Capital Southwest(CSWC) - 2020 Q3 - Quarterly Report

PART I FINANCIAL INFORMATION Consolidated Financial Statements The consolidated financial statements present Capital Southwest Corporation's financial position, results of operations, changes in net assets, and cash flows for the periods ended December 31, 2019 Consolidated Statements of Assets and Liabilities As of December 31, 2019, total assets increased to $599.3 million, while total net assets decreased to $311.9 million, leading to a decline in NAV per share Consolidated Assets and Liabilities (in thousands) | Metric | Dec 31, 2019 | Mar 31, 2019 | | :--- | :--- | :--- | | Total Investments (Fair Value) | $558,552 | $524,071 | | Total Assets | $599,348 | $551,843 | | Total Liabilities | $287,492 | $225,880 | | Total Net Assets | $311,856 | $325,963 | | Net Asset Value (NAV) per Share | $16.74 | $18.62 | Consolidated Statements of Operations For the three months ended December 31, 2019, the company reported a net decrease in net assets from operations of $6.8 million, primarily due to significant unrealized depreciation on investments Key Operational Results (in thousands, except per share data) | Metric | Three Months Ended Dec 31, 2019 | Three Months Ended Dec 31, 2018 | Nine Months Ended Dec 31, 2019 | Nine Months Ended Dec 31, 2018 | | :--- | :--- | :--- | :--- | :--- | | Total Investment Income | $15,984 | $13,871 | $47,001 | $37,572 | | Net Investment Income (NII) | $7,114 | $6,675 | $21,289 | $16,837 | | Net Realized Gain on Investments | $40,818 | $1,883 | $42,318 | $20,796 | | Net Unrealized (Depreciation) Appreciation | $(54,765) | $(4,238) | $(60,998) | $(15,073) | | Net (Decrease) Increase in Net Assets | $(6,833) | $4,320 | $2,609 | $22,560 | | NII per Share | $0.39 | $0.39 | $1.20 | $1.02 | | Net (Decrease) Increase in Net Assets per Share | $(0.38) | $0.25 | $0.15 | $1.36 | Consolidated Statements of Changes in Net Assets For the nine months ended December 31, 2019, net assets decreased by $14.1 million to $311.9 million, primarily due to dividends exceeding operational increases - Net assets decreased from $326.0 million at March 31, 2019 to $311.9 million at December 31, 2019[19] - Key changes during the nine months ended Dec 31, 2019 include a net increase from operations of $2.6 million, dividends to shareholders of $40.8 million, and proceeds from issuance of common stock of $22.3 million[19] Consolidated Statements of Cash Flows For the nine months ended December 31, 2019, net cash increased by $13.0 million, with financing activities providing significant inflows that offset cash used in operations Net Cash Flow Summary (in thousands) | Cash Flow Activity | Nine Months Ended Dec 31, 2019 | Nine Months Ended Dec 31, 2018 | | :--- | :--- | :--- | | Net Cash Used in Operating Activities | $(24,174) | $(77,560) | | Net Cash Provided by Financing Activities | $37,216 | $80,427 | | Net Increase in Cash | $13,042 | $2,867 | | Cash at End of Period | $22,966 | $10,774 | Consolidated Schedule of Investments As of December 31, 2019, the total investment portfolio had a fair value of $558.6 million, diversified across non-control/non-affiliate, affiliate, and control investments Investment Portfolio Summary as of Dec 31, 2019 (in thousands) | Investment Category | Cost | Fair Value | | :--- | :--- | :--- | | Non-control/Non-affiliate Investments | $415,222 | $409,388 | | Affiliate Investments | $89,481 | $90,870 | | Control Investments | $68,000 | $58,294 | | Total Investments | $572,703 | $558,552 | - The total fair value of investments increased to $558.6 million as of December 31, 2019, from $524.1 million as of March 31, 2019[12][45] Notes to Consolidated Financial Statements The notes provide detailed explanations of the company's accounting policies, investment strategy, fair value measurements, borrowings, tax status, equity programs, and joint venture specifics Note 1: Organization and Basis of Presentation Capital Southwest Corporation is an internally managed BDC and RIC specializing in financing for U.S. middle-market companies - CSWC is an internally managed BDC and has elected to be treated as a RIC for tax purposes[109][110] - The company targets investments in Lower Middle Market (LMM) companies with EBITDA between $3.0 million and $15.0 million, and Upper Middle Market (UMM) companies with EBITDA greater than $50.0 million[113] Note 3: Investments As of December 31, 2019, the investment portfolio's fair value was $558.6 million, with first lien loans comprising the largest portion and diversification across industries and geographies Portfolio Composition by Investment Type (Dec 31, 2019) | Investment Type | Fair Value | % of Total Portfolio | | :--- | :--- | :--- | | First lien loans | $410,908 | 73.6% | | Second lien loans | $35,572 | 6.4% | | Subordinated debt | $9,615 | 1.7% | | Preferred equity | $17,361 | 3.1% | | Common equity & warrants | $25,285 | 4.5% | | I-45 SLF LLC | $58,294 | 10.4% | | Total | $558,552 | 100.0% | - The top three industry concentrations by fair value as of Dec 31, 2019 were Business Services (16.5%), I-45 SLF LLC (10.4%), and Healthcare Services (9.6%)[166] Note 4: Fair Value Measurements The company's investment portfolio is entirely valued using Level 3 inputs, with valuation processes overseen by the Board and assisted by third-party firms - 100% of the investment portfolio consisted of debt and equity instruments of privately held companies, valued using significant unobservable Level 3 inputs[179] - Valuation techniques include the Market Approach, Income Approach (using discount rates from 8.0% to 41.9%), and Enterprise Value Waterfall Approach (using EBITDA multiples from 6.2x to 11.3x)[184][199] - For the nine months ended Dec 31, 2019, the fair value of Level 3 investments changed from $458.3 million to $500.3 million, with key drivers being $155.8 million in purchases, $51.7 million in repayments, and a net realized/unrealized loss of $6.7 million[203] Note 5: Borrowings As of December 31, 2019, total borrowings were $273.1 million, with the company maintaining a strong asset coverage ratio of 213% Outstanding Borrowings as of Dec 31, 2019 (in thousands) | Borrowing Instrument | Amount Outstanding | | :--- | :--- | | Credit Facility | $124,000 | | December 2022 Notes (5.95%) | $75,688 | | October 2024 Notes (5.375%) | $73,393 | | Total Borrowings | $273,081 | - The company's asset coverage ratio was 213% as of December 31, 2019, exceeding the minimum requirement of 150%[207] - In September/October 2019, the company issued a total of $75.0 million in aggregate principal amount of 5.375% Notes due 2024[227] Note 6: Income Taxes The company operates as a RIC, distributing most of its taxable income to avoid corporate-level federal income tax, and elected to retain certain capital gains - For the tax year ended Dec 31, 2019, CSWC elected to retain $16.5 million in net long-term capital gains and paid $3.5 million in federal taxes on behalf of shareholders as a "deemed distribution"[244] - Total dividends paid for the 2019 tax year were $2.72 per share, comprised of approximately $1.303 in ordinary income and $1.417 in long-term capital gains[238] - As of Dec 31, 2019, the company had a net deferred tax asset of $1.3 million and a net deferred tax liability of $1.1 million, resulting in a net deferred tax asset of $0.2 million[247] Note 7: Shareholders' Equity During the nine months ended December 31, 2019, the company raised $22.5 million through its Equity ATM Program and increased authorized common stock, while no shares were repurchased - During the nine months ended Dec 31, 2019, the company sold 1,049,932 shares under its Equity ATM Program, raising $22.5 million in net proceeds at a weighted-average price of $21.90 per share[256] - As of Dec 31, 2019, approximately $9.2 million remained available for repurchases under the company's share repurchase program[262] - On August 1, 2019, authorized shares of common stock were increased from 25,000,000 to 40,000,000[257] Note 10: Commitments and Contingencies As of December 31, 2019, the company had $20.4 million in unused financing commitments and an operating lease for its office space - Unused commitments to extend financing to portfolio companies totaled $20.4 million as of December 31, 2019[286] - The company has an operating lease for office space with total remaining commitments of $580,000 through its expiration in 2022[290] Note 13: Significant Subsidiaries The company sold Media Recovery, Inc. and its joint venture, I-45 SLF LLC, held $215.0 million in total assets as of December 31, 2019 - The company sold its investment in control subsidiary Media Recovery, Inc. on November 25, 2019[301] I-45 SLF LLC Financial Summary (in thousands) | Metric | Dec 31, 2019 | Mar 31, 2019 | | :--- | :--- | :--- | | Investments, at fair value | $206,208 | $237,547 | | Total Assets | $214,997 | $246,547 | | Senior credit facility payable | $139,000 | $160,000 | | Members' equity | $72,943 | $82,001 | Note 14: Subsequent Events On January 22, 2020, the Board of Directors declared a total dividend of $0.51 per share for the quarter ending March 31, 2020 - A total dividend of $0.51 per share (comprising a $0.41 regular and $0.10 supplemental dividend) was declared on January 22, 2020, for the quarter ending March 31, 2020[333] Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the company's performance, highlighting increased investment income offset by significant unrealized depreciation, while maintaining strong liquidity and actively managing capital structure Investment Portfolio Composition As of December 31, 2019, the $558.6 million investment portfolio was diversified across LMM and UMM companies, with a high proportion of floating-rate debt LMM vs. UMM Portfolio Breakdown (Dec 31, 2019) | Metric | LMM | UMM | | :--- | :--- | :--- | | Number of portfolio companies | 32 | 11 | | Fair value (in thousands) | $413,503 | $86,755 | | Weighted average annual effective yield | 11.6% | 7.4% | | Weighted average leverage through CSWC security | 3.6x | 4.6x | - As of Dec 31, 2019, 96.6% of the debt investment portfolio at fair value bore interest at floating rates[366] Portfolio Asset Quality As of December 31, 2019, 95.1% of the debt portfolio was rated 1 or 2, indicating performance at or above expectations, with a small portion on non-accrual status Debt Portfolio Quality by Fair Value (Dec 31, 2019) | Investment Rating | Debt Investments at Fair Value (thousands) | % of Debt Portfolio | | :--- | :--- | :--- | | 1 (Least Risk) | $49,123 | 10.8% | | 2 (Expected Performance) | $384,464 | 84.3% | | 3 (Below Expectations) | $16,560 | 3.6% | | 4 (Materially Below) | $5,948 | 1.3% | | Total | $456,095 | 100.0% | - As of December 31, 2019, three debt investments were on non-accrual status, representing 3.3% of the total investment portfolio's fair value[380] Results of Operations For the nine months ended Dec 31, 2019, total investment income and net investment income increased significantly, but net assets were negatively impacted by substantial unrealized depreciation Comparison of Nine Months Ended Dec 31, 2019 and 2018 (in thousands) | Metric | 2019 | 2018 | Change % | | :--- | :--- | :--- | :--- | | Total investment income | $47,001 | $37,572 | 25.1% | | Net investment income | $21,289 | $16,837 | 26.4% | | Net realized gain on investments | $42,318 | $20,796 | 103.5% | | Net unrealized (depreciation) | $(60,998) | $(15,073) | 304.7% | | Net increase in net assets | $2,609 | $22,560 | (88.4)% | - The significant increase in net unrealized depreciation was mainly due to the reversal of $49.3 million in prior period appreciation on realized investments and fair value markdowns on certain portfolio companies, including the I-45 SLF joint venture[411] Financial Liquidity and Capital Resources The company maintained strong liquidity with $23.0 million in cash and $167.6 million available on its credit facility, supported by new notes issuance and equity offerings - As of Dec 31, 2019, the company had $23.0 million in cash and cash equivalents and $167.6 million in available borrowings under its Credit Facility[417][456] - Key financing activities in the nine months to Dec 31, 2019 included issuing $73.5 million of October 2024 Notes and raising $22.5 million net from the Equity ATM Program[415][445] - The company paid $40.9 million in cash dividends during the nine months ended Dec 31, 2019[417] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate fluctuations, with its floating-rate debt portfolio providing a natural hedge against rising rates - The company's primary market risk exposure is to interest rate fluctuations[457][458] - As of Dec 31, 2019, 96.6% of the debt portfolio at fair value had floating interest rates, with 90.7% of those having contractual rate floors[460] - A hypothetical 100 basis point increase in interest rates could increase annual net investment income by a maximum of $3.5 million ($0.19/share), while a 100 basis point decrease could lower it by a maximum of $1.9 million ($0.11/share)[460] Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2019, with no material changes to internal control over financial reporting - Management concluded that disclosure controls and procedures were effective as of December 31, 2019[464] - No material changes were made to internal control over financial reporting during the three months ended December 31, 2019[465] PART II OTHER INFORMATION Legal Proceedings The company reports no currently pending material legal proceedings - The company has no pending material legal proceedings[469] Risk Factors There have been no material changes to the risk factors previously disclosed in the company's Annual Report on Form 10-K for the fiscal year ended March 31, 2019 - No material changes to risk factors were reported since the Annual Report on Form 10-K for the fiscal year ended March 31, 2019[470] Unregistered Sales of Equity Securities and Use of Proceeds The company reported no sales of unregistered securities and no share repurchases during the period, with $9.2 million remaining available for future repurchases - The company did not repurchase any shares under its share repurchase program during the nine months ended December 31, 2019[473] - As of December 31, 2019, approximately $9.2 million was available for additional repurchases under the share repurchase program[473] Defaults Upon Senior Securities None reported - None[475] Mine Safety Disclosures None reported - None[477] Other Information None reported - None[479] Exhibits The report lists the exhibits filed, including certifications from the President and Chief Executive Officer and the Chief Financial Officer - Exhibits filed include CEO and CFO certifications pursuant to Rule 13a-14(a), Rule 13a-14(b), and Section 1350 of the U.S. Code[481]