doesn't take a lot to disrupt the pond, if you will from a pricing perspective.

We say perspective. Probably three quarters ago, in fact, our spread over Silver was 750, two quarters ago, the June 30 quarter, it was 700, and this quarter, it was just a shade over 650. So we've seen obviously somewhere in the 50 to 100 basis points tightening on spread at the moment.

Yeah. All right, great. Thank you guys. I’ll leave it there.

Thank you. One moment for our next question. And our next question will be coming from Doug Harter of UBS. Your line is open.

Thanks. Can you talk about your appetite to continue to raise capital given the combination of the premium to book and the increased pipeline that you talked about?

Sure. So well, I'll start by saying we've done a lot of the hard work coming for today. We have close to $500 million of capital available either through cash or availability on our credit facilities. Now we're trading where we are 1.5 times book, we -- the ATM is constantly rating capital on a daily basis. I would say that we are always opportunistically looking to additional capital and certainly with an eye towards our funds in 2026, sort of refinance those in time. So I would tell you, yes, we're active there. You'll probably see us increase secure capacity a little bit. We certainly should expect over the next six to nine months to see some unsecured activity and raising ATM money will probably look like something in the $20 million to $40 million a quarter.

Great. Appreciate that. Thank you.

Thank you. One moment for our next question. And our next question will be coming from Bryce Rowe of B. Riley. Your line is open.

Thanks. Good morning. Maybe wanted to start around the discussion topic of the portfolio, a robust portfolio and a couple more questions around that. So Bowen, and maybe touch on the mix of the backlog, whether it be kind of newer portfolio companies versus existing portfolio companies. And I'm kind of curious, have you seen incremental spread compression since the end of September with some of the new deal activity that's kind of bled over into the fourth calendar quarter?

Yeah. So I mean the new deal activity is you say two thirds new platform companies in third add-ons, which has kind of been the mix historically in the last several quarters. So it's about the same. I'd say spreads have tightened slightly since September, but not -- that's not the biggest item of our concern, that change. It's kind of the same, but it's probably slightly tighter for quality credits.

Okay. That's helpful. And then maybe speak to -- I think you guys have talked in the past about how the loan rate resets kind of lag what we see from a short-term rate perspective, we saw a little bit of yield compression for the portfolio here in the September quarter. Maybe Michael or Bowen, can you kind of speak to what percentage of that was non-accrual inflows? What percentage of that was SOFR compression driven? And then what your expectation is for the portfolio yield given that lag?

Sure. So saw SOFR come in from essentially 5.1% in the previous quarter from to effective, I guess, 12 basis points, it came in effectively for the 9/30 quarter versus the 6/30 quarter, compression on yield came in about 15 basis points and then there was some compression due to elevated non-accruals during the quarter. So it brought our yield on this debt from 13.3% down to 12.9%. For the 12/31 quarter, we're expecting, based on the reset date, which was October 1, was 4.6%, so down from the pipeline in the previous quarter. So another 50 basis points anticipation -- so that's kind of good items to where we are on the compression today.

Yeah. Okay. Helpful. And then maybe just touch on the non-accruals. I mean, obviously, you saw the portfolio's weighted average risk rating improved in the quarter, but you did have a couple of non-accruals flow into that non-accrual bucket. Can you give us a little commentary around that, kind of what the expectation is for those particular assets?

Yeah. I mean, it's two new non-accruals, obviously, that's frustrating. It's part of our business. It's frustrating to see -- both of those names were three last quarter. So they were already on our watch list. One is a closeout sale company to lower end consumers, and I think that's my view of that. I think our view of that is that the lower-end consumer that's affected more acutely by the cost of eggs and gas and milk with inflation. And so that's hurt that business. And then the other one is it serves the -- it's the video content that streamed through Hulu, Netflix, Prime, those types of things, they're a video digital editor company. And so that's been affected by the strike. That's over, but the businesses -- the industry is still down. And then it's just -- the comeback of that business will be a function of the quantum of streaming content volume and how fast that recovers. Both non-accruals will most likely be restructured by the end of December. Both are in discussions right now. And I'm pretty confident that they'll be restructured by the end of December. So they'll be off that list anyway, but there'll be companies where we'll own equity in, and we'll continue to work with the management teams and turn around those businesses, hopefully.

Probably of course, just to be clarified, so a portion of the asset will be to get and the portion will be equity. But some of it will come back on accrual. I can't give you those percentages now, but that's anticipated.

Yeah. Okay. Last one for me, just a modeling question. You saw the comp line kind of come in let's call it, 40% or so quarter-over-quarter. Michael, can you help us think about what that comp line might look like for the balance of the fiscal year?

Yeah. I would tell you that the run rate for compensation -- for cash compensation of $3 million, stock comp number should be about $1.5 million to $4.5 million for compensation on a normal basis, run-rate basis and then SG&A is another $2.5 million on run rates of total set SG&A at $7 million is the run rate you should be working off of.

Okay, thank you all. Nice quarter.

One moment for our next question. Our next question will be coming from Matthew Hurwit of VP [ph]. Your line is open.

Hi, there. This is Matt Hurwit from Jefferies. Congrats on the quarter. Just to follow up on the non-accrual list. Are you able to provide any detail on some of the NPAs from last quarter like Gauge, American Nuts Research Now or Stat Meds?

Yeah. Research Now, I'll start with that because that's easy. That's gone. That was restructured and sold. And so that's actually the net realized loss this quarter. And then American Nuts, kind of flat to better business. And then what was the other one? -- Stat Meds, that's our one name that's a four, and that company continues to kind of struggle.

Okay, that’s very helpful. Thank you all.

And one moment for our next question. And our next question will be coming from Robert Dodd of Raymond James. Your line is open.

Hi, guys. On the net deployments, obviously, that is not what drives bonus accrual just the [Indiscernible] miss the point. But I mean with the number that you're looking at for the December quarter, I mean -- and you gave kind of some run rate comp numbers and stock comp I mean. Should we expect anything unusual in the fourth quarter given the level of deployments, which is healthy to say the least?

I mean I would say so, Robert. I think that from quarter-to-quarter, we assess what the bonus accrual will look like at year-end and then making -- just to provide everybody we accrued for the first three quarters based on what we think the run rate will look like at the end of the year and then the fourth quarter will be the true up as the final bonus payment, a payment that supposed only paid at one time at the end of our fiscal year. So I mean, certainly, as -- we definitely don't pay people based on originations. So the answer to that question is it will depend on what's going on with the company, how is our credit looking what we think we're able to pay out, first and foremost, to our shareholders for dividends for the remainder of the year, but also with the eye of being able to continue to pay out supplemental dividends and build up the UTI bucket. So I wouldn't expect anything dramatic because that is not how we compensate employees.

Got it. Thank you. And then on -- so just credit in general, I mean -- to your point, Bowen, I think you said you've got a low-end consumer business that's a new non-accruals business this quarter. Digital -- I mean these are not related industries, obviously. But I mean, is there any -- I mean, I would expect the low-end consumer and any other exposure that will be under pressure. But any other areas where there's any kind of emerging sign of weakness? I mean, to your point on the revenue and EBITDA, I mean EBITDA, I think, you said was up 1% quarter-over-quarter. So there's got to be a -- not everybody is up 1%. There's got to be a proportion that are now declining sequentially. And I mean -- any themes on where those pressures are and any incremental concerns given lower levels of EBITDA growth between some portion declining?

Yeah. Thanks, Robert. I would say, look, I mean, there are idiosyncratic stories all throughout any portfolio, right? So I would say if I were to zone out and think about what are the economic related or trends or things that show up that would be on an economic general list. I mean one is the lower end consumer. No question about it. We don't have a lot of businesses in that area, but like that's something that we've seen not necessarily, yeah, to our non-accrual. But if you look across the portfolio, another one or two discretionary low-end consumer type purchases that slowed, not necessarily becoming a credit problem, but you see that in the portfolio. And then the other I would say is just businesses that are serving other businesses, business-to-business that decisions are slower to make purchase decisions, candidly, probably as much business is cautious about the future in some ways. And so that -- I don't know that that's like material if you zone out, look at our overall portfolio, but you definitely -- there's definitely a narrative about that in that respect. And then I'll take a step back and like, all right, well, our rating migration, as you and Bryce both referenced, our rating migration, we have significant amount of upgrades, not a lot of downgrades, strong interest coverage in the portfolio on PIK interest this quarter as a percentage of income is down. So our cash -- our income is a higher percentage of cash and it's a higher percentage recurring. So you look at that and you feel pretty good about the engine that's paying the dividend and that's benefiting our shareholders. But at the margins, as you referenced, if you look at negative stories, other than just idiosyncratic, very fixable problems, bad management decisions, all those types of things that show up in any loan portfolio that are very fixable. If you think about what general themes are, those would be the two kind of the low-end consumer and B2B slower investment decision or purchase slower purchase decisions.

Got it. Thank you.

And I would now like to turn the conference back to Bowen Diehl for closing remarks.

Thanks, operator, and thanks, everybody, for joining us today. We appreciate the opportunity to give you an update on our company and portfolio. And we look forward to keeping you updated on events in the future.

And this concludes today's conference call. Thank you for participating. You may now disconnect.