Thank you for joining today's Capital Southwest Second Fiscal Quarter 2019 Earnings Call. Participating on the call today are Bowen Diehl, CEO; Michael Sarner, CFO; Chris Rehberger, VP 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 thanks to everyone for joining us for our Second Quarter Fiscal Year 2019 Earnings Call. Throughout our prepared remarks, we will refer to various slides in our earnings presentation, which can be found on our website at www.capitalsouthwest.com. We are pleased to be with you this morning to announce our quarterly results. In summary, we had a strong quarter of originations, as deal flow activity has been particularly robust over the past few quarters, and our deal teams have done an excellent job capitalizing on our relationships in the industry and closing on some interesting opportunities. As we have consistently stated, our focus remains on building a Lower Middle Market portfolio consisting largely of 1st Lien Senior Secured Debt with equity co-investments across the loan portfolio, where we believe significant equity upside opportunity exists. We continue to execute under our shareholder-friendly, internally-managed structure, which at its foundation closely aligns our interest with the interests of our fellow shareholders in generating sustainable, long-term value through stable, increasing dividends, capital preservation and NAV per share growth. Laid out on Slide 6 are some important summary points on our performance for the quarter ended September 30, 2018. This quarter, we earned $0.36 per share of pre-tax net investment income and paid a regular dividend of $0.34 per share. In addition, we paid a supplemental dividend of $0.10 per share funded from our sizable UTI balance generated by excess income and capital gains accumulated to date from our investment strategy. As stated previously, we expect that our current UTI balance, anticipated future capital gains from our portfolio equity investments, and earnings in excess of distribution should allow us to continue to pay $0.10 per share supplemental dividend to our shareholders each quarter for the foreseeable future. The $0.44 per share in…

Thanks, Bowen. As seen on Slide 15, our investment portfolio produced $12.6 million in investment income this quarter, with a weighted average yield on all investments of 11%. This represents an increase of $1.5 million versus $11.1 million from the previous quarter, mostly attributable to net portfolio growth. The weighted average yield on our credit portfolio was 11.6% for the quarter, slightly down from 11.7% the previous quarter. And as of the end of the quarter, there were no assets on non-accrual. Excluding interest expense, we incurred $3.7 million in operating expenses this quarter, which was flat with the previous quarter. For the quarter, we earned pre-tax net investment income of $5.8 million, or $0.36 per share compared to $0.31 per share during the prior quarter. As a result, we paid out $0.34 per share in regular dividends for the quarter, an increase of $0.05 per share over the $0.29 per share paid out in the prior quarter. We continue to focus on growing our regular dividends in a sustainable manner, demonstrated by our cumulative regular dividend coverage of 102% since the spin off. As Bowen mentioned earlier, we also paid out a $0.10 per share supplemental dividend this quarter as part of our recently announced Supplemental Dividend Program. This program allows our shareholders to meaningfully participate in the successful exits of our investment portfolio. The program will continue to be funded from our current estimated undistributable taxable income, which was earned from realized gains on both debt and equity, as well as undistributed net investment income over the past several quarters. As we think about the likely duration of the program, being mindful of our minimum regulated investment company distribution requirements, the unrealized appreciation currently in our portfolio, and the importance of equity co-investments across our Lower Middle Market…

Thanks, Michael, and thank you, everyone, for joining us today. Capital Southwest has grown, and the business and portfolio have developed, consistent with the vision and strategy we communicated to our shareholders almost four years ago. Our team has done an excellent job generating strong performance for our shareholders. Everyone here at Capital Southwest is totally dedicated to being good stewards of our shareholders' capital by continuing to deliver strong performance and creating long term sustainable value for our shareholders. This concludes our prepared remarks. Operator, we are ready to open the lines for Q&A.

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

Yes. Bowen and Michael, in June, you decided to pay the $0.60 special dividend and the total of $10 million. And a couple months later in October, you sold the common shares for proceeds of about $13 million. So, I'm assuming you had pretty good insight into the backlog across that time period. And I'd like to understand, or could you walk us through those decisions? Was this, well, cheaper than if you had declared a deemed distribution instead?

Yes. We've talked about this before. Yes, we have distribution requirements, they're really predicated on what your UTI balance is at the end of a year. So we've sized our balance, it's consistent with what we expect our dividend to be in the future. So the $0.60 distribution that we made really was, from our perspective, pretty much required to get us at a level that we felt comfortable, so we wouldn't have to increase our regular dividend in subsequent quarters. I think the equity offering that we raise, we currently talk about it, has different variables that we considered.

Well, and the equity offering, Mickey, as I mentioned, it really was a reverse inquiry, and so it was a decision made after the decision. Michael touched on the $0.60 kind of had to be paid out, but the equity offering is a separate decision. We -- based on where originations were coming in, based on leverage level and based on the -- frankly the 2 shareholders, ones we wanted in the shareholder base, we thought while it made sense to raise a modest amount of capital, which was a little bit of a Goldilocks situation, it wasn't too little so that they didn't get a meaningful position, but it wasn't too much, given where we were on our trajectory towards target leverage, and we didn't want to elongate that path too much and so it seemed like the right size and the right opportunity, all things considered to do.

And also from a UTI perspective, Mickey, we have to look at our unrealized depreciation. We've talked about in the past, Deepwater and MRI. So those are other assets that are prospective UTI balances in the future. So making a $0.60 distribution was a prudent thing to do with the time.

Okay. I think, I understand. And Bowen, I'm curious to also understand what sort of trends you're seeing in the fixed charge coverage ratios in your portfolio, given the meaningful increase in interest rates that we've seen over the last several quarters.

Yes. I mean, clearly, as rates go up, that's a larger fixed charge burden on the portfolio companies, all else equal. It's one of the things we look at when we're underwriting these deals. We look at -- as we've talked about quite a bit in the past, we look at recession performance, specifically in the Great Recession, and we just look at the inherent volatility of the business. And as you can see in our portfolio, our leverage level across the portfolio tends to be lower than many players in the industry. And in part, I think, that also provides, as you can imagine, a lot of cushion on the cash flow as well to cover interest rates increasing. And so while certainly interest rates going up is a negative on fixed charge coverage, it really comes down to how much cushion you have and you need to be leveraging the businesses at levels that are prudent in considering both internal -- or the inherent volatility in the business or potential volatility as well as the cash flow margins. And so, I would just say the lower leverage in the portfolio equals much more cushions on a fixed charge perspective.

But, clearly, interest rates going up is a pressure greater than zero on fixed charge coverage.

So Bowen, are you indicating then that interest expense, at least within your borrowers, is going up faster than their EBITDA?

No, I wouldn't say that in the last couple of quarters. It's about -- I don't have it in front of me, obviously, but it's probably about offset.

So that would...

Maybe it's a little, I mean, I would say, fixed charge coverage in the portfolio. I don't have it in front of me, but I would say it's probably increasing. So it's probably -- EBITDA is probably increasing across the portfolio slightly faster than rates are increasing on those particular companies, because remember the companies are -- I mean, our typical loan to value is -- the leverage level you can see on the average loan to value is typically 50% or -- certainly 30% to 50%. And so you've got a lot of equity below us in these companies, which obviously doesn't have an interest cost.

Our next question comes from Christopher Testa of National Securities Corporation.

Bowen and Michael, just curious, given that the SLF seems to kind of be flat on the quarter, and Bowen, you had cited obviously the frothiness in the Upper Middle Market, should we kind of expect the JV to sort of remain static absent a pretty significant dislocation in credit markets?

I think that's a fair assumption, Chris. We actually, in fact, have a couple of credits in the fund that are -- that we could trade out at par and leverage in some of the trends in the business we're not pristine, and we've actually taken the opportunity to trade out of the credits. So we still will have some refinancings inevitably happen. We have -- we are not afraid to sell a credit if we can get out of par, if we're not perfectly comfortable with it. And we're -- it's a great fund, it works for us, it works for Main Street. The market is what it is right now. So, as I've said, that -- you boil all that together and it's probably a flat fund [Technical Difficulty] at least for a while.

Okay. And have you seen any encouraging trends at least starting in the Upper Middle Market? I mean, obviously, we haven't seen the dreaded dividend recap type volume making up over 50% of the market anymore. We've seen more kind of LBOs and M&A, and some organic growth, excuse me. So is that kind of encouraging at all? Or is it still just as frothy and bad as ever going into the end of the calendar year here?

Well, you just kind of answered my question for me. I mean, that's right. So that trend in the market is definitely encouraging. As far as leverage levels and spreads, I'd say the market, in a couple of instances, been more sensitive to heavy, heavy add backs to EBITDA that we've seen. I hesitate to call that a trend necessarily, but we have seen that. Certainly the lack of dividend recaps in situations like that is encouraging.

Yes. I would agree, definitely. And just wanted to talk about Media Recovery. Obviously, this has been very successful for you guys. Don't have the benefit of having the Q in front of me yet. But just wondering what your thoughts are potentially on monetizing this if there's been any kind of change in how you're looking at this and maybe looking at the optics of kind of paring down a pretty large position within the portfolio and an equity wanted that.

Yes. That was a good question. I would say, there's two things. First and foremost, we are steadfast on our strategy of building a credit portfolio that generates attractive returns at lower risk for our shareholders to kind of optimize that risk return equation. That doesn't include $45 million, 100% equity investments, right. And so clearly Media Recovery is not core from that perspective. And so, as I've said in past calls and it's still true, is that's an asset that we see a lot of strategic interest in the asset. We think it's an interesting asset actually for someone [indiscernible] private equity firm to buy that could afford to put $20 million, $30 million, $40 million in the business to make acquisitions around it. As a platform, we think that's pretty attractive. We couldn't do that, right. So we're the wrong partner for that business. And so you look at all that, and it's like, okay, it's a sale candidate, the question is when. And as we kind of think about the different things the management team is doing with the business and kind of our strategy, it kind of feels like it's an intermediate. And I would say, over the next -- I think about it as kind of a sale candidate over the next 9 months plus or minus.

Okay, got it. That's helpful. Thank you, Bowen. And just remind me, is your credit facility -- is that already okay with the reduced asset coverage that you guys have over 167%?

No, that's something -- that's part of the negotiation that's ongoing with ING right now. That -- we're looking to do several things with that. We're hoping to stretch the duration, reduce the cost, increase capacity and also reduce asset coverage. Those are all part of the negotiation.

Got it, okay. And Michael, when would you kind of anticipate that happening? Is that kind of a one or two quarter event?

I would tell it's in the near term.

Okay, got it. And just want to talk, looking at the new originations during the quarter, you guys had a coal company on there with a 14% plus kind of yield maturity. Just wondering if you could give some color on that sort of potential -- excuse me, to the ability that you can discuss the attachment point leverage, and if there was a revolver in front of you and just things of that nature.

Yes. So you mean you want to know why in the world we would invest in a coal company?

Yes. Pretty much.

Yes. Right. So it's interesting. Blaschak is a very niche regional minor and distributor of coal -- anthracite coal for heating of homes in rural areas in the Northeast, where you can't build gas infrastructure, it's not really -- doesn't really pay to build that gas infrastructure. It's a very low leverage point. So, sub 2 times [indiscernible] sub two times, and it's got a significant amount of asset coverage. So as you mentioned -- as is I mentioned, it's a Split Lien loan. So we have 1st Lien on a -- several of the assets, including the coal reserves themselves. And so -- and it's got a significant amount of equity in it from a private equity sponsor. So, if you ever were to lend to a credit -- a coal company, this would be a pretty interesting one. And because a lot of people react, like you react, your rate is pretty interesting, given the risk. And so, I think about it as an asset -- well, well asset covered deal at a pretty interesting interest rate at a very low cash flow multiple and a niche business where it has a very significant reason to exist and a pretty nice moat around it to continue to exist. And so, pretty interesting credit.

Yes. No, that definitely does sound really unique.

[Operator Instructions]. And this does conclude our question-and-answer session. I would now like to turn the call back over to Bowen Diehl for any closing remarks.

Thank you, operator, and thanks again, everyone, for joining us today, and we look forward to keeping you apprised of our progress on future calls. Have a great week.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.