Capital Southwest(CSWC) - 2024 Q1 - Quarterly Report

FORM 10-Q Cover Page The cover page identifies CAPITAL SOUTHWEST CORPORATION as the registrant, its Nasdaq listing, and filing status as a non-accelerated filer Registrant Information Identifies CAPITAL SOUTHWEST CORPORATION as the Texas-incorporated registrant, listing its Dallas executive offices and Nasdaq trading symbols - Registrant: CAPITAL SOUTHWEST CORPORATION, incorporated in Texas[2] - Trading Symbols: CSWC (Common Stock, $0.25 par value), CSWCZ (7.75% Notes due 2028) on The Nasdaq Global Select Market[2][3] Filing Status The registrant is a non-accelerated filer, not an emerging growth or shell company, and has filed all required reports - Filing Status: Non-accelerated filer[4] - Not an emerging growth company or a shell company[4][12] - Compliance: Registrant has filed all required reports in the preceding 12 months[24] Securities Registered The company's Common Stock and 7.75% Notes due 2028 are registered on Nasdaq, with 39,939,918 shares outstanding - Securities registered: Common Stock ($0.25 par value) and 7.75% Notes due 2028[3] - Exchange: The Nasdaq Global Select Market[3] - Shares Outstanding: 39,939,918 shares of Common Stock as of August 4, 2023[24] PART I FINANCIAL INFORMATION Presents unaudited consolidated financial statements and management's discussion for the quarter ended June 30, 2023 Item 1. Consolidated Financial Statements Presents unaudited consolidated financial statements including assets, operations, net assets, cash flows, and detailed investment schedules Consolidated Statements of Assets and Liabilities Details the company's financial position, showing an increase in total assets and net assets from March 31 to June 30, 2023 | Metric (in thousands) | June 30, 2023 | March 31, 2023 | | :-------------------- | :------------ | :------------- | | Total Assets | $1,337,003 | $1,257,684 | | Total Liabilities | $700,802 | $667,276 | | Total Net Assets | $636,201 | $590,408 | | Net Asset Value per Share | $16.38 | $16.37 | - Total investments at fair value increased from $1,206,388 thousand to $1,285,318 thousand (QoQ increase of $78,930 thousand)[7] - August 2028 Notes (par value $71,875 thousand) were introduced, contributing $69,327 thousand to liabilities as of June 30, 2023[7] - Credit facility balance decreased from $235,000 thousand to $195,000 thousand[7] Consolidated Statements of Operations Reports a significant increase in net investment income and net assets from operations for the three months ended June 30, 2023 | Metric (in thousands) | Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | | :-------------------- | :------------------------------- | :------------------------------- | | Total Investment Income | $40,361 | $22,543 | | Total Operating Expenses | $15,358 | $9,913 | | Income Before Taxes | $25,003 | $12,630 | | Total Income Tax Provision | $447 | $192 | | Net Investment Income | $24,556 | $12,438 | | Net Realized (Loss) Gain | $(12,782) | $2,320 | | Net Unrealized Appreciation (Depreciation) | $12,038 | $(12,248) | | Net Increase in Net Assets from Operations | $23,812 | $2,510 | - Total investment income increased by $17,818 thousand (79.0%) YoY, primarily due to a $17.5 million increase in interest income from debt investments[28][101] - Net investment income increased by $12,118 thousand (97.4%) YoY[28][136] - Net realized loss on investments was $(12,782) thousand in Q2 2023, compared to a gain of $2,320 thousand in Q2 2022[28] Consolidated Statements of Changes in Net Assets Reflects the increase in total net assets driven by operations and common stock issuance, offset by shareholder dividends | Metric (in thousands) | March 31, 2023 | June 30, 2023 | | :-------------------- | :------------- | :------------ | | Balances at Period Start | $590,408 | $590,408 | | Issuance of Common Stock | $44,872 | $44,872 | | Cancellation of Treasury Stock | $(0) | $(0) | | Share-based Compensation | $963 | $963 | | Dividends to Shareholders | $(22,916) | $(22,916) |\ | Net Increase from Operations | $23,812 | $23,812 | | Balances at Period End | $636,201 | $636,201 | - Total net assets increased by $45,793 thousand from March 31, 2023, to June 30, 2023[18] - Issuance of common stock contributed $44,872 thousand to net assets[18] - Dividends to shareholders amounted to $(22,916) thousand[18] Consolidated Statements of Cash Flows Shows a net decrease in cash and cash equivalents, with operating activities using funds and financing activities providing them | Metric (in thousands) | Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | | :-------------------- | :------------------------------- | :------------------------------- | | Net Cash Used in Operating Activities | $(55,626) | $(69,803) | | Net Cash Used in Investing Activities | $(2) | $(156) | | Net Cash Provided by Financing Activities | $55,321 | $77,298 | | Net (Decrease) Increase in Cash and Cash Equivalents | $(307) | $7,339 | | Cash and Cash Equivalents at End of Period | $21,278 | $18,770 | - Operating activities used $55.6 million, primarily due to $104.1 million in new investments, partially offset by $24.7 million from debt repayments and $3.4 million from equity sales[31][140] - Financing activities provided $55.3 million, including $69.7 million from August 2028 Notes, $44.9 million from Equity ATM Program, and $4.9 million from SBA Debentures, offset by $40.0 million net repayments on Credit Facility and $22.9 million in dividends[31][140] Consolidated Schedule of Investments Provides a detailed breakdown of the investment portfolio by control, affiliate, and non-control/non-affiliate categories Consolidated Schedule of Investments as of June 30, 2023 Details the investment portfolio composition as of June 30, 2023, dominated by non-control/non-affiliate investments | Investment Type (in thousands) | Fair Value (June 30, 2023) | Cost (June 30, 2023) | | :----------------------------- | :------------------------- | :------------------- | | Non-control/Non-affiliate | $1,046,398 | $1,025,318 | | Affiliate | $187,058 | $180,907 | | Control | $51,862 | $80,800 | | Total Investments | $1,285,318 | $1,287,025 | - Non-control/Non-affiliate investments represent approximately 81.4% of the Company's investment assets at fair value[217] - Affiliate investments represent approximately 14.6% of the Company's investment assets at fair value[243] - Control investments represent approximately 4.0% of the Company's investment assets at fair value[243] Non-control/Non-affiliate Investments (June 30, 2023) Focuses on the largest segment of the portfolio, primarily first lien loans across diverse industries - Total Non-control/Non-affiliate investments at fair value: $1,046,398 thousand (Cost: $1,025,318 thousand)[7][211] - Key industries include Media & Marketing, Healthcare Services, Software & IT Services, and Consumer Products & Retail[20][21][23][35] - Majority of debt investments bear interest at floating rates, primarily SOFR-based, with contractual minimum interest rates[217] Affiliate Investments (June 30, 2023) Outlines investments where the company owns between 5% and 25% of voting securities - Total Affiliate investments at fair value: $187,058 thousand (Cost: $180,907 thousand)[7][241] - Examples include investments in Air Conditioning Specialist, Inc., Catbird NYC, LLC, Central Medical Supply LLC, and Roseland Management, LLC[215][234][241] - These investments are generally defined as those where the company owns between 5% and 25% of the voting securities[243] Control Investments (June 30, 2023) Details investments where the company owns more than 25% of voting securities, primarily I-45 SLF LLC - Total Control investments at fair value: $51,862 thousand (Cost: $80,800 thousand)[7][241] - Primary control investment is an 80% LLC equity interest in I-45 SLF LLC, a joint venture with Main Street Capital Corporation[241][341] - Control investments are defined as those where the company owns more than 25% of the voting securities[243] Consolidated Schedule of Investments as of March 31, 2023 Presents the investment portfolio composition as of March 31, 2023, with a similar structure to the June 30, 2023, portfolio | Investment Type (in thousands) | Fair Value (March 31, 2023) | Cost (March 31, 2023) | | :----------------------------- | :-------------------------- | :-------------------- | | Non-control/Non-affiliate | $966,627 | $947,829 | | Affiliate | $188,505 | $191,523 | | Control | $51,256 | $80,800 |\ | Total Investments | $1,206,388 | $1,220,152 | - Non-control/Non-affiliate investments represented approximately 80.1% of the Company's investment assets at fair value[313] - Affiliate investments represented approximately 15.6% of the Company's investment assets at fair value[291] - Control investments represented approximately 4.2% of the Company's investment assets at fair value[291] Non-control/Non-affiliate Investments (March 31, 2023) Details the non-control/non-affiliate investments as of March 31, 2023, focusing on first lien loans in various sectors - Total Non-control/Non-affiliate investments at fair value: $966,627 thousand (Cost: $947,829 thousand)[7][284] - Investments are spread across industries such as Media & Marketing, Healthcare Services, Food, Agriculture & Beverage, and Software & IT Services[273][278][280][282][284] Affiliate Investments (March 31, 2023) Presents affiliate investments as of March 31, 2023, including debt and equity instruments in various companies - Total Affiliate investments at fair value: $188,505 thousand (Cost: $191,523 thousand)[7][312] - Investments include various debt and equity instruments in companies such as Air Conditioning Specialist, Inc., Catbird NYC, LLC, and Central Medical Supply LLC[285][312] Control Investments (March 31, 2023) Details control investments as of March 31, 2023, primarily the 80% LLC equity interest in I-45 SLF LLC - Total Control investments at fair value: $51,256 thousand (Cost: $80,800 thousand)[7][312] - The main control investment is an 80% LLC equity interest in I-45 SLF LLC[312] Notes to Consolidated Financial Statements Provides detailed explanations of accounting policies, investment valuation, borrowings, income taxes, and other financial disclosures 1. ORGANIZATION AND BASIS OF PRESENTATION Describes Capital Southwest Corporation's structure as an internally managed BDC and its investment strategy - Capital Southwest Corporation is an internally managed BDC, regulated under the 1940 Act, and elects RIC tax treatment[318][295] - Investment Objective: Produce attractive risk-adjusted returns from debt investments (current income) and equity investments (capital appreciation)[85] - Investment Strategy: Focus on LMM companies (EBITDA $3.0M-$20.0M, investments $5.0M-$35.0M) and opportunistically UMM companies (EBITDA >$20.0M, investments $5.0M-$20.0M)[318][506][536] - SBIC I: Wholly-owned subsidiary licensed as a Small Business Investment Company, consolidated for financial reporting[319][320] - Investment Classification: Control (25%+ voting securities), Affiliate (5%-25% voting securities), Non-Control/Non-Affiliate (neither)[321] - Qualifying Assets: As of June 30, 2023, 85.2% of total assets (at fair value) were qualifying assets under the 1940 Act[299] 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Outlines key accounting policies, including fair value measurement, revenue recognition, and treatment of PIK interest - Investments are stated at fair value, determined by the Valuation Committee using Level 3 inputs, as 100% of the portfolio consists of privately held debt and equity instruments[303][46] - Interest and dividend income is recorded on an accrual basis; loans are placed on non-accrual status when collectability is uncertain. As of June 30, 2023, 1.7% of fair value and 2.5% of cost were on non-accrual status (vs. 0.3% and 1.3% at March 31, 2023)[353][354] - PIK interest is added to the principal balance and recorded as interest income, affecting RIC distribution requirements even if not collected in cash. For Q2 2023, 4.1% of total investment income was from PIK interest (vs. 3.0% in Q2 2022)[355] - The company operates in a singular segment as an investment company[304] - New accounting guidance (ASU 2022-03) on fair value measurement of equity securities with contractual sale restrictions is effective after December 15, 2023; the company does not expect a material impact[364] 3. INVESTMENTS Provides a detailed breakdown of the investment portfolio by type, industry, and geographic region Investment Portfolio Composition (in thousands) | Investment Type | Fair Value (June 30, 2023) | % of Total Portfolio (FV) | Cost (June 30, 2023) | % of Total Portfolio (Cost) | | :---------------- | :------------------------- | :------------------------ | :------------------- | :-------------------------- | | First lien loans | $1,075,200 | 83.7% | $1,081,838 | 84.1% | | Second lien loans | $34,935 | 2.7% | $44,030 | 3.4% | | Subordinated debt | $780 | 0.1% | $752 | 0.1% | | Preferred equity | $67,659 | 5.2% | $45,479 | 3.5% | | Common equity & warrants | $54,882 | 4.3% | $34,126 | 2.6% | | I-45 SLF LLC | $51,862 | 4.0% | $80,800 | 6.3% | | Total | $1,285,318 | 100.0% | $1,287,025 | 100.0% | Top 5 Industries by Fair Value (June 30, 2023, in thousands) | Industry | Fair Value (June 30, 2023) | % of Total Portfolio (FV) | | :----------------------------- | :------------------------- | :------------------------ | | Business Services | $164,196 | 12.8% | | Media & Marketing | $163,882 | 12.8% | | Healthcare Services | $135,403 | 10.5% | | Consumer Products and Retail | $98,022 | 7.6% | | Consumer Services | $97,949 | 7.6% | Top 5 Geographic Regions by Fair Value (June 30, 2023, in thousands) | Region | Fair Value (June 30, 2023) | % of Total Portfolio (FV) | | :------------ | :------------------------- | :------------------------ | | Northeast | $300,600 | 23.4% | | West | $252,718 | 19.7% | | Southeast | $251,212 | 19.5% | | Southwest | $227,175 | 17.7% | | Midwest | $157,164 | 12.2% | - I-45 SLF LLC is a joint venture primarily investing in syndicated senior secured loans to the UMM, with a diverse geographic and industry set[341][345] 4. FAIR VALUE MEASUREMENTS Details the fair value measurement process, relying on Level 3 inputs for privately held debt and equity instruments - Valuation Process: Led by the Valuation Committee (comprised of company officers) as the Valuation Designee, subject to Board oversight, for investments without readily available market quotations[79] - Fair Value Hierarchy: 100% of the investment portfolio (excluding NAV-measured investments) is valued using Level 3 inputs due to the private nature of the debt and equity instruments[46][66] - Valuation Approaches: Market Approach, Income Approach (discounting contractual cash flows using Required Market Yield), Enterprise Value Waterfall Approach (for equity, allocating enterprise value based on liquidation preference), and NAV Valuation Method (for investment funds)[51][53][57][60] Fair Value Hierarchy (June 30, 2023, in thousands) | Asset Category | Total | Level 1 | Level 2 | Level 3 | | :------------------------ | :------------ | :------ | :------ | :---------- | | First lien loans | $1,075,200 | — | — | $1,075,200 | | Second lien loans | $34,935 | — | — | $34,935 | | Subordinated debt | $780 | — | — | $780 | | Preferred equity | $67,659 | — | — | $67,659 | | Common equity & warrants | $54,882 | — | — | $54,882 | | Investments measured at NAV | $51,862 | — | — | — | | Total Investments | $1,285,318| — | — | $1,233,456| - No transfers between fair value levels occurred during the three months ended June 30, 2023, and 2022[72] 5. BORROWINGS Details outstanding borrowings, including credit facilities, various notes, and SBA Debentures, and compliance with covenants Borrowings Outstanding (in thousands) | Debt Instrument | Outstanding Balance (June 30, 2023) | Recorded Value (June 30, 2023) | | :-------------- | :---------------------------------- | :----------------------------- | | SBA Debentures | $125,000 | $121,352 | | Credit Facility | $195,000 | $195,000 | | January 2026 Notes | $140,000 | $139,135 | | October 2026 Notes | $150,000 | $147,448 | | August 2028 Notes | $71,875 | $69,327 | | Total | $681,875 | $672,262 | - Credit Facility: Borrowings outstanding were $195.0 million at June 30, 2023. Interest expense was $4.9 million (Q2 2023) vs. $1.9 million (Q2 2022), with weighted average interest rate increasing from 3.16% to 7.36%[379] - August 2028 Notes: Issued in June 2023 for $71.9 million aggregate principal, bearing 7.75% interest, maturing August 1, 2028[384][431] - SBA Debentures: Carrying amount $121.4 million at June 30, 2023. Weighted average interest rate increased from 2.50% (Q2 2022) to 3.94% (Q2 2023)[433] - Asset Coverage: Company's asset coverage was 237% as of June 30, 2023, exceeding the 150% regulatory requirement[391] 6. INCOME TAXES Explains the company's RIC tax treatment, the role of its Taxable Subsidiary, and deferred tax assets/liabilities - RIC Status: Company qualifies for RIC tax treatment, requiring annual distribution of at least 90% of investment company taxable income[408][437] - Taxable Subsidiary: Holds certain LLC interests to help maintain RIC status; taxed at corporate rates, not consolidated for tax purposes[442] Estimated Distributable Income (in thousands) | Metric | Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | | :------------------------------------------ | :------------------------------- | :------------------------------- | | Net increase in net assets from operations | $23,812 | $2,510 | | Estimated distributable income before deductions for distributions | $19,571 | $8,673 | - Deferred Tax Liability: The Taxable Subsidiary had a deferred tax liability of $11.9 million at June 30, 2023 (vs. $12.1 million at March 31, 2023)[415][417] - Income Tax Provision: Net income tax provision of $0.4 million for Q2 2023, primarily from U.S. federal excise tax and Taxable Subsidiary provision[447] 7. SHAREHOLDERS' EQUITY Details changes in shareholders' equity, including public offerings, the ATM Program, and treasury stock cancellation - Public Equity Offering (Nov 2022): Sold 2,534,436 shares at $18.15/share, raising $44.1 million net proceeds[448] - Equity ATM Program: Increased maximum offering to $650.0 million in August 2022. Cumulative sales of 19,140,580 shares at $20.39/share, raising $384.0 million net proceeds to date. $259.7 million available as of June 30, 2023[475][450] - Treasury Stock: 2,339,512 shares of treasury stock cancelled on April 26, 2023, increasing authorized and unissued shares[422][573] - Share Repurchases: No shares repurchased under the $20 million share repurchase program during Q2 2023 and Q2 2022[479][120] 8. STOCK BASED COMPENSATION PLANS Describes the company's stock-based compensation plans, including vesting schedules and expense recognition - 2021 Employee Plan: Makes 1,200,000 shares of common stock available for issuance to employees, with 722,267 shares remaining as of June 30, 2023. Awards generally vest in equal annual installments over four years[482][481] - 2021 Non-Employee Director Plan: Makes 120,000 shares available for non-employee directors, with 107,895 shares remaining as of June 30, 2023. Shares vest one year from grant date[424] - Compensation Expense: Total share-based compensation expense was $1.0 million for Q2 2023 (vs. $0.8 million for Q2 2022)[483] - Unrecognized Compensation: $11.6 million remaining as of June 30, 2023, to be amortized over a weighted-average vesting period of approximately 3.0 years[456] 9. OTHER EMPLOYEE COMPENSATION Briefly describes the company's 401(k) plan and matching contributions for eligible employees - 401(k) Plan: All full-time employees are eligible to participate[458] - Company Contributions: Up to 4.5% of eligible compensation, fully vested immediately. Matching contributions were approximately $0.1 million for both Q2 2023 and Q2 2022[458] 10. COMMITMENTS AND CONTINGENCIES Details unfunded debt and equity commitments, operating lease obligations, and legal contingencies Total Unfunded Debt Commitments (in thousands) | Commitment Type | June 30, 2023 | March 31, 2023 | | :------------------------ | :------------ | :------------- | | Total Revolving Loans | $105,187 | $87,554 | | Total Delayed Draw Term Loans | $24,747 | $37,083 | | Total Unfunded Debt Commitments | $129,934 | $124,637 | Unfunded Debt Commitments by Expiration Year (in thousands) | Expiration Year | June 30, 2023 | | :-------------- | :------------ | | 2024 | $16,353 | | 2025 | $10,912 | | 2026 | $9,615 | | 2027 | $38,925 | | 2028 | $41,290 | | 2029 | $12,839 | - Unfunded Equity Commitments: Total $537 thousand for both June 30, 2023, and March 31, 2023[463] - Letters of Credit: $0.9 million issued and outstanding as of June 30, 2023, not recorded as a liability[493] - Operating Lease: New office lease commenced Feb 1, 2022, expires Sep 30, 2032. Lease expense was $0.1 million for both Q2 2023 and Q2 2022. Remaining lease term 9.3 years, discount rate 7.57%[464][465] - Legal Proceedings: No currently pending material legal proceedings[467] 11. RELATED PARTY TRANSACTIONS Clarifies no management fees from portfolio companies and highlights transactions with I-45 SLF LLC - No management fees received from portfolio companies during Q2 2023 and Q2 2022[468] - Dividends Receivable from I-45 SLF LLC: $2.1 million (June 30, 2023) vs. $1.9 million (March 31, 2023)[468] - Administrative Fee Income from I-45 SLF LLC: $24.5 thousand for Q2 2023[468] 12. SUMMARY OF PER SHARE INFORMATION Provides per share data and key ratios, including investment income, operating expenses, and total investment return Per Share Data (Three Months Ended June 30) | Metric | 2023 | 2022 | | :---------------------- | :---- | :---- | | Investment income | $1.07 | $0.89 | | Operating expenses | $(0.40)| $(0.39)| | Net investment income | $0.65 | $0.49 | | Net realized (loss) gain, net of tax | $(0.34)| $0.09 | | Net unrealized appreciation (depreciation), net of tax | $0.32 | $(0.48)| | Total increase from investment operations | $0.63 | $0.10 | | Net asset value, end of period | $16.38| $16.54| Ratios and Supplemental Data (Three Months Ended June 30) | Metric | 2023 | 2022 | | :-------------------------------------- | :------ | :------ | | Ratio of operating expenses to average net assets | 9.88% | 9.12% | | Ratio of net investment income to average net assets | 15.80% | 11.48% | | Total investment return | 14.23% | (19.72)%| | Total return based on change in NAV | 3.67% | 1.84% | | Per share market value at end of period | $19.72 | $18.42 | | Weighted-average basic and diluted shares outstanding | 37,598 | 25,514 | 13. SUBSEQUENT EVENTS Discloses dividend declarations and the amendment of the Senior Secured Revolving Credit Agreement - Dividend Declaration: On August 3, 2023, a total dividend of $0.62 per share ($0.56 regular, $0.06 supplemental) was declared for Q3 2023[500][576] - Credit Facility Amendment: On August 2, 2023, the Third Amended and Restated Senior Secured Revolving Credit Agreement increased commitments from $400 million to $435 million, added an uncommitted accordion feature up to $750 million, and extended the revolving period to August 2, 2027, and final maturity to August 2, 2028[531][175] Consolidated Schedule of Investments in and Advances to Affiliates Provides a detailed breakdown of investments in and advances to affiliate and control companies Control Investments (in thousands) | Portfolio Company | Type of Investment | Fair Value (March 31, 2023) | Unrealized Gain/(Loss) | Fair Value (June 30, 2023) | | :---------------- | :----------------- | :-------------------------- | :--------------------- | :------------------------- | | I-45 SLF LLC | 80% LLC equity interest | $51,256 | $606 | $51,862 | Total Affiliate Investments (in thousands) | Metric | Fair Value (March 31, 2023) | Gross Additions | Gross Reductions | Realized Gain/(Loss) | Unrealized Gain/(Loss) | Fair Value (June 30, 2023) | | :------------------------------------ | :-------------------------- | :-------------- | :--------------- | :------------------- | :--------------------- | :------------------------- | | Total Affiliate Investments | $188,505 | $26,113 | $(30,091) | $(6,638) | $9,169 | $187,058 | - Gross additions include new investments, follow-on investments, accrued PIK interest, and OID accretion[503] - Gross reductions include principal repayments, sales, and security exchanges[503] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's perspective on financial condition and operational results, covering strategy, portfolio, and liquidity OVERVIEW Reaffirms Capital Southwest Corporation's role as an internally managed BDC focusing on LMM and UMM companies - Internally managed BDC, specializing in customized debt and equity financing for LMM and UMM companies[85][505] - Investment objective: attractive risk-adjusted returns from current income (debt) and capital appreciation (equity)[85] - Internally managed structure provides a beneficial operating expense structure, with LTM operating expenses (excluding interest) as a percentage of LTM average total assets at 1.90% for Q2 2023 (vs. 2.07% for Q2 2022)[538] CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES Identifies investment valuation and revenue recognition as critical estimates, detailing fair value and non-accrual policies - Most critical accounting estimates: investment valuation and revenue recognition[87][326] - Investment portfolio at fair value represented 96.1% of total assets at June 30, 2023 (vs. 95.9% at March 31, 2023)[509] - Fair value determination for investments without readily available market quotations is performed by the Valuation Committee, subject to Board oversight, using Level 3 inputs[540] - Non-accrual status: Investments on non-accrual status represented 1.7% of fair value and 2.5% of cost at June 30, 2023 (vs. 0.3% and 1.3% at March 31, 2023)[542] INVESTMENT PORTFOLIO COMPOSITION Presents key metrics and composition of the investment portfolio, including debt and equity percentages and yields Investment Portfolio Key Metrics | Metric | June 30, 2023 | March 31, 2023 | | :------------------------------------------ | :------------ | :------------- | | Number of portfolio companies | 90 | 86 | | Fair value (in thousands) | $1,285,318 | $1,206,388 | | Cost (in thousands) | $1,287,025 | $1,220,152 | | % of portfolio at fair value - debt | 90.1% | 89.8% | | % of portfolio at fair value - equity | 9.9% | 10.2% | | % of investments at fair value secured by first lien | 87.2% | 86.7% | | Weighted average annual effective yield on debt investments | 12.9% | 12.8% | | Weighted average annual effective yield on total investments | 12.6% | 12.1% | | Weighted average EBITDA (in thousands) | $20,172 | $21,049 | | Weighted average leverage through CSWC security | 3.8x | 4.0x | - Floating Rate Debt: Approximately 97.2% of the debt investment portfolio (at fair value) bore interest at floating rates, with 100.0% subject to contractual minimum interest rates as of June 30, 2023[92] - Fixed Rate Debt: Approximately 2.8% of the debt investment portfolio (at fair value) bore interest at fixed rates as of June 30, 2023[92] Portfolio Asset Quality Describes the internal investment rating system and the distribution of debt portfolio investments by risk rating - Investment Rating System: Utilizes a 1-4 scale to rate debt investments based on quantitative and qualitative factors, including expected returns and collectability[516] - Rating 1: Least risk, performing materially above expectations, favorable trends[95] - Rating 2: Performing as expected, favorable to neutral trends (all new loans initially rated 2)[547] - Rating 3: Performing below expectations, neutral to negative trends, potential impairment of interest payments[517] - Rating 4: Performing materially below expectations, negative trends, likely impairment of interest and principal payments[96] Debt Portfolio Investment Ratings (June 30, 2023, in thousands) | Investment Rating | Debt Investments at Fair Value | Percentage of Debt Portfolio | | :---------------- | :----------------------------- | :--------------------------- | | 1 | $153,118 | 14.8% | | 2 | $839,456 | 80.9% | | 3 | $44,726 | 4.3% | | 4 | $295 | 0.0% | | Total | $1,037,595 | 100.0% | - Non-accrual status: 1.7% of fair value and 2.5% of cost at June 30, 2023 (YoY increase from 0.3% and 1.3% at March 31, 2023)[550] Investment Activity Summarizes investment and divestment activities, including new investments, repayments, and fair value changes Total Portfolio Investment Activity (Three Months Ended June 30, 2023, in thousands) | Activity | First Lien Loans | Second Lien Loans | Subordinated Debt | Preferred & Common Equity | I-45 SLF, LLC | Total | | :-------------------------------------- | :--------------- | :---------------- | :---------------- | :------------------------ | :------------ | :------------ | | Fair value, beginning of period | $1,000,984 | $35,820 | $791 | $117,537 | $51,256 | $1,206,388 | | New investments | $99,134 | — | — | $4,972 | — | $104,106 | | Proceeds from sales of investments | — | — | — | $(3,402) | — | $(3,402) | | Principal repayments received | $(24,785) | $(71) | $(20) | — | — | $(24,876) | | Realized (loss) gain | $(10,414) | — | — | $(1,713) | — | $(12,127) | | Unrealized gain (loss) | $10,972 | $(876) | — | $1,356 | $606 | $12,058 | | Fair value, end of period | $1,075,200 | $34,935 | $780 | $122,541 | $51,862 | $1,285,318 | - Q2 2023: New debt investments of $81.2 million, follow-on debt investments of $13.3 million, and equity investments of $5.0 million[521] - Q2 2023: Contractual principal repayments of $18.2 million, proceeds from sales of equity investments of $3.4 million[521] - Q2 2022: New debt investments of $105.0 million, follow-on debt investments of $15.9 million, and equity investments of $3.3 million[582] - Q2 2022: Contractual principal repayments of $3.8 million, full prepayments of $47.9 million, proceeds from sales of equity investments of $1.7 million[582] RESULTS OF OPERATIONS Analyzes financial performance, highlighting increases in investment income and net investment income Key Financial Results (Three Months Ended June 30, in thousands) | Metric | 2023 | 2022 | Net Change | % Change | | :------------------------------------------ | :---------- | :---------- | :---------- | :------- | | Total investment income | $40,361 | $22,543 | $17,818 | 79.0% | | Interest expense | $(9,681) | $(5,484) | $(4,197) | 76.5% | | Other operating expenses | $(5,677) | $(4,429) | $(1,248) | 28.2% | | Income before taxes | $25,003 | $12,630 | $12,373 | 98.0% | | Income tax expense | $447 | $192 | $255 | 132.8% | | Net investment income | $24,556 | $12,438 | $12,118 | 97.4% | | Net realized (loss) gain on investments, net of tax | $(12,782) | $2,320 | $(15,102) | (650.9)% |\ | Net unrealized (depreciation) appreciation on investments, net of tax | $12,038 | $(12,248) | $24,286 | 198.3% | | Net increase (decrease) in net assets from operations | $23,812 | $2,510 | $21,302 | 848.7% | - Total investment income increased by 79.0% YoY, primarily due to a $17.5 million increase in interest income from debt investments, driven by a 27.9% increase in cost basis of debt investments and higher weighted average yield[101] - Total interest expense increased by $4.2 million (76.5%) YoY, due to increased average borrowings and a higher weighted average interest rate (3.51% to 5.23%)[585] - Total employee compensation expense increased by $1.1 million (47.0%) YoY, mainly due to higher accrued bonus compensation[103] Net Realized (Loss) Gain on Investments (Three Months Ended June 30, in thousands) | Category | 2023 (Net Total Gain (Loss)) | 2022 (Net Total Gain (Loss)) | | :------- | :--------------------------- | :--------------------------- | | Debt | $(10,748) | $1,321 | | Equity | $(2,034) | $999 | | Total| $(12,782) | $2,320 | Net Unrealized (Depreciation) Appreciation on Investments (Three Months Ended June 30, 2023, in thousands) | Category | Accounting reversals of net unrealized (appreciation) (gains) losses recognized in prior periods due to net realized (gains) losses recognized during the current period | Net unrealized (depreciation) appreciation relating to portfolio investments | Total Net Unrealized (Depreciation) Appreciation | | :------- | :-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | :--------------------------------------------------------------------------- | :------------------------------------------------- | | Debt | $10,527 | $(431) | $10,096 | | Equity | $1,900 | $(564) | $1,336 | | I-45 SLF LLC | — | $606 | $606 | | Total| $12,427 | $(389) | $12,038 | FINANCIAL LIQUIDITY AND CAPITAL RESOURCES Discusses liquidity sources, financing transactions, equity activities, and contractual obligations - Liquidity Sources: Cash flows from operations, public offerings of debt/equity, Credit Facility advances, and SBA Debentures[107] - Adequate Liquidity: Management believes existing cash, investments, and Credit Facility commitments are adequate for the next twelve months[107] Cash Flows Details cash flow activities, showing a net decrease in cash due to operating and financing movements - Q2 2023 Net Cash Change: Net decrease of $0.3 million in cash and cash equivalents[140] - Operating Activities (Q2 2023): Used $55.6 million, mainly for $104.1 million in new investments, partially offset by $24.7 million from debt repayments and $3.4 million from equity sales[140] - Financing Activities (Q2 2023): Provided $55.3 million, including $69.7 million from August 2028 Notes, $44.9 million from Equity ATM Program, and $4.9 million from SBA Debentures, offset by $40.0 million net repayments on Credit Facility and $22.9 million in dividends[140] - Cash and Cash Equivalents (June 30, 2023): Approximately $21.3 million[140] Financing Transactions Outlines various debt instruments, their terms, outstanding balances, and compliance with covenants - Credit Facility: Total commitments increased to $400 million (Nov 2022). Borrowings outstanding $195.0 million (June 30, 2023). Weighted average interest rate 7.36% (Q2 2023) vs. 3.16% (Q2 2022)[110][111] - January 2026 Notes: $140.0 million aggregate principal, 4.50% interest, maturing Jan 31, 2026. Carrying amount $139.1 million (June 30, 2023)[144][145] - October 2026 Notes: $150.0 million aggregate principal, 3.375% interest, maturing Oct 1, 2026. Carrying amount $147.4 million (June 30, 2023)[146][147] - August 2028 Notes: Issued June 2023 for $71.9 million aggregate principal, 7.75% interest, maturing Aug 1, 2028. Carrying amount $69.3 million (June 30, 2023)[148] - SBA Debentures: Total leverage commitment of $130.0 million, with $5.0 million unused (June 30, 2023). Carrying amount $121.4 million (June 30, 2023). Weighted average interest rate 3.94% (Q2 2023) vs. 2.50% (Q2 2022)[149][600] Equity Capital Activities Covers the company's equity-related capital activities, including the Equity ATM Program and the cancellation of treasury stock - Equity ATM Program: Maximum amount increased to $650.0 million (Aug 2022). Cumulative sales of 19,140,580 shares at $20.39/share, raising $384.0 million net proceeds. $259.7 million available as of June 30, 2023[601][119] Equity ATM Program Sales (in thousands) | Metric | Three Months Ended June 30, 2023 | Three Months Ended June 30, 2022 | | :------------------------------------ | :------------------------------- | :------------------------------- | | Number of shares sold | 2,527,458 | 2,262,852 | | Gross proceeds received | $45,572 | $46,753 | | Net proceeds received | $44,888 | $46,052 | | Weighted average price per share | $18.03 | $20.66 | - Treasury Stock: 2,339,512 shares cancelled on April 26, 2023[573] - Share Repurchase Program: No shares repurchased during Q2 2023 and Q2 2022 under the $20 million program[572] Contractual Obligations Summarizes contractual obligations, including operating leases and debt, with payments due by period Contractual Obligations (June 30, 2023, in thousands) | Contractual Obligations | Total | Less than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | | :---------------------- | :------ | :--------------- | :-------- | :-------- | :---------------- | | Operating lease obligations | $4,162 | $409 | $848 | $887 | $2,018 | | Credit Facility | $240,275| $14,600 | $29,120 | $196,555 | — | | January 2026 Notes | $158,900| $6,300 | $152,600 | — | — | | October 2026 Notes | $167,718| $5,062 | $10,125 | $152,531 | — | | August 2028 Notes | $100,454| $4,905 | $11,141 | $11,141 | $73,267 | | Total | $671,509| $31,276 | $203,834| $361,114| $75,285 | - The company believes its assets and available borrowings provide adequate coverage for unfunded commitments[575] OFF-BALANCE SHEET ARRANGEMENTS Describes unfunded commitments to extend financing and fund equity capital to portfolio companies - Off-balance sheet risk: Unfunded commitments to extend credit and fund equity capital to portfolio companies[604] - Total unfunded commitments: Approximately $130.5 million at June 30, 2023 (vs. $125.2 million at March 31, 2023)[122] - Letters of Credit: $0.9 million issued and outstanding as of June 30, 2023, not recorded as a liability[122] Item 3. Quantitative and Qualitative Disclosures About Market Risk Discusses exposure to market risk, particularly interest rate risk, and the impact of LIBOR transition - Market Risk: Exposure to changes in interest rates, commodity prices, equity prices, and other market factors[606] - Interest Rate Risk: Net investment income is sensitive to the difference between borrowing and investment rates. A rising interest rate environment could increase cost of funds and reduce net investment income[608] - Floating Rate Investments: As of June 30, 2023, 97.2% of the debt investment portfolio bore floating rates (100% with contractual minimums), primarily utilizing SOFR[607] - Fixed Rate Liabilities: October 2026 Notes, January 2026 Notes, August 2028 Notes, and SBA Debentures have fixed interest rates[156] Hypothetical Impact of Base Rate Changes on Net Investment Income (June 30, 2023, in thousands) | Basis Point Change | Increase (decrease) in net income | Increase (decrease) net investment income per share | | :----------------- | :-------------------------------- | :-------------------------------------------------- | | (200 bps) | $(19,108) | $(0.49) | | (150 bps) | $(14,331) | $(0.37) | | (100 bps) | $(9,554) | $(0.25) | | (50 bps) | $(4,777) | $(0.12) | | 50 bps | $4,777 | $0.12 | - LIBOR Transition: LIBOR tenors ceased on June 30, 2023. Loans referencing LIBOR have been amended to CME Term SOFR, which may not yield similar economic results[581][181] Item 4. Controls and Procedures Confirms the effectiveness of disclosure controls and procedures and no material changes in internal control over financial reporting - Disclosure Controls and Procedures: Management concluded they were effective as of June 30, 2023[158] - Internal Control over Financial Reporting: No material changes during the three months ended June 30, 2023[179] PART II OTHER INFORMATION Provides additional information on legal proceedings, risk factors, equity sales, defaults, and exhibits Item 1. Legal Proceedings States that there are no currently pending material legal proceedings - No currently pending material legal proceedings[159] Item 1A. Risk Factors Notes no material changes to risk factors, except for an updated risk factor regarding LIBOR decommissioning - No material changes to risk factors, except for the decommissioning of LIBOR[581] - LIBOR Decommissioning: Overnight, one, three, six, and twelve months USD LIBOR tenors ceased on June 30, 2023. Loans have transitioned to CME Term SOFR[581][181] - Alternative Reference Rates: CME Term SOFR may not yield the same or similar economic results as LIBOR, and an established liquid trading market may not develop[160][161][181] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Reports no unregistered sales of equity securities or share repurchases during the period - No unregistered sales of equity securities[162] - No shares repurchased under the share repurchase program during Q2 2023[183] Item 3. Defaults Upon Senior Securities Reports no defaults upon senior securities - No defaults upon senior securities[184] Item 4. Mine Safety Disclosures States that this item is not applicable - Not applicable[185] Item 5. Other Information Confirms no other information to report and no director/officer trading arrangements - No other information to report under sub-items (a) and (b)[186][168] - No director or officer entered into Rule 10b5-1 trading arrangements or non-Rule 10b5-1 trading arrangements during the period[187] - Company has insider trading policies designed to promote compliance with insider trading laws[169] Item 6. Exhibits Lists all exhibits filed with the Form 10-Q, including corporate governance and debt instrument documents - Exhibits include corporate governance documents (Articles of Incorporation, Bylaws), debt instrument indentures (4.50% Notes due 2026, 3.375% Notes due 2026, 7.75% Notes due 2028), and the Third Amended and Restated Senior Secured Revolving Credit Agreement[189] - Certifications by President/CEO and CFO are filed herewith, as required by Rule 13a-14(a) and 13a-14(b) of the Exchange Act and Section 1350 of Sarbanes-Oxley Act[189][171] SIGNATURES Contains the duly authorized signatures of the President/CEO and CFO for Capital Southwest Corporation Signatures Provides the authorized signatures of the President and CEO, and CFO, Secretary, and Treasurer - Signed by Bowen S. Diehl, President and Chief Executive Officer, and Michael S. Sarner, Chief Financial Officer, Secretary and Treasurer[193] - Date of signing: August 8, 2023[193]